Item 1. Business
The following description of our business should be read in conjunction with the information included elsewhere in this Report. This description contains forward-looking statements that involve risks and uncertainties. Our actual results could differ significantly from the results discussed in the forward-looking statements due to the factors set forth in "Forward-Looking Statements," "Risk Factors" and elsewhere in this Report. Unless the context otherwise requires, references in this Report to "we," "our," "us," or the "Company," refer to Alphabet Holding Company, Inc. together with its subsidiaries.
Our Company
We are the leading vertically integrated manufacturer, marketer, distributor and retailer of high-quality vitamins, nutritional supplements and related products in the United States, with operations worldwide. Our products are marketed through four operating segments: Wholesale, European Retail, Direct Response/E-Commerce and North American Retail. We currently market over 25,000 individual stock keeping units ("SKUs") under a portfolio of well-known brands, with leading category positions across their respective categories, channels and geographies. With our broad range of products, we are able to offer our wholesale customers a "one-stop" source for a wide assortment of both branded and private label products across the value spectrum. Additionally, we have a significant presence in virtually every major vitamins, minerals, herbs and supplements ("VMHS") product category and in multiple key distribution channels. We utilize our direct-to-consumer channels to identify new consumer trends and leverage our flexible manufacturing capabilities and strong supplier relationships to bring new products to market quickly. Through our extensive manufacturing operations and significant economies of scale, we believe we are a low-cost manufacturer that offers attractively priced products to retailers and consumers. In addition, we enjoy long-standing relationships with several domestic retailers, including Wal-Mart, Costco, CVS, Walgreens, Kroger and Target. We believe our diversified product, channel and geographic revenue mix, strong key customer relationships and strong demand for VMHS products provide for a diversified, stable and profitable business with strong cash flows.
Alphabet Holding Company, Inc. ("Holdings") was incorporated in Delaware in 2010. Holdings is the direct parent of NBTY, Inc. ("NBTY"). The principal executive offices for both Holdings and NBTY are located at 2100 Smithtown Avenue, Ronkonkoma, New York 11779. The telephone number and website for both Holdings and NBTY are (631) 567-9500, and www.nbty.com, respectively.
Carlyle Transaction
On October 1, 2010, NBTY consummated a merger (the "Merger") with an affiliate of The Carlyle Group ("Carlyle"), under which the Carlyle affiliate acquired 100% of NBTY's equity. Carlyle financed the Merger with equity financing provided by an investment fund affiliated with Carlyle, proceeds from the sale of NBTY's 9% senior notes due 2018 (the "Notes"), cash on hand at NBTY and senior secured credit facilities initially consisting of (1) senior secured term loan facilities of $1.75 billion and (2) a senior secured revolving credit facility with commitments of $250 million (the "senior secured credit facilities"). NBTY refinanced its senior secured credit facilities on March 1, 2011, March 21, 2013 and November 20, 2014.
See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" for additional information.
Operating Segments
We market our products through a global omni-channel distribution platform, supported by our industry-leading manufacturing operations and supply chain.
Wholesale. We are the leading wholesale manufacturer of VMHS products in the United States. We sell our products domestically in virtually all major mass merchandisers, club stores, drug store chains and supermarkets and to independent pharmacies, health food stores, the military and other retailers. We also sell our products internationally primarily through subsidiaries, distributors and key retailers. Our key brands include Nature's Bounty®, Osteo Bi-Flex®, Pure Protein®, Body Fortress®, Sundown®, MET-Rx®, Balance Bar® and Ester-C®. We sell directly to health and natural food stores under the Solgar®, SISU® and Good 'N Natural® brands, to health and natural food stores as well as wholesalers under our American Health®, Ester-C® and Home Health® brands and to healthcare practitioners through our Physiologics® brand. We also have licensing relationships with Disney Consumer Products, Inc. and Marvel Characters, B.V. to manufacture VMHS products for children using their character images and licensed art work. In addition to our strong brand positions, we are a leading private label manufacturer in the industry. Fiscal 2014 branded sales accounted for approximately 71% and private label sales accounted for approximately 29% of our Wholesale sales.
European Retail. We have significant retail operations throughout Europe. We are the leading VMHS specialty retailer in the United Kingdom. As of September 30, 2014, this segment generated revenue through the retail operations of 755 Holland & Barrett stores (including 29 franchised stores in China, 28 franchised stores in Singapore, 11 franchised stores in the United Arab Emirates, nine franchised stores in Cyprus, four franchised stores in Malta and one franchised store in each of Gibraltar and Iceland), 53 GNC-branded UK stores, 47 Nature's Way stores in Ireland, 146 De Tuinen stores in the Netherlands, including six franchised locations, and 15 Essenza stores in Belgium, as well as internet-based sales from www.hollandandbarrett.com, www.hollandandbarrett.co.uk, www.hollandandbarrett.ie, www.detuinen.nl and www.gnc.co.uk. Holland & Barrett, the leading VHMS specialty retailer in the United Kingdom, sells VMHS products and food products, such as fruits and nuts, through a broad range of approximately 4,800 SKUs. Our GNC-branded UK stores specialize in vitamins, minerals and sports nutrition products, marketing approximately 950 SKUs targeted at the more health-conscious sports enthusiasts and price-sensitive customers, and are a strong complement to the Holland & Barrett stores. We believe the breadth of our product offering, the superior customer service provided in our stores and the deep category and product knowledge of our well trained sales associates are key differentiators relative to our competitors.
Direct Response/E-Commerce. Through our internet platform and mail-order catalogs, we are a leader in the U.S. direct response VMHS industry, offering a full line of VMHS products and selected personal care and sports nutrition items under our Puritan's Pride® brand, as well as products manufactured by third parties, at prices that are generally at a discount to similar products sold in retail stores. During fiscal 2014, our Puritan's Pride website, www.puritan.com, generated an average of approximately 1.2 million unique visitors per month. As of September 30, 2014, Puritan's Pride products are sold through eight active websites in four languages. Puritan's Pride offers high-quality products at low direct-from-manufacturer prices, as well as multi-buy promotions, creating a seamless shopping experience for customers. Our highly automated equipment enables us to process orders quickly, economically and efficiently. Internet orders accounted for approximately 72% of our total fiscal 2014 Direct Response/E-Commerce orders.
North American Retail. As of September 30, 2014, we operated 414 Vitamin World retail stores throughout the United States, including Puerto Rico, Guam and the U.S. Virgin Islands, primarily in regional and outlet malls, as well as our Vitamin World website, www.vitaminworld.com. Each store carries a full line of store brand products, as well as products manufactured by third parties. Vitamin World stores serve as an effective channel to identify early consumer and market trends, as well as to
test new product introductions and ascertain product acceptance. We are able to provide insight into the marketplace to our domestic wholesale customers and can leverage our vertically integrated model to bring new products to the market quickly. We believe the direct-to-consumer channels also serve a key role in educating consumers on the VMHS category, including new products and the latest clinical studies and research.
Operating Segment and Geographic Financial Information
For a presentation of financial information for each of our operating segments, including financial information relating to the geographic areas in which we conduct our business, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations-Results of Operations," and Note 20 to the fiscal 2014 Consolidated Financial Statements included elsewhere in this Report.
Our Industry
The VMHS industry is comprised of several distinct product sub-categories:
• Vitamins. This sub-category includes single and multi-vitamin supplements. Products in the vitamin category include: vitamin C, vitamin E, B vitamins, vitamin A/beta carotene, niacin, folic acid, and multi-vitamin formulae.
• Minerals. This sub-category includes single and multi-mineral supplements. Products in the mineral category include: calcium, magnesium, chromium, zinc, selenium, potassium, iron, manganese, other single minerals and multi-mineral formulae.
• Herbs & Botanicals. Single herb or multi-herb supplements made primarily from plants or plant components. Products in this category include: echinacea, garlic, ginseng, and ginkgo biloba.
• Specialty Supplements. This sub-category includes supplements falling outside other sub-categories, such as glucosamine, melatonin, probiotics, docasahexanenoic acid ("DHA"), fish oils and shark cartilage, Co-enzyme Q10 ("Co-Q10"), amino acids and homeopathic remedies.
• Sports Nutrition. Sports Nutrition products include tablets, powders, nutrition bars and drinks formulated to enhance physical activity, and include creatine, amino acids and protein formulae, among others.
• Meal Replacements. This sub-category includes powders, nutrition bars and liquid nutritional formulae.
Our Strategy
We continuously evaluate strategies to drive revenues and cash flows at each of our operating segments by building on our leading market positions and strong customer relationships.
Increase Sales from Existing and New Customers
We expect to continue to drive organic growth through incremental shelf space with existing customers, new customer additions and focus on our branded products. We will continue our brand-building efforts for key brands by leveraging consumer insights and new product innovation capabilities to drive revenue and profit growth. Our ability to supply both branded and private label products across all price points broadens and deepens our partnerships with key retail customers, providing us more opportunities for category leadership and growth. We view the private label business as an important and valuable service that we provide to key accounts.
New Product Introductions
We have been among the first in the industry to introduce innovative products in response to health trends, consumer preferences and research studies. Given our presence in multiple distribution channels and our leading market positions, we have strong consumer insights and therefore, are well-positioned to identify trends and demand for new products. We have robust new product development capabilities that allow us to be at the forefront of innovation within the industry. We also have the manufacturing scale, expertise and supplier relationships to respond rapidly and bring new products to market. During fiscal 2014, we introduced approximately 165 new products.
Further Penetrate International Markets
Our products are currently marketed and sold in approximately 100 countries. However, only $1.3 billion (or 40%) of our sales in fiscal 2014 were sold to customers outside the United States, of which $767 million was to customers located in the United Kingdom. We plan to capitalize on our manufacturing and distribution capabilities to drive incremental international sales of our key brands in emerging markets, which are characterized by a rising middle class and a strong demand for high quality VMHS products from U.S.-based manufacturers. In addition, we plan to further strengthen Solgar's position in the premium segment in Western European markets, where there is a demand for high-quality VMHS products.
Drive Growth and Profitability in Retail Operations
We will continue to focus on positioning our Vitamin World operations for growth and profitability through various strategies, including a pricing strategy that focuses on value, optimization of our store base, a new store format and development of our associates. We have gradually been remodeling our stores to the new format and believe that the enhanced customer experience has a favorable impact on store sales. We continue to strengthen our position as a customer-centric specialty retailer through our associate development initiatives which provide associates at all levels with resources to enhance customer service and sales skills, to improve product knowledge and to provide a clear path for career growth.
We have also implemented several successful initiatives in our European Retail operations. We are focused on maximizing omni-channel business and driving increased customer traffic by modifying our promotional pricing strategy, increasing our focus on associate training, and developing loyalty and customer relationship management programs.
Free Cash Flow Generation
We expect our strong and stable cash flows to be driven by continued top-line growth and targeted initiatives for ongoing improvement in our manufacturing and supply chain operations, as well as improvements in working capital efficiency.
Enhance Manufacturing Efficiencies
We expect to continue to focus on reducing costs and improving efficiency in our manufacturing operations and driving supply chain strategies to maintain our low-cost manufacturing. On March 12, 2013, NBTY initiated a restructuring plan to streamline its operations and improve the profitability and return on invested capital of its manufacturing/packaging and distribution facilities. The restructuring involved the sale or closure of seven of NBTY's manufacturing/packaging and distribution facilities and was completed in fiscal 2014.
Disciplined Acquisition Strategy
Since 1986, we have acquired and successfully integrated more than 30 companies, expanding our brands, geographic presence, distribution channels and product offerings. In the fragmented, global VMHS industry, there remains a robust pool of acquisition opportunities across channels and geographies. We expect to continue to take a disciplined approach to acquisitions as these opportunities arise.
Employees
As of September 30, 2014, we employed approximately 13,500 persons. In addition, we sell products through commissioned sales representative organizations. As of September 30, 2014, CAW Local 468, Retail Wholesale Canada Division, represented approximately 290 of our associates in Canada under a collective bargaining agreement. We believe we have strong employee and labor relations both domestically and internationally, and historically have not experienced work stoppages that materially adversely affected our operations.
Advertising
For fiscal 2014, 2013 and 2012, we spent approximately $203 million, $189 million and $164 million, respectively, on advertising, promotions and catalogs, including print, media and cooperative advertising. Our in-house advertising staff creates most of the domestic advertising materials, which include print, radio, television and internet advertising. Our European Retail businesses advertise through various media channels and conduct sales promotions. Our Solgar business advertises in magazines, operates web sites and conducts sales promotions and our Vita Health business in Canada advertises in newspapers, trade publications and magazines and operates web sites.
Manufacturing, Distribution and Quality Control
At September 30, 2014, we employed approximately 3,850 manufacturing, shipping and packaging associates. We manufacture domestically in Arizona, California, Florida, New Jersey, New York and Texas. In addition, at September 30, 2014, we manufactured internationally in Winnipeg, Manitoba, Canada; Burton, United Kingdom; and Zhongshan, China. We have technologically advanced manufacturing and production facilities, with total production capacity of approximately 63 billion tablets, capsules and softgels per year.
All our domestic manufacturing operations are subject to GMPs, promulgated by the U.S. Food and Drug Administration ("FDA"), and other applicable regulatory standards. We believe our U.S. manufacturing processes comply with the GMPs for dietary supplements or foods, and our manufacturing and distribution facilities generally have sufficient capacity to meet our current business requirements and our currently anticipated sales. In certain instances, we outsource to third party manufacturers who we screen for compliance with the GMPs. We place special emphasis on quality control. We assign lot numbers to all raw materials and, except in rare cases, initially hold them in quarantine while our Quality Department evaluates them for compliance with established specifications. Once released, we retain samples and process the material according to approved formulae by blending, mixing and technically processing as necessary. We manufacture products in final delivery form as a capsule, tablet, powder, softgel, nutrition bar or liquid. After a product is manufactured, our laboratory analysts test its weight, purity, potency, disintegration and dissolution, if applicable. Except in rare instances, we hold the product in quarantine until we complete the quality evaluation and determine that the product meets all applicable specifications before packaging. In those instances when we release a product concurrently with testing, we implement a conditional release process to ensure the product is not distributed before we complete testing. When the manufactured product meets all specifications, our automated packaging equipment packages the product with at least one
tamper-evident safety seal and affixes a label, an indelible lot number and, in most cases, the expiration or "best by" date. We use sophisticated computer-generated documentation for picking and packing for order fulfillment.
We are subject to regulations and standards of a similar nature in Canada, China and the United Kingdom with respect to our manufacturing activities in those countries. We maintain Health Canada mandated natural health product and drug licenses, market authorizations and establishment and site licenses.
In the United States and Canada, we have received recognition from many prestigious private organizations, including U.S. Pharmacopeia GMP Certification (as part of their Dietary Supplement Verification Program). Additionally, we have been recognized in the United Kingdom with MHRA Importation License and Wholesale Dealers License, as well as the BRC Global Standard for Food Safety and the certificate of conformity of the Organic Food Federation.
Our manufacturing operations are designed to allow low-cost production of a wide variety of products of different quantities, physical sizes and packaging formats, while maintaining a high level of customer service and quality. Flexible production line changeover capabilities and reduced cycle times allow us to respond quickly to changes in manufacturing schedules and customer demands.
We have inventory control systems at our facilities that track each manufacturing and packaging component as we receive it from our supply sources through manufacturing and shipment of each product to customers. To facilitate this tracking, most products we sell are bar coded. Our inventory control systems report shipping, sales and, in most cases, individual SKU level inventory information. We manage the retail sales process by monitoring customer sales and inventory levels by product category. We believe our distribution capabilities increase our flexibility in responding to our customers' delivery requirements. Our purchasing and merchandising staff regularly reviews and analyzes information from our U.S. point-of-sale computer system and makes merchandise allocation and markdown decisions based on this information. We use an automated reorder system in the United States to maintain in-stock positions on key items. These systems give us the information we need to determine the proper timing and quantity of reorders.
Our financial reporting systems provide us with detailed financial reporting to support our operating decisions and cost control efforts. These systems provide functions such as payment scheduling, application of payment receipts, general ledger interface, vendor tracking and flexible reporting options.
Research and Development
We did not expend material amounts for research and development of new products during the last three fiscal years.
Competition; Customers
The market for nutritional supplement products is highly competitive. Our direct competition consists of publicly and privately owned companies, which tend to be highly fragmented in terms of both geographic market coverage and product categories. Competition is based primarily on quality and assortment of products, customer service (including timely deliveries), marketing support, availability of new products and price. Given our significant scale and broad scope relative to our competition, strong innovation capabilities, high-quality manufacturing and vertical integration, we believe that we are well positioned to capitalize on the industry's favorable long term secular trends and gain share.
There are numerous companies in the vitamin and nutritional supplement industry with which we compete that sell products to retailers, including mass merchandisers, convenience stores, drug store chains, club stores, independent drug stores, supermarkets and health food stores.
During fiscal 2014 and 2013, Wal-Mart, individually, accounted for 19% and 21% of our Wholesale segment's net sales, respectively, and 11% and 13% of our consolidated net sales, respectively. As of September 30, 2014, Wal- Mart, individually, accounted for 13% of our Wholesale segment's gross accounts receivable. We sell products to Wal-Mart under individual purchase orders placed by Wal-Mart under Wal-Mart's standard terms and conditions of sale. These terms and conditions include insurance requirements; representations by us with respect to the quality of our products and our manufacturing process; our obligations to comply with law; and indemnifications by us if we breach our representations or obligations. There is no commitment from Wal-Mart to purchase from us, or from us to sell to Wal-Mart, any minimum amount of product. The loss of Wal-Mart, or any other major customer, would have a material adverse effect on us if we were unable to replace that customer. See "Item 1A.
Item 1A. Risk Factors
Please carefully consider the following risk factors, which could materially adversely affect our business, financial condition, operating results and cash flows. The risk factors described below are not the only ones we face. Risks and uncertainties not known to us currently, or that may appear immaterial, also may have a material adverse effect on our business, financial condition, operating results and cash flows.
Risks Relating to Our Business
Unfavorable publicity or consumer perception of our products and any similar products distributed by other companies could have a material adverse effect on our business.
We believe the nutritional supplement market is highly dependent upon consumer perception regarding the safety, efficacy and quality of nutritional supplements generally, as well as of products distributed specifically by us. Consumer perception of our products can be significantly influenced by scientific research or findings, regulatory investigations, litigation, national media attention and other publicity regarding the consumption of nutritional supplements. There can be no assurance that future scientific research, findings, regulatory proceedings, litigation, media attention or other research findings or publicity will be favorable to the nutritional supplement market or any particular product, or consistent with earlier publicity. Future research reports, findings, regulatory proceedings, litigation, media attention or other publicity that are perceived as less favorable than, or that question, earlier research reports, findings or publicity could have a material adverse effect on the demand for our products and our business, results of operations, financial condition and cash flows. Our dependence upon consumer perceptions means that adverse scientific research reports, findings, regulatory proceedings, litigation, media attention or other publicity, whether or not accurate or with merit, could have a material adverse effect on us, the demand for our products, and our business, results of operations, financial condition and cash flows. Further, adverse publicity reports or other media attention regarding the safety, efficacy and quality of nutritional supplements in general, or our products specifically, or associating the consumption of nutritional supplements with illness, could have such a material adverse effect. Such adverse publicity reports or other media attention could arise even if the adverse effects associated with such products resulted from consumers' failure to consume such products appropriately or as directed.
Our success is linked to the size and growth rate of the vitamin, mineral and supplement market and an adverse change in the size or growth rate of that market could have a material adverse effect on us.
An adverse change in size or growth rate of the vitamin, mineral and supplement market could have a material adverse effect on us. Underlying market conditions are subject to change based on economic conditions, consumer preferences and other factors that are beyond our control, including media attention and scientific research, which may be positive or negative.
Our ability to obtain additional capital on commercially reasonable terms may be limited or non-existent.
Although we believe our cash, cash equivalents and short-term investments, as well as future cash from operations and availability under NBTY's revolving credit facility, provide adequate resources to fund ongoing operating requirements for the foreseeable future, we may need to seek additional financing to compete effectively.
If we are unable to obtain capital or obtain capital on commercially reasonable terms, it could:
• reduce funds available to us for purposes such as working capital, capital expenditures, research and development, strategic acquisitions and other general corporate purposes;
• restrict our ability to introduce new services or products or exploit business opportunities;
• increase our vulnerability to economic downturns and competitive pressures in the markets in which we operate; and
• place us at a competitive disadvantage.
Difficult and volatile conditions in the capital, credit and commodities markets and in the overall economy could materially adversely affect our financial position, results of operations and cash flows.
Our financial position, results of operations and cash flows could be materially adversely affected by difficult conditions and volatility in the capital, credit and commodities markets and in the overall economy. Difficult conditions in these markets and the overall economy affect our business in a number of ways. For example:
• under difficult market conditions there can be no assurance that borrowings under our revolving credit facility would be available or sufficient, and in such a case, we may not be able to successfully obtain additional financing on reasonable terms, or at all;
• in order to respond to market conditions, we may need to seek waivers of various provisions in NBTY's senior secured credit facilities, and we might not be able to obtain such waivers on reasonable terms, if at all; and
• market conditions could result in our key customers experiencing financial difficulties and/or electing to limit spending because many consumers consider the purchase of our products discretionary, which in turn could result in decreased sales and earnings for us.
Because a substantial majority of our sales are to or through retail stores, we are dependent to a large degree upon the success of this channel as well as the success of specific retailers in the channel.
Approximately 60% of our sales for fiscal 2014 were in the United States. In this market, we sell our products primarily to or through our retail stores and third-party retail stores. Because of this, we are dependent to a large degree upon the growth and success of that channel as well as the growth and success of specific retailers in the channel, which are outside our control. There can be no assurance that the retail channel will be able to grow as it faces price and service pressure from other channels.
One of our customers accounted for 11% of our consolidated net sales during fiscal 2014 and the loss of this customer, or any of our other major customers, could have a material adverse effect on our results of operations.
During fiscal 2014 and 2013, Wal-Mart, individually, accounted for 19% and 21% of our Wholesale segment's net sales, respectively, and 11% and 13% of our consolidated net sales, respectively. As of the end of fiscal 2014, Wal-Mart, individually, accounted for 13% of our Wholesale segment's total gross accounts receivable. Additionally, for fiscal 2014, our other top three wholesale customers collectively accounted for approximately 28%, of our Wholesale segment's net sales and 17% of our consolidated net sales. We do not have a long-term contract with Wal-Mart or any other major customer, and the loss of this customer or any other major customer could have a material adverse effect on our results of operations. In addition, our results of operations and ability to service our debt obligations would be impacted negatively to the extent Wal-Mart is unable to make payments to us, or does not make timely payments on outstanding accounts receivables.
Complying with new and existing government regulation, both in the United States and abroad, could increase our costs significantly, reduce our growth prospects and adversely affect our financial results.
The processing, formulation, manufacturing, packaging, labeling, advertising, distribution and sale of our products are subject to regulation by several U.S. federal agencies, including the FDA, the FTC, the CBP, the USPS, the CPSC, the Department of Agriculture, OSHA and the EPA, as well as various
state, local and international laws and agencies of the localities in which our products are sold, including Health Canada and the Competition Bureau in Canada, the Food Standards Agency ("FSA") and the Department of Health in the United Kingdom and similar regulators in Ireland, the Netherlands, the EU and China. Government regulations may prevent or delay the introduction, or require the reformulation or relabeling, of our products. Some agencies, such as the FDA, could require us to remove a particular product from the market, delay or prevent the import of raw materials for the manufacture of our products, or otherwise disrupt the marketing of our products. Any such government actions would result in additional costs to us, including lost revenues from any additional products that we are required to remove from the market, which could be material. Any such government actions also could lead to liability, substantial costs and reduced growth prospects. In addition, complying with the AER Act, GMPs and other legislation may impose additional costs on us, which could become significant. Moreover, there can be no assurance that new laws or regulations imposing more stringent regulatory requirements on the dietary supplement industry will not be enacted or issued or that certain agencies will not enforce the existing laws or regulations more strictly. We currently are subject to FTC consent decrees and a USPS consent order, prohibiting certain advertising claims for certain of our products. We also are subject to consent judgments under Proposition 65. A determination that we have violated these obligations could result in substantial monetary penalties, which could have a material adverse effect on our business, results of operations, financial condition and cash flows. In addition, we could incur costs as a result of violations of or liabilities hereunder, environmental laws and regulations, or to maintain compliance with such environmental laws, regulations or permit requirements.
Additional or more stringent regulations and enforcement of dietary supplements and other products have been considered from time to time in the United States and globally. These developments could require reformulation of certain products to meet new standards, recalls or discontinuance of certain products not able to be reformulated, additional record-keeping requirements, increased documentation of the properties of certain products, additional or different labeling, additional scientific substantiation, adverse event reporting or other new requirements. These developments also could increase our costs significantly.
In the United Kingdom, an application for judicial review was submitted to the High Court of Justice in 2013 on behalf of a holder of an EU-wide medicinal license for certain glucosamine products. The application sought an order that the MHRA should remove food supplement ("FS") status for all glucosamine products or, alternatively, remove the FS status of glucosamine-based products having dosages at levels equal to or above the licensed equivalents. The MHRA robustly defended the case and the application was rejected by the High Court in June 2014-as was a subsequent application to the High Court for leave to appeal. However, the applicant is now seeking leave to appeal by applying to the Court of Appeal itself. If such leave is granted and the applicant's appeal ultimately succeeds, there may be a material negative impact on the sales of numerous glucosamine-based products currently being sold by our retail stores in the United Kingdom.
In Europe, we anticipate the enactment of legislation that could significantly impact the formulation and marketing of our products. For example, in accordance with the Supplements Directive, maximum permitted content levels for vitamin and mineral supplements are expected to be enacted but have not yet been announced. European legislation regulating food supplements other than vitamins and minerals also is expected to be introduced. The introduction of this anticipated legislation could require us to reformulate our existing products to meet the new standards and, in some cases, may lead to some products being discontinued.
The Nutrition and Health Claims Regulation implemented in July 2007 controls the types of claims that can be made for foodstuffs (including supplements) in Europe, and the criteria a product must meet for the claims to be made. Except in relation to botanical products, after December 14, 2012, only
certain permitted health claims can be made for foodstuffs, and this may impact our sales of those products in Europe.
In addition, the General Product Safety Directive governing product safety came into force in Europe at the beginning of 2004. This legislation requires manufacturers to notify regulators as soon as they know that a product is unsafe and gives regulators in each EU member state the power to order a product recall and, if necessary, instigate the product recall themselves. A recall of any of our products in Europe could have a material adverse effect on our business, results of operations, financial condition and cash flows.
In China, the Food Safety Law, which replaced prior regulations, came into force on June 1, 2009. This legislation requires all imported food to comply with applicable national food safety standards and subjects it to inspection by the AQSIQ. Where there are no national food safety standards for some imported food, the NHFPC approval must be obtained before applying for the inspection; otherwise the food in question cannot be imported into China. The revision of the national food safety standards by the NHFPC and other government agencies is in progress and various new and updated standards are expected to be promulgated and implemented by the end of 2015. The introduction of these new food safety standards may require us to reformulate our existing products to meet the new standards and in some cases, may lead to some products being discontinued.
The Food Safety Law also requires overseas food manufacturers to register with AQSIQ or its local counterparts, which must establish records of the credit standing of importers, exporters and manufacturers of imported goods. The imported foods, importers, exporters or manufacturers with unsatisfactory records are subject to stricter inspection or even suspension of their import business. Any restriction or suspension of import of any of our products into China could have a material adverse effect on our business, results of operations, financial condition and cash flows.
The Food Safety Law provides for strict regulation and supervision over food claimed to have particular effects on human health, namely health food, which is mainly subject to the regulation by the CFDA. To the extent AQSIQ or CFDA determines some of our products fall into this category, the manufacture, exportation, importation and sale of such products could be subject to the more complicated registration and licensing requirements, and stricter inspection by CFDA and AQSIQ. We are in the process of applying for registration of certain of our products as health food to meet applicable requirements for manufacture and export of such products, however, the timing and successful completion of such registrations are uncertain due to the shifting landscape for registration of such products in China, as further explained immediately below.
On June 30, 2014, the Standing Committee of the NPC published for public comment the Food Safety Law Amendment. With respect to health food products, the Food Safety Law Amendment is intended to establish both "registration" and "notification" based systems depending on the type of health food product. Health food products that contain new health food ingredients or are imported into China for the first time will be subject to registration with the CFDA. All other health food products will be subject to a notification process with the provincial-level food and drug regulatory authorities. Although the public comment period has ended, the draft Food Safety Law Amendment is still under discussion among lawmakers of the Standing Committee of NPC.
AQSIQ promulgated the Imported and Exported Food Safety Regulatory Measures on July 22, 2011, which provide for detailed safety and inspection requirements applicable to imported and exported food. These regulations became effective on March 1, 2012 and require us to go through complicated procedures for importing and exporting our products into and from China.
Since the beginning of 2014, the CFDA, AQSIQ, their local counterparts and certain ports of entry have strengthened overall administration on "special forms of food products" which mainly target dietary supplement products in the form of tablets and capsules that have not obtained certain
registrations related to health foods (the "blue hat" registrations) from the CFDA. It is expected that the Food Safety Law Amendment will clarify the registration requirements for "health food" products and create a more streamlined and simplified registration system compared to the "blue hat" registration system that is currently in place with respect to certain of these products. However, the CFDA and AQSIQ may continue to take actions that can adversely impact our ability to import products into China and have a material adverse effect on our business, financial condition, results of operations and cash flows.
See "Item 1. Business-Government Regulation" for more information about the regulatory environment in which we conduct our business.
We may incur material product liability claims, which could increase our costs and adversely affect our reputation, revenues and operating income.
As a retailer, marketer and manufacturer of products designed for human and animal consumption, we are subject to product liability claims if the use of our products is alleged to have resulted in injury. Our products consist of vitamins, minerals, herbs and other ingredients that are classified as foods, dietary supplements, or NHPs, and, in most cases, are not necessarily subject to pre-market regulatory approval in the United States. One of our Canadian subsidiaries also manufactures and sells non-prescription medications such as headache and cold remedies and contract manufactures some prescription medications. Some of our products contain innovative ingredients that do not have long histories of human consumption. Previously unknown adverse reactions resulting from human consumption of these ingredients could occur. In addition, some of the products we sell are produced by third-party manufacturers. As a marketer of products manufactured by third parties, we also may be liable for various product liability claims for products we do not manufacture. We have been in the past, and may be in the future, subject to various product liability claims, including, among others, that our products include inadequate instructions for use or inadequate warnings concerning possible side effects and interactions with other substances. A product liability claim against us could result in increased costs and could adversely affect our reputation with our customers, which, in turn, could have a material adverse effect on our business, results of operations, financial condition and cash flows. See Item 3, "Legal Proceedings," for additional information.
If we experience product recalls, we may incur significant and unexpected costs, and our business reputation could be adversely affected.
We may be exposed to product recalls and adverse public relations if our products are mislabeled or alleged to cause injury or illness, or if we are alleged to have violated governmental regulations. A product recall could result in substantial and unexpected expenditures, which would reduce operating profit and cash flow. In addition, a product recall may require significant management attention. Product recalls may hurt the value of our brands and lead to decreased demand for our products. Product recalls also may lead to increased scrutiny by federal, state or international regulatory agencies of our operations and increased litigation and could have a material adverse effect on our business, results of operations, financial condition and cash flows. See "-Complying with new and existing government regulation, both in the United States and abroad, could increase our costs significantly, reduce our growth prospects and adversely affect our financial results" and other risks summarized in this Report.
Insurance coverage, even where available, may not be sufficient to cover losses we may incur.
Our business exposes us to the risk of liabilities arising from our operations. For example, we may be liable for claims brought by users of our products or by employees, customers or other third parties for personal injury or property damage occurring in the course of our operations. We seek to minimize these risks through various insurance contracts from third-party insurance carriers. However, our
insurance coverage is subject to large individual claim deductibles, individual claim and aggregate policy limits, and other terms and conditions. We retain an insurance risk for the deductible portion of each claim and for any gaps in insurance coverage. We do not view insurance, by itself, as a material mitigant to these business risks.
We cannot assure that our insurance will be sufficient to cover our losses. Any losses that insurance does not substantially cover could have a material adverse effect on our business, results of operations, financial condition and cash flows.
The insurance industry has become more selective in offering some types of coverage and we may not be able to obtain insurance coverage in the future.
The insurance industry has become more selective in offering some types of insurance, such as product liability, product recall, property and directors' and officers' liability insurance. Our current insurance program is consistent with both our past level of coverage and our risk management policies. However, we cannot assure that we will be able to obtain comparable insurance coverage on favorable terms, or at all, in the future.
International markets expose us to certain risks.
As of September 30, 2014, we operated 1,016 retail stores outside of the United States, including 89 franchised stores. In addition, we had significant wholesale sales outside of the United States. For fiscal 2014, international sales represented approximately 40% of our net sales. These international operations expose us to certain risks, including:
• local economic conditions;
• inflation;
• changes in or interpretations of foreign regulations that may limit our ability to sell certain products or repatriate profits or capital to the United States;
• exposure to currency fluctuations;
• potential imposition of trade or foreign exchange restrictions or increased tariffs;
• changes and limits in export and import controls;
• difficulty in collecting international accounts receivable;
• difficulty in staffing, developing and managing foreign operations;
• potentially longer payment cycles;
• difficulties in enforcement of contractual obligations and intellectual property rights;
• renegotiation or modification of various agreements;
• national and regional labor strikes;
• increased costs in maintaining international manufacturing and marketing efforts;
• quarantines for products or ingredients, or restricted mobility of key personnel due to disease outbreaks;
• government regulations and laws;
• geographic time zone, language and cultural differences between personnel in different areas of the world;
• political instability;
• trademarks availability and registration issues;
• changes in exchange rates;
• changes in taxation; and
• wars and other hostilities.
As we continue to expand our international operations, these and other risks associated with international operations are likely to increase. These risks, if they occur, could have a material adverse effect on our business and results of operations.
Our international operations require us to comply with anti-corruption laws and regulations of the U.S. government and various international jurisdictions in which we do business.
Doing business on a worldwide basis requires us and our subsidiaries to comply with the laws and regulations of the U.S. government and various international jurisdictions, and our failure to successfully comply with these rules and regulations may expose us to liabilities. These laws and regulations apply to companies, individual directors, officers, employees and agents, and may restrict our operations, trade practices, investment decisions and partnering activities. In particular, our international operations are subject to U.S. and foreign anti-corruption laws and regulations, such as the Foreign Corrupt Practices Act ("FCPA") and the U.K. Bribery Act ("UKBA"). The FCPA prohibits us from providing anything of value to foreign officials for the purposes of influencing official decisions or obtaining or retaining business or otherwise obtaining favorable treatment, and requires us to maintain adequate record-keeping and internal accounting practices to accurately reflect our transactions. As part of our business, we may deal with state-owned business enterprises, the employees and representatives of which may be considered foreign officials for purposes of the FCPA and UKBA. In addition, some of the international locations in which we operate lack a developed legal system and have elevated levels of corruption. As a result of the above activities, we are exposed to the risk of violating anti-corruption laws. Violations of these legal requirements are punishable by criminal fines and imprisonment, civil penalties, disgorgement of profits, injunctions, debarment from government contracts as well as other remedial measures. We have established policies and procedures designed to assist us and our personnel in complying with applicable U.S. and international laws and regulations. However, there can be no assurance that our policies and procedures will effectively prevent us from violating these regulations in every transaction in which we may engage, and such a violation could adversely affect our reputation, business, financial condition and results of operations.
We may not be successful in expanding globally.
We may experience difficulty entering new international markets due to regulatory barriers, the necessity of adapting to new regulatory systems, and problems related to entering new markets with different cultural bases and political systems. These difficulties may prevent, or significantly increase the cost of, our international expansion.
We may be exposed to legal proceedings initiated by regulators in the United States or abroad that could increase our costs and adversely affect our reputation, revenues and operating income.
In all jurisdictions in which we operate, non-compliance with relevant legislation can result in regulators bringing administrative, civil or, in some cases, criminal proceedings. In the United States, the FTC has brought and considered bringing actions against us in the past. In the United Kingdom, it is common for regulators to prosecute retailers and manufacturers for non-compliance with legislation governing foodstuffs and medicines. In the United States, we are undergoing an audit of our compliance of unclaimed or abandoned property (escheat) laws currently for nineteen states for the years 1986 through the present. Our failure to comply with applicable legislation could occur from time
to time, and prosecution for any such violations could have a material adverse effect on our business, results of operations, financial condition and cash flows. See "Item 1. Business-Government Regulation" for additional information.
We may not be successful in our future acquisition endeavors, if any, which may have an adverse effect on our business and results of operations.
Historically, we have engaged in substantial acquisition activity. We may be unable to identify suitable targets, opportunistic or otherwise, for acquisition in the future. If we identify a suitable acquisition candidate, our ability to successfully implement the acquisition will depend on a variety of factors, including our ability to obtain financing on acceptable terms and to comply with the restrictions contained in our debt agreements. Historical instability in the financial markets indicates that obtaining future financing to fund acquisitions may present significant challenges. If we need to obtain our lenders' consent to an acquisition, they may condition their consent on our compliance with additional restrictive covenants that may limit our operating flexibility. Acquisitions involve risks, including:
• significant expenditures of cash;
• the risk that acquired businesses may not perform in accordance with expectations;
• risks associated with integrating the operations, financial reporting, disparate technologies and personnel of acquired companies;
• managing geographically dispersed operations;
• diversion of management's attention from other business concerns;
• the inherent risks in entering markets or lines of business in which we have either limited or no direct experience;
• the potential loss of key employees, customers and strategic partners of acquired companies;
• incurrence of liabilities and claims arising out of acquired businesses;
• inability to obtain financing; and
• incurrence of indebtedness or issuance of additional stock.
We may not integrate any businesses or technologies we acquire in the future successfully and may not achieve anticipated operating efficiencies and effective coordination of sales and marketing as well as revenue and cost benefits. Acquisitions may be expensive, time consuming and may strain our resources. Acquisitions may impact our results of operations negatively as a result of, among other things, the incurrence of debt.
We are dependent on our executive officers and other key personnel, and we may not be able to pursue our current business strategy effectively if we lose them.
Our continued success will depend largely on the efforts and abilities of our executive officers and certain other key employees. For additional information about these individuals, see Item 10, "Directors, Executive Officers and Corporate Governance" elsewhere in this Report. Our ability to manage our operations and meet our business objectives could be affected adversely if, for any reason, we are unable to recruit and retain executive talent.
We are dependent on certain third-party suppliers.
We purchase from third-party suppliers certain important ingredients and raw materials. The principal raw materials required in our operations are vitamins, minerals, herbs, gelatin and packaging components. We purchase the majority of our vitamins, minerals and herbal raw materials from
manufacturers and distributors globally. Real or perceived quality control problems with raw materials outsourced from certain regions could negatively impact consumer confidence in our products, or expose us to liability. In addition, although raw materials are available from numerous sources, an unexpected interruption of supply or material increases in the price of raw materials, for any reason, such as changes in economic and political conditions, tariffs, trade disputes, regulatory requirements, import restrictions, loss of certifications, power interruptions, fires, hurricanes, drought or other climate-related events, war or other events, could have a material adverse effect on our business, results of operations, financial condition and cash flows. Also, currency fluctuations, including the decline in the value of the U.S. dollar, could result in higher costs for raw materials purchased abroad. In addition, we rely on outside printing services and availability of paper stock in our printed catalog operations.
We rely on our manufacturing operations to produce the vast majority of the nutritional supplements that we sell, and disruptions in our manufacturing system or losses of manufacturing certifications could affect our results of operations adversely.
During fiscal 2014, we manufactured approximately 87% of the nutritional supplements that our Wholesale segment sold. We currently operate manufacturing facilities in Arizona, California, Florida, New Jersey, New York and Texas in the United States, and in Canada, the United Kingdom and China. All our domestic and foreign operations manufacturing products for sale to the United States are subject to GMPs promulgated by the FDA and other applicable regulatory standards, including in the areas of environmental protection and worker health and safety. We are subject to similar regulations and standards in Canada, the United Kingdom and China. Any significant disruption in our operations at any of these facilities, including any disruption due to any regulatory requirement, could affect our ability to respond quickly to changes in consumer demand and could have a material adverse effect on our business, results of operations, financial condition and cash flows. Additionally, we may be exposed to risks relating to the transfer of work between facilities or risks associated with opening new facilities or closing existing facilities that may cause a disruption in our operations. There have been a number of well-publicized incidents of tainted food and drugs manufactured in foreign countries such as China in the past few years. Although we have implemented GMPs in our facilities, there can be no assurance that products manufactured in our other plants around the world, will not be contaminated or otherwise fail to meet our quality standards. Any such contamination or other quality failures could result in costly recalls, litigation, regulatory actions or damage to our reputation, which could have a material adverse effect on our business, results of operations, financial condition and cash flows.
We operate in a highly competitive industry, and our failure to compete effectively could affect our market share, financial condition and growth prospects adversely.
The VMHS industry is a large and growing industry and is highly fragmented in terms of both geographical market coverage and product categories. The market for vitamins and other nutritional supplements is highly competitive in all our channels of distribution. We compete with companies that may have broader product lines or larger sales volumes, or both, than we do, and our products compete with nationally advertised brand name products. Several of the national brand companies have resources greater than ours. Numerous companies compete with us in the development, manufacture and marketing of vitamins and nutritional supplements worldwide. In addition, our North American and European retail stores compete with specialty vitamin stores, health food stores and other retail stores worldwide. With respect to mail order sales, we compete with a large number of smaller mail order and internet companies, some of which manufacture their own products and some of which sell products manufactured by others. The market is highly sensitive to the introduction of new products, which may rapidly capture a significant share of the market. We also may face competition from low-cost entrants to the industry, including from international markets. Increased competition from companies that distribute through the wholesale channel, especially the private label market, could have
a material adverse effect on our business, results of operations, financial condition and cash flows as these competitors may have greater financial and other resources available to them and possess extensive manufacturing, distribution and marketing capabilities far greater than ours.
We may not be able to compete effectively in some or all our markets, and our attempt to do so may require us to reduce our prices, which may result in lower margins. Failure to compete effectively could have a material adverse effect on our market share, business, results of operations, financial condition, cash flows and growth prospects. See "Item 1. Business-Competition; Customers."
Our failure to appropriately respond to changing consumer preferences and demand for new products and services could harm our customer relationships and product sales significantly.
The nutritional supplement industry is characterized by rapid and frequent changes in demand for products and new product introductions. Our failure to accurately predict these trends could negatively impact consumer opinion of us as a source for the latest products, which, in turn, could harm our customer relationships and cause decreases in our net sales. The success of our new product offerings depends upon a number of factors, including our ability to:
• accurately anticipate customer needs;
• innovate and develop new products;
• successfully commercialize new products in a timely manner;
• price our products competitively;
• manufacture and deliver our products in sufficient volumes and in a timely manner; and
• differentiate our product offerings from those of our competitors.
In addition, we are subject to the risk of a potential shift in customer demand towards more private label products, which could have an adverse effect on our profitability. If any new products fail to gain market acceptance, are restricted by regulatory requirements or have quality problems, this would harm our results of operations. If we do not introduce new products or make enhancements to meet the changing needs of our customers in a timely manner, some of our products could be rendered obsolete, which could have a material adverse effect on our business, results of operations, financial condition and cash flows.
We are subject to acts of God, war, sabotage and terrorism risk.
Acts of God, war, sabotage and terrorist attacks or any similar risk may affect our operations in unpredictable ways, including disruptions of the shopping and commercial behavior of our customers, changes in the insurance markets and disruptions of fuel supplies and markets.
We may be subject to work stoppages at our facilities, which could negatively impact the profitability of our business.
As of September 30, 2014, we had approximately 13,500 employees. As of September 30, 2014, CAW Local 468, Retail Wholesale Canada Division represented approximately 290 of our associates in Canada under a collective bargaining agreement. If our employees were to engage in a strike, work stoppage or other slowdown in the future, we could experience a significant disruption of our operations, which could interfere with our ability to deliver products on a timely basis and could have other negative effects, such as decreased productivity and increased labor costs. Any interruption in the delivery of our products could reduce demand for our products and could have a material adverse effect on us.
We may be affected adversely by increased raw material, utility and fuel costs.
Inflation and other factors affect the cost of raw materials, goods and services we use. Increased raw material and other costs may adversely affect our results of operations to the extent we are unable to pass these costs through to our customers or to benefit from offsetting cost reductions in the manufacture and distribution of our products. Furthermore, increasing fuel costs may affect our results of operations adversely in that consumer traffic to our retail locations may be reduced and the costs of our sales may increase as we incur fuel costs in connection with our manufacturing operations and the transportation of goods from our warehouse and distribution facilities to stores or direct response/e-commerce customers. Also, high oil costs can affect the cost of our raw materials and components and the competitive environment in which we operate may limit our ability to recover higher costs resulting from rising fuel prices.
Our profits may be affected negatively by currency exchange rate fluctuations.
Our assets, earnings and cash flows are influenced by currency fluctuations due to the geographic diversity of our sales and the countries in which we operate. These fluctuations may have a significant impact on our financial results. For fiscal 2014, 35% of our sales were denominated in a currency other than the U.S. dollar, and as of fiscal 2014, 27% of our assets and 5% of our total liabilities were denominated in a currency other than the U.S. dollar. We have entered into various cross currency swap transactions. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Quantitative and Qualitative Disclosures About Market Risk."
Our success is dependent on the accuracy, reliability, and proper use of sophisticated and dependable information processing systems and management information technology and any interruption in these systems could have a material adverse effect on our business, financial condition, and results of operations.
Our success is dependent on the accuracy, reliability, and proper use of sophisticated and dependable information processing systems and management information technology. Our information technology systems are designed and selected to facilitate order entry and customer billing, maintain customer records, accurately track purchases and incentive payments, manage accounting, finance and manufacturing operations, generate reports, and provide customer service and technical support. Any interruption in these systems or any interruption associated with the transition of these systems to a new information technology platform could have a material adverse effect on our business, financial condition, and results of operations.
System interruptions or security breaches may affect sales.
Customer access to, and ability to use, our websites affects our Direct Response/E-Commerce sales, in addition to online sales within our European Retail and North American Retail segments. If we are unable to maintain and continually enhance the efficiency of our systems, we could experience system interruptions or delays that could affect our operating results negatively. In addition, we could be liable for breaches of security on our websites, loss or misuse of our customers' personal information or payment data. Although we have developed systems and processes that are designed to protect consumer information and prevent fraudulent credit card transactions and other security breaches, failure to prevent or mitigate such fraud or breaches may negatively affect our operating results.
We must successfully maintain and/or upgrade our information technology systems, and our failure to do so could have a material adverse effect on our business, financial condition or results of operations.
We rely on various information technology systems to manage our operations. Recently we have implemented, and we continue to implement, modifications and upgrades to such systems and acquired
new systems with new functionality. These types of activities subject us to inherent costs and risks associated with replacing and changing these systems, including impairment of our ability to fulfill customer orders, potential disruption of our internal control structure, substantial capital expenditures, additional administration and operating expenses, retention of sufficiently skilled personnel to implement and operate the new systems, demands on management time and other risks and costs of delays or difficulties in transitioning to or integrating new systems into our current systems. These implementations, modifications and upgrades may not result in productivity improvements at a level that outweighs the costs of implementation, or at all. In addition, the difficulties with implementing new technology systems may cause disruptions in our business operations and have a material adverse effect on our business, financial condition or results of operations.
Our inability to protect our intellectual property rights could adversely affect our business.
Despite our efforts, we may not be able to determine the extent of unauthorized use of our trademarks and patents. In any case, such efforts are difficult, expensive, and time-consuming, and there can be no assurance that infringing goods could not be manufactured without our knowledge and consent. Many of our products are not subject to patent protection, and thus they can be legally reverse-engineered by competitors. Moreover, even with respect to some of our products that are covered by patents, such as Ester-C® products, there are numerous similar yet non-infringing supplement products in the marketplace, and this negatively affects sales we might otherwise make. Our patents, or certain claims made in such patents, could be found to be invalid or unenforceable. From time to time we face opposition to our applications to register trademarks, and we may not ultimately be successful in our attempts to register certain trademarks. Further, there can be no assurance that in those foreign jurisdictions in which we conduct business the trademark and patent protection available to us will be as extensive as the protection available to us in the United States.
Intellectual property litigation and infringement claims against us could cause us to incur significant expenses or prevent us from manufacturing, selling or marketing our products, which could adversely affect our revenues and market share.
We may be subject to intellectual property litigation and infringement claims, which could cause us to incur significant expenses or prevent us from manufacturing, selling or marketing our products in various jurisdictions. Claims of intellectual property infringement also may require us to enter into costly royalty or license agreements. However, we may be unable to obtain royalty or license agreements on terms acceptable to us or at all. Claims that our technology or products infringe on intellectual property rights of others could be costly to defend or settle, could cause reputational injury and would divert the attention of management and key personnel, which in turn could have a material adverse effect on our business, results of operations, financial condition and cash flows.
We are party to a number of lawsuits that arise in the ordinary course of business and may become party to others in the future.
We are party to a number of lawsuits (including product liability, false advertising, intellectual property and Proposition 65 claims) that arise in the ordinary course of business and may become party to others in the future. The possibility of such litigation, and its timing, is in large part outside our control. It is possible that future litigation could arise, or developments could occur in existing litigation, that could have material adverse effects on us.
Failure to maintain effective internal control over financial reporting could have a material adverse effect on our business and operating results.
Effective internal control over financial reporting is necessary for us to provide reliable financial reports. If we cannot provide reliable financial reports, our business and operating results could be
harmed. The Sarbanes-Oxley Act of 2002, as well as related rules and regulations implemented by the Securities and Exchange Commission (the "SEC"), have required changes in the corporate governance practices and financial reporting standards for public companies. These laws, rules and regulations, including compliance with Section 404 of the Sarbanes-Oxley Act of 2002, have increased our legal and financial compliance costs and made many activities more time-consuming and more burdensome. The costs of compliance with these laws, rules and regulations may adversely affect our financial results. Moreover, we run the risk of non-compliance, which could adversely affect our financial condition or results of operations.
In the past we have discovered, and in the future we may discover, areas of our internal control over financial reporting that need improvement. We have devoted significant resources to remediate any deficiencies we discovered and to improve our internal control over financial reporting. Based upon management's assessment of the effectiveness of our internal control over financial reporting as of September 30, 2014, management concluded that our internal control over financial reporting was effective as of that date. We cannot be certain that these measures will ensure that we implement and maintain adequate controls over our financial processes and reporting in the future. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. Ineffective internal control over financial reporting could also cause investors to lose confidence in our reported financial information.
Risks Relating to Our Indebtedness
Our substantial indebtedness could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk to the extent of our variable rate debt and prevent us from meeting our obligations under the Notes and the $1.0 billion aggregate principal amount of 7.75%/8.50% Contingent Cash Pay Senior Notes due 2017 issued by Holdings (the "Holdco Notes").
We have a significant amount of indebtedness. At September 30, 2014, we had $3,159 million of indebtedness on a consolidated basis (including $1,000 million in aggregate principal amount of Holdco Notes, $1,508 million of borrowings under NBTY's senior secured credit facilities, $650 million in aggregate principal amount of Notes, and $1 million of other indebtedness), of which $1,508 million was secured indebtedness. As of September 30, 2014, after adjusting for outstanding letters of credit, NBTY also had an additional $196 million available under the revolving portion of NBTY's senior secured credit facilities, as amended. While NBTY has no direct obligation under the Holdco Notes, NBTY is the sole source of cash generation for Holdings.
Our substantial indebtedness could have important consequences. For example, it could:
• make it more difficult for NBTY to satisfy its obligations with respect to the Notes or Holdings to satisfy its obligations with respect to the Holdco Notes;
• require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund acquisitions, working capital, capital expenditures, research and development efforts and other general corporate purposes;
• increase our vulnerability to and limit our flexibility in planning for, or reacting to, changes in our business and the industries in which we operate;
• restrict us from making strategic acquisitions or cause us to make non-strategic divestitures;
• expose us to the risk of increased interest rates as borrowings under NBTY's senior secured credit facilities will be subject to variable rates of interest;
• expose us to additional risks related to currency exchange rates and repatriation of funds;
• place us at a competitive disadvantage compared to our competitors that have less debt; and
• limit our ability to obtain additional debt or equity financing for working capital, capital expenditures, business development, debt service requirements, acquisitions and general corporate or other purposes.
In addition, the agreements governing NBTY's senior secured credit facilities and the indentures governing the Notes and the Holdco Notes contain affirmative and negative covenants that limit our ability to engage in activities that may be in our long-term best interests. Our failure to comply with those covenants could result in an event of default which, if not cured or waived, could result in the acceleration of all of our debts.
Restrictive covenants in the indentures governing the Notes and the Holdco Notes and the credit agreement governing NBTY's senior secured credit facilities may restrict our ability to pursue our business strategies.
The indentures governing the Notes and the Holdco Notes and the credit agreement governing NBTY's senior secured credit facilities limit our ability, and the terms of any future indebtedness may limit our ability, among other things, to:
• incur or guarantee additional indebtedness;
• make certain investments;
• pay dividends or make distributions on our capital stock;
• sell assets, including capital stock of restricted subsidiaries;
• agree to payment restrictions affecting our restricted subsidiaries;
• consolidate, merge, sell or otherwise dispose of all or substantially all our assets;
• enter into transactions with our affiliates;
• incur liens; and
• designate any of our subsidiaries as unrestricted subsidiaries.
The restrictions contained in the indentures governing the Notes and the Holdco Notes and the credit agreement governing NBTY's senior secured credit facilities also could limit our ability to plan for, or react to, market conditions, meet capital needs or make acquisitions or otherwise restrict our activities or business plans.
A breach of any of these restrictive covenants (to the extent applicable at such time), or our inability to comply with the required financial ratios, could result in a default under the credit agreement governing NBTY's senior secured credit facilities. If a default occurs, the lenders under NBTY's senior secured credit facilities may elect to:
• declare all borrowings outstanding, together with accrued interest and other fees, to be immediately due and payable; or
• prevent us from making payments on the Notes,
either of which would result in an event of default under the indentures governing the Notes and the Holdco Notes. An event of default under either or both of these indentures or the senior secured credit facilities would permit some of our lenders to declare all amounts borrowed from them to be due and payable. The lenders also have the right in these circumstances to terminate any commitments they have to provide further borrowings. An event of default under either of these indentures or the senior secured credit facilities would likely result in a cross default under either or both of the other
instruments. If we are unable to repay outstanding borrowings when due, the lenders under NBTY's senior secured credit facilities also have the right to proceed against the collateral, including our available cash, granted to them to secure the indebtedness. If the indebtedness under NBTY's senior secured credit facilities, the Holdco Notes and/or the Notes were to be accelerated, we can give no assurance that our assets would be sufficient to repay in full that indebtedness and our other indebtedness, including the Notes and the Holdco Notes.
Despite current indebtedness levels and restrictive covenants, Holdings, NBTY and their subsidiaries may incur additional indebtedness in the future. This could further exacerbate the risks associated with our substantial financial leverage.
The terms of the indenture governing the Notes, the credit agreement governing NBTY's senior secured credit facilities and the indenture governing the Holdco Notes permit us to incur a substantial amount of additional debt, including secured debt. Any additional borrowings under the senior secured credit facilities, and any other secured debt, would be effectively senior to the Holdco Notes, the Notes and any guarantees thereof to the extent of the value of the collateral securing such indebtedness. If we incur any additional indebtedness that ranks equally with the Holdco Notes and the Notes, subject to collateral arrangements, the holders of that debt will be entitled to share ratably with noteholders in any proceeds distributed in connection with any insolvency, liquidation, reorganization, dissolution or other winding up of our company. This could reduce the amount of proceeds available to be paid to noteholders. These restrictions also will not prevent us from incurring obligations that do not constitute indebtedness. In addition, as of September 30, 2014, after adjusting for outstanding letters of credit, NBTY had an additional $196 million of unused commitments under the revolving portion of NBTY's senior secured credit facilities. Additionally, NBTY's senior secured credit facilities may be increased by up to $500 million (of which no more than $100 million may be under NBTY's revolving credit facility), subject to certain conditions. All of those borrowings would be secured indebtedness. If new debt is added to our and our subsidiaries' current debt levels, the risks that we now face as a result of our leverage would intensify.
To service our indebtedness, we will require a significant amount of cash and our ability to generate cash depends on many factors beyond our control.
Our ability to make cash payments on and to refinance our indebtedness, including the Holdco Notes and the Notes, and to fund planned capital expenditures, will depend on our ability to generate significant operating cash flow in the future. This, to a significant extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control.
Our business may not generate sufficient cash flow from operations and future borrowings may not be available under NBTY's senior secured credit facilities in an amount sufficient to enable us to pay our indebtedness, including the Notes and the Holdco Notes, or to fund our other liquidity needs. In such circumstances, we may need to refinance all or a portion of our indebtedness, including the Notes and the Holdco Notes, on or before maturity. We may not be able to refinance any of our indebtedness on commercially reasonable terms, or at all. If we cannot service our indebtedness, we may need to take actions such as selling assets, seeking additional equity or reducing or delaying capital expenditures, strategic acquisitions, investments and alliances. Such actions, if necessary, may not be effected on commercially reasonable terms or at all. The indentures governing the Notes and the Holdco Notes and the credit agreement governing NBTY's senior secured credit facilities restrict our ability to sell assets and use the proceeds from such sales.
If we are unable to generate sufficient cash flow or are otherwise unable to obtain funds necessary to meet required payments of principal, premium, if any, and interest on our indebtedness, or if we otherwise fail to comply with the various covenants in the instruments governing our indebtedness (including covenants in NBTY's senior secured credit facilities, the indenture governing the Notes and
the indenture governing the Holdco Notes), Holdco could be required to pay interest-in-kind and/or we could be in default under the terms of the agreements governing such indebtedness. In the event of such default, the holders of such indebtedness could elect to declare all the funds borrowed thereunder to be due and payable, together with accrued and unpaid interest, the lenders under NBTY's senior secured credit facilities could elect to terminate their commitments thereunder, cease making further loans and institute foreclosure proceedings against our assets, and we could be forced into bankruptcy or liquidation. If our operating performance declines, we may need to obtain waivers in the future from the required lenders under NBTY's senior secured credit facilities to avoid being in default. If we breach our covenants under NBTY's senior secured credit facilities and seek a waiver, we may not be able to obtain a waiver from the required lenders. If this occurs, we would be in default under NBTY's senior secured credit facilities, the lenders could exercise their rights, as described above, and we could be forced into bankruptcy or liquidation.
We are dependent upon our lenders for financing to execute our business strategy and meet our liquidity needs. If our lenders are unable to fund borrowings under their credit commitments or we are unable to borrow, it could negatively impact our business.
In volatile credit markets, there is a risk that any lenders, even those with strong balance sheets and sound lending practices, could fail or refuse to honor their legal commitments and obligations under existing credit commitments, including but not limited to: extending credit up to the maximum permitted by NBTY's senior secured credit facilities and otherwise accessing capital and/or honoring loan commitments. If our lenders are unable to fund borrowings under their credit commitments, or we are unable to borrow, it could be difficult in this environment to replace NBTY's senior secured credit facilities on similar terms.
Our variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly.
Borrowings under NBTY's senior secured credit facilities are at variable rates of interest and expose us to interest rate risk. Interest rates are currently at historically low levels. If interest rates increase, our debt service obligations on the variable rate indebtedness will increase even though the amount borrowed remained the same, and our net income and cash flows, including cash available for servicing our indebtedness, will correspondingly decrease. Assuming all revolving loans are fully drawn and the interest rates are above the interest rate floor set forth in NBTY's credit agreement, and excluding the portion of our variable rate debt subject to a fixed interest rate swap agreement, each quarter point change in interest rates would result in a $4.0 million change in annual interest expense on our indebtedness under NBTY's senior secured credit facilities. However, we may maintain interest rate swaps with respect to any of our variable rate indebtedness, and any swaps we enter into may not fully mitigate our interest rate risk.
Risks Relating to the Notes and the Holdco Notes
The right of holders of the Notes and the Holdco Notes to receive payments on the Notes and the Holdco Notes is effectively subordinated to the rights of our existing and future secured creditors. Further, the guarantees of the Notes and the Holdco Notes, if any, are effectively subordinated to all our guarantors' existing and future secured indebtedness.
The Notes and the Holdco Notes are general unsecured obligations. Holders of our secured indebtedness and the secured indebtedness of the guarantors of the Notes will have claims that are prior to the claims of holders of the Notes and the Holdco Notes to the extent of the value of the assets securing that other indebtedness. Notably, Holdings, NBTY and certain of its subsidiaries, including the guarantors of the Notes, are parties to the senior secured credit facilities, which are secured by liens on substantially all our assets and the assets of such guarantors. The Notes and Holdco
Notes are effectively subordinated to all our secured indebtedness to the extent of the value of the collateral securing such indebtedness. In the event of any distribution or payment of our assets in any foreclosure, dissolution, winding-up, liquidation, reorganization, or other bankruptcy proceeding, holders of secured indebtedness will have a prior claim to those of our assets that constitute their collateral. Holders of the Notes and the Holdco Notes participate ratably with all holders of our unsecured indebtedness that is deemed to be of the same class as the Notes and the Holdco Notes, and potentially with all our other general creditors, based upon the respective amounts owed to each holder or creditor, in our remaining assets. In any of the foregoing events, we cannot assure holders of the Notes and the Holdco Notes that there will be sufficient assets to pay amounts due on the Notes or the Holdco Notes. As a result, holders of the Notes or the Holdco Notes may receive less, ratably, than holders of secured indebtedness.
As of September 30, 2014, the aggregate amount of our secured indebtedness was approximately $1,508 million. As of September 30, 2014, we had $196 million of unused commitments available for additional borrowing under the revolving portion of NBTY's senior secured credit facilities, as amended. We are permitted to incur substantial additional indebtedness, including secured debt, in the future under the terms of the indentures governing the Notes and the Holdco Notes.
The trading prices of the Notes and the Holdco Notes may be volatile and can be affected by many factors, including our credit rating.
The trading price of the Notes and the Holdco Notes could be subject to significant fluctuation in response to, among other factors, changes in our operating results, interest rates, the market for non-investment grade securities, general economic conditions and securities analysts' recommendations, if any, regarding our securities.
Credit rating agencies continually revise their ratings for companies they follow, including us. Any ratings downgrade could adversely affect the trading price of the Notes and the Holdco Notes, or the trading market for the Notes and the Holdco Notes, to the extent a trading market for such securities develops. The condition of the financial and credit markets and prevailing interest rates have fluctuated in the past and are likely to fluctuate in the future and any fluctuation may impact the trading price of the Notes and the Holdco Notes.
We may not be able to satisfy our obligations to holders of the Notes or the Holdco Notes upon a change of control.
Upon the occurrence of a "change of control," as defined in the indentures governing the Notes and the Holdco Notes, each noteholder will have the right to require us to purchase the Notes and the Holdco Notes at a price equal to 101% of the principal amount, together with any accrued and unpaid interest. Our failure to purchase, or give notice of purchase of, the Notes or the Holdco Notes would be a default under the indentures governing the Notes and the Holdco Notes, which would in turn be a default under NBTY's senior secured credit facilities and the indentures governing the Notes and the Holdco Notes. In addition, a change of control may constitute an event of default under NBTY's senior secured credit facilities and the indentures governing the Notes and the Holdco Notes. A default under NBTY's senior secured credit facilities and the indentures governing the Notes and Holdco Notes could result in an event of default under the indentures if the lenders accelerate the debt under NBTY's senior secured credit facilities or the holders accelerate the debt under the indentures governing the Notes and the Holdco Notes.
If a change of control occurs, we may not have enough assets to satisfy all obligations under NBTY's senior secured credit facilities, the indenture related to the Notes and the indenture related to the Holdco Notes. Upon the occurrence of a change of control we could seek to refinance the indebtedness under NBTY's senior secured credit facilities, the indenture governing the Notes and the
indenture governing the Holdco Notes or obtain a waiver from the lenders and holders of the Notes or the Holdco Notes. We can give no assurance, however, that we would be able to obtain a waiver or refinance our indebtedness on commercially reasonable terms, if at all. No assurances can be given that any court would enforce the change of control provisions in the indentures governing the Notes and the Holdco Notes as written for the benefit of the holders, or as to how these change of control provisions would be impacted were we to become a debtor in a bankruptcy case.
Holders of the Notes or the Holdco Notes may not be able to determine when a change of control giving rise to their right to have the Notes or the Holdco Notes repurchased has occurred following a sale of "substantially all" of our assets.
The definition of change of control in the indentures governing the Notes and the Holdco Notes includes a phrase relating to the sale of "all or substantially all" of our assets. There is no precise established definition of the phrase "substantially all" under applicable law. Accordingly, the ability of a holder of the Notes or the Holdco Notes to require us to repurchase the Notes or Holdco Notes, respectively, as a result of a sale of less than all our assets to another person may be uncertain.
Certain private equity investment funds affiliated with Carlyle own substantially all the equity of Holdings, and their interests may not be aligned with those of the holders of the Notes and the Holdco Notes.
Carlyle owns substantially all the fully diluted equity of Holdings, and, therefore, has the power to control our affairs and policies. Carlyle also controls, to a large degree, the election of directors, the appointment of management, the entry into mergers, sales of substantially all our assets and other extraordinary transactions. The directors so elected have authority, subject to the terms of our debt, to issue additional stock, implement stock repurchase programs, declare dividends and make other decisions. Carlyle's interests could conflict with the interests of the holders of the Notes and the Holdco Notes. For example, if we encounter financial difficulties or are unable to pay our debts as they mature, the interests of Carlyle and certain of its affiliates and co-investors, as equity holders, might conflict with the interests of the holders of the Notes and the Holdco Notes. Carlyle also may have an interest in pursuing acquisitions, divestitures, financings or other transactions that, in their judgment, could enhance their equity investments, even though such transactions might involve risks to our noteholders. Additionally, Carlyle is in the business of making investments in companies, and from time to time in the future may acquire interests in businesses that directly or indirectly compete with certain portions of our business, or are suppliers or customers of ours.
Investment funds advised by entities affiliated with Carlyle and affiliates of Carlyle may buy or sell the Notes and the Holdco Notes in open market transactions at any time.
If a bankruptcy petition were filed by or against us, noteholders may receive a lesser amount for their claim than they paid for the Notes and the Holdco Notes.
If a bankruptcy petition were filed by or against us under the U.S. Bankruptcy Code, a noteholder's claim for the principal amount of the Notes or the Holdco Notes may be limited to an amount equal to the sum of:
• the lesser of (x) the original issue price for such notes and (y) the principal amount of such notes; and
• any amount of interest that does not constitute "unmatured interest" for purposes of the U.S. Bankruptcy Code.
Accordingly, under these circumstances, a noteholder may receive a lesser amount than it paid for such notes, even if sufficient funds are available.
Risks Relating to Ownership of the Notes
Claims of noteholders will be effectively subordinated to claims of creditors of all of NBTY's non-guarantor subsidiaries.
The Notes are guaranteed on a senior basis by NBTY's current and future domestic subsidiaries that are guarantors of NBTY's senior secured credit facilities. However, the historical consolidated financial statements included in this Report include all our domestic and foreign subsidiaries. NBTY's foreign subsidiaries, which do not guarantee the Notes, held approximately $1.3 billion, or 27%, of our total assets and $0.2 billion, or 6%, of NBTY's total liabilities as of September 30, 2014 and accounted for approximately $1.1 billion, or 35%, of NBTY's net sales, for fiscal 2014 (all amounts presented exclude intercompany balances). In addition, NBTY has the ability to designate certain of its subsidiaries as unrestricted subsidiaries under the terms of the indenture governing the Notes, and any subsidiary so designated will not be a guarantor of the Notes.
NBTY's non-guarantor subsidiaries are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay any amounts due under the Notes, or to make any funds available therefor, whether by dividends, loans, distributions or other payments. Any right that NBTY or its subsidiary guarantors have to receive any assets of any of its non-guarantor subsidiaries upon the liquidation or reorganization of those subsidiaries, and the consequent rights of noteholders to realize proceeds from the sale of any of those subsidiaries' assets, will be effectively subordinated to the claims of those subsidiaries' creditors, including trade creditors and holders of debt of that subsidiary.
NBTY is a holding company with no operations and may not have access to sufficient cash to make payments on its credit obligations.
NBTY is a holding company and has limited direct operations. NBTY's most significant assets are the equity interests it holds in its subsidiaries. As a result, it is dependent upon dividends and other payments from its subsidiaries to generate the funds necessary to meet its outstanding debt service and other obligations and such dividends may be restricted by law or the instruments governing its indebtedness, including the indenture governing the Notes, the credit agreement governing its senior secured credit facilities or other agreements of its subsidiaries. NBTY's subsidiaries may not generate sufficient cash from operations to enable it to make principal and interest payments on its indebtedness, including the Notes. In addition, its subsidiaries are separate and distinct legal entities and, except for its existing and future subsidiaries that will be the guarantors of the Notes, any payments on dividends, distributions, loans or advances to NBTY by its subsidiaries could be subject to legal and contractual restrictions on dividends. In addition, payments to NBTY by its subsidiaries will be contingent upon its subsidiaries' earnings. Additionally, NBTY may be limited in its ability to cause its existing and any future joint ventures to distribute their earnings to it. Subject to certain qualifications, its subsidiaries are permitted under the terms of its indebtedness, including the indenture governing the Notes, to incur additional indebtedness that may restrict payments from those subsidiaries to it. NBTY can give no assurance that agreements governing the current and future indebtedness of its subsidiaries will permit those subsidiaries to provide it with sufficient cash to fund payments of principal premiums, if any, and interest on the Notes when due. In addition, any guarantee of the Notes will be subordinated to any senior secured indebtedness of a subsidiary guarantor to the extent of the assets securing such indebtedness.
Federal and state statutes may allow courts, under specific circumstances, to void the Notes and/or the guarantees of the Notes and require noteholders to return payments received on the Notes.
Under federal bankruptcy law and comparable provisions of state fraudulent transfer laws, the Notes or the guarantees thereof could be deemed a fraudulent transfer if NBTY or any of the
guarantors of the Notes, as applicable, received less than a reasonably equivalent value in exchange for either issuing the Notes or giving the guarantee and:
• NBTY or any such guarantors, as applicable, was insolvent on the date that it issued the Notes or gave the guarantee or became insolvent as a result of issuing the Notes or giving the guarantee; or
• the issuance of the Notes or the giving of such guarantee left NBTY or any of such guarantors, as applicable, with an unreasonably small amount of capital to carry on the business; or
• NBTY or any of such guarantors intended to incur, or believed that NBTY or such guarantor would incur, debts that would be beyond NBTY's or such guarantor's ability to pay as those debts matured.
The Notes and/or a guarantee thereof could also be deemed a fraudulent transfer if it was given with actual intent to hinder, delay or defraud any entity to which NBTY or any such guarantor was or became, on or after the date of issuance of the Notes or the giving of the guarantee, as applicable, indebted.
The measures of insolvency for purposes of the foregoing considerations will vary depending upon the law applied in any proceeding with respect to the foregoing. Generally, however, NBTY or any such guarantor would be considered insolvent if:
• the sum of its debts, including contingent liabilities, is greater than all its assets, at a fair valuation; or
• the present fair saleable value of its assets is less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature; or
• it could not pay its debts as they become due.
We cannot predict:
• what standard a court would apply to determine whether NBTY or any such guarantor was insolvent as of the date it issued the Notes or its guarantee, as applicable, or whether, regardless of the method of valuation, a court would determine that NBTY or such guarantor was insolvent on that date; or
• whether a court would determine that the payments under the Notes or such guarantee constituted fraudulent transfers or conveyances on other grounds.
The indenture governing the Notes contains a "savings clause" intended to limit each subsidiary guarantor's liability under its guarantee to the maximum amount that it could incur without causing the guarantee to be a fraudulent transfer under applicable law. There can be no assurance that this provision will be upheld as intended. In a case brought to the U.S. Bankruptcy Court in the Southern District of Florida, the court found this kind of provision to be ineffective, and held the subsidiary guarantees to be fraudulent transfers and voided them in their entirety. Although this ruling was reversed, there can be no assurance that other courts will not reach the same conclusion as the U.S. Bankruptcy Court in the Southern District of Florida.
If a guarantee is deemed to be a fraudulent transfer, it could be voided altogether, or it could be subordinated to all other debts of such guarantor. In that case, any payment by such guarantor under its guarantee could be required to be returned to the guarantor or to a fund for the benefit of the creditors of the guarantor. If a guarantee is voided or held unenforceable for any other reason, holders of the Notes would cease to have a claim against the subsidiary based on the guarantee and would be
creditors only of NBTY and any guarantor whose guarantee was not similarly voided or otherwise held unenforceable.
If a court were to find that the issuance of the Notes or the incurrence of a guarantee was a fraudulent transfer or conveyance, the court could void the payment obligations under the Notes or that guarantee, could subordinate the Notes or that guarantee to presently existing and future indebtedness of ours or of the related guarantor or could require the holders of the Notes to repay any amounts received with respect to that guarantee. In the event of a finding that a fraudulent transfer or conveyance occurred, holders of the Notes may not receive any repayment on the Notes. Further, the avoidance of the Notes could result in an event of default with respect to our and our subsidiaries' other debt that could result in acceleration of that debt.
The lenders under NBTY's senior secured credit facilities have the discretion to release the guarantors under NBTY's senior secured credit facilities in a variety of circumstances, which will cause those guarantors to be released from their guarantees of the Notes.
While any obligations under NBTY's senior secured credit facilities remain outstanding, any guarantee of the Notes may be released without action by, or consent of, any holder of the Notes or the trustee under the indenture governing the Notes, at the discretion of lenders under NBTY's senior secured credit facilities, if such guarantor is no longer a guarantor of obligations under NBTY's senior secured credit facilities or any other indebtedness. The lenders under NBTY's senior secured credit facilities will have the discretion to release the guarantees under NBTY's senior secured credit facilities in a variety of circumstances. A noteholder will not have a claim as a creditor against any subsidiary that is no longer a guarantor of the Notes, and the indebtedness and other liabilities, including trade payables, whether secured or unsecured, of those subsidiaries will effectively be senior to claims of noteholders.
Risks Relating to Ownership of the Holdco Notes
Holdings is a holding company and relies on dividends, loans and other payments and distributions from its subsidiaries to meet its debt service and other obligations.
Holdings is a holding company with no business operations, revenues, expenses, liabilities other than the $1.0 billion aggregate principal amount of Holdco Notes or assets other than the capital stock of NBTY. Because Holdings' assets consist of the equity interests it holds in NBTY, Holdings is dependent upon dividends and other payments from NBTY to generate the funds necessary to meet its outstanding debt service and other obligations and such dividends may be restricted by law or the instruments governing certain indebtedness, including the indenture governing the Notes, the credit agreement governing NBTY's senior secured credit facilities, the indenture governing the Holdco Notes or other agreements of its subsidiaries. The earnings of Holdings' subsidiaries will depend substantially on their respective financial and operating results, which will be affected by prevailing economic and competitive conditions and by financial, business and other factors beyond Holdings' and its subsidiaries' control. Holdings' subsidiaries may not generate sufficient cash from operations to enable Holdings to make principal and interest payments on its indebtedness, including the Holdco Notes, or to fund Holdings' and its subsidiaries' other cash obligations.
NBTY's ability to pay dividends or make other distributions to Holdings ("restricted payment capacity") is limited under certain covenants in the credit agreement governing NBTY's senior secured credit facilities and the indenture governing the Notes. For example, under the indenture governing the Notes, NBTY is permitted to pay dividends or make other distributions to Holdings if the total amount thereof does not exceed a formula based on the sum of (a) 50% of NBTY's consolidated net income for periods beginning with its fiscal quarter commencing October 1, 2010 and (b) the amount of certain cash proceeds and the fair market value of certain property received by or contributed to NBTY.
Similarly, under the credit agreement governing NBTY's senior secured credit facilities, NBTY is permitted to pay dividends and make other distributions (or to make loans or advances in lieu thereof) to Holdings but the total amount is limited and such payments are subject to certain terms and conditions. Pursuant to the credit agreement governing NBTY's senior secured credit facilities, NBTY is permitted to pay dividends or make other distributions (or to make loans or advances in lieu thereof) to Holdings pursuant to the Notes formula payment of dividends, subject to certain terms and conditions.
As of September 30, 2014, prior to giving effect to the November 2014 interest payment of $38.8 million, NBTY had approximately $252 million of restricted payments capacity under its senior secured credit facilities and approximately $287 million of restricted payments capacity under the indenture governing the Notes.
Holdings' subsidiaries are permitted, under the terms of their existing indebtedness, to incur additional indebtedness that may restrict payments from those subsidiaries to Holdings. The indenture governing the Holdco Notes may also permit these subsidiaries to incur additional indebtedness even if Holdings would not be able to incur additional indebtedness. Agreements governing current and future indebtedness of Holdings' subsidiaries may not permit those subsidiaries to provide Holdings with sufficient cash to fund payments on the Holdco Notes when due.
Holdings' subsidiaries are separate and distinct legal entities and will have no obligation, contingent or otherwise, to pay amounts due under the Holdco Notes or to make any funds available to pay those amounts whether by dividend, distribution, loan or other payment.
Claims of holders of Holdco Notes will be effectively subordinated to claims of creditors of all of Holdings' subsidiaries.
The Holdco Notes will not be guaranteed by any of Holdings' subsidiaries. However, the historical consolidated financial statements included in this Report include all of Holdings' subsidiaries. Holdings had $1.0 billion of liabilities as of September 30, 2014 and Holdings' subsidiaries held almost all of its assets and accounted for all of its net sales as of and for the year ended September 30, 2014.
Holdings' subsidiaries are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay any amounts due pursuant to the Holdco Notes, or to make any funds available therefor, whether by dividends, loans, distributions or other payments. Any right that Holdings has to receive any assets of any of its subsidiaries upon the liquidation or reorganization of such subsidiaries, and the consequent rights of holders of Holdco Notes to realize proceeds from the sale of any of such subsidiaries' assets, will be structurally subordinated to the claims of Holdings' subsidiaries' creditors, including trade creditors and holders of debt of that subsidiary.
If certain conditions for the payment of cash interest are not met, interest on the Holdco Notes may be payment in kind ("PIK") interest.
Holdings is required to pay interest on the Holdco Notes entirely in cash unless certain conditions exist, in which case Holdings will be entitled to pay PIK interest. The terms of the Holdco Notes do not restrict Holdings' ability to use its dividend payment capacity for such alternative uses. In addition, the credit agreement governing NBTY's senior secured credit facilities, the indenture governing the Notes and the indenture governing the Holdco Notes allow NBTY and its subsidiaries to utilize amounts that would otherwise be available to pay cash dividends to Holdings for purposes such as making restricted investments, capital expenditures and prepaying subordinated indebtedness and, subject to certain limitations, making cash dividends to and other payments in respect of equityholders, and such uses would reduce the amounts available to pay dividends to Holdings in order to pay cash interest on the Holdco Notes. The indenture governing the Holdco Notes does not restrict Holdings' ability to use its dividends payment capacity for such alternative uses. As a result, there can be no
assurance that Holdings will be required (or able) to make cash interest payments on the Holdco Notes. The payment of interest through PIK interest will increase the amount of Holdings' indebtedness and would exacerbate the risks associated with such a high level of indebtedness.
Federal and state statutes may allow courts, under specific circumstances, to void the Holdco Notes and require holders to return payments received from Holdings.
Under federal bankruptcy law and comparable provisions of state fraudulent transfer laws, issuance of notes could be deemed a fraudulent transfer if Holdings received less than a reasonably equivalent value in exchange for issuing the Holdco Notes and
• Holdings was insolvent on the date that it issued the Holdco Notes or became insolvent as a result of issuing the Holdco Notes, or
• Holdings was engaged in business or a transaction, or was about to engage in business or a transaction, for which property remaining with Holdings was an unreasonably small capital, or
• Holdings intended to incur, or believed that it would incur, debts that would be beyond its ability to pay as those debts matured.
The measures of insolvency for purposes of the foregoing considerations will vary depending upon the law applied in any proceeding with respect to the foregoing. Generally, however, an entity would be considered insolvent if:
• the sum of its debts, including contingent liabilities, is greater than all its assets, at a fair valuation, or
• the present fair saleable value of its assets is less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature, or
• it could not pay its debts as they become due.
We cannot predict:
• what standard a court would apply in order to determine whether Holdings was insolvent as of the date Holdings issued the Holdco Notes or whether, regardless of the method of valuation, a court would determine that Holdings was insolvent on that date; or
• whether a court would determine that the payments under the Holdco Notes constituted fraudulent transfers or conveyances on other grounds.
If issuance of the Holdco Notes is deemed to be a fraudulent transfer, it could be voided altogether, or it could be subordinated to all other debts of Holdings. In the event of a finding that a fraudulent transfer or conveyance occurred, holders of the Holdco Notes may not receive any repayment on the Holdco Notes. Further, the voidance of the Holdco Notes could result in an event of default with respect to Holdings and its subsidiaries' other debt that could result in acceleration of that debt.
Finally, as a court of equity, the bankruptcy court may subordinate the claims in respect of the Holdco Notes to other claims against Holdings under the principle of equitable subordination if the court determines that (1) the holder of Holdco Notes engaged in some type of inequitable conduct, (2) the inequitable conduct resulted in injury to Holdings' other creditors or conferred an unfair advantage upon the holders of Holdco Notes and (3) equitable subordination is not inconsistent with the provisions of the bankruptcy code.
The Holdco Notes were issued with original issue discount for U.S. federal income tax purposes.
Because no portion of the stated interest on the Holdco Notes is unconditionally payable in cash at least annually, interest payments on the notes are not treated as qualified stated interest for U.S. federal income tax purposes. As a result, the Holdco Notes were issued with original issue discount for U.S. federal income tax purposes ("OID") in an amount equal to the excess of the total payments of principal and interest on the Holdco Notes over their issue price. A holder subject to U.S. federal income taxation, whether on the cash or accrual method for U.S. federal income tax purposes, generally will be required to include the OID in gross income (as ordinary interest income) as the OID accrues (on a constant yield to maturity basis), regardless of whether such holder receives any cash payment attributable to such income at such time.
Item 2.
Item 2. Properties
United States. As of September 30, 2014, we owned a total of approximately 2.28 million square feet, and lease approximately 1.4 million square feet, of administrative, manufacturing, warehouse and distribution space in various locations in the United States and its territories. In addition, as of September 30, 2014, we operated 414 Vitamin World retail locations in 43 states in the United States, Guam, Puerto Rico and the Virgin Islands. Generally, we lease retail properties for five to ten years at varying annual base rents and percentage rents. The Vitamin World retail stores are, on average, approximately 1,248 square feet.
UK/Ireland. As of September 30, 2014, Holland & Barrett owned a 270,000 square foot administrative and distribution facility and a 133,220 square foot manufacturing facility in Burton, United Kingdom. Holland & Barrett owns a 30,000 square foot administrative facility in Nuneaton, United Kingdom. Solgar leased 50,000 square feet of administrative and distribution space in Tring, United Kingdom. As of September 30, 2014, we leased all but one of our 772 Holland & Barrett, GNC-branded UK and Nature's Way retail stores for varying terms, at varying annual base rents. Fifty-one Holland & Barrett stores, two GNC-branded UK stores and 15 Nature's Way stores are subject to percentage rents. As of September 30, 2014, Holland & Barrett stores have an average of approximately 1,000 square feet, Nature's Way stores have an average of approximately 900 square feet and the GNC-branded UK stores have an average of approximately 800 square feet.
Benelux. As of September 30, 2014, De Tuinen leased a 64,600 square foot administrative and distribution facility and an additional 12,755 square foot administrative and distribution facility in Beverwijk. At September 30, 2014, De Tuinen leased locations for 146 retail stores on varying terms at varying annual base rents. Of these, 140 are operated as company stores and six are sub-leased to, and operated by, franchisees. No De Tuinen or Essenza store is subject to percentage rents. De Tuinen stores are an average of approximately 1,450 square feet. Essenza stores are an average of approximately 1,650 square feet.
Canada. As of September 30, 2014, Vita Health owned a 185,000 square foot manufacturing, packaging, distribution and administration building in Winnipeg, Manitoba. Vita Health also leased a 52,000 square foot distribution facility in Winnipeg, Manitoba. SISU leases a 19,200 square foot administrative, distribution and warehouse facility in Burnaby, British Columbia.
China. As of September 30, 2014, our subsidiary, Ultimate Biopharma (Zhongshan) Corporation ("Ultimate") owned in Zhongshan, China: a 50,000 square foot facility for manufacturing softgel capsules and for administrative offices, a recently built 75,000 square foot warehouse facility with packaging capabilities and 18.5 acres of vacant land adjacent to the manufacturing facility. In addition, Ultimate leased 11,300 square feet of dormitory space in Zhongshan City. Also, one of our subsidiaries leased 106,294 square feet of warehouse space in Beijing.
The following is a listing, as of September 30, 2014, of all material properties that we own or lease (excluding retail locations, de minimis locations with less than 4,000 square feet and temporary storage facilities leased for less than six months). We are required to pay real estate taxes and maintenance costs relating to most of our leased properties. All our segments benefit from the use of our material properties.
Owned Properties
(1)We currently sub-lease several small offices in this building on a short-term basis to unaffiliated tenants.
(2)This facility is closed.
(3)Operations for the manufacturing and packaging of supplements in powder form commenced in a portion of this facility in October 2014.
Leased Properties
(1)Operations have ceased at the Naples facilities.
(2)This facility has been downsized and is used solely for warehousing.
(3)New leased facility as of September 4, 2014, will replace the current leased facility, which lease expires January 31, 2015.
Warehousing and Distribution
As of September 30, 2014, we had approximately 2.7 million square feet dedicated primarily to warehousing and distribution. This figure includes our facilities in Long Island, New York; Anaheim and Santa Fe Springs, California; Lyndhurst and Leonia, New Jersey; Boca Raton and Pompano Beach, Florida; Sparks, Nevada; Hazleton, Pennsylvania; Prescott, Arizona; Burton and Tring, United Kingdom; Winnipeg, Manitoba and Burnaby, British Columbia, Canada; Madrid, Spain; Randburg, South Africa; Auckland, New Zealand; Beverwijk, Netherlands and Beijing and Zhongshan City, China.
We currently distribute our products to our customers from distribution centers through contract and common carriers globally. In addition, we ship products overseas in pallet amounts and by container loads. We also operate additional distribution centers in Burton and Tring, United Kingdom; Madrid, Spain; Auckland, New Zealand; Randburg, South Africa, Beverwijk, Netherlands; Winnipeg, Manitoba; and Beijing, China. Deliveries are made directly to Vitamin World stores once per week or once every other week, depending on the needs at various store locations. Deliveries are made directly to company-owned and operated Holland & Barrett and GNC-branded UK stores, through company owned trucks, and Nature's Way, De Tuinen and Essenza stores, through third parties, once or twice per week, depending on each store's inventory requirements.
Our direct response and e-commerce orders are handled by our domestic distribution center that is integrated with our order entry systems. Once a customer's telephone, mail or internet order is completed, our computer system forwards the order to our distribution center, where all necessary distribution and shipping documents are printed to facilitate processing. Then, the orders are prepared, picked, packed and shipped continually throughout the business day. We operate a proprietary, automated picking and packing system for frequently shipped items. We are capable of fulfilling 20,000 direct response and e-commerce orders daily. A system of conveyors automatically routes boxes carrying merchandise throughout our primary Long Island distribution center for fulfillment of orders. Completed orders are bar-coded and scanned and the merchandise and ship date are verified and entered automatically into the customer order file for access by sales associates before shipment.
All our properties are covered by all-risk and liability insurance, in amounts and on terms that we believe are customary for our industry.
We believe that these properties, taken as a whole, are generally well-maintained, and are adequate for current and reasonably foreseeable business needs. We also believe that substantially all our properties are being utilized to a significant degree.
Item 3.
Item 3. Legal Proceedings
Glucosamine-Based Dietary Supplements
Beginning in June 2011, certain putative class actions have been filed in various jurisdictions against NBTY, its subsidiary Rexall Sundown, Inc. ("Rexall"), and/or other companies as to which there may be a duty to defend and indemnify, challenging the marketing of glucosamine-based dietary supplements, under various states' consumer protection statutes. The lawsuits against NBTY and its subsidiaries are: Cardenas v. NBTY, Inc. and Rexall Sundown, Inc. (filed June 14, 2011) in the United States District Court for the Eastern District of California, on behalf of a putative class of California consumers seeking unspecified compensatory damages based on theories of restitution and disgorgement, plus punitive damages and injunctive relief; Jennings v. Rexall Sundown, Inc. (filed August 22, 2011) in the United States District Court for the District of Massachusetts, on behalf of a
putative class of Massachusetts consumers seeking unspecified trebled compensatory damages; and Nunez v. NBTY, Inc. et al. (filed March 1, 2013) in the United States District Court for the Southern District of California (the "Nunez Case"), on behalf of a putative class of California consumers seeking unspecified compensatory damages based on theories of restitution and disgorgement, plus injunctive relief, as well as other cases in California and Illinois against certain wholesale customers as to which we may have certain indemnification obligations. The Nunez Case settled on an individual basis on June 20, 2013.
In March 2013, NBTY agreed upon a proposed settlement with the remaining plaintiffs, which includes all cases and resolves all pending claims without any admission of or concession of liability by NBTY, and which provides for a release of all claims in return for payments to the class, together with attorneys' fees, and notice and administrative costs. Fairness Hearings took place on October 4, 2013 and November 20, 2013. On January 3, 2014, the court issued an opinion and order approving the settlement as modified (the "Order"). The final judgment was issued on January 22, 2014 (the "Judgment"). Certain objectors filed a notice of appeal of the Order and the Judgment on January 29, 2014 and the plaintiffs filed a notice of appeal on February 3, 2014. On November 19, 2014, the appellate court issued a decision granting the objectors' appeal. The appellate court reversed and remanded the matter to the district court for further proceedings consistent with the appellate court's decision.
In fiscal 2013, NBTY recorded a provision of $12 million reflecting its best estimate of exposure for payments to the class together with attorney's fees, and notice and administrative costs in connection with this class action settlement. As a result of the court's approval of the settlement and the closure of the claims period, NBTY reduced its estimate of exposure to $6 million. This reduction in the estimated exposure was reflected in the Company's first quarter results for fiscal 2014. Until the cases are resolved, no final determination can be made as to the ultimate outcome of the litigation or the amount of liability on the part of NBTY.
Telephone Consumer Protection Act Claim
NBTY, and certain of its subsidiaries, are defendants in a class-action lawsuit, captioned John H. Lary Jr. v. Rexall Sundown, Inc.; Rexall Sundown 3001, LLC; Rexall, Inc.; NBTY, Inc.; Corporate Mailings, Inc. d/b/a CCG Marketing Solutions ("CCG") and John Does 1-10 (originally filed October 22, 2013), brought in the United States District Court for the Eastern District of New York. The plaintiff alleges that the defendants faxed advertisements to plaintiff and others without invitation or permission, in violation of the Telephone Consumer Protection Act ("TCPA").
On May 2, 2014, NBTY and its named subsidiary defendants cross-claimed against CCG, who was a third-party vendor engaged by NBTY, and CCG cross-claimed against NBTY and named subsidiary defendants on June 13, 2014. CCG brought a third-party complaint against an unrelated entity, Healthcare Data Experts, LLC, on June 27, 2014. On July 21, 2014, CCG filed a motion to dismiss the amended complaint and that motion is pending.
At this time, no determination can be made as to the ultimate outcome of the litigation or the amount of liability on the part of NBTY, however we do not believe the ultimate outcome will have a material adverse effect on our consolidated financial statements.
Claims in the Ordinary Course
In addition to the foregoing, other regulatory inquiries, audits, claims, suits and complaints (including product liability, false advertising, intellectual property, escheat laws and Proposition 65 claims) arise from time to time in the ordinary course of our business. We believe that such other inquiries, claims, suits and complaints would not have a material adverse effect on our consolidated financial statements, if adversely determined against us.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market for Common Stock
As of the date of this Report, we are a wholly owned subsidiary of certain investment funds affiliated with Carlyle, and there is no public market for our common stock.
Dividend Policy
In December 2013, Holdings issued and sold $450.0 million in aggregate principal amount of 7.75%/8.50% Contingent Cash Pay Senior Notes due 2017 and used $445.5 million of such proceeds to pay a cash dividend to its shareholders. In November 2013 and May 2014, NBTY paid a cash dividend of approximately $21.3 million and $38.8 million, respectively, to Holdings, in order for Holdings to make an interest payment on the Holdco Notes. Future determination as to the payment of cash or stock dividends will depend upon our results of operations, financial condition, capital requirements, restrictions contained in NBTY's senior secured credit facilities, limitations contained in the indentures governing the Notes and the Holdco Notes, and such other factors as our Board considers appropriate.
For additional information regarding NBTY's senior secured credit facilities, the Notes and the Holdco Notes, see Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources," and Note 12 to the consolidated financial statements in this Report.
For information regarding securities authorized for issuance under our equity compensation plans as of September 30, 2014, see Item 12, "Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters" in this Report.
Item 6.
Item 6. Selected Financial Data
(1)On October 1, 2010 we consummated the Merger which required us to record acquisition accounting adjustments that primarily impacted cost of sales due to recording the acquired inventory to fair value of $122,104, depreciation and amortization expense within our selling, general and administrative costs due to the recording of our property plant and equipment and various intangible assets to fair value as well as additional interest expense relating to the additional long-term debt associated with the Merger.
(2)May 11, 2010 (date of inception) to September 30, 2010.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The statements in the following discussion and analysis regarding industry outlook, our expectations regarding the performance of our business and the forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in this Report under the heading Forward Looking Statements" and "Risk Factors." Our actual results may differ materially from those contained in or implied by any forward-looking statements. You should read the following discussion together with the consolidated financial statements, including the related notes, contained elsewhere herein. All references to years, unless otherwise noted, refer to our fiscal years, which end on September 30. All dollar values in this section, unless otherwise noted, are denoted in thousands. Numerical figures have been subject to rounding adjustments. Accordingly, numerical figures shown as totals in various tables may not be arithmetic aggregations of the figures that precede them.
Carlyle Transaction
On October 1, 2010, NBTY consummated the Merger with an affiliate of Carlyle under which the Carlyle affiliate acquired 100% of NBTY for a net purchase price of $3,635,949. The purchase price was funded through the net proceeds of our $1,750,000 senior secured credit facilities, the issuance of $650,000 principal amount of notes and a cash equity contribution of $1,550,000 from an affiliate of Carlyle.
As a result of the Merger and the application of acquisition accounting, our assets and liabilities have been adjusted to their fair values as of October 1, 2010, the closing date of the Merger and related financings. Additionally, the excess of the total purchase price over the fair value of our assets and liabilities at closing was allocated to goodwill.
Goodwill and Other Intangible Asset Impairment Charges
The Direct Response/E-Commerce and North American Retail segments have seen increased competition as well as increased use of promotions in order to maintain sales levels. During the fourth quarter of fiscal 2014, the Direct Response/E-Commerce and North American Retail segments recorded an impairment charge of $61,590 and $25,744, respectively, related to the impairment of goodwill. This was in connection with our annual impairment assessment and the completion of a strategic planning process relating to the rates of growth of sales, profit and cash flow and expectations for future performance. In addition, as a part of this process, we recorded an impairment charge of $110,000 and $10,000 on the indefinite lived tradenames of the Direct Response / E-Commerce and North American Retail segments, respectively.
The assessment did not reveal any impairment indicators in the Wholesale and European Retail segments and a 10% change in the estimate of fair value of these segments would not have impacted our assessment.
Consent Solicitation and Debt Offering
On December 2, 2013, Holdings launched a consent solicitation (the "Consent Solicitation") of consents from holders of Holdings' $550,000 in aggregate principal amount of 7.75%/8.50% contingent cash pay senior notes due 2017 that were originally issued on October 17, 2012 (the "original Holdco Notes"). The purpose of the Consent Solicitation was to amend the restricted payment covenant in the indenture governing the Holdco Notes. Holdings sought consent to add a new "basket" in the restricted payment covenant (Section 3.4 of the indenture governing the Holdco Notes) for a dividend or distribution to Holdings' shareholders up to the net proceeds of the offering of Holdings' additional 7.75%/8.50% contingent cash pay senior notes in an aggregate principal amount of $450,000 due 2017 (the "additional Holdco Notes" and, together with the original Holdco Notes, the "Holdco Notes") less
the amount available as of September 30, 2013 for restricted payments under the "builder" basket in Section 3.4(a)(C) of the indenture governing the Holdco Notes (the "Proposed Amendments").
On December 10, 2013, the requisite holders of the existing Holdco Notes consented to the Proposed Amendments and Holdings entered into a supplemental indenture (the "First Supplemental Indenture") to the indenture governing the Holdco Notes. The First Supplemental Indenture became operative upon the payment of the consent fee by Holdings to the paying agent on behalf of the holders of the existing Holdco Notes, which was paid concurrently with the closing of the offering of the additional Holdco Notes.
On December 12, 2013, Holdings issued the additional Holdco Notes in an aggregate principal amount of $450,000. The $450,000 of additional Holdco Notes and the $550,000 of original Holdco Notes have identical terms and are treated as a single class for all purposes under the indenture governing the Holdco Notes. The proceeds from the offering of the $450,000 additional Holdco Notes were used to pay transaction fees and expenses, including the consent fee of $18,560, and a $445,537 dividend to Holdings' shareholders in December 2013.
Plan of Restructuring
On March 12, 2013, NBTY initiated a restructuring plan to streamline its operations and improve the profitability and return on invested capital of its manufacturing/packaging and distribution facilities. The restructuring involved the sale or closure of seven of NBTY's manufacturing/packaging and distribution facilities. The restructuring plan commenced in the second quarter of fiscal 2013 and was completed in fiscal 2014. The restructuring resulted in cumulative charges of $32,695 before tax over that period, of which non-cash charges consisted primarily of accelerated depreciation of approximately $12,588.
Refinancing
On March 21, 2013, NBTY, Holdings, Barclays Bank PLC, as administrative agent, and several other lenders entered into the Third Amendment and Second Refinancing Agreement amending the credit agreement governing NBTY's senior secured credit facilities (the "Second Refinancing") pursuant to which NBTY repriced its term loan B-1 under its credit agreement. Under the terms of the Second Refinancing, the $1,750,000 term loan B-1 was replaced with a new $1,507,500 (the current principal amount outstanding) term loan B-2. Borrowings under term loan B-2 bear interest at a floating rate which can be, at NBTY's option, either (i) Eurodollar (LIBOR) rate plus an applicable margin, or (ii) base rate plus an applicable margin, in each case, subject to a Eurodollar (LIBOR) rate floor of 1.00% or a base rate floor of 2.00%, as applicable. The applicable margin for term loan B-2 is 2.50% per annum for Eurodollar (LIBOR) loans and 1.50% per annum for base rate loans. Substantially all other terms are consistent with the original term loan B-1, including the maturity dates. As a result of the Second Refinancing, $4,232 of previously capitalized deferred financing costs, as well as $1,151 of the call premium on term loan B-1, were expensed. In addition, costs incurred and recorded as deferred financing costs were approximately $15,190, including $13,924 of the call premium paid on term loan B-1, and will be amortized using the effective interest method.
Discontinued Operations
On July 2, 2012, Julian Graves Limited ("Julian Graves"), an NBTY subsidiary organized under the laws of the United Kingdom and Wales, was placed into administration and its management, affairs, business and property were under the direct control of Deloitte LLP as administrator. During the course of the administration, attempts to sell the business were unsuccessful and the operations were wound down by the end of August 2012. Additionally, on August 31, 2012, we sold Le Naturiste Inc. ("Le Naturiste"), an NBTY subsidiary organized under the laws of Canada, to an unrelated third party.
As a result of these events, the results of these two former subsidiaries are not reflected in the results of operations for fiscal 2012, but are reflected as discontinued operations. In addition, all prior periods in the Management's Discussion and Analysis of Financial Condition and Results of Operations below are presented exclusive of discontinued operations. There were no results of operations for Julian Graves or Le Naturiste in fiscal 2014 or 2013.
Executive Summary
Alphabet Holding Company, Inc. is a holding company with no operations and is dependent on its wholly owned subsidiary, NBTY, Inc. and its wholly owned subsidiaries to service its debt and other obligations.
NBTY is the leading vertically integrated manufacturer, marketer, distributor and retailer of high-quality vitamins, nutritional supplements and related products in the United States, with operations worldwide. We currently market over 25,000 SKUs under numerous owned and private-label brands, including Nature's Bounty®, Ester-C®, Solgar®, MET-Rx®, American Health®, Osteo Bi-Flex®, SISU®, Sundown®, Rexall®, Pure Protein®, Balance Bar®, Body Fortress®, Natural Wealth®, Puritan's Pride®, Holland & Barrett®, GNC (UK)®, Physiologics®, De Tuinen®, Essenza® and Vitamin World®. Our vertical integration includes purchasing raw materials and formulating and manufacturing products, which we then market through the following four channels of distribution.
• Wholesale-This segment sells products worldwide under various brand names and third-party private labels, each targeting specific market groups which include virtually all major mass merchandisers, club stores, drug store chains and supermarkets in the United States. This segment also sells products to independent pharmacies, health food stores, the military and other retailers.
• European Retail-This segment generates revenue through its 755 Holland & Barrett stores (including franchised stores in the following countries: 29 in China, 28 in Singapore, 11 in United Arab Emirates, 9 in Cyprus, four in Malta and one in each of Gibraltar and Iceland), 146 De Tuinen stores (including 6 franchised locations) in the Netherlands, 53 GNC branded UK stores, 47 Nature's Way stores in Ireland and 15 Essenza stores in Belgium, as well as internet-based sales from www.hollandandbarrett.com, www.hollandandbarrett.co.uk, www.hollandandbarrett.ie,www.detuinen.nl and www.gnc.co.uk. Such revenue consists of sales of proprietary brand and third-party products as well as franchise fees.
• Direct Response/E-Commerce-This segment generates revenue through the sale of proprietary brand and third-party products primarily through mail order catalog and the internet under the Puritan's Pride tradename. Catalogs are strategically mailed to customers who order by mail, internet, or phone.
• North American Retail-This segment generates revenue through its 414 owned and operated Vitamin World stores selling proprietary brand and third-party products, as well as internet-based sales from www.vitaminworld.com.
Operating data for each of the four distribution channels does not include the impact of any intercompany transfer pricing mark-up, corporate general and administrative expenses, interest expense and other miscellaneous income/expense items. Corporate general and administrative expenses include, but are not limited to, human resources, legal, finance and various other corporate-level activity related expenses. We attribute such unallocated expenses to corporate.
We have continued to grow through our marketing practices and through a series of strategic acquisitions. Since 1986, we have acquired and successfully integrated approximately 30 companies or
businesses engaged in the manufacturing, retail and direct response sale of nutritional supplements, including:
• Fiscal 1997: Holland & Barrett;
• Fiscal 1998: Nutrition Headquarters Group;
• Fiscal 2000: Nutrition Warehouse Group;
• Fiscal 2001: Global Health Sciences, NatureSmart and Nature's Way;
• Fiscal 2002: Healthcentral.com, Knox NutraJoint®, and Synergy Plus® product lines/operations;
• Fiscal 2003: Rexall Sundown Inc., Health and Diet Group Ltd. ("GNC (UK)"), FSC Wholesale, and the De Tuinen chain of retail stores;
• Fiscal 2005: Le Naturiste Jean-Marc Brunet, SISU, Inc. ("SISU") and Solgar Vitamin and Herb ("Solgar"), formerly a division of Wyeth Consumer Healthcare;
• Fiscal 2007: The Ester-C Company (formerly Zila Nutraceuticals, Inc.);
• Fiscal 2008: Doctor's Trust, Leiner and Julian Graves;
• Fiscal 2010: Ultimate Biopharma (Zongshen) Corporation;
• Fiscal 2011: Vitarich Laboratories, Inc. and Sun Valley Natural Products, LLC; and
• Fiscal 2013: Balance Bar Company and Essenza N.V.
Critical Accounting Estimates and Policies
The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements and reported amounts of revenues and expenses during the reporting periods. These judgments can be subjective and complex, and consequently actual results could differ materially from those estimates and assumptions. We base our estimates on historical experience and on various other assumptions that we believe 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. As with any set of assumptions and estimates, there is a range of reasonably likely amounts that may be reported.
The following critical accounting policies have been identified as those that affect the more significant judgments and estimates used in the preparation of the consolidated financial statements.
Revenue Recognition
We recognize product revenue when title and risk of loss have transferred to the customer, there is persuasive evidence of an arrangement to deliver a product, delivery has occurred, the sales price is fixed or determinable and collectability is reasonably assured. The delivery terms for most sales within the Wholesale and Direct Response/ E-Commerce segments are F.O.B. destination. Generally, title and risk of loss transfer to the customer at the time the product is received by the customer. With respect to our retail store operations, we recognize revenue upon sale of products to customers. Net sales represent gross sales invoiced to customers, less certain related charges for discounts, returns, and other promotional program incentive allowances.
Allowance for Sales Returns
Estimates for sales returns are based on a variety of factors, including actual return experience of specific products or similar products. We are able to make reasonable and reliable estimates of product returns based on our 40-year history in this business. We also review our estimates for product returns based on expected return data communicated to us by customers. Additionally, we monitor the levels of inventory at some of our largest customers to avoid excessive customer stocking of merchandise. Allowances for returns of new products are estimated by reviewing data of any prior relevant new product introduction return information. We also monitor the buying patterns of the end-users of our products based on sales data received by our retail outlets in North America and Europe. Historically, the difference in the amount of actual sales returns compared to our estimate for sales returns has not been significant.
Promotional Program Incentive Allowance
We estimate our allowance for promotional program incentives based on specific outstanding marketing programs and historical experience. The allowance for sales incentives offered to customers is based on various contractual terms or other arrangements agreed to in advance with certain customers. Generally, customers earn such incentives as they achieve sales volumes. We accrue these incentives as a reduction to sales either at the time of sale or over the period of time in which they are earned, depending on the nature of the program. Historically, we have not experienced material adjustments to the estimate of our promotional program incentive allowance and we do not expect that there will be a material change in the future estimates and assumptions we use.
Allowance for Doubtful Accounts
We perform on-going credit evaluations of our customers and adjust credit limits based upon payment history and the customers' current creditworthiness, as determined by our review of current credit information. We estimate bad debt expense based upon historical experience as well as customer collection issues to adjust the carrying amount of the related receivable to its estimated net realizable value. While such bad debt expense has historically been within expectations and allowances established, we cannot guarantee that we will continue to experience the same credit loss rates that we had in the past. If the financial condition of one or more of our customers were to deteriorate, additional bad debt expense may be required.
Inventories
Inventories are stated at the lower of cost (first-in first-out method) or market. The cost elements of inventories include materials, labor and overhead. In evaluating whether inventories are stated at the lower of cost or market, we consider such factors as the amount of inventory on hand, estimated time required to sell such inventory, remaining shelf life and current and expected market conditions, including levels of competition. Based on this evaluation, we record an adjustment to cost of goods sold to reduce inventories to net realizable value. These adjustments are estimates, which could vary significantly, either favorably or unfavorably, from actual requirements if future economic conditions, customer demand or competition differ from expectations.
Long-Lived Assets
We evaluate the need for an impairment charge relating to long-lived assets whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. We consider the following to be some examples of important indicators that may trigger an impairment review: (i) a history of cash flow losses at retail stores; (ii) significant changes in the manner or use of
the acquired assets in our overall business strategy; (iii) significant negative industry or economic trends; (iv) increased competitive pressures; and (v) regulatory changes.
Goodwill and Intangible Assets
Goodwill is tested for impairment using a two-step process. In the first step, the fair value of a reporting unit is compared to its carrying value. If the fair value of a reporting unit exceeds the carrying value of the net assets assigned to a reporting unit, goodwill is not considered impaired and no further testing is required. If the carrying amount of the reporting unit exceeds its fair value, a second step is performed to determine whether there is a goodwill impairment, and if so, the amount of the impairment. This step revalues all assets and liabilities of the reporting unit to their current fair value and then compares the implied fair value of the reporting unit's goodwill to the carrying amount of that goodwill. If the carrying amount of the reporting unit's goodwill exceeds the implied fair value of the goodwill, an impairment is recognized in an amount equal to the excess. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. We use a combination of the income and market approaches, weighted equally, to estimate the fair value of our reporting units.
The fair value of our trademarks is determined based on the relief from royalty method under the income approach, which requires us to estimate a reasonable royalty rate, identify relevant projected revenues and expenses, and select an appropriate discount rate. The evaluation of indefinite-lived intangible assets for impairment requires management to use significant judgments and estimates including, but not limited to, projected future net sales, operating results, and cash flows of our business.
We base our fair value estimates on assumptions we believe to be reasonable, but such assumptions are subject to inherent uncertainties. If actual external conditions or future operating results differ from our judgments, this may result in an impairment of our goodwill and/or intangible assets. An impairment charge would reduce operating income in the period it was determined that the charge was needed.
On a quarterly basis, we monitor the key drivers of fair value to detect events or other changes that would warrant an interim impairment test of our goodwill and intangibles. The key assumptions that drive the cash flows of our reporting units and intangible assets are estimated revenue growth rates and levels of profitability. Terminal value growth rate assumptions, weighted average cost of capital rates ("WACC") as well as royalty rates are used in conjunction with these key assumptions in order to derive the estimated fair value. These assumptions are subject to uncertainties, including our ability to grow revenue and improve or maintain profitability levels. Relatively small declines in the future performance and cash flows of a reporting unit or asset group or small changes in other key assumptions may result in the recognition of significant asset impairment charges. For example, keeping all other variables constant, an increase in the WACC applied of 175 basis points or a 270 basis point decrease in the terminal year profit margin would require that we perform the second step of the goodwill impairment test for the Wholesale reporting unit. The estimates used for our future cash flows and discount rates represent management's best estimates, which we believe to be reasonable, but future declines in business performance may impair the recoverability of our goodwill and intangible asset balances. Currently the estimated fair value of the Wholesale reporting unit exceeds its carrying value by 10% and the carrying value of the goodwill that is within the Wholesale reporting unit is $638,630.
Income Taxes
We record the estimated future tax effects of temporary differences between the tax bases of assets and liabilities and amounts reported in the accompanying consolidated balance sheets, as well as tax credit carrybacks and carryforwards. We periodically review the recoverability of deferred tax assets recorded on the balance sheet and provide valuation allowances as we deem necessary to reduce such deferred tax assets to the amount that will, more likely than not, be realized. We make judgments as to the interpretation of the tax laws that might be challenged upon an audit and cause changes to previous estimates of tax liability. In addition, we operate within multiple taxing jurisdictions and are subject to audit in these jurisdictions. In our opinion, adequate provisions for income taxes have been made for all years. If actual taxable income by tax jurisdiction varies from estimates, additional allowances or reversals of reserves may be necessary.
Accruals for Litigation and Other Contingencies
We are subject to legal proceedings, lawsuits and other claims related to various matters. We are required to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses. We determine the amount of reserves needed, if any, for each individual issue based on our knowledge and experience and discussions with legal counsel. These reserves may change in the future due to new developments in each matter (including the enactment of new laws), the ultimate resolution of each matter or changes in approach, such as a change in settlement strategy. In some instances, we may be unable to make a reasonable estimate of the liabilities that may result from the final resolution of certain contingencies disclosed and accordingly, no reserve is recorded until such time that a reasonable estimate may be made.
Recent Accounting Developments
In March 2013, the FASB issued guidance on a parent's accounting for the cumulative translation adjustment upon derecognition of a subsidiary or group of assets within a foreign entity. This new guidance requires that the parent release any related cumulative translation adjustment into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. The new guidance has been effective for us since October 1, 2014. The adoption of this guidance is not expected to have a material impact on the Company's consolidated financial statements.
In July 2013, the FASB issued guidance which amends the guidance related to the presentation of unrecognized tax benefits and allows for the reduction of a deferred tax asset for a net operating loss carryforward whenever the net operating loss carryforward or tax credit carryforward would be available to reduce the additional taxable income or tax due if the tax position is disallowed. The new guidance has been effective for us since October 1, 2014. The adoption of this guidance is not expected to have a material impact on the Company's consolidated financial statements.
In April 2014, the FASB issued revised guidance to reduce diversity in practice for reporting discontinued operations. The revised guidance only allows disposals of components of an entity that represent a strategic shift (e.g., disposal of a major geographical area, a major line of business, a major equity method investment or other major parts of an entity) and that have a major effect on a reporting entity's operations and financial results to be reported as discontinued operations. The revised guidance also requires expanded disclosure in the financial statements for discontinued operations as well as for disposals of significant components of an entity that do not qualify for discontinued operations presentation. The revised guidance is effective for all disposals (or classifications as held for sale) of components for us beginning October 1, 2015, and early adoption is permitted. The adoption of this guidance is not expected to have a material impact on the Company's consolidated financial statements.
In May 2014, the FASB issued guidance on revenue from contracts with customers that will supersede virtually all existing revenue recognition guidance, including industry-specific guidance, and is designed to create greater comparability for financial statement users across industries and jurisdictions. The underlying principle is that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. The guidance provides a five-step analysis of transactions to determine when and how revenue is recognized. The guidance also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity's contracts with customers. The guidance is effective for us beginning October 1, 2017 (early adoption is not permitted). The guidance permits the use of either a retrospective or cumulative effect transition method. We have not yet selected a transition method and are currently evaluating the impact of the amended guidance on our consolidated financial statements and related disclosures.
In June 2014, the FASB issued guidance to clarify the proper method of accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. The guidance requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The guidance is effective for us beginning October 1, 2016, and early adoption is permitted. The adoption of this guidance is not expected to have a material impact on the Company's consolidated financial statements.
In August 2014, the FASB issued guidance which requires management to assess an entity's ability to continue as a going concern every reporting period, and provide certain disclosures if management has substantial doubt about the entity's ability to operate as a going concern, or an express statement if not, by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. The guidance is effective for us for the annual period ending September 30, 2017, and for interim periods thereafter. Early application is permitted. The adoption of this guidance is not expected to have an impact on our consolidated financial statements.
Revision
A revision was made to the Statements of Operations and Comprehensive Income (loss) to correct the prior year presentation, whereby changes in the fair value of the cross-currency swap were reclassified from changes in the fair value of interest rate swaps to foreign currency translation adjustments.
Results of Operations
The following table sets forth for the periods indicated, the consolidated statements of operations and comprehensive income (loss). Items are expressed as a percentage of total net sales. Percentages may not sum to 100% due to rounding.
Fiscal Year Ended September 30, 2014 ("fiscal 2014") Compared to Fiscal Year Ended September 30, 2013 ("fiscal 2013")
Net Sales
Net sales by segment were as follows:
Wholesale
Net sales for the Wholesale segment decreased $59,440, or 3.1%, to $1,879,481 in fiscal 2014 from $1,938,921 in fiscal 2013. The decrease was primarily attributable to the following:
• $(57,845) from decreased sales of domestic private label products, primarily driven by lower volume to existing customers and pricing pressure,
• $(20,914) from decreased sales of domestic branded products, primarily driven by decreases in joint care and sports nutrition categories, partially offset by continued growth in Nature's Bounty®, and
• $19,319 from increased sales of branded and private label sales to international customers.
We continue to adjust shelf space allocation between the Wholesale brands to provide the best overall product mix and to respond to changing market conditions. These efforts have helped to strengthen Wholesale's position in the mass market. Wholesale continues to leverage valuable consumer sales information obtained from our retail stores and Direct Response/E-Commerce operations to provide our mass-market customers with data and analyses to drive mass market sales.
We use targeted promotions to grow overall sales. Promotional programs and rebates were $371,344, or 16.2% of sales for fiscal 2014 as compared to $326,963, or 14.2% of sales for fiscal 2013.
Product returns represented $37,520, or 1.6% of sales for fiscal 2014 as compared to $31,087, or 1.4% of sales for fiscal 2013. The product returns for fiscal 2014 and fiscal 2013 were mainly attributable to returns in the ordinary course of business. We expect returns relating to normal operations to trend between 1% to 2% of Wholesale's sales in future years.
One customer, Wal-Mart, represented 19% and 21% of the Wholesale segment's net sales for fiscal 2014 and 2013, respectively. It also represented 11% and 13% of consolidated net sales for fiscal 2014 and 2013, respectively. The loss of this customer, or any of our other major customers, could have a material adverse effect on our results of operations if we were unable to replace that customer.
European Retail
Net sales for the European Retail segment increased $106,936, or 14.4%, to $850,797 in fiscal 2014 from $743,861 in fiscal 2013. For fiscal 2014 same store sales in U.S. dollars increased 10.1%, or $71,230, as compared to fiscal 2013 (same store sales include online sales). In local currency, same store sales increased 4.2% as compared to fiscal 2013. The average exchange rate of the British pound sterling to the U.S. dollar strengthened 6.1% and the euro to the US dollar strengthened 3.4% as compared to the prior comparable period.
The following is a summary of European Retail store activity:
Direct Response/E-Commerce
Net sales for the Direct Response/E-Commerce segment increased $3,493, or 1.4%, to $250,224 in fiscal 2014 from $246,731 in fiscal 2013. The total number of orders increased approximately 7% and the average order size declined 5% for fiscal 2014 as compared to fiscal 2013. Online orders comprised 71.8% of this segment's net sales for fiscal 2014 as compared to 70.1% for fiscal 2013.
This segment continues to vary its promotional strategy throughout the fiscal year, utilizing highly promotional catalogs which are not offered in every quarter.
North American Retail
Net sales for the North American Retail segment decreased $8,252, or 3.5%, to $225,276 in fiscal 2014 from $233,528 in fiscal 2013. Same store sales (including online sales) decreased 3.0% due to declines in volume which are partially attributable to a softer retail environment and lower revenue in the weight management product category due to positive media attention for certain products in this category in the prior comparable period.
The following is a summary of North American Retail store activity:
Cost of Sales
Cost of sales was as follows:
The increase in cost of sales relates primarily to increased sales in our European Retail segment. Cost of sales as a percentage of net sales increased by 0.5 percentage points as compared to the prior comparable period. This was the result of higher promotions to maintain sales, lower sales prices for our private label products as well as costs at our facilities which were not absorbed by certain private label and contract manufacturing products due to lower demand.
Advertising, Promotion and Catalog Expenses
Total advertising, promotion and catalog expenses were as follows:
Advertising promotion and catalog expenses have increased by 0.3 percentage points as a percentage of net sales. The increase in advertising, promotion and catalog expense is primarily due to media and website advertising in our Wholesale segment, as we continue to increase our focus on branded products. To a lesser extent, there were increases in our Direct Response/E-commerce segment due to increased costs associated with internet advertising and in our European Retail segment in which advertising costs increased proportionate to the increase in net sales.
Selling, General and Administrative Expenses
Selling, general and administrative expenses ("SG&A") were as follows:
SG&A for fiscal 2014 increased by $42,150, or 0.9 percentage points as a percentage of net sales compared to fiscal 2013 primarily due to increases of: $16,415 in building and occupancy costs due to additional stores and foreign currency fluctuations in the European Retail segment; $11,099 in payroll and payroll related costs due to increases in salaries in our European Retail segment resulting from the increase in stores and foreign currency fluctuations partially offset by a reduction to performance based compensation; $10,918 in professional services associated with ongoing implementation and support of our ERP system; $9,092 of additional depreciation and amortization due to the implementation of our new ERP system in the third quarter of fiscal 2013, additional stores and the implementation of our new Point of Sale (POS) system in the European Retail segment in the second quarter of fiscal 2014; $5,321 in freight costs due to increased product and equipment movement between facilities as a result of the facility restructuring. These increases were partially offset by a $13,309 reduction in legal and
professional expenses primarily due to the accrual for the Glucosamine case in the prior comparable period of $12,000, of which, approximately $6,000 of that accrual was reversed in the current period, offset by other settlements in the current year.
Income (Loss) from Operations
Income (loss) from operations was as follows:
The decrease in the Wholesale segment is primarily due to decreased net sales as a result of the continued decline in private label sales as well as a decline in the joint care and sports nutrition categories. Furthermore the Wholesale segment experienced a slight reduction in margins relating to promotional activity due to increased competition, as well as increased marketing and advertising expenses in order to maintain sales. The increase in the European Retail segment was the result of higher sales volume, partially offset by increased advertising and SG&A costs (primarily payroll costs and building costs associated with new and acquired stores), as well as significant fluctuations in foreign currency as the U.S. dollar weakened as compared to the British pound sterling and the euro. The decrease in the Direct Response/E-Commerce segment was primarily due to the impairment of goodwill and intangible assets of $171,590, as well as increased promotions and advertising costs in order to maintain sales. The decrease in the North American Retail segment was primarily due to the impairment of goodwill and intangible assets of $35,744 as well as the decrease in net sales from same store sales and increased SG&A costs. Corporate/Manufacturing loss decreased from the prior comparable period due to the costs of $32,695 associated with the facilities restructuring in the prior year.
Interest Expense
Interest expense for fiscal 2014 increased as compared to fiscal 2013 due to the issuance of the additional $450,000 of Holdco Notes on December 12, 2013, partially offset by the lower interest rate on the term loan B-2 due to the refinancing that took place in March 2013 and the write-off of deferred financing costs and call premium totaling $5,383 relating to the refinancing in the prior comparable period. See "Liquidity and Capital Resources" for a description of the senior secured credit facilities, the Notes and the Holdco Notes.
Miscellaneous, net
The components of miscellaneous, net were as follows:
Provision for Income Taxes
Our (benefit) provision for income taxes is impacted by a number of factors, including federal taxes, our international tax structure, state tax rates in the jurisdictions where we conduct business and our ability to utilize state tax credits that expire between 2014 and 2028. Our overall effective income tax rate could vary as a result of these factors. The effective income tax rate for fiscal 2014 and 2013 was 14.8% and 28.9%, respectively. The effective income tax rate was lower for fiscal 2014 primarily due to the impact of the impairment of goodwill during fiscal 2014, for which no income tax benefit was recorded.
Fiscal Year Ended September 30, 2013 Compared to Fiscal Year Ended September 30, 2012("fiscal 2012")
Net Sales
Net sales by segment were as follows:
Wholesale
Net sales for the Wholesale segment were $1,938,921 for fiscal 2013 as compared to $1,826,780 for fiscal 2012. The increase of $112,141 or 6.1% was primarily attributable to the following:
• $120,468 from increased sales of domestic branded products, primarily driven by continued growth in key brands such as Nature's Bounty® , Osteo Bi-Flex® and sports nutrition brands (such as Pure Protein® and Body Fortress®),
• ($64,211) from decreased sales of domestic private label products, primarily driven by decreased SKUs to existing customers and pricing pressure, and
• $55,884 from increased sales of branded and private label sales to international customers.
We continue to adjust shelf space allocation between the Wholesale brands to provide the best overall product mix and to respond to changing market conditions. These efforts have helped to strengthen Wholesale's position in the mass market. The Wholesale segment continues to leverage valuable consumer sales information obtained from our retail stores and Direct Response/E-Commerce operations to provide our mass market customers with data and analyses to drive mass market sales.
We use targeted promotions to grow overall sales. Promotional programs and rebates were $326,963, or 14.2% of sales for fiscal 2013 as compared to $295,325, or 13.7% of sales for fiscal 2012.
Product returns represented $31,087, or 1.4% of sales for fiscal 2013 as compared to $28,333 or 1.3% of sales for fiscal 2012. The product returns for fiscal 2013 and fiscal 2012 were mainly attributable to returns in the ordinary course of business. We expect returns relating to normal operations to trend between 1% to 2% of Wholesale's sales in future years.
One customer, Wal-Mart, represented 21% and 23% of the Wholesale segment's net sales for fiscal 2013 and 2012, respectively. It also represented 13% and 14% of consolidated net sales for fiscal
and 2012, respectively. The loss of this customer, or any of our other major customers, could have a material adverse effect on our results of operations if we were unable to replace that customer.
European Retail
Net sales for the European Retail segment increased $44,186, or 6.3%, to $743,861 in fiscal 2013 from $699,675 for fiscal 2012. For fiscal 2013 same store sales in U.S. dollars increased 2.4%, or $16,419, as compared to fiscal 2012 (same store sales include internet sales for such segment). In local currency, same store sales increased 3.1% as compared to fiscal 2012.
The following is a summary of European Retail store activity:
*includes stores that were converted from Julian Graves to either Holland & Barrett, GNC (UK) or Nature's Way stores.
Direct Response/E-Commerce
Net sales for the Direct Response/E-Commerce segment increased $7,322, or 3.1%, to $246,731 in fiscal 2013 from $239,409 in fiscal 2012. The total number of orders increased approximately 8% and the average order size declined 7% for fiscal 2013 as compared to fiscal 2012. Online net sales comprised 65.8% of this segment's net sales for fiscal 2013 as compared to 61.3% for fiscal 2012.
This segment continues to vary its promotional strategy throughout the fiscal year, utilizing highly promotional catalogs which are not offered in every quarter.
North American Retail
Net sales for the North American Retail segment remained relatively consistent when compared to fiscal 2012. Same store sales increased 1.3%, (same store sales include online sales for such segment).
The following is a summary of North American Retail store activity:
Cost of Sales
Cost of sales was as follows:
The increase in cost of sales relates primarily to increased sales in our Wholesale and European Retail segments. Cost of sales as a percentage of net sales increased by 0.2 percentage points as compared to the prior comparable period. This was the result of (i) costs at our facilities which were not absorbed by certain private label and contract manufacturing products due to lower demand (which we expect to be addressed with the supply chain restructuring discussed above at "Plan of Restructuring"), and (ii) a one-time increase of $2,417 in cost of sales related to a fair value adjustment on inventory acquired from Balance Bar, partially offset by (i) increased sales of our branded products which have higher margins and (ii) localized sourcing which has increased margins in our European retail segment. Cost of sales as a percentage of net sales has fluctuated in the last few years, in part due to competitive pressures in the private label business, product mix and fluctuations in the costs of certain raw materials. To address these matters, we continuously seek to implement improvements in our supply chain, and are also increasing our focus on branded sales.
Advertising, Promotion and Catalog Expenses
Total advertising, promotion and catalog expenses were as follows:
As a percentage of sales, advertising promotion and catalog expense has increased by 0.5 percentage points as a percentage of net sales. The increase in advertising, promotion and catalog expense is primarily due to media and website advertising in our Wholesale segment, as we continue to increase our focus on branded products.
Selling, General and Administrative Expenses
SG&A were as follows:
As a percentage of sales, SG&A remained relatively consistent. SG&A costs increased by $77,902 compared to fiscal 2012 due to increases of: $23,615 in professional and legal fees primarily relating to the settlement of the glucosamine product litigation and consultants for supply chain enhancements; payroll and payroll related costs increases of approximately $10,275 relating primarily to salary increases and increased number of stores in the European Retail segment; $9,962 of temporary help and outside services primarily related to the increased use of temporary personnel in our distribution centers as well as at some of our international retail locations; freight cost increases of approximately $6,279 primarily due to increased sales and higher fuel costs; building cost increases of $5,469 due to new or acquired stores in our European Retail segment; amortization and depreciation increases of $3,658 as a result of amortizing intangible assets acquired with Balance Bar during fiscal 2013 as well as assets put into service in relation to our new ERP system; and other cost increases of $11,256 as a result of various items such as additional market and brand research costs, product donations and certain new facility start-up costs.
Income from Operations
Income from operations was as follows:
The decrease in the Wholesale segment is primarily due to increased advertising and professional fees. The increase in the European Retail segment is related to the increase in sales partially offset by higher SG&A costs (primarily salaries and store occupancy costs due to new or acquired stores during fiscal 2013). The decrease in the Direct Response/E-Commerce segment is primarily due to lower gross margins due to increased promotional activity and higher SG&A costs. The decrease in the North American Retail segment is a result of lower margins when compared to the prior comparable period due to increased promotional activity. The increase in the loss at Corporate primarily relates to the facility restructuring costs of $32,695 as well as the accrual of the glucosamine litigation settlement described above.
Interest Expense
Interest expense increased by $32,696 to $191,280 primarily due to additional interest expense of $44,180 relating to the $550,000 Holdco Notes that were issued in fiscal 2013 as well as the write-off of
deferred financing costs of $4,232 and $1,151 of the call premium associated with the refinancing of Term Loan B-1 in fiscal 2013 and additional interest on our revolving credit facility as we drew down $80,000 in November 2012 to fund the acquisition of Balance Bar. These increases were partially offset by the refinancing in the second quarter of fiscal 2013 as well as the write-off of deferred financing costs of $9,289 associated the the prepayment of $225,000 of our Term loan B-1 in fiscal 2012. The revolving credit facility has been repaid in its entirety as of September 30, 2013. See "Liquidity and Capital Resources" for a description of the senior secured credit facilities and the Notes and the Holdco Notes.
Miscellaneous, net
The components of miscellaneous, net were as follows:
Provision for Income Taxes
Our provision for income taxes was impacted by a number of factors, including federal taxes, our international tax structure, state tax rates in the jurisdictions where we conduct business and our ability to utilize state tax credits that expire between 2014 and 2029. Our overall effective income tax rate could vary as a result of these factors. The effective income tax rate has increased for fiscal 2013 to 28.9% compared to 27.8% in the prior fiscal year, primarily due to the tax benefit for the sale of Le Naturiste in fiscal 2012, which did not reoccur in fiscal 2013.
Liquidity and Capital Resources
Holdings is the parent company of NBTY and its primary source of liquidity and capital resources are issuances of debt and dividends from NBTY, and Holdings expects that ongoing requirements for debt service will be funded from dividends from NBTY. NBTY's primary sources of liquidity and capital resources are cash generated from operations and funds available under its revolving credit facility. We expect that ongoing requirements for debt service and capital expenditures will be funded from these sources.
The following table sets forth, for the periods indicated, cash balances and working capital:
The increase in working capital of $98,746 at September 30, 2014 as compared to September 30, 2013 was primarily due to increases in inventory to achieve higher order fulfillment rates, partially offset by a decrease in accounts payable due to the timing of payments. The decrease in cash and cash equivalents of $59,086 at September 30, 2014 as compared to September 30, 2013 was primarily due to net cash used in operations, primarily for inventory, and purchases of property, plant and equipment.
The decrease in working capital of $150,560 and cash and cash equivalents of $116,547 at September 30, 2013 as compared to September 30, 2012 was primarily due to the dividend payments of $721,682 net of the impact of the issuance of the Holdco Notes, discussed above.
We monitor current and anticipated future levels of cash and cash equivalents in relation to anticipated operating, investing and financing requirements. As of September 30, 2014, cash and cash equivalents of $61,187 was held by our foreign subsidiaries and are generally subject to U.S. income taxes upon repatriation to the United States. We generally repatriate all earnings from our foreign subsidiaries where permitted under local law. However, during fiscal 2013 and 2012 we permanently reinvested approximately $27,000 and $25,000, respectively, of our foreign earnings outside of the United States.
The following table sets forth, for the periods indicated, net cash flows provided by (used in) operating, investing and financing activities and other operating measures:
Net cash provided by operating activities of $46,818 during fiscal 2014 was attributable to income earned from operations after adjusting for the impairment charge in our Direct Response/E-commerce and North American Retail segments partially offset by increases in inventory to maintain satisfactory customer fulfillment rates. During fiscal 2014, net cash used in investing activities consisted of purchases of property, plant and equipment, partially offset by cash received from the sale of certain facilities. During fiscal 2014, net cash used in financing activities related to dividends paid to shareholders and payments for financing fees related to the Holdco Notes, partially offset by proceeds from borrowings under the Holdco Notes.
Cash provided by operating activities of $288,715 during fiscal 2013 was mainly attributable to net income of $99,448 and changes in operating assets and liabilities. During fiscal 2013, cash flows used in investing activities consisted primarily of cash paid for acquisitions relating to Balance Bar and purchases of property, plant and equipment. During fiscal 2013, cash flows from financing activities primarily related to the offering of the Holdco Notes and the dividend discussed above.
Cash provided by operating activities of $234,050 during fiscal 2012 was mainly attributable to net income of $146,471. During fiscal 2012, cash flows used in investing activities consisted primarily of cash paid for purchases of property, plant and equipment. During fiscal 2012, cash flows used in financing activities relate to principal payments under long-term debt agreements.
We expect our fiscal 2015 capital expenditures to be higher than fiscal 2014 as a result of the continued investment in our ERP systems, as well as additional investments in stores of our European Retail segment.
Senior Secured Credit Facilities, Holdco Notes and Notes
On October 1, 2010, NBTY entered into senior secured credit facilities totaling $2,000,000, consisting of $1,750,000 term loan facilities and a $250,000 revolving credit facility. In addition, NBTY issued $650,000 aggregate principal amount of the Notes with an interest rate of 9% and a maturity date of October 1, 2018.
On March 1, 2011, NBTY, Holdings and Barclays Bank PLC, as administrative agent, and several other lenders entered into the First Amendment and Refinancing Agreement (the "First Refinancing"). Under the terms of the agreement, the $1,750,000 term loan B-1 and revolving credit facility of $200,000 were established. Substantially all other terms are consistent with the original term loan B, including the amortization schedule of term loan B-1 and maturity dates.
On December 30, 2011, NBTY prepaid $225,000 of principal on its term loan B-1. As a result of this prepayment, $9,289 of deferred financing costs were written off. In accordance with the prepayment provisions of the First Refinancing, no scheduled payments of principal will be required until the final balloon payment in October 2017.
On October 11, 2012, NBTY amended its credit agreement to allow Holdings to issue and sell Holdco Notes. In addition, among other things, the amendment (i) increased the general restricted payments basket to $50,000, (ii) increased the maximum total leverage ratio test which governs the making of restricted payments using Cumulative Credit (as defined in the credit agreement) and (iii) modified the definition of Cumulative Credit so that it conforms to the builder basket used in NBTY's indenture governing the Notes. Interest on the Holdco Notes is paid via dividends from NBTY to Holdings, to the extent that it is permitted under its credit agreement and the indenture governing the Notes. Expenses of $6,121 related to the amendment were capitalized as a deferred financing cost and are being amortized using the effective interest method. In conjunction with the amendment, NBTY paid Holdings a cash dividend of approximately $193,956 in October 2012.
On March 21, 2013, NBTY, Holdings, Barclays Bank PLC, as administrative agent, and several other lenders entered into the Third Amendment and Second Refinancing Agreement and completed the Second Refinancing amending the credit agreement governing NBTY's senior secured credit facilities pursuant to which NBTY repriced its term loan B-1 under its then existing credit agreement. Under the terms of the Second Refinancing, the $1,750,000 term loan B-1 was replaced with a new $1,507,500 (the current principal amount outstanding) term loan B-2. Borrowings under term loan B-2 and the revolving credit facility bear interest at a floating rate which can be, at NBTY's option, either (i) eurodollar (LIBOR) rate plus an applicable margin, or (ii) base rate plus an applicable margin, in each case, subject to a eurodollar (LIBOR) rate floor of 1.00% or a base rate floor of 2.00%, as applicable. The applicable margin for term loan B-2 is 2.50% per annum for eurodollar (LIBOR) loans and 1.50% per annum for base rate loans. The applicable margin for the revolving credit facility remained at 3.25% per annum for eurodollar (LIBOR) loans and 2.25% per annum for base rate loans, with a step-down of 25 basis points upon the achievement of a total senior secured leverage ratio as set forth in the senior secured credit facilities. Substantially all other terms are consistent with the original term loan B-1, including the maturity dates. As a result of the Second Refinancing, $4,232 of previously capitalized deferred financing costs as well as $1,151 of the call premium on term loan B-1 were expensed and costs incurred and recorded as deferred financing costs were approximately $15,190, including $13,924 of the call premium paid on term loan B-1, and will be amortized using the effective interest method.
On November 20, 2014, NBTY amended its senior secured revolving credit facility, extending its maturity to September 2017 and reducing the commitment from $200,000 to $175,000. In connection with this amendment, deferred financing costs of approximately $600 were incurred and will be amortized over the remaining period.
NBTY must make prepayments on the term loan B-2 facility with the net cash proceeds of asset sales, casualty and condemnation events, the incurrence or issuance of indebtedness (other than indebtedness permitted to be incurred under its senior secured credit facilities unless specifically incurred to refinance a portion of its senior secured credit facilities) and 50% of excess cash flow (such percentage subject to reduction based on achievement of specified total senior secured leverage ratios), in each case, subject to certain reinvestment rights and other exceptions. NBTY is also required to
make prepayments under its revolving credit facility at any time when, and to the extent that, the aggregate amount of the outstanding loans and letters of credit under the revolving credit facility exceeds the aggregate amount of commitments in respect of the revolving credit facility.
In addition, the credit agreement requires the maintenance of a maximum total senior secured leverage ratio on a quarterly basis, calculated with respect to Consolidated EBITDA, as defined therein, if at any time amounts are outstanding under the revolving credit facility (including swingline loans and letters of credit). All other financial covenants required by the senior secured credit facilities were removed as part of the First Refinancing. As of September 30, 2014, NBTY was in compliance with all covenants under the agreement.
As of September 30, 2014 there were no borrowings drawn from the $200,000 revolving credit facility and there was a letter of credit totaling $4,400, reducing the net availability to $195,600.
Original Holdco Notes
On October 17, 2012, Holdings issued $550,000 of the original Holdco Notes. Interest on the original Holdco Notes accrues at the rate of 7.75% per annum with respect to Cash Interest and 8.50% per annum with respect to any paid-in-kind interest. The proceeds from the offering of the original Holdco Notes, along with the $200,000 from NBTY, were used to pay transaction fees and expenses and a dividend of approximately $721,682 to Holdings' shareholders.
Additional Holdco Notes
On December 2, 2013, Holdings launched the Consent Solicitation. The purpose of the Consent Solicitation was to amend the restricted payment covenant in the indenture governing the Holdco Notes. Holdings sought consent to add a new "basket" in the restricted payment covenant (Section 3.4 of the indenture governing the Holdco Notes) for a dividend or distribution to Holdings' shareholders up to the net proceeds of the offering of additional Holdco Notes in the aggregate principal amount of $450,000 less the amount available as of September 30, 2013 for restricted payments under the "builder" basket in Section 3.4(a)(C) of the indenture governing the Holdco Notes.
On December 10, 2013, the requisite holders of the original Holdco Notes had consented to the Proposed Amendments and Holdings entered into the First Supplemental Indenture to the indenture governing the Holdco Notes. The First Supplemental Indenture became operative upon the payment of the consent fee by Holdings to the paying agent on behalf of the holders of the original Holdco Notes, which was paid concurrently with the closing of the offering of the additional Holdco Notes.
On December 12, 2013, Holdings issued $450,000 of additional Holdco Notes that mature on November 1, 2017. The $450,000 of additional Holdco Notes and the $550,000 of original Holdco Notes previously issued on October 17, 2012 have identical terms and are treated as a single class for all purposes under the indenture governing the Holdco Notes. The gross proceeds from the offering of the $450,000 of additional Holdco Notes was $460,125, inclusive of a $10,125 premium, which was used to pay transaction fees and expenses, including the consent fee, and a $445,537 dividend to Holdings' shareholders in December 2013.
Interest on the Holdco Notes is payable semi-annually in arrears on May 1 and November 1 of each year. Holdings is a holding company with no operations of its own and has no ability to service interest or principal on the Holdco Notes, other than through dividends it may receive from NBTY. NBTY is restricted, in certain circumstances, from paying dividends to Holdings by the terms of the indenture governing the Notes and the senior secured credit facilities. NBTY has not guaranteed the indebtedness of Holdings, nor pledged any of its assets as collateral and the Holdco Notes are not reflected on NBTY's balance sheet.
Interest on the Holdco Notes is payable entirely in cash ("Cash Interest") to the extent that it is less than the maximum amount of allowable dividends and distributions, plus cash at Holdings ("Applicable Amount") as defined by the indenture governing the Holdco Notes. For any interest period after May 1, 2013 (other than the final interest period ending at stated maturity), if the Applicable Amount for such interest period will:
(i) equal or exceed 75%, but be less than 100%, of the aggregate amount of Cash Interest that would otherwise be due on the relevant interest payment date, then Holdings may, at its option, elect to pay interest on (a) 25% of the then outstanding principal amount of the Holdco Notes by increasing the principal amount of the outstanding Holdco Notes or by issuing other PIK notes under the indenture governing the Holdco Notes, on the same terms and conditions of the Holdco Notes, in a principal amount equal to such interest ("PIK Interest") and (b) 75% of the then outstanding principal amount of the Holdco Notes as Cash Interest;
(ii) equal or exceed 50%, but be less than 75%, of the aggregate amount of Cash Interest that would otherwise be due on the relevant interest payment date, then Holdings may, at its option, elect to pay interest on (a) 50% of the then outstanding principal amount of the Holdco Notes as PIK Interest and (b) 50% of the then outstanding principal amount of the Holdco Notes as Cash Interest;
(iii) equal or exceed 25%, but be less than 50%, of the aggregate amount of Cash Interest that would otherwise be due on the relevant interest payment date, then Holdings may, at its option, elect to pay interest on (a) 75% of the then outstanding principal amount of the Holdco Notes as PIK Interest and (b) 25% of the then outstanding principal amount of the Holdco Notes as Cash Interest; or
(iv) be less than 25% of the aggregate amount of Cash Interest that would otherwise be due on the relevant interest payment date, then Holdings may, at its option, elect to pay interest on the Holdco Notes as PIK Interest.
As described above, Holdings' ability to pay PIK Interest depends on the calculation of the Applicable Amount regardless of the availability of cash at Holdings. All interest payments made to date have been in cash. As of September 30, 2014, NBTY currently anticipates that it will have sufficient restricted payment capacity to enable Holdings to pay cash interest on the Holdco Notes for the current interest period; however, this may change as a result of a variety of factors. To the extent Holdings makes such interest payments in cash, NBTY will be required to provide the necessary funding.
The indenture governing the Notes, the credit agreement and the indenture governing the Holdco Notes contain a number of covenants imposing significant restrictions on our business. These restrictions may affect our ability to operate our business and may limit our ability to take advantage of potential business opportunities as they arise. The restrictions these covenants place on us include limitations on our ability to:
• incur or guarantee additional indebtedness;
• make certain investments;
• pay dividends or make distributions on our capital stock;
• sell assets, including capital stock of restricted subsidiaries;
• agree to payment restrictions affecting our restricted subsidiaries;
• consolidate, merge, sell or otherwise dispose of all or substantially all of our assets;
• enter into transactions with our affiliates;
• incur liens; and
• designate any of our subsidiaries as unrestricted subsidiaries.
Our ability to make payments on and to refinance our indebtedness, including the Notes and Holdco Notes, will depend on our ability to generate cash in the future. We believe that our cash on hand, together with dividends from NBTY generated by NBTY's cash from operations and, if required, available borrowing capacity under the revolving portion of our senior secured credit facilities, will be sufficient for our cash requirements for the next twelve months.
We or our affiliates, at any time and from time to time, may purchase Notes, Holdco Notes, or other indebtedness. Any such purchases may be made through the open market or privately negotiated transactions with third parties or pursuant to one or more tender or exchange offers or otherwise, upon such terms and at such prices, as well as with such consideration, as we, or any of our affiliates, may determine.
EBITDA and Consolidated EBITDA
EBITDA consists of earnings before interest expense, taxes, depreciation and amortization. Consolidated EBITDA, as defined in our senior secured credit facilities, as amended, eliminates the impact of a number of items we do not consider indicative of our ongoing operating performance. You are encouraged to evaluate each adjustment and the reasons we consider it appropriate for supplemental analysis. Consolidated EBITDA is a component of certain covenants under NBTY's senior secured credit facilities. We present Consolidated EBITDA because NBTY's senior secured credit facilities provide for certain total senior secured leverage ratio thresholds calculated on a period of four consecutive fiscal quarters, with respect to Consolidated EBITDA and the senior secured debt which can be reduced by unrestricted cash-on-hand up to a maximum of $150 million during any fiscal quarter end that revolving loans or letters of credit (to the extent not cash collateralized) are outstanding or at the time of incurrence of revolving loans. The maximum senior secured leverage ratio thresholds, to the extent then applicable, are as follows: 4.00 to 1.00 in fiscal 2014; 3.75 to 1.00 in fiscal 2015; 3.50 to 1.00 in fiscal 2016 and 3.25 to 1.00 in fiscal 2017. Furthermore, we present both EBITDA and Consolidated EBITDA because we consider these items to be important supplemental measures of our performance and believe these measures are frequently used by securities analysts, investors and other interested parties in the evaluation of companies in our industry with similar capital structures. We believe issuers of debt securities also present EBITDA and Consolidated EBITDA because investors, analysts and rating agencies consider it useful in measuring the ability of those issuers to meet debt service obligations. We believe that these items are appropriate supplemental measures of debt service capacity, because cash expenditures for interest are, by definition, available to pay interest, and tax expense is inversely correlated to interest expense because tax expense goes down as deductible interest expense goes up; and depreciation and amortization are non-cash charges.
The computation of NBTY's senior secured leverage ratio is as follows:
EBITDA and Consolidated EBITDA have limitations as analytical tools, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
• EBITDA and Consolidated EBITDA:
• exclude certain tax payments that may represent a reduction in cash available to us;
• do not reflect our cash expenditures, or future requirements, for capital expenditures or contractual commitments;
• do not reflect changes in, or cash requirements for, our working capital needs; and
• do not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments on our debt, including the Notes and the Holdco Notes;
• although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and EBITDA and Consolidated EBITDA do not reflect any cash requirements for such replacements; and
• other companies in our industry may calculate EBITDA and Consolidated EBITDA differently than we do, limiting their usefulness as comparative measures.
Because of these limitations, EBITDA and Consolidated EBITDA should not be considered as measures of discretionary cash available to us to invest in the growth of our business. As a result, we rely primarily on our GAAP results and use EBITDA and Consolidated EBITDA only supplementally.
In addition, in calculating Consolidated EBITDA, we make certain adjustments that are based on assumptions and estimates that may prove to be inaccurate.
In addition, in evaluating Consolidated EBITDA, you should be aware that in the future we may incur expenses similar to those eliminated in this presentation. Our presentation of Consolidated EBITDA should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items.
The following table reconciles net income (loss) to EBITDA and Consolidated EBITDA (as defined in our senior secured credit facilities) for the four consecutive quarters ended September 30, 2014, 2013 and 2012:
(1)Consolidated EBITDA has been calculated in a manner consistent with NBTY's senior secured credit facilities.
(a)Reflects the exclusion of severance costs incurred at various subsidiaries of the Company. Included in fiscal 2013 are workforce reduction costs of $16,752, which relate to the facility restructuring.
(b)Reflects the exclusion of non-cash expenses related to stock options.
(c)Reflects the exclusion of the Carlyle consulting fee.
(d)Reflects the exclusion of the sell-through of the increased fair value of opening inventory at time of acquisition required under acquisition accounting.
(e)Reflects the exclusion of consulting fees, as permitted in our senior secured credit facilities, for items such as business optimization consulting.
(f)Reflects the impairment of certain assets, including the impairment of $207, 334 relating to goodwill and intangible assets in our Direct Response / E-commerce and North American Retail segments in fiscal 2014 and $27,509 relating to the impairment and disposal of Julian Graves Limited in fiscal 2012.
(g)Reflects the exclusion of various items, as permitted in NBTY's senior secured credit facilities, which among other items includes: restructuring charges, business optimization expenses, ineffectiveness on certain derivative instruments, gains and losses on dispositions and integration costs associated with acquisitions.
(h)Reflects four consecutive quarters of prospective savings permitted in accordance with NBTY's senior secured credit facilities; specifically, the amount of cost savings expected to be realized from operating expense reductions and other operating improvements as a result of specified actions taken or initiated, less the amount of any actual cost savings realized during the period.
(i)In accordance with the definition of Consolidated EBITDA under NBTY's senior secured credit facilities, this represents the limitation of certain Consolidated EBITDA adjustments such as pro forma cost savings, restructuring charges, business optimization expenses and integration costs associated with acquisitions that exceed 10% of Consolidated EBITDA for the applicable period, without giving effect to these adjustments.
(j)Consists of selling, general and administrative costs related solely to Holdings and differences in the amount of limitation on certain EBITDA adjustments, as dictated by the NBTY senior secured credit facilities.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements. For additional information relating to certain contractual cash obligations see below.
Contractual Obligations
A summary of contractual cash obligations as of September 30, 2014 is as follows:
Future interest expense included in the above table on our variable rate debt is calculated based on the current rate in effect after the Second Refinancing. Variable interest on our senior secured credit facilities, included in the above table, is calculated assuming the current interest rate following the Second Refinancing of 3.5% (which assumes a 2.5% spread over the LIBOR floor of 1.00%) remains in effect for all future periods. To the extent future LIBOR rates are greater than 1.00%, actual future interest expense will be greater than noted in the above table. Interest on the Holdco Notes is calculated at 7.75%.
We conduct retail operations under operating leases, which generally have lease terms between 5 and 15 years, with the longest lease term expiring in 2034. Some of the leases contain escalation clauses, as well as renewal options, and provide for contingent rent based upon sales plus certain tax and maintenance costs. At September 30, 2014, we had $685,252 in future minimum rental payments (excluding real estate tax and maintenance costs) for retail locations and other leases that have initial or noncancelable lease terms in excess of one year. Future minimum rental payments (excluding real estate tax and maintenance costs) for retail locations and other leases that have initial or noncancelable lease terms in excess of one year are noted in the above table.
A management fee of $3,000 per year is paid to Carlyle. For the purposes of the above table, a term of five years was assumed. See Item 13. Certain Relationships and Related Party Transactions, and Director Independence-Consulting Agreement-Carlyle.
During fiscal 2014, no one supplier individually represented greater than 10% of our raw material purchases. We do not believe that the loss of any single supplier would have a material adverse effect on our consolidated financial statements. We were committed to make future purchases for inventory related items, such as raw materials and finished goods, under various purchase arrangements, with fixed price provisions as well as open capital commitments, primarily related to leasehold improvements, manufacturing equipment, computer hardware and software aggregating $185,178 at September 30, 2014. Generally, most of our purchase commitments are cancelable at our discretion until the order has been shipped, but require repayment of all expenses incurred through the date of cancellation.
At September 30, 2014, we had a liability of $8,030 for unrecognized tax benefits, the recognition of which would have an effect of $5,961 on income tax expense and the effective income tax rate. We do not believe that the amount will change significantly in the next 12 months. At this time, we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months due to uncertainties in the timing of tax audit outcomes.
Seasonality
Although we believe that our business is not seasonal in nature, historically we have experienced, and expect to continue to experience, a substantial variation in our net sales and operating results from quarter to quarter. The factors that influence this variability of quarterly results include general economic and industry conditions affecting consumer spending, changing consumer demands and current news on nutritional supplements, the timing of our introduction of new products, promotional program incentives offered to customers, the timing of catalog promotions, the level of consumer acceptance of new products and actions of competitors. Accordingly, a comparison of our results of operations from consecutive periods is not necessarily meaningful, and our results of operations for any period are not necessarily indicative of future performance. Additionally, we may experience higher net sales in a quarter depending upon when we have engaged in significant promotional activities.
Foreign Currency
Approximately 35%, 32% and 31% of our net sales for fiscal 2014, 2013 and 2012, respectively, were denominated in currencies other than U.S. dollars, principally British pounds sterling and to a lesser extent euros, Canadian dollars and Chinese renminbi. A significant weakening of such currencies versus the U.S. dollar could have a material adverse effect on us, as this would result in a decrease in our consolidated operating results.
Our foreign subsidiaries accounted for the following percentages of assets and total liabilities as of September 30, 2014 and 2013:
In preparing the consolidated financial statements, the financial statements of the foreign subsidiaries are translated from the functional currency, generally the local currency, into U.S. dollars. This process results in exchange rate gains and losses, which are included as a separate component of stockholders' equity under the caption "Accumulated other comprehensive income (loss)."
During fiscal 2014, 2013 and 2012, translation (losses)/gains of ($18,800), $607, and $16,740, respectively, were included in determining other comprehensive income (loss). Accordingly, cumulative translation losses of approximately ($28,481) and ($9,680) were included as part of accumulated other comprehensive income (loss) within the consolidated balance sheet at September 30, 2014 and 2013, respectively.
The magnitude of these gains or losses is dependent upon movements in the exchange rates of the foreign currencies against the U.S. dollar. These currencies include the British pound sterling, the euro, the Canadian dollar and the Chinese renminbi. Any future translation gains or losses could be significantly different than those noted in each of these years.
Inflation
Inflation affects the cost of raw materials, goods and services we use. High energy costs and fluctuations in commodity prices can affect the cost of all raw materials and components. The competitive environment somewhat limits our ability to recover higher costs resulting from inflation by raising prices. However, we anticipate passing these costs to our customers, to the extent possible. We seek to mitigate the adverse effects of inflation primarily through improved productivity and strategic buying initiatives.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are subject to currency fluctuations, primarily with respect to the British pound sterling, the euro, the Canadian dollar and the Chinese renminbi, and interest rate risks that arise from normal business operations. We regularly assess these risks.
We have subsidiaries whose operations are denominated in foreign currencies (primarily the British pound, the euro, the Canadian dollar and the Chinese renminbi). We consolidate the earnings of our foreign subsidiaries by translating them into U.S. dollars at the average exchange rates in each applicable period. To the extent the U.S. dollar weakens against foreign currencies, the remeasurement of these foreign currency denominated transactions results in increased net sales, operating expenses and net income. Similarly, our net sales, operating expenses and net income will decrease when the U.S. dollar strengthens against foreign currencies.
To manage the potential exposure from adverse changes in currency exchange rates, specifically the British pound sterling, arising from our net investment in British pound sterling denominated operations, on December 16, 2010, we entered into three cross currency swap contracts to hedge a portion of the net investment in our British pound sterling denominated foreign operations. The aggregate notional amount of the swap contracts is 194,200 British pounds sterling (approximately $300,000 U.S. dollars), with a forward rate of 1.56, and a termination date of September 30, 2017.
Net sales denominated in foreign currencies were approximately $1,126,301, or 35% of total net sales, for fiscal 2014. A majority of our foreign currency exposure is denominated in the British pound sterling, euro, Canadian dollars and the Chinese renminbi. For fiscal 2014, as compared to the prior comparable period the following currencies fluctuated against the U.S. dollar as follows: the British pound sterling increased 5.9%; the euro increased 3.7%; the Canadian dollar decreased 6.9%; and the renminbi increased 1.9%. The combined effect of the changes in these currency rates resulted in an increase of $40,833 in net sales and an increase of $10,787 in operating income.
We are exposed to changes in interest rates on our senior secured credit facilities. We are a party to three interest rate swap contracts that fix the LIBOR indexed interest rates on a portion of our senior secured credit facilities until the indicated expiration dates of these swap contracts. Each swap contract had an initial notional amount of $333,333 (for a total of one billion dollars), with a fixed interest rate of 1.92% for a four-year term. The notional amount of each swap decreased to $266,666
in December 2012, decreased to $166,666 in December 2013 and has a maturity date of December 2014. Under the terms of the swap contracts, variable interest payments for a portion of our senior secured credit facilities are swapped for fixed interest payments.
Assuming NBTY's senior secured credit facilities are fully drawn, each one eighth percentage point increase or decrease in the applicable interest rates would correspondingly change our interest expense on our senior secured credit facilities by approximately $1,978 per year.
Item 8.
Item 8. Financial Statements and Supplemental Data
See the "Index to Consolidated Financial Statements" included in this Report.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our chief executive officer ("CEO") and chief financial officer ("CFO"), we have evaluated the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15(d)-15(e) of the Exchange Act as of September 30, 2014, the end of the period covered by this Report. Based on that evaluation, our CEO and CFO have concluded that our disclosure controls and procedures are effective to provide reasonable assurance that information we are required to disclose in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and (2) accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosures.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act, during the three months ended September 30, 2014 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management's Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act. Under the supervision and with the participation of our management, including our CEO and CFO, management assessed, as of September 30, 2014, the effectiveness of our internal control over financial reporting. This assessment was based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013 ("COSO"). Based on our assessment using those criteria, management concluded that our internal control over financial reporting, as of September 30, 2014, was effective.
The effectiveness of our internal control over financial reporting as of September 30, 2014 has been audited by PricewaterhouseCoopers, LLP, an independent registered public accounting firm, as stated in their report, which is included herein.
Internal control over financial reporting is defined as a process designed by, or under the supervision of, our principal executive and principal financial officers and effected by our Board, management and other personnel, to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with GAAP, and includes those policies and procedures that:
• pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;
• provide reasonable assurance that transactions are recorded as necessary to permit the preparation of financial statements in accordance with GAAP principles and that our receipts and expenditures are being made only in accordance with authorization of our management and directors; and
• provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The following table sets forth the names and ages of members of our Board of Directors (the "Board" or "Directors") and executive officers and the positions they held with us as of November 24, 2014, each of whom serves an indefinite term until his or her successor has been appointed and qualified.
Sandra J. Horbach
Sandra J. Horbach has served as a member of our Board since October 2010 and Chairman of the Board since May 2011. She is a Managing Director of The Carlyle Group, where she focuses on U.S. buyout investment opportunities in the consumer and retail industries and serves as head of the Global Consumer and Retail team. She currently serves on the Board of Directors of Acosta, Inc., Dunkin' Brands, CVC Brasil Operadora e Agencia de Viagens S.A. and Vogue International. Ms. Horbach is a member of the Board of Trustees at Rockefeller University and the Investment Committee at Rockefeller University, is Chairman of the Stanford Business School Advisory Council, and serves on the Board of Trustees of The Chapin School in New York. Before joining Carlyle, Ms. Horbach spent 18 years at Forstmann Little, a private investment firm. She also spent two years in the mergers and acquisition department of Morgan Stanley. Ms. Horbach received her Master's in Business Administration from the Stanford University Graduate School of Business and her Bachelor of Arts from Wellesley College. This experience, in particular her extensive experience in the retail and consumer industries, and her experience on other boards, led to the conclusion that Ms. Horbach should serve as a Director.
Susan Arnold
Susan Arnold has served as a member of our Board since November 2013. She is an Operating Executive at The Carlyle Group focused on global investment opportunities in the consumer and retail sectors. Prior to joining Carlyle, Ms. Arnold was an executive with Procter & Gamble for more than 29 years. Prior to retiring in 2009 as President of Procter & Gamble's Global Business Units, Ms. Arnold held various positions within the firm, including Vice Chair of Global Beauty and Health. She has been a director of McDonalds Corporation since 2008 and Director of The Walt Disney
Company since 2007. This experience, including her prior executive and other leadership roles at a major consumer goods company, led to the conclusion that Ms. Arnold should serve as a Director.
David Bernauer
David Bernauer has served as a member of our Board since February 2011. He is the retired Chairman and Chief Executive Officer of Walgreen Co. He previously served as Chairman of Walgreen from July 2006 until July 2007. From 2003 until July 2006, Mr. Bernauer served as Chairman and Chief Executive Officer of Walgreen. From 2002 to 2003, he served as President and Chief Executive Officer of Walgreen; from 1999 to 2002 as President and Chief Operating Officer of Walgreen; and he has served in various management positions, with increasing areas of responsibility at Walgreen since 1966. Currently, he also is a lead director of Lowe's Companies, Inc. Mr. Bernauer also served on the Board of Office Depot, Inc. from 2004 to April 2011. This experience, including his prior executive and other leadership roles at a major national retailer, led to the conclusion that Mr. Bernauer should serve as a Director.
Marco De Benedetti
Marco De Benedetti has served as a member of our Board since October 2010. He is a Partner and Managing Director of The Carlyle Group and Co-Head of its Europe buyout team. He is based in Milan, Italy. Mr. De Benedetti serves on the Board of Directors of Cofide S.p.A (since 1994), CIR S.p.A. (since 2014), Moncler (since 2008), Commscope (since 2010), Twin-Set Simona Barbieri (since 2012), and Marelli Motori S.p.A. (since 2013), as well as Save the Children Italia. Before joining Carlyle, Mr. De Benedetti was the Chief Executive Officer of Telecom Italia. Mr. De Benedetti was the Chief Executive Officer of Telecom Italia Mobile from 1999 until its merger with Telecom Italia. Previously, Mr. De Benedetti was the Chairman of Infostrada, the main alternative fixed-line carrier for voice services and internet access in Italy, and Chief Executive Officer of Olivetti Telemedia, the telecommunications and multimedia business of the Olivetti Group. Between 1987 and 1989, Mr. De Benedetti worked for Wasserstein, Perrella & Co. in New York. In 1990, he joined the Olivetti Group as Assistant to the Chief Executive Officer of Olivetti Systems and Networks, and he was later appointed as Group Director of Marketing and Services. In 1992, he was appointed General Manager of Olivetti Portugal. Mr. De Benedetti received his Bachelor's degree in history and economics from Wesleyan University and his Masters in Business Administration from the Wharton School at the University of Pennsylvania. This experience, in particular his extensive executive and business management experience, led to the conclusion that Mr. De Benedetti should serve as a Director.
Robert Essner
Robert Essner has served as a member of our Board since February 2011. He is an Operating Executive at The Carlyle Group focused on global investment opportunities in the healthcare sector. Mr. Essner was Chairman for Wyeth from 2003 until 2008 and Chief Executive Officer for Wyeth from 2001 until 2008. Mr. Essner worked for 32 years in the pharmaceutical industry and during that time served in many leadership roles, including Chairman of the Pharmaceutical Research and Manufacturers Association. Mr. Essner is currently a director of MassMutual Life Insurance Company, Pharmaceutical Product Development, LLC and Amicus Therapeutics, Inc. He currently serves as Chairman of the not-for-profit Children's Health Fund and as Trustee of Mote Marine Laboratories. Mr. Essner is Executive-in-Residence and Adjunct Professor at Columbia Business School, where he teaches courses in Healthcare Management. Mr. Essner received a Master's degree from the University of Chicago and a Bachelor's degree from Miami University. This experience, including his extensive background and experience in the pharmaceutical industry, led to the conclusion that Mr. Essner should serve as a Director.
Allan Holt
Allan Holt has served as a member of our Board since October 2010. Mr. Holt, a Partner and Managing Director of The Carlyle Group, is currently a Co-head of its US Buyout group. Mr. Holt is a graduate of Rutgers University and received his Masters in Business Administration from the University of California, Berkeley. He serves on the boards of directors of Axalta Coating Systems, Booz Allen Hamilton Holding Corporation, Ortho Clinical Diagnostics and SS&C Technologies, Inc., and the boards of managers of HCR ManorCare, LLC and HCRMC Operations, LLC. He is also a member of the United States Holocaust Memorial Museum Council and serves on the board of advisors or directors of the non-profit DC Greens and The Hillside Foundation. Mr. Holt's prior board service includes the boards of directors of HD Supply, Inc. (June 2007 to April 2012), Sequa Corporation (July 2007 to February 2011) and Vought Aircraft Industries, Inc. (July 2000 to June 2010). This experience and his extensive knowledge of finance led to the conclusion that Mr. Holt should serve as a Director.
Elliot Wagner
Elliot Wagner has served as a member of our Board since October 2010. He is a Managing Director of The Carlyle Group, where he focuses on U.S. buyout opportunities in the consumer and retail sector. From 2000 to 2008, Mr. Wagner was a member of Carlyle's Global Aerospace, Defense, and Government/Business Services team. Before joining Carlyle in 2000, Mr. Wagner was with Lehman Brothers Inc., focusing on mergers, acquisitions and financings for aerospace, defense, consumer and technology companies. Mr. Wagner received his Bachelor of Science degree from Cornell University, where he currently serves on the Advisory Council of the Dyson School of Applied Economics and Management. Mr. Wagner also currently serves on the Board of Directors for Acosta, Inc. Mr. Wagner was previously a member of the board of directors and audit committee of Sequa Corporation and Wesco Aircraft Hardware Corporation. This experience, in particular his experience with companies in the retail and consumer industries, led to the conclusion that Mr. Wagner should serve as a Director.
Steven Cahillane
Steven Cahillane has served as a member of our Board and has been our Chief Executive Officer and President since September 8, 2014. Prior to joining our company, Mr. Cahillane served as Executive Vice President of The Coca Cola Company from February 2013 to February 2014 and President of Coca-Cola Americas from January 2013 to February 2014. Mr. Cahillane served as President of various Coca-Cola operating groups from 2007 to 2012. From 2003 until 2005, Mr. Cahillane served as the Chief Executive for Interbrew UK and Ireland, a division of InBev S.A and from 2005 to 2007 he served as the Chief Commercial Officer of InBev S.A. Mr. Cahillane received his bachelor's degree from Northwestern University and his Masters in Business Administration from Harvard University.
Dipak Golechha
Dipak Golechha became our Chief Financial Officer on August 25, 2014. Prior to joining NBTY, he served as Chief Financial Officer of Chobani from January 2014 until June 2014. From 1995 to 2013, Mr. Golechha served in several leadership positions at Procter & Gamble, including Chief Financial Officer of the snacks global business unit from 2009 until 2012 and Chief Financial Officer of the feminine health & hygiene global business unit from 2012 to 2013. Mr. Golechha received both his bachelor's and master's degrees in economics from St. John's College, Cambridge University.
Harvey Kamil
Harvey Kamil was the President of NBTY from 2002 and CFO from 1982, when he joined our company. Effective June 13, 2011, Mr. Kamil stepped down as President and CFO of NBTY and
became Holdings' and NBTY's Vice Chairman. Mr. Kamil taught as an adjunct associate professor at Suffolk County Community College for thirteen years. He serves on the Board of Directors of the Council for Responsible Nutrition and on the Board of Directors of the Natural Products Association. Presently, he is a member of the Dean's Advisory Council of the Zicklin School of Business of Baruch College and a member of the NY State Regional Economic Development Council for Long Island. Mr. Kamil received his Bachelor of Business Administration and Masters in Business Administration from the Baruch School of Business, City University of New York, and is a Certified Public Accountant and Certified Management Accountant.
Joseph Looney
Joseph Looney has served as Chief Accounting Officer since September 2012 and as Vice President-Finance since joining NBTY in June 2006. Mr. Looney was the Chief Financial Officer of EVCI Career College Holding Corp. from October 2005 to May 2006. Previously, he had been the Chief Financial Officer and Secretary of Astrex, Inc., a distributor of electronic components, since 2002. From 1996 to 2002, he was the Chief Financial Officer, V.P. of Finance and Assistant Secretary of Manchester Technologies, Inc., a network integrator and reseller of computer products. From 1984 to 1996, he was employed by the accounting firm of KPMG LLP. He is a Certified Public Accountant and has a B.A. from Queens College, City University of New York and an M.S. from Long Island University. Since 1996, Mr. Looney has also been an Adjunct Professor of Accounting and Business Law at Hofstra University.
Christopher Brennan
Christopher Brennan has served as our Senior Vice President/General Counsel since March 2012, Corporate Secretary since January 2013 and Chief Compliance Officer since February 2013. Mr. Brennan served as Senior Vice President/General Counsel at PharmaNet Development Group, Inc., a contract research organization serving the clinical research needs of large and medium sized multi-national pharmaceutical companies from 2009 to early 2012. Before joining PharmaNet, Mr. Brennan was Executive Vice President/Corporate Affairs & General Counsel at Quinnova Pharmaceuticals, Inc., a specialty pharmaceutical company with global operations. Prior to joining Quinnova in 2005, Mr. Brennan was a corporate associate at the law firms of Cravath, Swaine & Moore LLP and Dechert LLP. Mr. Brennan served as a Captain in the United States Air Force for five years prior to attending law school. He received his Bachelor of Arts and Juris Doctorate degrees from Fordham University.
James Flaherty
James Flaherty has been the Senior Vice President/Marketing and Advertising of NBTY since 1987. He joined NBTY in 1979 as a Marketing Manager. In his current position, he directs the in-house staff of marketing, advertising, media and graphic design professionals in the planning, creation and execution of the Company's advertising, packaging and promotional programs across all mediums. Mr. Flaherty is Vice Chair of Council for Responsible Nutrition ("CRN") and serves on its Media Relations committee. Mr. Flaherty received his Bachelor of Science degree in Business Administration and Marketing from the State University of New York at Albany.
Karla Packer
Karla Packer has served as Senior Vice President/Human Resources since April 2011. Ms. Packer previously served as Senior Vice President of Human Resources at IMS Health Incorporated, a leading provider of market intelligence to the pharmaceutical and healthcare industries since 2007. Before joining IMS Health, Ms. Packer was Vice President of Human Resources for IAC/InteractiveCorp, a $6 billion E-Commerce entity, whose brands include Ticketmaster, Expedia and Home Shopping
Network. Ms. Packer spent six years at Avon Products, where she developed human resources strategies in support of Global Marketing, Brand Development, Manufacturing, Supply Chain Strategy, and Research and Development. She started her career at IBM, where she held several positions in the areas of information technology, sales, marketing and human resources. Ms. Packer received her Bachelor of Science in Mathematics from Tufts University.
Bernard O'Keefe
Bernard O'Keefe has served as our Chief Supply Chain Officer, since September 2012. Mr. O'Keefe served as Vice President of Product Supply, for multiple businesses of Procter & Gamble, including Global Feminine Care, Corporate Manufacturing and Global Personal Health Care & Pharmaceuticals since 2002. Prior to 2002, Mr. O'Keefe held several positions in the areas of supply chain management within Procter & Gamble in Asia, Latin America and North America.
Director Independence and Selection
Following the Merger, NBTY's equity securities are owned by Holdings; certain investment funds affiliated with Carlyle own substantially all the outstanding equity of Holdings. As of November 24, 2014, our Board of Directors consisted of Steven Cahillane and seven persons associated with and appointed by Carlyle. Our Board has not made a formal determination as to whether each director is "independent" because we have no equity securities listed for trading on a national securities exchange. Because of their relationships with Carlyle or with us, however, we do not believe that any of our directors would be considered independent under the NYSE's definition of independence.
In identifying nominees for director, consideration is given to the diversity of professional experience, education and backgrounds among the directors so that a variety of points of view are represented in Board discussions and deliberations concerning our business.
Committees of the Board of Directors
Following the Merger, the Board has three standing committees: (i) the Audit Committee; (ii) the Compensation Committee; and (iii) the Executive Committee.
Audit Committee. The Audit Committee is comprised of Messrs. Bernauer and Wagner and assists the Board in its oversight of:
• the qualifications, independence and performance of our independent accountants and the performance of our internal auditors and internal audit function;
• the integrity of our financial statements and our financial reporting processes and systems of internal control; and
• our compliance with legal and regulatory requirements.
The Audit Committee provides an avenue of communication among management, the independent accountants, the internal auditors and the Board. In carrying out its responsibilities, the Audit Committee also meets with the Company's internal audit staff and with the independent accountants in executive session, without members of management present.
Mr. Wagner is an Audit Committee "financial expert," as defined by SEC rules, based on the experience noted in his biography above.
Compensation Committee. The Compensation Committee is comprised of Mr. De Benedetti and Ms. Horbach and assists the Board in:
• developing and periodically reviewing our compensation policies, including equity and similar awards, consistent with, and linked to, our strategies;
• evaluating the performance of our CEO and determining his compensation annually;
• evaluating the performance and compensation of our other executive officers annually;
• reviewing management's recommendations on executive compensation policies and programs;
• recommending to the Board the fees of outside directors;
• reviewing and approving new company benefit plans and amendments to existing benefit plans;
• approving all equity-based compensation plans; and
• reviewing benefit plan administration.
The Compensation Committee has the authority to retain and terminate any consultants, including legal counsel, to assist it in performing its duties and to approve all fee arrangements with consultants. From time to time, the Compensation Committee may seek information and advice regarding executive compensation market practices from outside independent consultants.
Executive Committee. The Executive Committee is composed of Messrs. Cahillane and Wagner and Ms. Horbach. Its primary function is to act on behalf of the Board during intervals between regularly scheduled meetings of the Board. The Executive Committee may exercise all powers of the Board, except as otherwise provided by law and our by-laws. The Board reviews all actions taken by the Executive Committee between Board meetings at the following Board meeting.
Code of Ethics for Senior Financial Officers
We have adopted a Code of Ethics for its Directors, officers and employees, including its senior financial officers and CEO. We will provide a copy of the Code of Ethics to any person upon written request made to Christopher Brennan, our General Counsel, at our headquarters at 2100 Smithtown Avenue, Ronkonkoma, New York 11779. We intend to satisfy the disclosure requirements of amendments to or waivers from a provision of the code of ethics applicable to our principal executive officer, principal financial officer, principal accounting officer or persons performing similar functions by posting such information on our website, www.nbty.com. Our website and the information in or connected to its website are not incorporated into this annual report.
Item 11.
Item 11. Executive Compensation
Compensation Discussion and Analysis
This Compensation Discussion and Analysis (this "CD&A") describes the principles underlying our compensation policy for fiscal 2014 with respect to the individuals listed below and in the "2014 Summary Compensation Table", whom we call our "named executive officers".
Steven Cahillane, Chief Executive Officer and President (effective September 8, 2014)
Dipak Golechha, Chief Financial Officer (effective August 25, 2014)
Jeffrey Nagel, former Chief Executive Officer (resigned, effective September 8, 2014)
Michael Collins, former Chief Financial Officer (resigned, effective September 5, 2014)
Harvey Kamil, Vice Chairman
Glenn Schneider, President-Global Wholesale (resigned, effective October 31, 2014)
Bernard O'Keefe, Chief Supply Chain Officer
Overview; Compensation Philosophy and Objectives
During fiscal 2014, the boards of directors of NBTY and Holdings, and the compensation committees of NBTY and Holdings, each comprised of the same individuals (collectively, the
"Compensation Committee" or the "Committee"), oversaw our executive compensation program. The Committee designed an executive compensation program to achieve the following goals:
• Attract and retain talented professionals by providing competitive compensation levels;
• Align the interests of our executive officers with those of our primary stockholder through equity-based awards with long-term value; and
• Reward our executives for their contributions to our overall performance as well as for their individual performance.
The ratio of short-term compensation to long-term compensation for each executive varies depending upon the roles and responsibilities of the executive, with generally higher proportions of long-term compensation for more senior executives.
The Compensation Committee seeks to encourage our executives to maximize their performance to achieve our strategy and goals. As part of its compensation assessment, the Compensation Committee considers many factors to understand the compensation landscape among similarly-sized companies. Although the Compensation Committee does not target specific compensation levels based upon an established group, the Compensation Committee uses external data to inform the decision-making process.
Executive Compensation Determinations for Fiscal 2014
During fiscal 2014, total compensation for some or all of our named executive officers consisted of the following components, each discussed in more detail below:
• base salary,
• annual cash bonuses,
• long-term incentive (equity) compensation,
• retirement plans, and
• perquisites.
Role of CEO in Compensation Determinations
Our Compensation Committee determines the nature and amount of all compensation for our executive officers. Our Chief Executive Officer (or "CEO") typically provides recommendations to our Compensation Committee with respect to all elements of compensation for the named executed officers, except himself, and for the other executives that report to him. Our CEO attends Compensation Committee meetings, except those that address his own compensation. Historically, the Compensation Committee has given substantial weight to our CEO's recommendations, insights and observations. However, the Compensation Committee may modify or reject any of our CEO's recommendations.
An Overview
The Compensation Committee's approach to compensation is consistent with that at other Carlyle portfolio companies, but takes into account factors particular to our company to establish compensation levels appropriate to each executive's skills, experience and potential value to our company.
Discussed below is how the Compensation Committee determined the amount and type of compensation best suited to our goals and how the Compensation Committee believes these decisions reflect our compensation philosophy. The Compensation Committee seeks to establish competitive
levels of compensation, align executive interests with those of our primary stockholder and closely link compensation to both short-term and long-term company and individual performance.
Competitive Market/Retention of Talent. The Compensation Committee considered the market for executive talent and attempted to set compensation at competitive levels when measured against other similarly-sized companies (based on revenue), regardless of industry. We seek to set our total compensation to be competitive with the market but do not target specific compensation levels based upon an established group.
Company Performance. In evaluating performance, the Compensation Committee considered our overall financial and operating performance during the period, as well as our achievement of strategic and tactical goals. In fiscal 2014, the Committee principally assessed company performance based on earnings before interest, tax, depreciation and amortization, or "EBITDA", adjusted for non-recurring and extraordinary items ("Adjusted EBITDA"). The Compensation Committee believes that Adjusted EBITDA is a useful performance metric for a portfolio company, and correlates closely with financial success and growth in equity value.
Individual Contributions and Performance. As discussed in further detail below, the Compensation Committee evaluated each executive's contributions to our financial and operational achievements. The Compensation Committee considered each executive's individual performance, both in terms of personal responsibilities and contributions to company goals. The Compensation Committee also considered the executive's potential for future contributions to our long-term success, and evaluated the executive's experience, management skills and leadership abilities.
Base Salary
We consider base salary adjustments, if any, annually, and we determine these adjustments based upon individual performance, assumption of new responsibilities, employee retention efforts, our annual salary budget guidelines, and other factors that the Compensation Committee considers relevant, such as compensation packages that competitively-sized (based on revenue) companies offer their executives. Larger annual increases may be made to higher performers and key contributors, if the overall increases are within our budgeted guidelines. We believe we must offer competitive base salaries to attract and retain high-quality executives who provide our primary stockholder and other stakeholders with increased value. Base salaries provide executives with a fixed level of income security, offering stability and predictability. Our executives understand that our entrepreneurial atmosphere and need for performance accountability place their employment, and not their income alone, at risk. The actual base salaries paid to all of our named executive officers during fiscal 2014 are set forth in the "Summary Compensation Table" below.
The Compensation Committee determined that the level of base salaries was appropriate for the named executive officers and there were no base salary increases for our named executive officers in fiscal 2014. Messrs. Cahillane and Golechha joined our company in 2014 and their initial base salaries were determined as a result of arms-length negotiations.
Incentive Compensation; Annual Cash Bonuses
We believe that annual cash bonuses reward our executives on a short-term basis for their individual performance and contributions to our overall performance and motivate them to advance our goals on a year-over-year basis. Our employment agreements with Messrs. Nagel, Collins, Schneider and O'Keefe provide for a targeted annual cash bonus of 100%, 75%, 75% and 65% of annual base salary, respectively. Historically, Mr. Kamil has been provided a targeted annual cash bonus of 75% of annual base salary, subject to upward or downward adjustment at the discretion of the Compensation Committee. Because Messrs. Cahillane and Golechha joined our company towards the end of fiscal
2014, their employment agreements provide for a targeted annual cash bonus of 100% and 75% of annual base salary, respectively, effective beginning in fiscal 2015. In each case, the Compensation Committee may adjust the cash bonus amount to reflect the executive's performance.
Under the terms of the annual bonus plan, results of at least 94.8% of the Adjusted EBITDA performance target must be achieved in order for executives to earn 50.0% of their targeted award. Achievement of 100% of the Adjusted EBITDA performance target results in an award of 100% of the targeted award. Achievement of at least 110.5% of the Adjusted EBITDA performance target results in an award of 200% of the targeted award. Performance for levels achieved between threshold, target and maximum are linearly interpolated. Once the achievement of the Adjusted EBITDA performance target has been determined, the Compensation Committee makes a subjective assessment of personal performance for each officer, and may adjust the award upward or downward based upon that assessment. In addition, incentive amounts paid under the performance-based programs may be adjusted by the Compensation Committee to account for extraordinary transactions.
For fiscal 2014, we achieved $478 million, or 80.9%, of the Adjusted EBITDA performance target of $591 million. Accordingly, before factoring in the achievement of personal objectives, the executive officers did not achieve any percentage of the target award.
Based on the criteria discussed above, Messrs. Nagel, Collins, Kamil, Schneider and O'Keefe were not awarded cash bonuses for fiscal 2014. Messrs. Cahillane and Golechha are not permitted to participate in the annual bonus plan until fiscal 2015.
Incentive Compensation; Long-Term Compensation
In 2011, we implemented an equity compensation program to provide our management team an opportunity to develop an ownership stake in Holdings. Because we are now owned by a private equity investor, the Compensation Committee has concluded that equity awards generally will be granted based on target levels covering a multi-year period, without an expectation that an executive will receive successive annual grants. This approach more closely aligns the interests of the executive with the long-term investment horizon of our primary stockholder.
The Compensation Committee reserves the right to grant equity awards from time-to-time, in its discretion, to maintain the competitiveness of our compensation program and to provide incentives to high performance and long-term service by our executives. The Compensation Committee did not make any grants to named executive officers in fiscal 2014. Equity awards to Messrs. Nagel, Collins, Kamil and Schneider were granted in fiscal 2011. Mr. O'Keefe was granted an initial award upon his joining our company in September 2012. The time-based portion of these awards typically vests in equal increments over five years, subject to continued employment, whereas the performance-based portion vests only upon the occurrence of a liquidity event and pre-determined performance criteria, also typically subject to continued employment.
Retirement Plans
During fiscal 2014, our executive officers (including our named executive officers) participated in the same retirement plans on the same terms as provided to most of our associates. The plan is known as The NBTY Retirement Plan (the "Plan") and consists of both a 401(k) and a profit sharing component. During fiscal 2014, we made a profit sharing contribution of $3,722,743 for the 2013 plan year, which was allocated to eligible participants based upon their relative eligible compensation. We do not intend to make a contribution to the Plan for the 2014 plan year due to the company's performance. The profit-sharing and 401(k) matching contributions are subject to certain limits under the Internal Revenue Code and represent relatively small components of an executive's compensation. Profit-sharing contributions, if any, will be allocated among participants who completed at least 1,000 hours of service in the plan year and who were employed on the last day of the plan year, based
upon their relative compensation for the year. Under the terms of the Plan, we provide a matching contribution of up to 4% of the eligible compensation of each participant who has met the eligibility requirements and defers salary into the Plan.
Perquisites
During fiscal 2014, we provided a limited number of perquisites to our named executive officers. One such perquisite is a life insurance arrangement under which Mr. Kamil is entitled to payments upon retirement, on or after age 65, or death. See the narrative disclosure under the "Nonqualified Deferred Compensation," table below. The Compensation Committee believes that this cash value insurance program, which is similar to a defined contribution arrangement, provides an element of retirement income at reasonable annual cost to us. The cost of the fiscal 2014 company-paid premiums is reflected as compensation to Mr. Kamil in the "All Other Compensation" column of the Summary Compensation Table.
Each of our named executive officers is also entitled to either a company-paid automobile lease or an automobile allowance, with the exception of Messrs. Cahillane and Golechha. In fiscal 2014, we reimbursed Mr. O'Keefe for housing expenses and Mr. Golechha for certain moving and temporary housing expenses, which are fully taxable to the executive. In addition, Mr. Cahillane will have use of the corporate jet to commute from Atlanta, Georgia to Ronkonkoma, New York, up to $200,000 per calendar year. Mr. Cahillane is also entitled to the reimbursement of up to $20,000 in legal fees incurred in connection with the negotiation of his employment agreement. We do not consider perquisites to be a principal component of our executives' compensation and we believe that these benefits are reasonable and competitive with benefits and perquisites provided to executive officers of similarly-sized companies.
Other Benefits
We also offer certain benefits to substantially all employees, including our named executive officers. These include health and welfare benefits, disability and life insurance, education and tuition reimbursement and an employee assistance program.
Severance and Change in Control Benefits
As more fully described below in the sections entitled "Employment Agreements" and "Potential Payments upon Termination or Change in Control", in fiscal 2014 Messrs. Cahillane, Golechha, Nagel, Collins, Schneider, and O'Keefe were parties to employment agreements that each provide for certain payments and benefits upon a qualifying termination of employment, including salary continuation and a pro-rated bonus for the fiscal year of termination. In addition, our named executive officers may be eligible to receive acceleration of certain unvested equity awards in connection with a qualifying termination of employment or qualifying corporate event involving our company.
We believe that such severance and change in control benefits are reasonable and competitive with such benefits provided to executive officers of similarly-sized companies and are necessary to sustain a fully competitive executive compensation program.
Employment Agreements
Employment Agreement with Steven Cahillane
NBTY and Holdings entered into an employment agreement, dated August 18, 2014, with Steven Cahillane under which Mr. Cahillane serves as Chief Executive Officer and President of Holdings and NBTY, as well as a member of the board of directors of each of Holdings and NBTY, effective September 8, 2014. The agreement has an initial five-year term, beginning on September 8, 2014, and
provides for successive one-year renewals at the expiration of each term, unless prior written notice of non-renewal by any party is provided 60 days in advance. Under the employment agreement, Mr. Cahillane's initial annual base salary is $850,000. His base salary may be increased but not decreased upon periodic review by the Compensation Committee. Beginning with the fiscal year ending September 30, 2015, Mr. Cahillane will be eligible to receive an annual performance-based bonus targeted at 100% of his annual base salary (i.e., $850,000), subject to adjustments between the range of 50% and 200% of such target for under- or over-performance, as determined by the Compensation Committee. In addition, pursuant to his employment agreement, Mr. Cahillane will be entitled to receive a stock option award to purchase 50,000 shares of common stock of Holdings at an exercise price equal to the stock's fair market value on the grant date, which grant will be subject to certain vesting provisions. Mr. Cahillane is also entitled to the reimbursement of up to $20,000 in legal fees and expenses incurred in connection with the negotiation of his employment agreement, and reimbursement of reasonable moving expenses incurred in connection with his relocation to Long Island, New York.
The employment agreement provides that if Mr. Cahillane's employment is terminated by us without "cause" or by Mr. Cahillane for "good reason" (each, as defined in his employment agreement), due to non-extension of the term by NBTY and Holdings, or due to death or disability, then, subject to his (or, in the event of his death or disability, his eligible representative's) timely execution and non-revocation of a release, he will be entitled to receive an amount equal to his annual base salary, payable over the one-year period following his employment termination, and a pro-rata bonus for the fiscal year in which the termination occurs if his employment termination occurs after April 1st of the applicable fiscal year. The employment agreement contains customary confidentiality provisions, and non-solicitation and non-competition terms applicable to Mr. Cahillane that survive for a period of one year following the termination of his employment with NBTY and Holdings.
Employment Agreement with Jeffrey Nagel
Effective December 6, 2010, NBTY and Holdings entered into an employment agreement with Jeffrey Nagel under which Mr. Nagel was appointed as CEO of Holdings and NBTY, as well as a member of the board of directors of each of Holdings and NBTY. Under the employment agreement, Mr. Nagel's initial annual base salary was $750,000 and he was is eligible to receive a performance-based bonus under NBTY's annual bonus program targeted at 100% of annual base salary, subject to adjustments between the range of 50% and 200% of such target for under or over performance, as determined by the Compensation Committee. Effective September 8, 2014, Mr. Nagel resigned from his position as CEO and member of the boards of directors and executive committees of NBTY and Holdings. In connection with his resignation, Mr. Nagel is eligible to receive the following payments: (i) an amount equal to two times his annual base salary, payable over the two-year period following his employment termination and (ii) a pro rata bonus, based on actual fiscal results, for fiscal 2014 (though no fiscal 2014 bonus is due to Mr. Nagel due to financial underperformance). The employment agreement contained customary confidentiality provisions, and non-solicitation and non-competition terms applicable to Mr. Nagel that survive for a period of two years following the termination of his employment with NBTY and Holdings.
Employment Agreement with Dipak Golechha
NBTY and Holdings entered into an employment agreement, dated August 14, 2014, with Dipak Golechha under which Mr. Golechha serves as Senior Vice President and Chief Financial Officer of Holdings and NBTY. The agreement has an initial five-year term, beginning on August 25, 2014, and provides for successive one-year renewals at the expiration of each term, unless prior written notice of non-renewal by any party is provided 60 days in advance. Under the employment agreement, Mr. Golechha's initial annual base salary is $550,000. His base salary may be increased but not
decreased upon periodic review by the Compensation Committee. Beginning with the fiscal year ending September 30, 2015, Mr. Golechha will be eligible to receive an annual performance-based bonus targeted at 75% of his annual base salary (i.e., $412,500), subject to adjustments between the range of 50% and 200% of such target for under- or over-performance, as determined by the Compensation Committee. In addition, pursuant to his employment agreement, Mr. Golechha will be entitled to receive a stock option award to purchase 10,000 shares of common stock of Holdings at an exercise price equal to the stock's fair market value on the grant date, which grant shall be subject to certain vesting provisions. Mr. Golechha is also entitled to the reimbursement of reasonable moving expenses incurred in connection with his relocation to Long Island, New York.
The employment agreement provides that if Mr. Golechha's employment is terminated by us without "cause" or by Mr. Golechha with "good reason" (each, as defined in his employment agreement), or due to non-extension of the term by NBTY and Holdings, then, subject to his timely execution and non-revocation of a release, he will be entitled to receive an amount equal to his annual base salary, payable over the one-year period following his employment termination, and a pro-rata bonus for the fiscal year in which the termination occurs if his employment termination occurs after April 1st of the applicable fiscal year. The employment agreement contains customary confidentiality provisions, and non-solicitation and non-competition terms applicable to Mr. Golechha that survive for a period of one year following the termination of his employment with NBTY and Holdings.
Employment Agreement with Michael Collins
NBTY and Holdings entered into an employment agreement, dated May 24, 2011, with Mr. Collins under which Mr. Collins served as Chief Financial Officer of Holdings and NBTY, beginning June 13, 2011. Under the employment agreement, Mr. Collins's initial annual base salary was $600,000 and he was eligible to receive a performance-based bonus under NBTY's annual bonus program targeted at 75% of annual base salary, subject to adjustments between the range of 50% and 200% of such target for under or over performance, as determined by the Compensation Committee. Effective September 5, 2014, Mr. Collins resigned from his position as Chief Financial Officer of NBTY and Holdings. In connection with his resignation, Mr. Collins is eligible to receive the following payments: (i) an amount equal to his annual base salary, payable over the one-year period following his employment termination, and (ii) a pro-rata bonus for fiscal 2014 (though no fiscal 2014 bonus is due to Mr. Collins due to financial underperformance). The employment agreement contained customary confidentiality provisions, and non-solicitation and non-competition terms applicable to Mr. Collins that survive for a period of one year following the termination of his employment with NBTY and Holdings.
Harvey Kamil Agreement
Under a letter agreement dated May 18, 2011, which amended an employment agreement that we and Mr. Kamil entered into in 2008 (the "2008 Agreement"), Mr. Kamil agreed to serve as our Vice Chairman. As Vice Chairman, Mr. Kamil provides services on an as-needed basis and is entitled to receive annual compensation at an annual rate of total compensation of $624,600. The amendment also provides that the provisions of the 2008 Agreement that were intended to survive the termination of the 2008 Agreement will continue to survive according to their terms, including the non-competition and non-solicitation of business provisions that continue for one-year beyond the termination of Mr. Kamil's employment, and non-solicitation of employees provision that continues for two-years beyond the termination of Mr. Kamil's employment. Mr. Kamil is not entitled to severance benefits under the letter agreement.
Employment Agreement with Bernard O'Keefe
NBTY and Holdings entered into an employment agreement, dated August 14, 2012, with Bernard O'Keefe under which Mr. O'Keefe serves as Chief Supply Chain Officer of Holdings and NBTY. The
agreement has an initial five-year term and provides for successive one-year renewals at the expiration of each term, unless prior written notice of non-renewal by any party is provided 60 days in advance. Under the employment agreement, Mr. O'Keefe's initial annual base salary is $480,000. His base salary may be increased but not decreased upon periodic review by the Compensation Committee. Mr. O'Keefe also is eligible to receive a performance-based bonus targeted at 65% of annual base salary, subject to adjustments between the range of 50% and 200% of such target for under or over performance, as determined by the Compensation Committee. In addition, under the employment agreement, to maintain a local residence, Mr. O'Keefe is entitled to the reimbursement of up to $3,000 in rent plus utilities each month for the duration of his agreement.
The employment agreement provides that if Mr. O'Keefe's employment is terminated by us without "cause" or by Mr. O'Keefe with "good reason" (each, as defined in his employment agreement), or due to non-extension of the term by NBTY and Holdings, then, subject to his timely execution and non-revocation of a release, he will be entitled to receive an amount equal to his annual base salary, payable over the one-year period following his employment termination, and a pro-rata bonus for the fiscal year in which the termination occurs if his employment termination occurs after April 1st of the applicable fiscal year. The employment agreement contains customary confidentiality provisions, and non-solicitation and non-competition terms applicable to Mr. O'Keefe that survive for a period of 18 months following the termination of his employment with NBTY and Holdings.
Employment Agreement with Glenn Schneider
NBTY and Holdings entered into an employment agreement, dated August 6, 2012, with Glenn Schneider under which Mr. Schneider serves as President, Global Wholesale of Holdings and NBTY. Under the employment agreement, Mr. Schneider's initial annual base salary was $525,000. Mr. Schneider also is eligible to receive a performance-based bonus targeted at 75% of annual base salary, subject to adjustments between the range of 50% and 200% of such target for under or over performance, as determined by the Compensation Committee.
Effective October 31, 2014, Mr. Schneider resigned from his position as President Global Wholesale of NBTY and Holdings. The employment agreement provided that in connection with his resignation Mr. Schneider was entitled to receive an amount equal to his annual base salary, payable over the one-year period following his employment termination, and a pro-rata bonus for the fiscal year in which the termination occurred if his employment termination occurred after April 1st of the applicable fiscal year. The employment agreement contained customary confidentiality provisions, and non-solicitation and non-competition terms applicable to Mr. Schneider that survive for a period of one year following the termination of his employment with NBTY and Holdings. No fiscal 2014 bonus is due to Mr. Schneider due to financial underperformance.
NBTY and Holdings entered into an agreement, dated November 19, 2014, with Mr. Schneider pursuant to which he will provide certain consulting services to NBTY for one year. Under the agreement, Mr. Schneider shall receive aggregate fees of $525,000 for his services. In addition, during the term of the agreement, Mr. Schneider's time-based options shall continue to vest in accordance with the schedule set forth in his stock-option grant. Mr. Schneider agreed to be subject to non-solicitation and non-competition obligations that survive until October 31, 2016 or a liquidation event occurs. NBTY, Holdings and Mr. Schneider separately agreed that any severance payments payable under Mr. Schneider's employment agreement shall be postponed until after the expiration of the consulting agreement.
For a discussion of amounts payable to each of our named executive officers if his or her employment were terminated, or if a change in control occurred, as of the end of our most recent fiscal year, see "Potential Payments upon Termination or Change in Control" below.
Tax and Accounting Considerations
Section 162(m) of the Internal Revenue Code
Generally, Section 162(m) of the Internal Revenue Code, or Section 162(m), disallows a tax deduction for any publicly-held corporation for individual compensation exceeding $1.0 million in any taxable year to its chief executive officer and each of its three other most highly compensated executive officers, other than its chief financial officer, unless compensation qualifies as "performance-based compensation" within the meaning of the Internal Revenue Code. We are not currently subject to the deduction limits of Section 162(m) and as a result we do not take Section 162(m) into consideration in setting compensation.
Section 409A of the Internal Revenue Code
Section 409A of the Internal Revenue Code, or Section 409A, requires that "nonqualified deferred compensation" be deferred and paid under plans or arrangements that satisfy the requirements of the statute with respect to the timing of deferral elections, timing of payments and certain other matters. Failure to satisfy these requirements can expose employees and other service providers to accelerated income tax liabilities and penalty taxes and interest on their vested compensation under such plans. Accordingly, we generally intend to design and administer our compensation and benefits plans and arrangements for all of our employees and other service providers, including our named executive officers, so that they are either exempt from, or satisfy the requirements of, Section 409A.
Section 280G of the Internal Revenue Code
Section 280G of the Internal Revenue Code, or Section 280G, disallows a tax deduction with respect to excess parachute payments to certain executives of companies which undergo a change in control. In addition, Section 4999 of the Internal Revenue Code, or Section 4999, imposes a 20% penalty on the individual receiving the excess payment.
Parachute payments are compensation that is linked to or triggered by a change in control and may include, but are not limited to, bonus payments, severance payments, certain fringe benefits, and payments and acceleration of vesting from long-term incentive plans including stock options and other equity-based compensation. Excess parachute payments are parachute payments that exceed a threshold determined under Section 280G based on the executive's prior compensation. In approving the compensation arrangements for our named executive officers in the future, the Committee will consider all elements of the cost to us of providing such compensation, including the potential impact of Section 280G. However, the Committee may, in its judgment, authorize compensation arrangements that could give rise to loss of deductibility under Section 280G and the imposition of excise taxes under Section 4999 when it believes that such arrangements are appropriate to attract and retain executive talent.
Accounting Standards
ASC Topic 718, Compensation-Stock Compensation, or ASC Topic 718 (formerly known as FASB 123(R)), requires us to recognize an expense for the fair value of equity-based compensation awards. Grants of stock options, restricted stock, restricted stock units and performance units under our equity incentive award plans are accounted for under ASC Topic 718. The Committee regularly considers the accounting implications of significant compensation decisions, especially in connection with decisions that relate to our equity incentive award plans and programs. As accounting standards change, we may revise certain programs to appropriately align accounting expenses of our equity awards with our overall executive compensation philosophy and objectives.
Compensation Committee Report
The members of our Compensation Committee reviewed and discussed the above CD&A with our management and, based on that review and discussion, recommended to the Board that the CD&A be included in this Report.
By the Company's Compensation Committee
/s/ Sandra Horbach
/s/ Marco DeBenedetti
Compensation Committee Interlocks and Insider Participation
As of September 30, 2014, the Compensation Committee consisted of Sandra Horbach and Marco DeBenedetti. No member of the Compensation Committee had a relationship during fiscal 2014 requiring disclosure under Item 404 of Regulation S-K.
During fiscal 2014, none of our executive officers served as a member of the board or compensation committee of any other company that has one or more executive officers serving as a member of our Board or Compensation Committee.
2014 Summary Compensation Table
The following table sets forth information concerning total compensation earned by or paid to our named executive officers for service in fiscal 2014, 2013 and 2012. Mr. O'Keefe's total compensation is only shown for fiscal 2014 and 2013 because fiscal 2013 was the year in which he was first deemed a named executive officer of our company.
(1)For Messrs. Cahillane, Golechha, Nagel and Collins, amounts represent the executive's base salary for the partial-year of service with us in 2014.
(2)Amounts reflected in table under "All Other Compensation" for fiscal 2014 consist of the following:
(a)In fiscal 2014, Mr. Cahillane did not use the company's airplane; instead, the amount reflects the incremental cost to the company associated with Mr. Cahillane's personal use of company-paid private charter aircraft.
(b)In fiscal 2014, Mr. Golechha was reimbursed $70,568 for relocation. Mr. O'Keefe is reimbursed up to $3,000 per month plus utilities to maintain a local residence, which, in fiscal 2014, was $36,000.
Grants of Plan-Based Awards in 2014
The following table sets forth information regarding grants of plan-based awards made to our named executive officers during fiscal 2014. Messrs. Cahillane and Golechha were not granted any plan-based awards in fiscal 2014.
2014 Outstanding Equity Awards at Fiscal Year-End
The following table shows the outstanding equity-based awards relating to the common stock of Holdings that were held by our named executive officers as of September 30, 2014. Messrs. Cahillane and Golechha did not hold any outstanding equity-based awards as of September 30, 2014.
(1)The grants vest in five equal increments on each of September 4, 2012 (for Mr. O'Keefe) and January 1, 2011 (for Messrs. Kamil and Schneider).
(2)The grants vest upon achievement of a certain performance condition and a market condition relating to the achievement of a minimum investor rate of return.
(3)Due to their respective resignations, Messrs. Nagel and Collins forfeited their unexercisable and unearned stock options.
Nonqualified Deferred Compensation
The following table shows the non-qualified deferred compensation benefits for Mr. Kamil for fiscal 2014. Our other named executive officers do not participate in a non-qualified deferred compensation plan.
(1)Represents the amounts credited in fiscal 2014 as company contributions. These amounts are also reported in the "2014 Summary Compensation Table" in the "All Other Compensation" column.
(2)Represents the net amounts credited to Mr. Kamil's account as a result of the performance of the investment vehicles in which his account was deemed invested, as well as a 4% annual interest rate. These amounts do not represent above-market earnings, and thus are not reported in the "2014 Summary Compensation Table."
(3)Represents the amount of Mr. Kamil's account balance at the end of fiscal 2014, $ 46,444 of which was previously reported as compensation for Mr. Kamil in the "2014 Summary Compensation Table."
We entered into a deferred compensation life insurance agreement with Mr. Kamil. This agreement requires us to maintain a variable life insurance policy on his life.
Upon retirement on or after age 65, this agreement provides that Mr. Kamil will be entitled to receive (i) the cash surrender value of the insurance policy maintained on his life, pursuant to his previously made election (A) in a cash lump sum, or (B) in monthly installments to be paid over a period not to exceed 10 years, or (ii) the insurance policy. The cash surrender value of the policy will vary over time.
If Mr. Kamil dies while employed by us, or retires and subsequently dies before receiving all the post-retirement payments, his beneficiary will be entitled to receive a lump sum payment equal to the death benefit under the insurance policy in full discharge of all of our obligations under the deferred compensation agreement.
If Mr. Kamil's employment with us is terminated involuntarily due to a permanent disability (as defined in the relevant deferred compensation life insurance agreement) before his voluntary retirement from us, Mr. Kamil will receive a lump sum payment equal to the cash surrender value of the insurance policy unless he elects that we transfer the policy to him, and such payment or transfer will fully discharge all our obligations under the deferred compensation agreement.
Mr. Kamil will not be entitled to any benefits under the deferred compensation agreement if his employment with us is terminated under circumstances other than as described above.
Potential Payments upon Termination or Change in Control
Our named executive officers are entitled to certain payments and benefits upon a qualifying termination of employment or a change in control. The following discussion describes the payments and benefits to which our named executive officers (other than Messrs. Nagel and Collins) would have become entitled upon a qualifying termination of employment or a change in control occurring on September 30, 2014. Because Messrs. Nagel and Collins resigned in fiscal 2014, the following discussion describes the payments and benefits they actually received in connection with their resignations.
As described above, Messrs. Cahillane, Golechha, Schneider and O'Keefe each would receive an amount equal to their respective annual base salaries, payable over the one-year period following the date of termination. In addition, each would receive a pro-rata bonus with respect to the fiscal year in which the employment termination occurs (if the termination occurs on or after April 1).
In addition, Messrs. Schneider and O'Keefe may be entitled to accelerated vesting of their Holdings stock options in the event of a qualifying termination of employment or certain change in control transactions. Our named executive officers have stock option agreements under which vesting will accelerate under certain scenarios. Any and all time-based vesting options will become fully vested at the effective time of a "liquidity event," as defined in the option agreement. In the event of a "change in control" (as defined in the option agreement) that is not also a liquidity event, any and all time-based vesting options will become fully vested if the executive is terminated without cause or the executive resigns with good reason, in either case, within the 12 month period following the change in control, provided certain other conditions are met. The portion of each option grant that is subject to performance-based conditions vests, in whole or in part, as of the effective date of the first liquidity event based upon the achievement of pre-determined internal rate of return targets, as long as the named executive officer remains continuously in service through the effective date of such liquidity event. Based on the most recent valuation, as of September 30, 2014, the value of the common stock underlying the options was $473 per share.
As described above, in connection with their resignations, Messrs. Nagel and Collins are eligible to receive the following payments: (i) an amount equal to the executive's annual base salary (2x, for Mr. Nagel), payable over the one-year period (two-year period, for Mr. Nagel) following his employment termination, and (ii) a pro-rata bonus for fiscal 2014. Based on the company's performance, Messrs. Nagel and Collins will not receive a pro-rata bonus for fiscal 2014.
Under the terms of a December 6, 2010 stock option grant to Mr. Nagel relating to Holdings common stock, 24,734 options were subject to time-based vesting provisions and 24,734 options were subject to performance-based vesting provisions. The options subject to time-based vesting provisions were scheduled to vest in five equal increments on each of the first five anniversaries of December 6, 2010. Upon Mr. Nagel's resignation on September 8, 2014, 60% of the options, or 14,840 options, had vested. In connection with his resignation, a pro rata portion of the unvested options subject to time-based vesting provisions that would otherwise have vested on December 6, 2014 vested, as specified in Mr. Nagel's employment agreements, increasing the total number of Mr. Nagel's vested options to 18,567. The vesting of Mr. Nagel's performance-based options were not accelerated upon his termination and were therefore forfeited.
Under the terms of a June 13, 2011 stock option grant to Mr. Collins relating to Holdings common stock, 6,000 options were subject to time-based vesting provisions and 6,000 options were subject to performance-based vesting provisions. The options subject to time-based vesting provisions were scheduled to vest in five equal increments on each of the first five anniversaries of June 13, 2011. Upon Mr. Collins's resignation on September 5, 2014, 60% of the options, or 3,600 options, had vested. The vesting of Mr. Collins's performance-based options were not accelerated upon his termination and were therefore forfeited.
Please refer to the narrative under the "Nonqualified Deferred Compensation" table above for a description of payments that may be made to Mr. Kamil in the event of the termination of his employment due to death or disability under his deferred compensation life insurance agreement.
Summary of Potential Payments
The following table summarizes the payments that would be made to Messrs. Cahillane, Golechha, Schneider and O'Keefe upon the occurrence of a qualifying termination of employment, change in control or liquidity event, assuming that each named executive officer's termination of employment with
our company occurred on September 30, 2014 or a change in control of our company or liquidity event occurred on September 30, 2014, as applicable. Because Messrs. Nagel and Collins resigned in fiscal 2014, the following table summarizes the payments and benefits they actually received in connection with their resignations. Amounts shown do not include (i) accrued but unpaid salary through the date of termination, and (ii) other benefits earned or accrued by the named executive officer during his employment that are available to all employees, such as accrued vacation.
(1)With respect to Messrs. Cahillane, Golechha, Schneider and O'Keefe, a qualifying termination includes a termination of employment by us without cause, by the executive for good reason or in connection with our non-extension of the executive's employment agreement term.
(2)Amount represents (1) cash severance and (2) a cash bonus for the 2014 fiscal year; however, none of the named executive officers received a cash bonus for the 2014 fiscal year due to the company's performance.
(3)Amounts represent the aggregate value of the executive's unvested time-vesting stock options that would have vested on the applicable event. Upon the occurrence of a liquidity event on
September 30, 2014, no outstanding performance-based vesting stock options would have accelerated since the minimum internal rate of return would not have been achieved as of such date. The value of the accelerated stock option was calculated by multiplying (x) the number of shares subject to acceleration by (y) the difference between the fair market value of a share of our common stock on September 30, 2014 ($473) and the per share exercise price of the accelerated option.
(4)Mr. Schneider has entered into a one-year consulting agreement with NBTY and Holdings pursuant to which he will receive $525,000 in fees. In addition, during the term of the agreement, Mr. Schneider's time-based options shall continue to vest in accordance with the schedule set forth in his stock-option grant. NBTY, Holdings and Mr. Schneider separately agreed that any severance payments payable under Mr. Schneider's employment agreement shall be postponed until after the expiration of the consulting agreement.
Directors
Set forth below is a discussion of compensation we paid during fiscal 2014 to our non-employee Directors. In addition, each Director (other than Steven Cahillane and Jeffrey Nagel) was reimbursed for out-of-pocket expenses incurred by him or her to attend meetings of our Board. Directors are also eligible for option grants or other equity awards (each relating to or exercisable for common stock of Holdings) under our equity awards plans, as determined in the discretion of the Compensation Committee. We do not offer a pension plan or other compensation to our Directors. During fiscal 2014, any Director who was also our executive officer did not receive additional compensation for his services as a Director. See "2014 Summary Compensation Table" above for information regarding Steven Cahillane's and Jeffrey Nagel's compensation.
The aggregate number of option awards outstanding at September 30, 2014 was 600 for Messrs. Bernauer and Essner, and 1,600 for Ms. Arnold. Ms. Arnold was awarded additional options in fiscal 2014 to recognize her increased role during the management transition.
(1)Amounts shown represent the grant date fair value of stock options awards made during fiscal 2014. We calculated this fair value based on the Monte Carlo Simulation option-pricing model, determined in accordance with GAAP based on the assumptions described in Note 14 to our audited financial statements included in this Report. Ms. Arnold's stock option is scheduled to vest in five increments on each of the first five anniversaries of the vesting commencement date, subject to continued service. The number of shares subject to outstanding stock option awards as of September 30, 2014 was 600 for Messrs. Bernauer and Essner, and 1,600 for Ms. Arnold.
Risk Assessment of Compensation Practices
Our Compensation Committee, with input from our management, assists our Board in reviewing and assessing whether any of our compensation policies and programs could potentially encourage
excessive risk-taking. In considering our employee compensation policies and practices, the Compensation Committee reviews, in depth, our policies related to payment of salaries and wages, benefits, bonuses, stock-based compensation and other compensation-related practices and considers the relationship between risk management policies and practices, corporate strategy and compensation. A primary focus of our compensation program is intended to incentivize and reward growth in Adjusted EBITDA among other metrics. We believe these metrics are positive indicators of our long-term growth, operating results and increased stockholder value and therefore believe that our compensation program does not create risks that are reasonably likely to have a material adverse effect on us.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
NBTY is a direct, wholly-owned subsidiary of Holdings. All the outstanding capital stock of Holdings is owned by Carlyle and certain of its affiliates and co-investors.
The following table sets forth the number of shares of Holdings common stock beneficially owned as of November 24, 2014 by: (i) each of our Directors; (ii) the executive officers named in the Summary Compensation Table set forth above under Item 11, "Executive Compensation;" and (iii) the current Directors and executive officers as a group:
(1)The shares beneficially owned by directors and named executive officers, except for Mr. Nagel's, are Class B non-voting shares. This Column includes shares which Directors and executive officers have the right to acquire within 60 days after November 24, 2014.
(2)* Indicates percentage ownership of less than one percent.
(3)Consists of 1,902,202 shares of Class A common stock owned directly by Carlyle Partners V, L.P., 38,256 shares of Class A common stock owned directly by Carlyle Partners V-A, L.P., 71,759 shares of Class A common stock owned directly by CP V Coinvestment A, L.P., 8,846 shares of Class A common stock owned directly by CP V Coinvestment B, L.P., 278,937 shares of Class A common stock owned directly by Carlyle NBTY Coinvestment, L.P., and 800,000 shares of Class A common stock owned directly by CEP III Participations S.à r.l., SICAR. Carlyle Group Management L.L.C. is the general partner of The Carlyle Group L.P., which is a publicly traded entity listed on NASDAQ. The Carlyle Group L.P. is the managing member of Carlyle Holdings II GP L.L.C., which is the general partner of Carlyle Holdings II L.P., which is the general partner of TC Group Cayman Investment Holdings, L.P., which is the general partner of TC Group Cayman Investment Holdings Sub L.P., which is the managing member of TC Group V, L.L.C. and the sole shareholder of CEP III Managing GP Holdings, Ltd. TC Group V, L.L.C. is the general partner of TC Group V, L.P., which is the general partner of each of Carlyle Partners V, L.P., Carlyle Partners V-A, L.P., CP V Coinvestment A, L.P., CP V Coinvestment B, L.P. and Carlyle NBTY Coinvestment, L.P.
CEP III Managing GP Holdings, Ltd. is the general partner of CEP III Managing GP, L.P., which is the general partner of Carlyle Europe Partners III, L.P., which is the sole shareholder of CEP III Participations S.à r.l., SICAR. Accordingly, each of Carlyle Group Management L.L.C., The Carlyle Group L.P., Carlyle Holdings II GP L.L.C., Carlyle Holdings II L.P., TC Group Cayman Investment Holdings, L.P., TC Group Cayman Investment Holdings Sub L.P., TC Group V, L.L.C., TC Group V, L.P., CEP III Managing GP Holdings, Ltd., CEP III Managing GP, L.P., and Carlyle Europe Partners III, L.P. may be deemed to share beneficial ownership of the Class A common stock held of record by each of Carlyle Partners V, L.P., Carlyle Partners V-A, L.P., CP V Coinvestment A, L.P., CP V Coinvestment B, L.P., Carlyle NBTY Coinvestment, L.P. and CEP III Participations S.à r.l., SICAR.
(4)The address of each of our named executive officers and Directors is our headquarters at 2100 Smithtown Avenue, Ronkonkoma, New York 11779.
(5)Does not include shares of common stock of Holdings held by Carlyle. Messrs. DeBenedetti, Holt and Wagner and Ms. Horbach are directors of NBTY Inc. and Managing Directors of Carlyle. Such persons disclaim beneficial ownership of the shares of Holdings held by Carlyle.
(6)Mr. Schneider was our former President Global Wholesale and resigned effective October 31, 2014.
(7)Mr. Nagel was our former Chief Executive Officer and director and resigned effective September 8, 2014.
(8)Mr. Collins was our former Chief Financial Officer and resigned effective September 5, 2014.
Securities Authorized for Issuance under Equity Compensation Plans
The following table summarizes the Equity Incentive Plan of Holdings, as of September 30, 2014:
Item 13.
Item 13. Certain Relationships and Related Party Transactions, and Director Independence
Procedures for Review, Approval or Ratification of Related Person Transactions
Our Code of Business Conduct requires our Directors, officers and employees to act in the best interests of the Company, regardless of personal relationships. To avoid actual or perceived conflicts of interests, the Board has implemented a written policy requiring the Board to review and approve all transactions in which any of the following persons had, has, or will have, a direct or indirect material interest:
• any Director, nominee for Director, or executive officer;
• any person we know beneficially owns more than 5% of our common stock;
• any immediate family member of any Director, executive officer, or 5% beneficial owner; and
• any entity in which any such person is employed or has a 5% or greater beneficial interest, or of which any such person is a partner or principal (or holds a similar position).
The Board (excluding the interested Director, if any) is responsible for reviewing and approving these transactions. Except as disclosed below, no transactions required review since the beginning of the last fiscal year and no proposed transactions are currently being considered.
The Board will approve only those transactions that are in, or are not inconsistent with, the best interests of the Company.
Related Party Transactions
Consulting Agreement-Carlyle
In connection with the Merger, NBTY entered into a consulting agreement with Carlyle under which NBTY pays Carlyle a fee for consulting services Carlyle provides to us and our subsidiaries. Pursuant to this agreement, NBTY pays an annual consulting fee to Carlyle of $3 million and may pay Carlyle additional fees associated with other future transactions. This agreement is effective until the date as of which Carlyle or one or more of its affiliates no longer collectively control, in the aggregate, at least 5% of the equity interests of NBTY, or such earlier date as NBTY and Carlyle may mutually agree.
Consulting Agreement-Glenn Schneider
On November 19, 2014, NBTY and Holdings entered into a consulting agreement with Glenn Schneider. See Item 11. Executive Compensation-Employment Agreements-Employment Agreement for Glenn Schneider.
Employees Related to Our Directors and Officers
NBTY employs certain members of the immediate family of Glenn Schneider (an officer of the Company). During fiscal 2014, two of Mr. Schneider's immediate family members received aggregate compensation (excluding bonuses) and fringe benefits from NBTY totaling $653,477, of which $ 466,470, was paid to Darren Schneider and $187,007 (primarily severance payments) was paid to Jeffrey Schneider, for services they rendered as associates of NBTY. Mr. Jeffrey Schneider is no longer an employee of NBTY.
Stockholders Agreement
On December 3, 2010, Holdings entered into a stockholders agreement with Carlyle, certain affiliates of Carlyle, and a former member of management who purchased common stock and was awarded options to purchase common stock on or about such date. Certain other employees of Holdings who purchase common stock or exercise options from time to time may also become parties to this agreement. We refer to Carlyle and its affiliates as the Carlyle Shareholders and to the member of management and to each of the other employees who becomes a party to the agreement as an Employee Shareholder. The stockholders agreement contains, among other things:
• a restriction on the transfer of shares by the Employee Shareholders without the consent of the board of directors of Holdings;
• an agreement by the Employee Shareholders to sell a pro rata portion of their shares and options in the event of a transfer of common stock by Carlyle Shareholders to a third party purchaser; and
• a right of Holdings or its designee to repurchase the shares and options of an Employee Shareholder following the termination of such Employee Shareholder's employment by Holdings or its affiliates or the expiration of Employee Shareholder's vested options.
The stockholders agreement will terminate when Holdings becomes a reporting company and its common stock is listed on one or more National Securities Exchanges or is quoted on NASDAQ, or upon a resolution of the Board of Directors.
Director Independence
Information on the independence of our Board is included above under Item 10, "Directors, Executive Officers and Corporate Governance-Director Independence and Selection."
Item 14.
Item 14. Principal Accounting Fees and Services
Audit Fees
PricewaterhouseCoopers LLP audit services during fiscal 2014 consisted of the examination of our financial statements and services related to our filings with the SEC. All fees paid to PricewaterhouseCoopers LLP and all services provided by PricewaterhouseCoopers LLP during fiscal 2014 were reviewed, considered for independence, and approved by the Audit Committee.
Aggregate fees billed to the Company for fiscal 2014 and 2013 represent the fees for services performed by PricewaterhouseCoopers LLP.
Audit Fees
For fiscal 2014 aggregate audit fees, including out-of-pocket expenses, were for professional services rendered in connection with (i) the integrated audit of our consolidated financial statements and internal control over financial reporting as of, and for the year ended, September 30, 2014, including statutory audits of the financial statements of our affiliates, (ii) review of our unaudited condensed consolidated interim financial statements as of December 31, 2013, March 31, 2014 and June 30, 2014, (iii) reviews of documents filed with the SEC and (iv) agreed upon procedures for certain affiliates.
For fiscal 2013 aggregate audit fees, including out-of-pocket expenses, were for professional services rendered in connection with (i) the integrated audit of our consolidated financial statements and internal control over financial reporting as of, and for the year ended, September 30, 2013, including statutory audits of the financial statements of our affiliates, (ii) review of our unaudited condensed consolidated interim financial statements as of December 31, 2012, March 31, 2013 and June 30, 2013, (iii) reviews of documents filed with the SEC and (iv) agreed upon procedures for certain affiliates.
Audit-Related Fees
For both fiscal 2014 and 2013, aggregate audit-related fees, including out-of-pocket expenses, were for professional services related to due diligence procedures in connection with acquisitions.
Tax Fees
For both fiscal 2014 and 2013, aggregate tax fees, including out-of-pocket expenses, were for professional services rendered in connection with tax compliance and advice for the applicable fiscal year. Tax services included U.S. and foreign tax compliance assistance, consultation and advice on various foreign tax matters.
All Other Fees
For fiscal 2014 and 2013 other fees were for accounting research software license fees.
Procedures for Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of Independent Auditor
The Charter for the Audit Committee provides that the Audit Committee pre-approve, on an annual basis, the audit, audit-related, tax and other non-audit services to be rendered by the Company's accountants, based on historical information and anticipated requirements for the following fiscal year. The Audit Committee must pre-approve specific types or categories of engagements constituting audit, audit-related, tax and other non-audit services, as well as the range of fee amounts corresponding to each such engagement. During fiscal 2014, the Audit Committee approved all fees for audit, audit-related, tax services and non-audit services rendered to the Company under this policy.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) Financial Statements and Financial Statement Schedule.
See the "Index to Consolidated Financial Statements" included in this Report.
(b) Exhibits. The following exhibits are attached as a part of this Report, or incorporated by reference, and will be furnished to any security holder upon request for such exhibit and payment of any reasonable expenses incurred by us. A security holder should send requests for any of the exhibits set forth below to Alphabet Holding Company, Inc., 2100 Smithtown Avenue, Ronkonkoma, New York 11779, Attention: General Counsel.
Exhibit No.
Description
2.1
Agreement and Plan of Merger, dated July 15, 2010, among NBTY, Inc., Alphabet Holding Company, Inc. and Alphabet Merger Sub, Inc.(1)
2.2
Stock Purchase Agreement among NBTY, Inc., Balance Bar Company, Balance Bar Holdings LLC dated November 19, 2012.(2)
3.1
Third Amended and Restated Certificate of Incorporation of Alphabet Holding Company, Inc.(*)
3.2
Second Amended and Restated By-Laws of Alphabet Holding Company, Inc.(3)
4.1
Indenture, dated as of October 17, 2012, between Alphabet Holding Company, Inc. and The Bank of New York Mellon, as trustee, governing the 7.75% / 8.50% Contingent Cash Pay Senior Notes due 2017.(4)
4.2
Form of 7.75% / 8.50% Contingent Cash Pay Senior Notes due 2017 (included as Exhibit A to Exhibit 4.1).
4.3
First Supplemental Indenture dated December 10, 2013 between Alphabet Holding Company, Inc. and The Bank of New York Mellon, as trustee.(5)
4.4
Second Supplemental Indenture dated December 12, 2013 between Alphabet Holding Company, Inc. and The Bank of New York Mellon, as trustee.(5)
10.1
Employment Agreement, dated November 8, 2010, by and among NBTY, Inc., Alphabet Holding Company, Inc. and Jeffrey A. Nagel(6)
10.2
Stock Option Agreement, dated December 6, 2010, by and between Alphabet Holding Company, Inc. and Jeffrey Nagel(6)
10.3
Stock Purchase Agreement, dated December 17, 2010, by and between Alphabet Holding Company, Inc. and Jeffrey Nagel(6)
10.4
Employment Agreement, dated May 24, 2011, by and among NBTY, Inc., Alphabet Holding Company, Inc. and Michael Collins(7)
10.5
Employment Agreement, effective March 1, 2008, by and between NBTY, Inc. and Harvey Kamil(8)
10.6
Indemnification Agreement, dated May 18, 2011 between NBTY, Inc. and Harvey Kamil(7)
10.7
Letter Agreement, dated May 18, 2011, by and between NBTY, Inc. and Harvey Kamil(7)
10.8
Employment Agreement, dated April 25, 2011, by and among NBTY, Inc., Alphabet Holding Company, Inc. and Karla Packer(7)
10.9
NBTY, Inc. Retirement Profit Sharing Plan(9)
10.10
Credit Agreement, dated October 1, 2010 (the "Credit Agreement"), among NBTY, Inc., Alphabet Holding Company, Inc., Barclays Bank PLC and the other lenders party thereto.(6)
10.11
First Amendment and Refinancing Agreement, dated March 1, 2011, amending the Credit Agreement.(6)
10.12
Subsidiary Guaranty, dated October 1, 2010, from the Guarantors named therein in favor of the secured parties named in the Credit Agreement(6)
Exhibit No.
Description
10.13
Security Agreement, dated October 1, 2010, from the Grantors named therein to Barclays Bank PLC.(6)
10.14
Form of Director Indemnification Agreement(6)
10.15
Equity Incentive Plan of Alphabet Holding Company, Inc.(6)
10.16
Form of Stock Option Agreement for Equity Incentive Plan of Alphabet Holding Company, Inc.(6)
10.17
Executive Severance Pay Plan(9)
10.18
Form of Employment Agreement dated February 29, 2012, by and among NBTY, Inc., Alphabet Holding Company, Inc. and Katia Facchetti.(10)
10.19
Form of Employment Agreement dated March 2, 2012, by and among NBTY, Inc., Alphabet Holding Company, Inc. and Christopher S. Brennan.(10)
10.20
Employment Agreement, dated August 6, 2012, by and among NBTY, Inc., Alphabet Holding Company, Inc. and Glenn Schneider.(11)
10.21
Employment Agreement, dated August 14, 2012, by and among NBTY, Inc., Alphabet Holding Company, Inc. and Bernard O'Keefe.(4)
10.22
Second Amendment Agreement, dated October 11, 2012, amending the Credit Agreement.(4)
10.23
Third Amendment and Second Refinancing Agreement, dated March 21, 2013, by and among NBTY, Inc. as Borrower, Alphabet Holding Company, Inc., Barclays Bank PLC as Lead Arranger and Bookrunner, Barclays Bank PLC as Administrative Agent, and the banks and other financial institutions party thereto as lenders.(12)
10.24
Management Incentive Plan of NBTY, Inc. for U.S. based associates.(13)
10.25
Stockholders Agreement dated December 3, 2010 by and between Alphabet Holding Company, Inc. and certain Carlyle entities(3)
10.26
Employment Agreement, dated August 14, 2014, by and among NBTY, Inc., Alphabet Holding Company, Inc. and Dipak Golechha*
10.27
Employment Agreement, dated August 18, 2014, by and among NBTY, Inc., Alphabet Holding Company, Inc. and Steven Cahillane*
10.28
Fourth Amendment and Third Refinancing to Credit Agreement, dated November 20, 2014, by and among, NBTY, Inc., Alphabet Holding Company, Inc., Barclays Bank PLC, and the banks and other financial institutions party thereto as lenders.*
10.29.
Consulting Agreement dated November 19, 2014, among NBTY, Inc., Alphabet Holding Company, Inc. and Glenn Schneider.*
10.30
Agreement and Release, dated November 19, 2014, among NBTY, Inc., Alphabet Holding Company, Inc. and Glenn Schneider.*
12.1
Statement regarding Computation of Ratio of Earnings to Fixed Charges*
21.1
Subsidiaries of Alphabet Holding Company, Inc.*
31.1
Rule 13a-14(a) Certification of Principal Executive Officer.*
31.2
Rule 13a-14(a) Certification of Principal Financial Officer.*
32.1
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
32.2
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
101.INS
XBRL Instance Document.**
101.SCH
XBRL Taxonomy Extension Schema Document**
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document**
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document**
101.LAB
XBRL Taxonomy Extension Label Linkbase Document**
Exhibit No.
Description
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document**
*Filed herewith.
**Pursuant to rule 406T of Regulation S-T, the Interactive Data Files included in Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
(1)Incorporated by reference to NBTY, Inc.'s Form 8-K, filed July 16, 2010 (File #001-31788).
(2)Incorporated by reference to NBTY, Inc.'s Form 8-K, filed November 26, 2012 (File #001-31788).
(3)Incorporated by reference to Alphabet Holding Company, Inc.'s Registration Statement on Form S-4, filed February 22, 2013 (File #333-186802).
(4)Incorporated by reference to NBTY, Inc.'s Form 10-K, filed November 27, 2012 (File #001-31788).
(5)Incorporated by reference to Holdings' Form 8-K, filed December 13, 2013 File #333-186802)
(6)Incorporated by reference to NBTY, Inc.'s Registration Statement on Form S-4, filed March 21, 2011 (File #333-172973).
(7)Incorporated by reference to NBTY, Inc.'s Amendment No. 1 to the Registration Statement on Form S-4/A, filed June 10, 2011 (File #333-172973).
(8)Incorporated by reference to NBTY, Inc.'s Form 8-K, filed April 3, 2008 (File #001-31788).
(9)Incorporated by reference to NBTY, Inc.'s Form 10-K, filed November 23, 2011 (File #001-31788).
(10)Incorporated by reference to NBTY, Inc.'s Form 10-Q, filed May 9, 2012 (File #001-31788).
(11)Incorporated by reference to NBTY, Inc.'s Form 10-Q, filed August 7, 2012 (File #001-31788).
(12)Incorporated by reference to NBTY, Inc.'s Form 8-K, filed March 21, 2013 (File #001-31788).
(13)Incorporated by reference to NBTY, Inc.'s Form 10-Q, filed August 7, 2013 (File #001-31788).
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
ALPHABET HOLDING COMPANY, INC.
(Registrant)
By:
/s/ STEVEN CAHILLANE
Steven Cahillane
Chief Executive Officer, President and Director
Dated: November 24, 2014
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Alphabet Holding Company, Inc., and Subsidiary
Index to Consolidated Financial Statements
September 30, 2014, 2013 and 2012
Page(s)
Report of Independent Registered Public Accounting Firm
Consolidated Financial Statements
Balance Sheets
Statements of Operations and Comprehensive Income (Loss)
Statements of Stockholders' Equity
Statements of Cash Flows
Notes to Financial Statements
Parent Company Information
S-1
Valuation and Qualifying Accounts
S-6
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Alphabet Holding Company, Inc.:
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Alphabet Holding Company, Inc. and its subsidiary at September 30, 2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2014 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2014, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). The Company's management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company's internal control over financial reporting based on our audit, which was an integrated audit in 2014. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
New York, New York
November 24, 2014
Alphabet Holding Company, Inc., and Subsidiary
Consolidated Balance Sheets
September 30, 2014 and 2013
(in thousands, except share and per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
Alphabet Holding Company, Inc., and Subsidiary
Consolidated Statements of Operations and Comprehensive Income (Loss)
Years Ended September 30, 2014, 2013 and 2012
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
Alphabet Holding Company, Inc., and Subsidiary
Consolidated Statements of Stockholders' Equity
Years Ended September 30, 2014, 2013 and 2012
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
Alphabet Holding Company, Inc., and Subsidiary
Consolidated Statements of Cash Flows
Years Ended September 30, 2014, 2013 and 2012
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements
(in thousands, except share amounts)
1. Nature of Business
Alphabet Holding Company, Inc. ("Holdings"), and together with its subsidiary, NBTY, Inc. ("NBTY"), together with NBTY's Subsidiaries, (the "Company," "we," or "us") is the leading global vertically integrated manufacturer, marketer, distributor and retailer of a broad line of high-quality vitamins, nutritional supplements and related products in the United States, with operations worldwide. Our products are marketed through four operating segments: Wholesale, European Retail, Direct Response/E-Commerce and North American Retail. We market over 25,000 individual stock keeping units ("SKUs") under numerous owned and private-label brands, including Nature's Bounty®, Ester-C®, Balance Bar®, Solgar®, MET-Rx®, American Health®, Osteo Bi-Flex®, SISU®, Sundown®, Pure Protein®, Body Fortress®, Natural Wealth®, Puritan's Pride®, Holland & Barrett®, GNC® (UK), Physiologics®, De Tuinen®, Essenza® and Vitamin World®.
2. Summary of Significant Accounting Policies
Basis of Presentation and Consolidation
On October 1, 2010, pursuant to an Agreement and Plan of Merger, dated as of July 15, 2010, among NBTY, Holdings formed by an affiliate of TC Group, L.L.C. (d/b/a The Carlyle Group) and Alphabet Merger Sub, Inc., a Delaware corporation and a wholly owned subsidiary of Holdings ("Merger Sub") formed solely for the purpose of entering into the Merger, Merger Sub merged with and into NBTY with NBTY as the surviving corporation (also referred herein as the "Merger"). As a result of the Merger, NBTY became a wholly owned subsidiary of Holdings.
Our financial statements are prepared in conformity with U.S. generally accepted accounting principles ("GAAP"). The consolidated financial statements include the financial statements of the Company and its wholly-owned subsidiaries. All inter-company balances and transactions are eliminated in consolidation.
Effective July 2, 2012, Julian Graves Limited was placed into administration under the laws of the United Kingdom and Wales, and this former subsidiary is reported as discontinued operations in the accompanying financial statements. During the course of the administration, attempts to sell the business were unsuccessful and the operations were wound down by the end of August 2012. The operations of this subsidiary were previously reported in the European Retail segment.
Effective August 31, 2012, we sold certain assets and liabilities of Le Naturiste, Inc., and have reported this former subsidiary as discontinued operations in the accompanying financial statements. The operations of this subsidiary were previously reported in the North American Retail segment.
All amounts related to discontinued operations are excluded from the notes to the consolidated financial statements unless otherwise indicated. See Note 4 for additional information about discontinued operations.
Estimates
The preparation of financial statements in conformity with GAAP requires that we make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosures of contingent assets and liabilities at the dates of the financial statements and reported amounts of revenues and expenses during the reporting periods. These judgments can be subjective and complex, and consequently actual results could differ materially from those estimates and assumptions. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share amounts)
2. Summary of Significant Accounting Policies (Continued)
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. Our most significant estimates include: sales returns, promotions and other allowances; inventory valuation and obsolescence; valuation and recoverability of long-lived assets, including goodwill and intangible assets; stock-based compensation; income taxes; and accruals for the outcome of current litigation.
Cash and Cash Equivalents
We consider all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
Revenue Recognition
We recognize product revenue when title and risk of loss have transferred to the customer, there is persuasive evidence of an arrangement to deliver a product, delivery has occurred, the sales price is fixed or determinable and collectibility is reasonably assured. The delivery terms for most sales within the Wholesale and Direct Response/E-Commerce segments are F.O.B. destination. Generally, title and risk of loss transfer to the customer at the time the product is received by the customer. With respect to retail store operations, we recognize revenue upon the sale of products to customers. Net sales represent gross sales invoiced to customers, less certain related charges for discounts, returns and other promotional program incentive allowances.
Sales Returns and Other Allowances
Allowance for sales returns: Estimates for sales returns are based on a variety of factors, including actual return experience of specific products or similar products. We are able to make reasonable and reliable estimates of product returns based on our 40 plus year history in this business. We also review our estimates for product returns based on expected return data communicated to us by customers. Additionally, we monitor the levels of inventory at our largest customers to avoid excessive customer stocking of merchandise. Allowances for returns of new products are estimated by reviewing data of any prior relevant new product return information. We also monitor the buying patterns of the end-users of our products based on sales data received by our retail outlets in North America and Europe.
Promotional program incentive allowances: We estimate our allowance for promotional program incentives based upon specific outstanding marketing programs and historical experience. The allowance for sales incentives offered to customers is based on various contractual terms or other arrangements agreed to in advance with certain customers. Generally, customers earn such incentives as specified sales volumes are achieved. We accrue these incentives as a reduction to sales either at the time of sale or over the period of time in which they are earned, depending on the nature of the program.
Allowance for doubtful accounts: We perform on-going credit evaluations of our customers and adjust credit limits based upon payment history and the customer's current credit worthiness, as determined by our review of current credit information. We estimate bad debt expense based upon historical experience as well as specifically identified customer collection issues to adjust the carrying amount of the related receivable to its estimated net realizable value.
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(in thousands, except share amounts)
2. Summary of Significant Accounting Policies (Continued)
Accounts receivable are presented net of the following reserves at September 30:
Inventories
Inventories are stated at the lower of cost (first-in first-out method) or market. The cost elements of inventories include materials, labor and overhead. In evaluating whether inventories are stated at the lower of cost or market, we consider such factors as the amount of inventory on hand, estimated time required to sell such inventory, remaining shelf life and current and expected market conditions, including levels of competition. Based on this evaluation, we record an adjustment to cost of sales to reduce inventories to its estimated net realizable value.
Property, Plant and Equipment
Property, plant and equipment are carried at cost. Depreciation is charged on a straight-line basis over the estimated useful lives of the related assets. The costs of normal maintenance and repairs are charged to expense when incurred. Expenditures which significantly improve or extend the life of an asset are capitalized and depreciated over the asset's remaining useful life. Amortization of leasehold improvements is computed using the straight-line method over the shorter of the estimated useful lives of the related assets or the remaining lease term. Upon sale or disposition, the related cost and accumulated depreciation are removed from the accounts and the resulting gain or loss, if any, is reflected in operations.
Capitalized Software Costs
We capitalize certain costs related to the acquisition and development of software for internal use and amortize these costs using the straight-line method over the estimated useful life of the software. These costs are included in property, plant and equipment in the accompanying Consolidated Balance Sheets.
Goodwill and Intangible Assets
Goodwill and indefinite-lived intangible assets are tested for impairment annually or more frequently if impairment indicators are present. We consider the following to be some examples of important indicators that may trigger an impairment review: (i) a history of cash flow losses at retail stores; (ii) significant changes in the manner or use of the acquired assets in our overall business strategy; (iii) significant negative industry or economic trends; (iv) increased competitive pressures; and (v) regulatory changes. Our annual impairment testing date is as of July 1, the first day of our fourth quarter.
Goodwill is tested for impairment using a two-step process. In the first step, the fair value of a reporting unit is compared to its carrying value. If the fair value of a reporting unit exceeds the carrying value of the net assets assigned to a reporting unit, goodwill is not considered impaired and no
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2. Summary of Significant Accounting Policies (Continued)
further testing is required. If the carrying amount of the reporting unit exceeds its fair value, a second step is performed to determine whether there is a goodwill impairment, and if so, the amount of the impairment. This step revalues all assets and liabilities of the reporting unit to their current fair value and then compares the implied fair value of the reporting unit's goodwill to the carrying amount of that goodwill. If the carrying amount of the reporting unit's goodwill exceeds the implied fair value of the goodwill, an impairment loss is recognized in an amount equal to the excess. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. We use a combination of the income and market approaches, weighted equally, to estimate the fair value of our reporting units.
The fair value of our trademarks is determined based on the relief from royalty method under the income approach, which requires us to estimate a reasonable royalty rate, identify relevant projected revenues and expenses, and select an appropriate discount rate. The evaluation of indefinite-lived intangible assets for impairment requires management to use significant judgments and estimates including, but not limited to, projected future net sales, operating results, and cash flows of our business.
We base our fair value estimates on assumptions we believe to be reasonable, but such assumptions are subject to inherent uncertainties. Accordingly, if actual results fall short of such estimates, significant future impairments could result. An impairment charge would reduce income from operations in the period it was determined that the charge was needed. Goodwill and intangible assets are further discussed in Note 8 to the Consolidated Financial Statements.
Impairment of Long-Lived Assets
We evaluate the need for an impairment charge relating to long-lived assets, including definite lived intangible assets, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability is measured by comparing the carrying amount of an asset group to its expected future net cash flows generated by the asset group. If the carrying amount of an asset group exceeds its estimated undiscounted future cash flows, the carrying amount is compared to its fair value and an impairment charge is recognized to the extent of the difference. On a quarterly basis, we assess whether events or changes in circumstances occur that potentially indicate that the carrying value of long-lived assets may not be recoverable. Considerable management judgment is necessary to estimate projected future operating cash flows. Accordingly, if actual results fall short of such estimates, significant future impairments could result.
Income Taxes
We recognize deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. We estimate the degree to which tax assets and credit carryforwards will result in a benefit based on expected profitability by tax jurisdiction. A valuation allowance for such tax assets and loss carryforwards is provided when it is determined that such assets will, more likely than not, go unused. If it becomes more likely than not that a tax asset will be used, the related valuation allowance on such assets would be reversed. Management makes judgments as to the interpretation of the tax laws that
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2. Summary of Significant Accounting Policies (Continued)
might be challenged upon an audit and cause changes to previous estimates of tax liability. In addition, we operate within multiple taxing jurisdictions and are subject to audit in these jurisdictions. We believe adequate provisions for income taxes have been made for all years. If actual taxable income by tax jurisdiction varies from estimates, additional allowances or reversals of reserves may be necessary.
Accruals for Litigation and Other Contingencies
We are subject to legal proceedings, lawsuits and other claims related to various matters. We are required to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses. We determine the amount of reserves needed, if any, for each individual issue based on our knowledge and experience and discussions with legal counsel. These reserves may change in the future due to new developments in each matter (including the enactment of new laws), the ultimate resolution of each matter or changes in approach, such as a change in settlement strategy. In some instances, we may be unable to make a reasonable estimate of the liabilities that may result from the final resolution of certain contingencies disclosed and accordingly, no reserve is recorded until such time that a reasonable estimate may be made.
Shipping and Handling Costs
We incur shipping and handling costs in all segments of our operations. These costs, included in selling, general and administrative expenses in the Consolidated Statements of Operations and Comprehensive Income (Loss), were $97,382, $92,062 and $85,784 for the fiscal years ended September 30, 2014, 2013 and 2012, respectively. Of these amounts, $20,862, $14,050 and $13,831 have been billed to customers and are included in net sales for the fiscal years ended September 30, 2014, 2013 and 2012, respectively.
Advertising, Promotion and Catalog
We expense the production costs of advertising as incurred, except for the cost of mail order catalogs, which are capitalized and amortized over our expected period of future benefit, which typically approximates two months. Capitalized costs for mail order catalogs at September 30, 2014 and 2013 were $671 and $740, respectively. Total mail order catalog expense was $9,093, $7,713 and $9,378 for the fiscal years ended September 30, 2014, 2013 and 2012, respectively, and is included in advertising, promotion and catalog in the Consolidated Statements of Operations and Comprehensive Income (Loss).
Foreign Currency
The functional currency of our foreign subsidiaries is the applicable local currency. The translation of the applicable foreign currencies into U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts and cash flows using average rates of exchange prevailing during the year. Adjustments resulting from the translation of foreign currency financial statements are accumulated in a separate component of stockholders' equity.
Derivatives and Hedging Activities
All derivative financial instruments are recognized as either assets or liabilities in the Consolidated Balance Sheets and measurement of those instruments is at fair value. Changes in the fair values of
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2. Summary of Significant Accounting Policies (Continued)
these derivatives are reported in operations or accumulated other comprehensive income (loss) depending on the designation of the derivative and whether it qualifies for hedge accounting. For derivatives that have been formally designated as cash flow hedges (interest rate swap agreements), the effective portion of changes in the fair value of the derivative is recorded in accumulated other comprehensive income (loss) and reclassified into operations when interest expense on the underlying borrowings is recognized. For hedges of the net investment in foreign subsidiaries (cross currency swap agreements), changes in fair value of the derivative are recorded in accumulated other comprehensive income (loss) to offset the change in the value of the net investment being hedged. We do not use derivative financial instruments for trading purposes.
Revision
A revision was made to the Statements of Operations and Comprehensive Income (Loss) to correct the prior year presentation, whereby changes in the fair value of the cross-currency swap were reclassified from changes in the fair value of interest rate swaps to foreign currency translation adjustments.
Recent Accounting Developments
In March 2013, the FASB issued guidance on a parent's accounting for the cumulative translation adjustment upon derecognition of a subsidiary or group of assets within a foreign entity. This new guidance requires that the parent release any related cumulative translation adjustment into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. The new guidance has been effective for us since October 1, 2014. The adoption of this guidance is not expected to have a material impact on the Company's consolidated financial statements.
In July 2013, the FASB issued guidance which amends the guidance related to the presentation of unrecognized tax benefits and allows for the reduction of a deferred tax asset for a net operating loss carryforward whenever the net operating loss carryforward or tax credit carryforward would be available to reduce the additional taxable income or tax due if the tax position is disallowed. The new guidance has been effective for us since October 1, 2014. The adoption of this guidance is not expected to have a material impact on the Company's consolidated financial statements.
In April 2014, the FASB issued revised guidance to reduce diversity in practice for reporting discontinued operations. The revised guidance only allows disposals of components of an entity that represent a strategic shift (e.g., disposal of a major geographical area, a major line of business, a major equity method investment, or other major parts of an entity) and that have a major effect on a reporting entity's operations and financial results to be reported as discontinued operations. The revised guidance also requires expanded disclosure in the financial statements for discontinued operations as well as for disposals of significant components of an entity that do not qualify for discontinued operations presentation. The revised guidance is effective for all disposals (or classifications as held for sale) of components for us beginning October 1, 2015, and early adoption is permitted. The adoption of this guidance is not expected to have a material impact on the Company's consolidated financial statements.
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Notes to Consolidated Financial Statements (Continued)
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2. Summary of Significant Accounting Policies (Continued)
In May 2014, the FASB issued guidance on revenue from contracts with customers that will supersede virtually all existing revenue recognition guidance, including industry-specific guidance, and is designed to create greater comparability for financial statement users across industries and jurisdictions. The underlying principle is that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. The guidance provides a five-step analysis of transactions to determine when and how revenue is recognized. The guidance also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity's contracts with customers. The guidance is effective for us beginning October 1, 2017 (early adoption is not permitted). The guidance permits the use of either a retrospective or cumulative effect transition method. We have not yet selected a transition method and are currently evaluating the impact of the amended guidance on our consolidated financial statements and related disclosures.
In June 2014, the FASB issued guidance to clarify the proper method of accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. The guidance requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The guidance is effective for us beginning October 1, 2016, and early adoption is permitted. The adoption of this guidance is not expected to have a material impact on the Company's consolidated financial statements.
In August 2014, the FASB issued guidance which requires management to assess an entity's ability to continue as a going concern every reporting period, and provide certain disclosures if management has substantial doubt about the entity's ability to operate as a going concern, or an express statement if not, by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. The guidance is effective for us for the annual period ending September 30, 2017, and for interim periods thereafter. Early application is permitted. The adoption of this guidance is not expected to have an impact on our consolidated financial statements.
3. Facility Restructuring Charge
On March 12, 2013, NBTY initiated a restructuring plan to streamline its operations and improve the profitability and return on invested capital of its manufacturing/packaging and distribution facilities. The restructuring involved the sale or closure of seven of NBTY's manufacturing/packaging and distribution facilities. The restructuring plan commenced in the second quarter of fiscal 2013 and was completed in fiscal 2014. The restructuring resulted in cumulative charges of $32,695 before tax over that period, of which non-cash charges consisted primarily of accelerated depreciation of approximately $12,588.
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3. Facility Restructuring Charge (Continued)
The following summarizes the restructuring cash charges recorded and reconciles these charges to accrued expenses:
4. Discontinued Operations
Julian Graves
On July 2, 2012, the board of directors of Julian Graves Limited, a company organized under the laws of the United Kingdom and Wales (the "UK Debtor") and an indirect, wholly-owned subsidiary of the Company, Deloitte LLP (the "Administrators") were appointed as administrators in respect of the UK Debtor (the "UK Administration"). The UK Administration, which was limited to the UK Debtor, was initiated in response to continuing operating losses of the UK Debtor and their related impact on the Company's cash flows. The effect of the UK Debtor's entry into administration was to place the management, affairs, business and property of the UK Debtor under the direct control of the Administrators. The Administrators have wound the operations down and there are no material adjustments anticipated.
The results of the Julian Graves business included in discontinued operations (previously in the European Retail Segment) for the fiscal year ended September 30, 2012 are summarized in the following table:
As of June 30, 2012, the carrying value of all assets relating to the UK Debtor were evaluated and an impairment of $20,106, primarily relating to the Julian Graves Tradename, was recorded. As of July 2, 2012, concurrent with the transfer of control of the UK Debtor to the Administrator, a deconsolidation loss of approximately $7,403 was recorded.
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4. Discontinued Operations (Continued)
Le Naturiste
On August 31, 2012 we sold certain assets and liabilities of our subsidiary Le Naturiste, Inc. for a net sales price of $1,600. The sale of Le Naturiste resulted in a loss of approximately $3,088 which is included in discontinued operations for the year ended September 30, 2012. The results of the Le Naturiste business included in discontinued operations (previously in the North American Retail Segment) for the fiscal year ended September 30, 2012 are summarized in the following table:
5. Acquisitions
Balance Bar
On November 26, 2012, NBTY acquired all of the outstanding shares of Balance Bar Company ("Balance Bar"), a company that markets and sells nutritional bars, for a purchase price of $77,978 of cash. NBTY used funds drawn from the revolving portion of its senior secured credit facilities to finance this acquisition.
The purchase price has been allocated to assets acquired and liabilities assumed based on the fair value of such assets and liabilities at the date of the acquisition. The fair values of the net assets acquired were determined using discounted cash flow analyses and estimates made by management. The purchase price was allocated to intangible assets as follows: approximately $35,500 to goodwill, which is non-amortizable under GAAP and is not currently deductible for income tax purposes, approximately $26,000 to tradenames, which are amortizable over 30 years and approximately $29,000 to customer relationships, which are amortizable over 22 years. Amortization of the acquired intangible assets is not currently deductible for income tax purposes. The acquisition of Balance Bar has expanded our operations in the Wholesale segment in the distribution of nutritional bars.
Essenza
In June 2013, our subsidiary, NBTY Europe Limited, acquired Essenza N.V. ("Essenza"), a Belgian company operating 13 retail stores, for a net purchase price of approximately $4,163 (€3,200 euros). The allocation of net assets acquired consisted of cash, inventory, property, plant and equipment, tradename, goodwill, accounts payable and accrued liabilities and long term debt. The goodwill of approximately $4,200 associated with this acquisition is not currently deductible for tax purposes.
Pro forma financial information and actual year to date results related to Essenza and Balance Bar are not provided as their impact was not material to our consolidated financial statements, individually or in the aggregate.
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6. Inventories
The components of inventories are as follows at September 30:
7. Property, Plant and Equipment
Property, plant and equipment is as follows at September 30:
Included in construction in process are assets related to implementing a new world-wide ERP system.
Depreciation and amortization of property, plant and equipment for the fiscal years ended September 30, 2014, 2013 and 2012 was approximately $60,530, $64,883 and $58,311, respectively.
8. Goodwill and Intangible Assets
The Company's goodwill and intangible assets relate primarily to assets valued as a result of the Merger on October 1, 2010. The Company does not amortize its goodwill or indefinite lived intangible assets. Instead, the Company performs an assessment to test these assets for impairment annually, or more frequently if events or changes in circumstances indicate they may be impaired.
On a quarterly basis, we monitor the key drivers of fair value to detect events or other changes that would warrant an interim impairment test of our goodwill and intangibles. The key assumptions that drive the cash flows of our reporting units and intangible assets are estimated revenue growth rates and levels of profitability. Terminal value growth rate assumptions, weighted average cost of capital rates ("WACC") as well as royalty rates are used in conjunction with these key assumptions in order to
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8. Goodwill and Intangible Assets (Continued)
derive the estimated fair value. These assumptions are subject to uncertainty, including our ability to grow revenue and improve or maintain profitability levels. Relatively small declines in the future performance and cash flows of a reporting unit or asset group or small changes in other key assumptions may result in the recognition of significant asset impairment charges.
Goodwill and Other Intangible Asset Impairment Charges
The North American Retail and Direct Response/E-Commerce segments have seen increased competition as well as increased use of promotions in order to maintain sales levels. During the fourth fiscal quarter of 2014, the Direct Response/E-Commerce and North American Retail segments recorded impairment charges of $61,590 and $25,744, respectively, related to goodwill. This was in connection with our annual impairment assessment and the completion of a strategic planning process relating to the rates of growth of sales, profit and cash flow and expectations for future performance. In addition, as a part of this process, we recorded impairment charges of $110,000 and $10,000 on the indefinite lived tradenames of the Direct Response/E-Commerce and North American Retail segments, respectively.
Goodwill
The changes in the carrying amount of goodwill by segment for the fiscal years ended September 30, 2014 and 2013 are as follows:
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8. Goodwill and Intangible Assets (Continued)
Other Intangible Assets
The carrying amounts of acquired other intangible assets are as follows at September 30:
Aggregate amortization expense of other definite lived intangible assets included in the Consolidated Statements of Operations and Comprehensive Income (Loss) in selling, general and administrative expenses in fiscal 2014, 2013 and 2012 was $46,027, $45,753 and $43,960, respectively.
Assuming no changes in our other intangible assets, estimated amortization expense for each of the five succeeding years will be approximately $46,000 per year.
9. Accrued Expenses and Other Current Liabilities
The components of accrued expenses and other current liabilities are as follows at September 30:
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10. Long-Term Debt
Long-term debt consists of the following at September 30:
Senior secured credit facilities
On October 1, 2010, NBTY entered into its senior secured credit facilities (the "senior secured credit facilities") consisting of a $250,000 revolving credit facility, a $250,000 term loan A and a $1,500,000 term loan B.
On March 1, 2011, NBTY, Holdings and Barclays Bank PLC, as administrative agent, and several other lenders entered into the First Amendment and Refinancing Agreement pursuant to which NBTY repriced its loans. Under the terms of the agreement, the $1,750,000 term loan B-1 and revolving credit facility of $200,000 were established. Substantially all other terms are consistent with the original term loan B, including the amortization schedule of term loan B-1 and maturity dates.
On December 30, 2011, NBTY prepaid $225,000 of its future principal payments on its term loan B-1. As a result of this prepayment $9,289 of deferred financing costs were charged to interest expense. In accordance with the prepayment provisions of the credit agreement governing the senior secured credit facilities, future scheduled payments of principal will not be required until the final balloon payment in October 2017.
On October 11, 2012, NBTY amended its credit agreement to allow Holdings to issue and sell the Holdco Notes. In addition, among other things, the amendment (i) increased the general restricted payments basket to $50,000, (ii) increased the maximum total leverage ratio test which governs the making of restricted payments using Cumulative Credit (as defined in the credit agreement) and (iii) modified the definition of Cumulative Credit so that it conforms to the builder basket used in NBTY's indenture governing the Notes. Interest on the Holdco Notes is paid via dividends from NBTY to Holdings, to the extent that NBTY is permitted under its credit agreement and the indenture governing the Notes. Expenses of $6,121 related to the amendment were capitalized as a deferred financing cost and are being amortized using the effective interest method. In conjunction with the amendment, NBTY paid Holdings a dividend of $193,956 in October 2012.
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10. Long-Term Debt (Continued)
On March 21, 2013 (the "Second Refinancing Date"), NBTY, Holdings, Barclays Bank PLC, as administrative agent, and several other lenders entered into the Third Amendment and Second Refinancing Agreement (the "Second Refinancing") pursuant to which NBTY repriced its term loan B-1 under its credit agreement. Under the terms of the Second Refinancing, the $1,750,000 term loan B-1 was replaced with a new $1,507,500 term loan B-2. Borrowings under term loan B-2 and the revolving credit facility bear interest at a floating rate which can be, at NBTY's option, either (i) eurodollar (LIBOR) rate plus an applicable margin, or (ii) base rate plus an applicable margin, in each case, subject to a eurodollar (LIBOR) rate floor of 1.00% or a base rate floor of 2.00%, as applicable. The applicable margin for term loan B-2 is 2.50% per annum for eurodollar (LIBOR) loans and 1.50% per annum for base rate loans. The applicable margin for the revolving credit facility remained at 3.25% per annum for eurodollar (LIBOR) loans and 2.25% per annum for base rate loans, with a step-down of 25 basis points upon the achievement of a total senior secured leverage ratio as set forth in the senior secured credit facilities. Substantially all other terms are consistent with the original term loan B- 1, including the maturity dates. As a result of the Second Refinancing, $4,232 of previously capitalized deferred financing costs, as well as $1,151 of the call premium on term loan B-1, were expensed and included in interest expense. In addition, costs incurred and recorded as deferred financing costs were approximately $15,190, including $13,924 of the call premium paid on term loan B-1, and are being amortized using the effective interest method.
On November 20, 2014, NBTY amended its senior secured revolving credit facility, extending its maturity to September 2017 and reducing the commitment from $200,000 to $175,000. In connection with this amendment, deferred financing costs of approximately $600 were incurred and will be amortized over the remaining period.
The following fees are applicable under the revolving credit facility: (i) an unused line fee of 0.50% per annum, based on the unused portion of the revolving credit facility; (ii) a letter of credit participation fee on the aggregate stated amount of each letter of credit available to be drawn equal to the applicable margin for eurodollar rate loans; (iii) a letter of credit fronting fee equal to 0.25% per annum on the daily amount of each letter of credit available to be drawn; and (iv) certain other customary fees and expenses of our letter of credit issuers.
As of September 30, 2014, there were no borrowings drawn from our $200,000 revolving credit facility and there were letters of credit totaling $4,400, reducing the net availability to $195,600.
NBTY may voluntarily prepay loans or reduce commitments under its senior secured credit facilities, in whole or in part, subject to minimum amounts, with prior notice but without premium or penalty.
NBTY must make prepayments on the term loan B-2 facility with the net cash proceeds of certain asset sales, casualty and condemnation events, the incurrence or issuance of indebtedness (other than indebtedness permitted to be incurred under its senior secured credit facilities unless specifically incurred to refinance a portion of its senior secured credit facilities) and 50% of excess cash flow, as defined in the credit agreement (such percentage subject to reduction based on achievement of total senior secured leverage ratios), in each case, subject to certain reinvestment rights and other exceptions. NBTY is also required to make prepayments under its revolving credit facility at any time when, and to the extent that, the aggregate amount of the outstanding loans and letters of credit under
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10. Long-Term Debt (Continued)
the revolving credit facility exceeds the aggregate amount of commitments in respect of the revolving credit facility.
Obligations under the senior secured credit facilities are guaranteed by Holdings and each of NBTY's current and future direct and indirect subsidiaries other than (i) foreign subsidiaries, (ii) unrestricted subsidiaries, (iii) non-wholly owned subsidiaries, (iv) certain receivables financing subsidiaries, (v) certain immaterial subsidiaries and (vi) certain holding companies of foreign subsidiaries, and are secured by a first lien on substantially all of their assets, including capital stock of subsidiaries (subject to certain exceptions).
The senior secured credit facilities contain customary negative covenants, including, but not limited to, restrictions on NBTY and its restricted subsidiaries' ability to merge and consolidate with other companies, incur indebtedness, grant liens or security interests on assets, make acquisitions, loans, advances or investments, pay dividends, sell or otherwise transfer assets, prepay or modify terms of certain junior indebtedness, enter into transactions with affiliates, amend organizational documents, or change our line of business or fiscal year. In addition, NBTY's senior secured credit facilities require the maintenance of a maximum total senior secured leverage ratio on a quarterly basis, calculated with respect to Consolidated EBITDA, as defined therein, if at any time amounts are outstanding under the revolving credit facility, including swingline loans and letters of credit. NBTY was in compliance with all covenants under the senior secured credit facilities at September 30, 2014.
The senior secured credit facilities provide that, upon the occurrence of certain events of default, the obligations thereunder may be accelerated and the lending commitments terminated. Such events of default include payment defaults to the lenders, material inaccuracies of representations and warranties, covenant defaults, cross-defaults to other material indebtedness, voluntary and involuntary bankruptcy proceedings, material money judgments, material ERISA/pension plan events, certain change of control events and other customary events of default.
Holdco Notes
On October 17, 2012, Holdings issued $550,000 in aggregate principal amount of 7.75%/8.50% contingent cash pay senior notes ("Holdco Notes") that mature on November 1, 2017. Interest on the Holdco Notes accrues at the rate of 7.75% per annum with respect to cash interest and 8.50% per annum with respect to any paid-in-kind interest ("PIK Interest"). Interest on the Holdco Notes is payable semi-annually in arrears on May 1 and November 1 of each year. All interest payments made to date have been in cash. Holdings is a holding company with no operations and has no ability to service interest or principal on the Holdco Notes, other than through dividends it may receive from NBTY. NBTY is restricted, in certain circumstances, from paying dividends to Holdings by the terms of the indenture governing NBTY's 9.00% Senior Notes due 2018 ("Notes") and the senior secured credit facilities. NBTY has not guaranteed the indebtedness of Holdings, nor pledged any of its assets as collateral, and the Holdco Notes are not reflected in NBTY's financial statements. The proceeds from the offering of the Holdco Notes, along with $200,000 of cash on hand from NBTY, as described below, were used to pay transaction fees and expenses, including a consent fee, totaling $17,345 and a $721,682 dividend to Holdings' shareholders in October 2012.
On December 12, 2013, Holdings issued an additional $450,000 in aggregate principal amount of Holdco Notes that mature on November 1, 2017. The additional $450,000 Holdco Notes and the
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10. Long-Term Debt (Continued)
$550,000 of original Holdco Notes previously issued on October 17, 2012 have identical terms and are treated as a single class for all purposes under the indenture governing the Holdco Notes. The gross proceeds from the offering of the $450,000 additional Holdco Notes was $460,125, inclusive of a $10,125 premium, which were used to pay transaction fees and expenses, including a consent fee, totaling $18,560 and a $445,537 dividend to Holdings' shareholders in December 2013.
Interest on the Holdco Notes is payable semi-annually in arrears on May 1 and November 1 of each year. Holdings is a holding company with no operations of its own and has no ability to service interest or principal on the Holdco Notes, other than through dividends it may receive from NBTY. NBTY is restricted, in certain circumstances, from paying dividends to Holdings by the terms of the indenture governing the Notes and the senior secured credit facilities. NBTY has not guaranteed the indebtedness of Holdings, nor pledged any of its assets as collateral and the Holdco Notes are not reflected on NBTY's balance sheet.
Interest on the Holdco Notes shall be payable entirely in cash ("Cash Interest") to the extent that it is less than the maximum amount of allowable dividends and distributions plus any cash at Holdings ("Applicable Amount") as defined by the indenture governing the Holdco Notes. For any interest period after May 1, 2013 (other than the final interest period ending at stated maturity), if the Applicable Amount for such interest period will:
(i) equal or exceed 75%, but be less than 100%, of the aggregate amount of Cash Interest that would otherwise be due on the relevant interest payment date, then Holdings may, at its option, elect to pay interest on (a) 25% of the then outstanding principal amount of the Holdco Notes by increasing the principal amount of the outstanding Holdco Notes or by issuing payment in kind notes ("PIK Notes") in a principal amount equal to such interest and (b) 75% of the then outstanding principal amount of the Holdco Notes as Cash Interest;
(ii) equal or exceed 50%, but be less than 75%, of the aggregate amount of Cash Interest that would otherwise be due on the relevant interest payment date, then Holdings may, at its option, elect to pay interest on (a) 50% of the then outstanding principal amount of the Holdco Notes as PIK Interest and (b) 50% of the then outstanding principal amount of the Holdco Notes as Cash Interest;
(iii) equal or exceed 25%, but be less than 50%, of the aggregate amount of Cash Interest that would otherwise be due on the relevant interest payment date, then Holdings may, at its option, elect to pay interest on (a) 75% of the then outstanding principal amount of the Holdco Notes as PIK Interest and (b) 25% of the then outstanding principal amount of the Holdco Notes as Cash Interest; or
(iv) be less than 25% of the aggregate amount of Cash Interest that would otherwise be due on the relevant interest payment date, then Holdings may, at its option, elect to pay interest on the Holdco Notes as PIK Interest.
As described above, Holdings' ability to pay PIK Interest depends on the calculation of the Applicable Amount regardless of the availability of cash at Holdings.
The interest on the Holdco Notes was paid in cash on May 1, 2013, November 1, 2013 and May 1, 2014 and was funded by a dividend of $22,970, $21,313 and $38,750, respectively from NBTY.
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share amounts)
10. Long-Term Debt (Continued)
On or after November 1, 2013, Holdings may redeem the Holdco Notes, at its option, in whole at any time or in part from time to time, at the following redemption prices (expressed as a percentage of principal amount), plus accrued and unpaid interest to the redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date), if redeemed during the 12-month period commencing on November 1 of the years set forth below:
On March 10, 2014 and June 21, 2013, $450,000 and $549,925, respectively, in aggregate principal amount of the Holdco Notes were exchanged for substantially identical notes that were registered under the Securities Act of 1933, as amended, and therefore are freely tradable.
Notes
On October 1, 2010, NBTY issued $650,000 in aggregate principal amount of senior notes bearing interest at 9% in a private placement. On August 2, 2011, these privately placed notes were exchanged for substantially identical notes that were registered under the Securities Act of 1933, as amended, and therefore are freely tradable (the privately placed notes and such registered notes exchanged therefor, the "Notes"). The Notes are senior unsecured obligations and mature on October 1, 2018. Interest on the Notes is paid on April 1 and October 1 of each year, and commenced on April 1, 2011.
On or after October 1, 2014, NBTY may redeem the Notes, at its option, in whole at any time or in part from time to time, at the following redemption prices (expressed as a percentage of principal amount), plus accrued and unpaid interest to the redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date), if redeemed during the 12-month period commencing on October 1 of the years set forth below:
The Notes are jointly and severally irrevocably and unconditionally guaranteed by each of NBTY's subsidiaries that is a guarantor under the credit agreement. The Notes are uncollateralized and rank senior in right of payment to existing and future indebtedness that is expressly subordinated to the Notes, rank equally in right of payment to NBTY and its subsidiary guarantors' senior unsecured debt, and are effectively junior to any of NBTY or its subsidiary guarantors' secured debt, to the extent of the value of the collateral securing such debt. The Notes contain certain customary covenants including, but not limited to, restrictions on NBTY and its restricted subsidiaries' ability to merge and consolidate with other companies, incur indebtedness, grant liens or security interests on assets, make acquisitions,
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share amounts)
10. Long-Term Debt (Continued)
loans, advances or investments, or pay dividends. NBTY was in compliance with all covenants under the Notes at September 30, 2014.
11. Fair Value of Financial Instruments
GAAP establishes a framework for measuring fair value and includes disclosures about fair value measurements. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. GAAP also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. There are three levels of inputs that may be used to measure fair value:
• Level 1-Quoted prices in active markets for identical assets or liabilities.
• Level 2-Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
• Level 3-Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
The following table summarizes the liabilities measured at fair value on a recurring basis at September 30:
The Company's swap contracts are measured at fair value based on a market approach valuation technique. With the market approach, fair value is derived using prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. Although non-performance risk of the Company and the counterparty is present in all swap contracts and is a component of the estimated fair values, we do not view non-performance risk to be a significant input to the fair value for the interest rate swap contracts. However, with respect to our cross currency swap contracts, we believe that non-performance risk is higher; therefore the Company classifies these swap contracts as "Level 3" in the fair value hierarchy and, accordingly, records estimated fair value adjustments based on internal projections and views of those contracts. The performance risk for the cross currency swap contracts as a percentage of the unadjusted liabilities ranged from 8.1% to 8.5%
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share amounts)
11. Fair Value of Financial Instruments (Continued)
(8.3% weighted average) as of September 30, 2014 and 9.5% to 10.3% (9.8% weighted average) as of September 30, 2013.
The following table shows the Level 3 activity related to our cross currency swaps for the fiscal years ended September 30:
Assets Re-measured at Fair Value on a Non-recurring Basis
In connection with our annual impairment assessment of goodwill and intangible assets, an impairment was recorded for the Direct Response/E-Commerce and North American Retail segments of $171,590and $35,744, respectively (See Note 8). In connection with the UK Administration (See Note 4), we re-measured the Julian Graves tradename and certain fixed assets using Level 3 inputs, which resulted in an impairment of $20,106 in fiscal 2012.
Interest Rate Swaps
To manage the potential risk arising from changing interest rates and their impact on long-term debt, our policy is to maintain a combination of available fixed and variable rate financial instruments.
During March 2011, in connection with the Refinancing, we entered into three interest rate swap contracts to fix the LIBOR indexed interest rates on a portion of our senior credit facilities until the indicated expiration dates of these swap contracts. Each swap contract has an initial notional amount of $333,333 (for a total of one billion dollars), with a fixed interest rate of 1.92% and a term ending December 30, 2014. The notional amount of each swap decreased to $266,666 in December 2012, decreased to $166,666 in December 2013 and has a maturity date of December 2014. Under the terms of the swap contracts, variable interest payments for a portion of our senior credit facilities are swapped for fixed interest payments. These interest rate swap contracts were designated as a cash flow hedge of the variable interest payments on a portion of our term loan debt. Hedge effectiveness will be assessed based on the overall changes in the fair value of the interest rate swap contracts. Any potential ineffectiveness is measured using the hypothetical derivative method and will be recognized in current operations. Hedge ineffectiveness from inception to September 30, 2014 was insignificant and recorded in Miscellaneous, net.
Cross Currency Swaps
To manage the potential exposure from adverse changes in currency exchange rates, specifically the British pound, arising from our net investment in British pound denominated operations, during December 2010, we entered into three cross currency swap contracts to hedge a portion of the net investment in our British pound denominated foreign operations. The aggregate notional amount of the swap contracts is 194,200 British pounds (approximately $300,000 U.S. dollars), with a forward rate of 1.56, and a termination date of September 30, 2017.
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share amounts)
11. Fair Value of Financial Instruments (Continued)
These cross currency contracts were designated as a net investment hedge to the net investment in our British pound denominated operations. Hedge effectiveness is assessed based on the overall changes in the fair value of the cross currency swap contracts. Any potential hedge ineffectiveness is measured using the hypothetical derivative method and is recognized in current operations. Hedge ineffectiveness for the years ended September 30, 2014, 2013 and 2012 resulted in gains (losses) of $966, $1,611 and ($3,358), respectively, and is recorded in Miscellaneous, net.
The following table shows the effect of the Company's derivative instruments designated as cash flow and net investment hedging instruments for the years ended September 30, 2014 and 2013:
Notes and Holdco Notes
The fair value of the Notes and Holdco Notes, based on quoted market prices (Level 2), was approximately $676,000 and $980,000, respectively, as of September 30, 2014.
Term loan B-2
The face amount of the term loan B-2 is $1,507,500, which approximates fair value based on Level 2 inputs, as this loan accrues interest at a variable interest rate.
Other Fair Value Considerations
During the fourth quarter of each year, the Company evaluates goodwill at the reporting unit level and indefinite-lived intangibles for impairment using market data and a cash flow model using Level 3 inputs. Additionally, on a nonrecurring basis, the Company uses fair value measures when analyzing asset impairment. Long-lived assets and certain identifiable intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If it is determined such indicators are present and the review indicates that the assets will not be fully recoverable, based on undiscounted estimated cash flows over the remaining amortization periods, their carrying values are reduced to estimated fair value.
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share amounts)
12. Litigation Summary
Glucosamine-Based Dietary Supplements
Beginning in June 2011, certain putative class actions have been filed in various jurisdictions against NBTY, its subsidiary Rexall Sundown, Inc. ("Rexall"), and/or other companies as to which there may be a duty to defend and indemnify, challenging the marketing of glucosamine- based dietary supplements, under various states' consumer protection statutes. The lawsuits against NBTY and its subsidiaries are: Cardenas v. NBTY, Inc. and Rexall Sundown, Inc. (filed June 14, 2011) in the United States District Court for the Eastern District of California, on behalf of a putative class of California consumers seeking unspecified compensatory damages based on theories of restitution and disgorgement, plus punitive damages and injunctive relief; Jennings v. Rexall Sundown, Inc. (filed August 22, 2011) in the United States District Court for the District of Massachusetts, on behalf of a putative class of Massachusetts consumers seeking unspecified trebled compensatory damages; and Nunez v. NBTY, Inc. et al. (filed March 1, 2013) in the United States District Court for the Southern District of California (the "Nunez Case"), on behalf of a putative class of California consumers seeking unspecified compensatory damages based on theories of restitution and disgorgement, plus injunctive relief, as well as other cases in California and Illinois against certain wholesale customers as to which we may have certain indemnification obligations. The Nunez Case settled on an individual basis on June 20, 2013.
In March 2013, NBTY agreed upon a proposed settlement with the remaining plaintiffs, which includes all cases and resolves all pending claims without any admission of or concession of liability by NBTY, and which provides for a release of all claims in return for payments to the class, together with attorneys' fees, and notice and administrative costs. Fairness Hearings took place on October 4, 2013 and November 20, 2013. On January 3, 2014, the court issued an opinion and order approving the settlement as modified (the "Order"). The final judgment was issued on January 22, 2014 (the "Judgment"). Certain objectors filed a notice of appeal of the Order and the Judgment on January 29, 2014 and the plaintiffs filed a notice of appeal on February 3, 2014. On November 19, 2014, the appellate court issued a decision granting the objectors' appeal. The appellate court reversed and remanded the matter to the district court for further proceedings consistent with the appellate court's decision.
In fiscal 2013, NBTY recorded a provision of $12 million reflecting its best estimate of exposure for payments to the class together with attorney's fees, and notice and administrative costs in connection with this class action settlement. As a result of the court's approval of the settlement and the closure of the claims period, NBTY reduced its estimate of exposure to $6 million. This reduction in the estimated exposure was reflected in the Company's first quarter results for fiscal 2014. Until the cases are resolved, no final determination can be made as to the ultimate outcome of the litigation or the amount of liability on the part of NBTY.
Telephone Consumer Protection Act Claim
NBTY, and certain of its subsidiaries, are defendants in a class-action lawsuit, captioned John H. Lary Jr. v. Rexall Sundown, Inc.; Rexall Sundown 3001, LLC; Rexall, Inc.; NBTY, Inc.; Corporate Mailings, Inc. d/b/a CCG Marketing Solutions ("CCG") and John Does 1-10 (originally filed October 22, 2013), brought in the United States District Court, Eastern District of New York. The plaintiff alleges that the defendants faxed advertisements to plaintiff and others without invitation or permission, in violation of the Telephone Consumer Protection Act ("TCPA").
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share amounts)
12. Litigation Summary (Continued)
On May 2, 2014, NBTY and its named subsidiary defendants cross-claimed against CCG, who was a third party vendor engaged by NBTY, and CCG cross-claimed against NBTY and named subsidiary defendants on June 13, 2014. CCG brought a third party complaint against an unrelated entity, Healthcare Data Experts, LLC, on June 27, 2014. On July 21, 2014, CCG filed a motion to dismiss the amended complaint and that motion is pending.
At this time, no determination can be made as to the ultimate outcome of the litigation or the amount of liability on the part of NBTY, however, we do not believe the ultimate outcome will have a material adverse effect on each of our consolidated financial statements.
Claims in the Ordinary Course
In addition to the foregoing, other regulatory inquiries, claims, suits and complaints (including product liability, false advertising, intellectual property and Proposition 65 claims) arise from time to time in the ordinary course of our business. We believe that such other inquiries, claims, suits and complaints would not have a material adverse effect on each of our consolidated financial statements, if adversely determined against us.
13. Income Taxes
(Loss) income from continuing operations before income taxes consists of the following components for the fiscal years ended September 30:
(Benefit) provision for income taxes consists of the following for the fiscal years ended September 30:
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share amounts)
13. Income Taxes (Continued)
The following is a reconciliation of the (benefit) provision for income taxes on continuing operations computed using the statutory Federal income tax rate to the actual income tax expense and the effective income tax rate for the fiscal years ended September 30:
The difference in the effective rate in fiscal 2014 as compared to the statutory rate is mainly attributable to the impact of the goodwill impairment during fiscal 2014 for which no income tax benefit was recorded.
The difference in the effective rate in fiscal 2013 as compared to the statutory rate is mainly attributable to the restructuring which had a favorable impact on our state tax rate due to the closing of facilities in California (a relatively high tax state) and the partial indefinite reinvestment of foreign earnings.
The difference in the effective rate in fiscal 2012 as compared to the statutory rate is mainly attributable to the benefit attributable to the sale of Le Naturiste, as well as the partial indefinite reinvestment of certain foreign earnings in the year.
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share amounts)
13. Income Taxes (Continued)
The components of deferred tax assets and liabilities are as follows as of September 30:
At September 30, 2014 and 2013, we had the following foreign net operating losses, foreign tax credit and New York State ("NYS") investment tax credit carryforwards:
At September 30, 2014 and 2013, we maintained the following valuation allowances:
The NYS investment tax credits expire primarily between 2014 and 2029 and the foreign net operating loss carryforwards expire in accordance with applicable tax law. We provide a valuation allowance for these credit and loss carryforwards because we do not consider realization of such assets to be more likely than not. We continue to monitor the need for these valuation allowances on an on-going basis.
At September 30, 2014, we had $111,547 of undistributed international earnings on which we have not provided any U.S. tax expense as we intend to permanently reinvest these earnings outside of the U.S. If these earnings are repatriated to the United States, or if the Company determines that such earnings will be remitted in the foreseeable future, additional tax provisions may be required. Due to
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share amounts)
13. Income Taxes (Continued)
the complexities in the tax laws and the assumptions that would have to be made, it is not practicable to estimate the amounts of income tax provisions that may be required.
The following table summarizes the changes in the valuation allowance for the fiscal years ended September 30:
The following table summarizes the activity related to gross unrecognized tax benefits for the fiscal years ended September 30:
These liabilities are primarily included as a component of other liabilities in our consolidated balance sheet because we generally do not anticipate that settlement of the liabilities will require payment of cash within the next twelve months.
Our total unrecognized tax benefits that, if recognized, would affect our effective tax rate were $5,961 and $10,263 as of September 30, 2014 and 2013, respectively. We do not believe that the amount will significantly change in the next 12 months.
We accrue interest and penalties related to unrecognized tax benefits in income tax expense. This methodology is consistent with previous periods. At September 30, 2014, we had accrued $332 and $174 for the potential payment of interest and penalties, respectively. As of September 30, 2014, we were subject to U.S. Federal Income Tax examinations for the tax years 2011 through 2013, and to non-US examinations for the tax years of 2008 through 2014. In addition, we are generally subject to state and local examinations for fiscal years 2011 through 2014. The changes to accrued penalties and interest during the fiscal year ended September 30, 2014 were primarily a result of the effective settlement of the IRS examination for the years 2007 through 2010. The Company received an effective settlement with the IRS for tax years 2007 through 2010 which resulted in a reduction of its unrecognized tax benefit.
The Company is under an Internal Revenue Service ("IRS") examination for tax years 2011 through 2012. Among other issues, the IRS has questioned the values used by the Company to transfer product and provide services to an international subsidiary. The Company believes it has appropriately
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share amounts)
13. Income Taxes (Continued)
valued such product transfers and services and intends to continue to support this position as the IRS examination continues to progress.
14. Stock-Based Compensation and Employee Benefit Plans
On November 30, 2010, Holdings adopted the Equity Incentive Plan of Alphabet Holding Company, Inc. (the "Plan"), pursuant to which Holdings may grant options to selected employees and directors of the Company. The aggregate number of shares which may be issued under the Plan is 50,268 shares of the Class A common stock and 208,404 shares of the Class B common stock. Options granted under the Plan expire no later than 10 years from the date of grant and the exercise price may not be less than the fair market value of the common stock on the date of grant.
During fiscal 2014, 2013 and 2012, Holdings granted 13,430, 19,180 and 24,850, respectively, of Class B common stock options to certain Company employees under the Plan. Vesting of the awards is based on the passage of time, in equal installments over five years /or the achievement of a performance condition (i.e., a liquidity event as defined in the plan agreement) and market conditions (i.e., the achievement of a minimum investor rate of return). The fair value of each of the Holdings time-based stock option awards is expensed in the Company's records on a straight-line basis over the requisite service period, which is generally the five year vesting period of the options. However, for options granted with a performance condition, compensation expense is recognized when it is probable that the performance condition will be met. As the Company has determined it is not probable the performance condition will be achieved, no compensation cost has been recognized relating to the performance based awards. Pursuant to the Plan, Holdings is required to modify all options in an equitable manner under certain circumstances. The dividends of $445,537 and $721,682 in fiscal 2014 and 2013, respectively, as described in the Long-Term Debt Note, required this modification.
The weighted-average grant date fair value per share of options granted in fiscal 2014 was $147 for time based vesting and $98 for performance based vesting. The weighted-average grant date fair value per share of options granted in fiscal 2013 was $167 for time based vesting and $96 for performance based vesting. The weighted-average grant date fair value per share of options granted in fiscal 2012 was $239 for time based vesting and $108 for performance based vesting. The fair value of each option
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share amounts)
14. Stock-Based Compensation and Employee Benefit Plans (Continued)
award is estimated on the date of grant utilizing a Monte Carlo simulation model. The following weighted-average assumptions were used for the options granted:
(1)The risk free interest rate assumption was based on yields of U.S. Treasury securities in effect at the date of grant with terms similar to the expected term.
(2)The expected term of the options was estimated utilizing the simplified method. We utilize the simplified method because the Company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term. The simplified method was used for all stock options that require only a service vesting condition.
(3)Expected volatility was estimated based on historical volatility of peer companies over a period equivalent to the expected term. Peer companies are determined based on relevant industry and/or market capitalization.
(4)The expected term of the options was estimated utilizing a Monte Carlo simulation model.
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share amounts)
14. Stock-Based Compensation and Employee Benefit Plans (Continued)
A summary of stock option activity follows:
As share-based compensation expense recognized is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures of 0% and 5% per year for senior management and other management, respectively. Forfeitures are required to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on historical and forecasted turnover.
The following table summarizes information about stock options outstanding at September 30, 2014:
As of September 30, 2014, $4,748 of total unrecognized compensation cost related to the non-vested time-based vesting options is expected to be recognized over the weighted average period of 2.7 years.
As of September 30, 2014, the total potential unrecognized compensation cost related to the performance-based vesting options is $4,022 and no compensation cost will be recognized until the related performance condition is deemed probable of occurring.
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share amounts)
14. Stock-Based Compensation and Employee Benefit Plans (Continued)
Employee Benefit Plans
We sponsor a Retirement Savings Plan consisting of a 401(k) plan covering substantially all employees with more than six months of service. As allowed under Section 401(k) of the Internal Revenue Code, the Plan provides tax-deferred salary deductions for eligible employees. Employees may contribute from one to fifty percent of their annual compensation to the Plan, limited to a maximum annual amount as set, and periodically updated, by the Internal Revenue Service. We provide a Company match of 100% of employee contributions, up to three percent of the employee's gross earnings and 50% match of the next two percent of earnings, limited to an annual match contribution of $10 per employee. Employees become fully vested in employer match contributions after three years of service.
We also have an Associate Profit Sharing Plan ("PSP), which is allocated among participants who have completed 1,000 hours of service in the plan year end who were employed on the last day of the plan year, based upon their relative compensation for the year. Contributions are discretionary and are based on performance targets set forth by management. As of September 30, 2014 and 2013, the amount allocated and accrued for the PSP was approximately $0 and $3,723, respectively.
15. Commitments
Operating Leases
We conduct retail operations under operating leases, which expire at various dates through 2034. Some of the leases contain escalation clauses, as well as renewal options, and provide for contingent rent based upon sales plus certain tax and maintenance costs.
Future minimum rental payments (excluding real estate tax and maintenance costs) for retail locations and other leases that have initial or noncancelable lease terms are as follows for the fiscal year ending September 30:
Operating lease rent expense (including real estate taxes and maintenance costs) and leases on a month to month basis were approximately $154,889, $146,843 and $153,763 during fiscal years ended September 30, 2014, 2013 and 2012, respectively.
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share amounts)
15. Commitments (Continued)
Purchase Commitments
We were committed to make future purchases primarily for inventory related items, such as raw materials and finished goods, under various purchase arrangements with fixed price provisions aggregating approximately $185,178 at September 30, 2014.
16. Related Party Transactions
Consulting Agreement-Carlyle
NBTY entered into a consulting agreement with Carlyle under which it pays Carlyle a fee for consulting services Carlyle provides to it and its subsidiaries. Under this agreement, subject to certain conditions, NBTY expects to pay an annual consulting fee to Carlyle of $3,000; NBTY will reimburse them for out-of-pocket expenses, and may pay Carlyle additional fees associated with other future transactions. For the years ended September 30, 2014, 2013 and 2012 these fees totaled $3,000 and are recorded in Selling, general and administrative expenses. Out of pocket expenditures paid to Carlyle for the years ended September 30, 2014, 2013 and 2012 were $915, $311 and $0, respectively.
Holdings
Holdings does not have any operations or cashflow other than dividends from NBTY. Holdings has $1,000,000 of Holdco Notes and relies on dividends from NBTY to service the debt. See the Long-Term Debt Note for further information.
17. Accumulated Other Comprehensive Income (Loss)
Additions to and reclassifications out of accumulated other comprehensive income (loss) attributable to the Company were as follows:
(1)All amounts are net of tax, amounts in parentheses indicate debits.
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share amounts)
17. Accumulated Other Comprehensive Income (Loss) (Continued)
(2)These (gains) losses are reclassified into Interest expense. See Note 11, Fair Value of Financial Instruments.
(1)All amounts are net of tax, amounts in parentheses indicate debits.
(2)These (gains) losses are reclassified into Interest expense. See Note 11, Fair Value of Financial Instruments.
(1)All amounts are net of tax, amounts in parentheses indicate debits.
(2)These (gains) losses are reclassified into Interest expense. See Note 11, Fair Value of Financial Instruments.
During the fiscal years ended September 30, 2014, 2013 and 2012 we recorded an (increase) decrease in our deferred tax liability relating to other comprehensive income (loss) incurred during the year of ($7,722), ($240) and $2,136, respectively.
18. Business and Credit Concentration
Financial instruments
Financial instruments which potentially subject us to credit risk consist primarily of cash and cash equivalents (the amounts of which may, at times, exceed Federal Deposit Insurance Corporation limits
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share amounts)
18. Business and Credit Concentration (Continued)
on insurable amounts), investments and trade accounts receivable. We mitigate our risk by investing in or through major financial institutions.
Customers
We perform on-going credit evaluations of our customers and adjust credit limits based upon payment history and the customers' current creditworthiness, as determined by review of their current credit information. Customers' account activity is continuously monitored. As a result of this review process, we record bad debt expense, which is based upon historical experience as well as specific customer collection issues that have been identified, to adjust the carrying amount of the related receivable to its estimated realizable value. While such bad debt expenses historically have been within expectations and the allowances established, if the financial condition of one or more of our customers were to deteriorate, additional bad debt provisions may be required.
One customer accounted for the following percentages of net sales for the fiscal years ended September 30:
The loss of this customer, or any of our other major customers, would have a material adverse effect on our consolidated results of operations if we were unable to replace such customer(s).
The following customers accounted for the following percentages of the Wholesale Segment's gross accounts receivable at fiscal years ended:
Suppliers
During fiscal 2014, 2013 and 2012, no one supplier provided more than 10% of our raw material purchases. We do not believe that the loss of any single supplier would have a material adverse effect on our consolidated financial condition or results of operations.
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share amounts)
19. Supplemental Disclosure of Cash Flow Information
20. Segment Information
We are organized by segments on a worldwide basis. We evaluate performance based on a number of factors; however, the primary measures of performance are the net sales and income or loss from operations (before corporate allocations) of each segment, as these are the key performance indicators that we review. Operating income or loss for each segment does not include the impact of any intercompany transfer pricing mark-up, corporate general and administrative expenses, interest expense and other miscellaneous income/expense items. Corporate general and administrative expenses include, but are not limited to, human resources, legal, finance, and various other corporate level activity related expenses. Such unallocated expenses remain within Corporate/Manufacturing.
All of our products fall into one or more of these four segments:
•Wholesale-This segment sells products worldwide under various brand names and third-party private labels, each targeting specific market groups which include virtually all major mass merchandisers, club stores, drug store chains and supermarkets in the United States. This segment also sells products to independent pharmacies, health food stores, the military and other retailers.
•European Retail-This segment generates revenue through its 755 Holland & Barrett stores (including franchised stores in the following countries: 29 in China, 28 in Singapore, 11 in United Arab Emirates, 9 in Cyprus, four in Malta and one in each of Gibraltar and Iceland), 146 De Tuinen stores (including 6 franchised locations) in the Netherlands, 53 GNC branded UK stores, 47 Nature's Way stores in Ireland and 15 Essenza stores in Belgium, as well as internet-based sales from www.hollandandbarrett.com, www.hollandandbarrett.co.uk, www.hollandandbarrett.ie,www.detuinen.nl and www.gnc.co.uk. Such revenue consists of sales of proprietary brand and third-party products as well as franchise fees.
•Direct Response/E-Commerce-This segment generates revenue through the sale of proprietary brand and third-party products primarily through mail order catalog and the internet under the Puritan's Pride tradename. Catalogs are strategically mailed to customers who order by mail, internet, or phone.
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share amounts)
20. Segment Information (Continued)
•North American Retail-This segment generates revenue through its 414 owned and operated Vitamin World stores selling proprietary brand and third-party products, as well as internet-based sales from www.vitaminworld.com.
The following table represents key financial information of our business segments:
(1)Includes charges of $171,590 and $35,744 for the Direct Response/E-Commerce and North American Retail segments, respectively, relating to the goodwill and intangible asset impairment charges (see Note 8).
(2)Includes charges of $32,695 relating to the facility restructuring (see Note 3) and $12,000 relating to the accrual of an anticipated legal settlement (see Note 12).
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share amounts)
20. Segment Information (Continued)
Total assets by segment as of September 30 are as follows:
Total net sales by location of customer for the fiscal years ended September 30, are as follows:
Long-lived assets-Property, plant and equipment as of September 30, are as follows:
Approximately 35%, 32% and 31% of our net sales for the fiscal years ended September 30, 2014, 2013 and 2012, respectively, were denominated in currencies other than U.S. dollars, principally British pounds, euros, Renminbi and Canadian dollars. A significant weakening of such currencies versus the U.S. dollar could have a material adverse effect on the Company, as this would result in a decrease in our consolidated operating results.
Alphabet Holding Company, Inc., and Subsidiary
Notes to Consolidated Financial Statements (Continued)
(in thousands, except share amounts)
20. Segment Information (Continued)
Foreign subsidiaries accounted for the following percentages of total assets and total liabilities as of September 30:
21. Quarterly Results of Operations (Unaudited)
The following is a summary of the unaudited quarterly results of operations for fiscal 2014 and 2013 (amounts may not equal fiscal year totals due to rounding):
(1)Includes charges of $207,334 relating to the goodwill and intangible asset impairment charges (see Note 8).
(2)Includes charges of $30,200 relating to the facility restructuring (see Note 3) and $12,000 relating to the accrual of an anticipated legal settlement (see Note 12).
Alphabet Holding Company, Inc.
Schedule I-Condensed Parent Company Statements of Income
(In thousands)
See accompanying notes to Condensed Financial Statements.
S-1
Alphabet Holding Company, Inc.
Schedule I-Condensed Parent Company Balance Sheets
(In thousands)
See accompanying notes to Condensed Financial Statements.
S-2
Alphabet Holding Company, Inc.
Schedule I-Condensed Parent Company Statement of Cash Flows
(In thousands)
See accompanying notes to Condensed Financial Statements.
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Alphabet Holding Company, Inc.
Condensed Notes to Schedule 1
(In thousands)
NOTE A-BASIS OF PRESENTATION
Alphabet Holding Company, Inc. (the "Parent Company") is a holding company that conducts substantially all of its business operations through its wholly owned subsidiary, NBTY, Inc. As specified in certain of NBTY's debt agreements, there are restrictions on the Parent Company's ability to obtain funds through dividends, loans or advances (refer to Note 10 to our Consolidated Financial Statements entitled "Long-Term Debt"). Accordingly, these condensed financial statements have been presented on a "parent-only" basis. Under a parent-only presentation, the Parent Company's investments in its consolidated subsidiaries are presented under the equity method of accounting. These parent-only financial statements should be read in conjunction with Alphabet Holding Company, Inc.'s audited Consolidated Financial Statements included elsewhere herein.
On October 1, 2010, an affiliate of The Carlyle Group ("Carlyle") and the Parent Company completed its Acquisition of NBTY for $55.00 per share of NBTY's common stock, or $3,570,191, plus the repayment of NBTY's historical debt of $427,367 (which includes accrued interest and a redemption premium on the notes) and net of cash acquired of $361,609 (which includes restricted cash collateral of $15,126) for a total net purchase price of $3,635,949. The purchase price was funded through the net proceeds from NBTY's $1,750,000 senior credit facilities, the issuance of $650,000 senior notes and a cash equity contribution of $1,550,400 from the Parent Company.
NOTE B-COMMITMENTS AND CONTINGENCIES
The Parent Company is a guarantor on certain debt obligations entered into by its subsidiaries. For a discussion of the lease obligations of the Parent Company and its subsidiaries, see Note 10 to our Consolidated Financial Statements entitled "Long-Term Debt."
NOTE C-LONG TERM DEBT
On October 17, 2012 the Parent Company issued $550,000 senior unsecured notes (the "Holdco Notes") that mature on November 1, 2017. Interest on the Holdco Notes will accrue at the rate of 7.75% per annum with respect to Cash Interest and 8.50% per annum with respect to any paid-in-kind interest ("PIK Interest"). The proceeds from the offering of the Holdco Notes, along with $193,956 of dividends from NBTY, were used to pay transactions fees and expenses and a $721,682 dividend to the Parent Company's shareholders.
On December 12, 2013, the Parent Company issued an additional $450,000 in aggregate principal amount of Holdco Notes that mature on November 1, 2017. The additional $450,000 Holdco Notes and the $550,000 of existing Holdco Notes previously issued on October 17, 2012 have identical terms and are treated as a single class for all purposes under the indenture governing the Holdco Notes. The gross proceeds from the offering of the $450,000 additional Holdco Notes was $460,125, inclusive of a $10,125 premium, which were used to pay transaction fees and expenses, including a consent fee, totaling $18,560 and a $445,537 dividend to the Parent Company's shareholders.
Interest on the Holdco Notes is payable semi-annually in arrears on May 1 and November 1 of each year. NBTY has not guaranteed the indebtedness of the Parent Company, nor pledged any of its assets as collateral. Dividends from NBTY to the Parent Company were used to pay interest on the Holdco Notes.
S-4
Alphabet Holding Company, Inc.
Condensed Notes to Schedule 1
(In thousands)
NOTE C-LONG TERM DEBT (Continued)
On or after November 1, 2013, the Parent Company may redeem the Holdco Notes, at its option, in whole at any time or in part from time to time, at the following redemption prices (expressed as a percentage of principal amount), plus accrued and unpaid interest and additional interest, if any, to the redemption date (subject to the right of holders of record on the relevant record date to receive interest due on the relevant interest payment date), if redeemed during the 12-month period commencing on November 1 of the years set forth below:
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SCHEDULE II
Alphabet Holding Company, Inc. and Subsidiary
Valuation and Qualifying Accounts
(a)Uncollectible accounts written off.
(b)Represents actual product returns.
S-6