Item 1. Business
General
NBTY, Inc. (together with its subsidiaries, the "Company," "NBTY," "we," or "us") is a leading global vertically integrated manufacturer, marketer and
retailer of a broad line of high quality, value-priced nutritional supplements in the United States and throughout the world. We market approximately 22,000 products under numerous brands, including
Nature's Bounty®, Vitamin World®, Puritan's Pride®, Holland & Barrett®, Rexall®, Osteo-Bi-Flex®, Flex-a-min®,
Knox®, Sundown®, MET-Rx®, WORLDWIDE Sport Nutrition®, American Health®, DeTuinen®, Le Naturiste,
SISU®, Solgar® and Ester-C®. Our vertical integration includes the purchase of raw materials, formulation and manufacture of products, which we then
market through the following four channels of distribution:
-
-
Wholesale/US
Nutritiondistributes products under various brand names, each targeting specific market groups that include wholesalers, distributors, food, drug
and mass merchandisers, pharmacies, health food stores, bulk and international customers;
-
-
North
American Retailoperations include 457 Vitamin World stores selling proprietary brand and third-party products in the United States and our Canadian
operation of 80 Le Naturiste stores;
2
-
-
European
Retailoperations include 507 Holland & Barrett stores and 31 GNC stores in the UK, 69 DeTuinen stores in the Netherlands and 19 Nature's Way
stores in Ireland selling proprietary brand and third-party products; and
-
-
Direct
Response/E-Commerceoperations include the sale of proprietary brand and third-party products primarily through mail order catalog and the
internet.
At
September 30, 2007, we manufactured approximately 90% of the nutritional supplements we sold.
The
Company was incorporated in Delaware in 1979 under the name Nature's Bounty, Inc. On March 26, 1995, we changed our name to NBTY, Inc. Our principal executive
offices are at 90 Orville Drive, Bohemia, New York 11716, our telephone number is (631) 567-9500, and our website is
www.nbty.com
.
Our UK subsidiary, NBTY Europe, has its principal executive offices in Nuneaton, UK, and our Dutch subsidiary, De Tuinen, B.V., has its principal executive offices in Beverwijk, Netherlands.
Our
annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to these reports
filed or furnished under Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), are available at no cost on our website. We make these reports available
as soon as reasonably practicable after we file them electronically with the Securities and Exchange Commission (the "SEC").
Business Strategy
The Company targets the growing number of value-conscious consumers by offering high-quality products at a value price. Our objectives are to increase
sales, improve manufacturing efficiencies, increase profitability and strengthen our market position through the following key strategies:
Expand Existing Channels of Distribution.
We plan to continue expanding and improving our existing
channels of distribution through aggressive marketing and synergistic acquisitions, to the extent available on terms acceptable to us, to increase our sales and profitability and enhance our overall
market share. Specific plans to expand channels of distribution include the following:
-
-
Increase Wholesale Sales in the US and in Foreign Markets.
We expect to strengthen our wholesale business by
continuing to increase our sales in food, drug and mass merchandising channels by (i) increasing revenues from existing customers through strong promotional activities and aggressive
introduction of new and innovative products, (ii) increasing shelf space in major retailers, (iii) leveraging the advertising and promotion of our major specialty brands, such as
Osteo-Bi-Flex®, MET-Rx®, Flex-a-min®, Knox®, and, most recently,
Ester-C®, and (iv) continuing to increase our private label revenue with new customers and timely product introductions. In addition, we continue to seek to form new
distribution alliances throughout the world for our products, while strengthening existing relationships.
-
-
Increase Retail Sales and Profitability in North America.
We intend to continue focusing on the development of a
nationwide chain of profitable retail stores in the United States and Canada. To that end, at September 30, 2007, we operated 457 Vitamin World and Nutrition Warehouse retail stores in regional
and outlet malls throughout the United States, and 80 Le Naturiste retail stores throughout Quebec, Canada. During fiscal 2007, we opened one Vitamin World store and closed 20 underperforming Vitamin
World stores. As a result, as of September 30, 2007, we operated 19 fewer Vitamin World stores and 16 fewer Le Naturiste stores than in the fiscal year ended September 30, 2006. Although
we plan to open between 10 and 12 new stores during the 2008 fiscal year, we may close up to 20 existing Vitamin World and Le Naturiste stores during that time. There are 71 Vitamin World retail store
leases due to expire during the 2008 fiscal year, and, in an effort to improve profitability, any store whose lease cannot be renegotiated on favorable terms may be closed when its lease expires. We
maintain our Savings
3
Passport
Card, a customer loyalty program that we believe increases customer traffic and provides incentives to purchase at Vitamin World stores. The Savings Passport Card also helps us track customer
preferences and purchasing trends. At the end of fiscal 2007, we had approximately 8,000,000 (eight million) Savings Passport Card members. In addition, the
www.vitaminworld.com
site permits customers
to locate our retail stores, which we believe increases customer traffic.
-
-
Increase Retail Sales in the UK, Ireland and Europe.
We continue to selectively expand the number of our
Holland & Barrett stores throughout the UK. At September 30, 2007, we had 507 Holland & Barrett stores operating in the UK and 19 Nature's Way stores operating in Ireland. In
fiscal 2007, Holland & Barrett opened 10 new stores and closed one store. We project that, during the next fiscal year, we will open 34 additional retail stores in the UK, Ireland and the
Netherlands. At September 30, 2007, there were 31 GNC (UK) retail stores in operation in the UK and 69 De Tuinen retail stores in the Netherlands, including 22 franchise De Tuinen locations. We
will continue to evaluate opportunities to open additional GNC (UK) stores in the UK and De Tuinen stores in Europe.
-
-
Increase Direct Response/Puritan's Pride® Sales.
We expect to continue to strengthen the leading
position of our Puritan's Pride brand in the e-commerce/direct response business by (i) continuing to build brand and customer loyalty across catalog and internet channels,
(ii) increasing e-commerce activity from a variety of online media channels, including search, e-mail marketing, affiliate marketing and shopping portals,
(iii) focusing on enhanced retention and re-activation programs on-line and off-line, while testing new promotions to further improve response rates,
(iv) improving the shopping experience available to our customers with website enhancements and call center system upgrades, (v) improving automated picking and packing to fulfill sales
order requests with greater speed and accuracy, and (vi) increasing manufacturing capability to quickly introduce and deliver new products in response to customer demand. We also intend to
continue our strategy of acquiring customer lists, brand names and inventory of other mail order companies that have similar or complementary products that we believe we can integrate into our
operations efficiently, without adding substantial overhead. We plan to continue introducing direct internet channels that support our brands, such as
www.hollandandbarret.com
and
www.vitaminworld.com
Introduce Innovative New Products.
We have consistently been among the first in the industry to
introduce innovative products in response to new studies, research and consumer preferences. Given the changing nature of consumer demand for new products and the continued publicity about the
importance of vitamins, minerals and nutritional supplements in the promotion of general health, we believe that we will continue to maintain our core customer base and attract new customers based
upon our ability to respond rapidly to consumer demand with high quality, value-oriented products.
Enhance Vertical Integration.
We believe our vertical integration gives us a significant competitive
advantage by allowing us to (i) maintain higher quality standards while lowering product costs, which we pass on to our customers as lower prices, (ii) respond to scientific and popular
reports and consumer buying trends more quickly, (iii) meet customer delivery schedules more effectively and (iv) improve overall operating margins. We continually evaluate ways to
enhance our vertical integration by leveraging purchasing, manufacturing, distribution and marketing capabilities, and otherwise improving the efficiency of our operations.
Build Infrastructure to Support Growth.
We have technologically advanced,
state-of-the-art manufacturing and production facilities, with total production capacity of approximately 44 billion tablets, capsules and softgels per year.
In 2007, we acquired a nutritional bar manufacturing plant in North Amityville, New York, which we are in the process of upgrading. We expect to begin
4
manufacturing
nutrition bars in this facility during fiscal 2008. We regularly evaluate our manufacturing operations and make investments in infrastructure, as necessary, to support our continuing
growth.
Implement Strategic Acquisitions.
In the normal course of our business, we seek global acquisition
opportunities, both in the United States and internationally, of companies that complement or extend our existing product lines, increase our market presence, expand our distribution channels, and are
compatible with our business philosophy. We have successfully acquired more than 30 companies or businesses since 1986, enabling us to expand our product lines and scope of distribution significantly.
On October 2, 2006, we acquired Zila Nutraceutical, Inc., and renamed it The Ester C Company. For more information about our acquisitions, see Item 7, "Management's Discussion and
Analysis of Financial Condition and Results of Operation," and the notes to our financial statements in this Annual Report. We will continue to evaluate acquisition opportunities across industry
segments and around the world.
Utilize Management Team Experience.
Our management team has extensive experience in the nutritional
supplement industry and has developed long-standing relationships with our suppliers and customers. Our executive officers have an average of over 20 years in the industry. We will
continue to utilize the talent, experience and expertise of our management team to realize our goals.
Operating Segments
We operate in the nutritional supplement industry and are organized along our channels of distribution, which are: Wholesale/US Nutrition, North American Retail,
European Retail and Direct Response/E-Commerce.
The
following table sets forth the percentage of net sales for each of our operating segments:
|
|
Fiscal Year Ended September 30,
|
|
|
|
2007
|
|
2006
|
|
2005
|
|
Wholesale/US Nutrition
|
|
48
|
%
|
47
|
%
|
43
|
%
|
North American Retail
|
|
11
|
%
|
13
|
%
|
13
|
%
|
European Retail
|
|
31
|
%
|
30
|
%
|
33
|
%
|
Direct Response/E-Commerce
|
|
10
|
%
|
10
|
%
|
11
|
%
|
|
|
|
|
|
|
|
|
|
|
100
|
%
|
100
|
%
|
100
|
%
|
Additional
information about our financial results by segment can be found in Note 20 to the consolidated financial statements in this Annual Report.
Wholesale/US Nutrition.
We market our products under various brand names, each targeting special
market groups which include leading mass merchandisers, drug store chains and supermarkets, independent pharmacies, health food stores, health food store wholesalers, and other retailers. We sell
Nature's Bounty®, Rexall®, Sundown® Osteo-Bi-Flex®, MET-Rx®,
Flex-a-min®, Knox®, and Ester-C® brands to mass merchandisers, drug store chains, drug wholesalers, supermarket chains and wholesalers. We
also sell directly to health food stores under the Solgar®, SISU® and Good 'N Natural® brands, and sell products, including a specialty line of vitamins, to health
food wholesalers under our American Health® brand. Over the past several years, we have expanded our international product sales to include many countries throughout Europe, Asia and Latin
America.
North American Retail.
At the end of fiscal 2007, we operated 457 Vitamin World and Nutrition
Warehouse retail stores in regional and outlet malls throughout the United States, and 80 Le Naturiste retail stores throughout Quebec, Canada. Each store carries a full line of products of our
brands, as well as products manufactured by others. Nutritional supplement products that we manufactured accounted for approximately 71% of North American Retail's total sales in fiscal 2007. Our
direct
5
interaction
with our retail customers helps us identify regional buying trends, customer preferences, product acceptances and price trends. We use this information in initiating sales programs and new
product introductions for all our divisions. In addition to
www.puritan.com
and
www.vitamins.com
, which
focus on our direct response segment, we also maintain
www.vitaminworld.com
. We designed the
www.vitaminworld.com
site to permit our customers to purchase
nutritional supplements on the internet and to locate our retail stores. This website also
provides information about the products we offer in our retail stores, and an easy and effective way to purchase Vitamin World® products through our e-commerce portal.
European Retail.
We generate revenue through the retail operations from 507 Holland & Barrett
stores in the UK, 19 Nature's Way stores in Ireland, 31 GNC (UK) stores in the UK, and 69 DeTuinen stores in the Netherlands. Holland & Barrett, one of the UK's leading nutritional supplement
retailers, markets a broad line of nutritional supplement products, including vitamins, minerals and other nutritional supplements. Holland & Barrett stores also sell food products, such as
fruits and nuts, and confectionery. Our Nature's Way® product offerings are similar to those of Holland & Barrett. GNC (UK) stores specialize in vitamins, minerals and sports
nutrition products. De Tuinen is a leading retailer of health food products, selected confectionery, and lifestyle giftware. Nutritional supplement products that we manufactured accounted for
approximately 43% of European Retail's total sales in fiscal 2007.
Direct Response/E-Commerce.
We offer, through mail order and e-commerce, a
full line of vitamins and other nutritional supplement products as well as selected personal care items, under our Puritan's Pride® and other brand names at prices that are generally at a
discount from those of similar products sold in retail stores. Through our Puritan's Pride® brand, we are a leader in the US direct response nutritional supplement industry. We have more
than three million customers on our customer list, with response rates that we believe are above the industry average. In addition, we offer products focusing on our other brands through other direct
channel sites, such as
www.vitaminworld.com
,
www.hollandandbarrett.com
and
www.gnc.co.uk
. We intend to
attract new customers in our direct response operation through aggressive marketing techniques in the United States and
around the world, and through selective acquisitions. We regularly update our mail order lists by adding new customers and deleting those who have not placed orders within a designated period of time.
We believe this maximizes catalog sales while reducing mailing and printing costs. We also advertise in newspaper supplements and conduct insert programs with other mail order companies to add new
customers to our mailing lists and websites, and to increase the average order size. Our use of state-of-the-art equipment, such as computerized mailing,
bar-coded addresses and automated picking and packing systems, enables us to process orders quickly, economically and efficiently. Typically, we fill orders within 24 hours of
receipt. Our equipment and expertise also lowers our per customer distribution costs, thereby enhancing margins and enabling us to lower our prices. Our
www.puritan.com
and
www.vitamins.com
websites provide a practical and convenient method for consumers
wishing to purchase products that promote healthy living. Through these websites, consumers have access to more than 1,500 products offered through our Puritan's Pride® mail order catalog.
See
Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operation," and the notes to our consolidated financial statements in this Annual Report,
for more information regarding financial information about the geographic areas where we conduct our business.
Employees and Advertising
As of September 30, 2007, we employed approximately 10,800 persons, including:
-
-
2,175
sales associates located throughout the United States in our Vitamin World and Nutrition Warehouse retail stores;
-
-
2,810
manufacturing, shipping and packaging associates throughout the United States;
6
-
-
565
associates in administration throughout the United States;
-
-
168
associates who sell to wholesale distributors and customers;
-
-
62
in-house advertising associates;
-
-
3,590
associates in our Holland & Barrett operations, including:
-
-
3,127
retail associates,
-
-
251
associates in distribution, and
-
-
212
associates in administration;
-
-
390
associates in our De Tuinen operations, including:
-
-
347
retail associates, and
-
-
43
associates in administration and warehousing;
-
-
157
associates in GNC (UK) retail stores;
-
-
115
associates in Nature's Way retail stores; and
-
-
313
associates in Le Naturiste operations, including:
-
-
259
retail associates,
-
-
17
associates in distribution, and
-
-
37
associates in administration;
-
-
233
associates in Direct Response operations;
-
-
84
associates in SISU operations (including 42 manufacturing associates in Canada); and
-
-
98
associates in Solgar international operations.
In
addition, we sell products through commissioned sales representative organizations. We believe we have satisfactory employee and labor relations.
For
the fiscal years ended September 30, 2007, 2006 and 2005, we spent approximately $120 million, $104 million and $108 million, respectively, on advertising
and promotions, including print, media and cooperative advertising. We create our own advertising materials through our in-house staff of associates. In the UK and Ireland, both
Holland & Barrett and Nature's Way advertise on television and in national newspapers, and conduct sales promotions. GNC (UK) and De Tuinen also advertise in newspapers and conduct sales
promotions. In addition, Holland & Barrett and De Tuinen each publish their own magazines with articles and promotional materials. SISU advertises in trade journals and magazines and conducts
sales promotions.
Manufacturing, Distribution and Quality Control
At September 30, 2007, we employed approximately 2,810 manufacturing, shipping and packaging associates throughout the United States and 42 such associates
in British Columbia, Canada. We manufacture in Arizona, California, Florida, Illinois, New Jersey, New York in the US, and in Canada and the UK. We have technologically advanced,
state-of-the-art manufacturing and production facilities, with total production capacity of approximately 44 billion tablets, capsules and softgels per year.
All
our manufacturing operations are subject to good manufacturing practice regulations, or GMPs, promulgated by the United States Food and Drug Administration, or FDA, and other
applicable regulatory standards. We are subject to similar regulations and standards in Canada. We believe our manufacturing processes will timely comply with the recently published GMPs, which will
be
7
effective
for us in June 2008. We have received certifications from Schuster Laboratories Qualification Program as well as the Natural Products Association. We manufacture products for our four
operating segments and for third parties. We believe our manufacturing and distribution facilities generally are adequate to meet our current business requirements and our currently anticipated
increases in sales.
We
place special emphasis on quality control. We assign a lot number to all raw materials and initially hold them in quarantine, while our laboratory chemists assay them for compliance
with established
specifications. Once released, samples are retained, and we process the material according to approved formulae by mixing, granulating, compressing, encapsulating and, sometimes, coating operations.
After a tablet or capsule is manufactured, laboratory chemists and technicians test its weight, purity, potency, disintegration and dissolution, if applicable. We hold the product in quarantine until
we complete this evaluation, and determine that the product meets all applicable specifications. Generally, when products such as vitamin tablets are ready for bottling, our automated equipment counts
the tablets, inserts them into bottles, adds a tamper-resistant cap with an inner safety seal and affixes a label with a lot number and expiration date. We use computer-generated documentation for
picking and packing for order fulfillment.
Our
manufacturing operations are designed to allow low-cost production of a wide variety of products of different quantities, sizes and packaging, 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.
Inventory Control.
We have installed inventory control systems at our facilities that track each
product 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 individual stock keeping unit (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 staff regularly reviews and analyzes
information from our point-of-sale computer system and makes merchandise allocation and markdown decisions based on this information. We use an automated reorder system 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.
Financial Reporting.
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 scheduling of payments, receiving of payments, 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 years.
Competition; Customers
The market for nutritional supplement products is highly competitive. Competition is based primarily on price, quality and assortment of products, customer
service, marketing support, and availability of new products. We believe we compete favorably in all these areas.
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. We also
compete with companies that may have broader product lines, larger sales volumes, or both. Our products also compete with nationally advertised brand name products. Most of the national brand
companies have resources greater than we do.
8
There
are numerous companies in the vitamin and nutritional supplement industry selling products to retailers, including mass merchandisers, drug store chains, independent drug stores,
supermarkets and health food stores. Many companies within the industry are privately held. Therefore, we cannot assess precisely the size of all our competitors, or where we rank in comparison to
such privately held competitors with respect to sales to retailers.
During
fiscal 2007, two individual customers accounted for the following percentages of the Wholesale/US Nutrition division's net sales:
Customer A
|
|
8
|
%
|
Customer B
|
|
18
|
%
|
Customer A
is primarily a supplier to Customer B. Therefore, the loss of Customer B would likely result in the loss of most of the net sales to Customer A.
As
of September 30, 2007, Customer B above accounted for 14% of the Wholesale/US Nutrition division's total gross accounts receivable as of September 30, 2007.
While
no one customer represented, individually, more than 10% of our consolidated net sales, for fiscal 2007, the loss of either Customer A or Customer B would have a
material adverse effect on the Wholesale/US Nutrition division if we were unable to replace this customer.
Government Regulation
United States.
The formulation, manufacturing, packaging, labeling, advertising, distribution and
sale of our products are subject to regulation by federal agencies, including the FDA, the Federal Trade Commission ("FTC"), the United States Postal Service ("USPS"), the Consumer Product Safety
Commission, the Department of Agriculture, and the Environmental Protection Agency ("EPA"). These activities also are subject to regulation by various agencies of the states, localities and foreign
countries in which our products are sold. In particular, the FDA, under the Federal Food, Drug, and Cosmetic Act (the "FDCA"), regulates the formulation, manufacturing, packaging, labeling,
distribution and sale of foods, including dietary supplements, vitamins, minerals and herbs, and of over-the-counter ("OTC") drugs. The FTC regulates the advertising of these
products, and the USPS regulates advertising claims with respect to such products sold by mail order. The National Advertising Division ("NAD") of the Council of Better Business Bureaus oversees an
industry-sponsored self-regulatory system that permits competitors to resolve disputes over advertising claims. The NAD has no enforcement authority of its own, but may refer matters that
the NAD views as violating FTC guides or rules to the FTC for further action.
The
FDCA has been amended several times with respect to dietary supplements, in particular by the Dietary Supplement Health and Education Act of 1994, known as DSHEA. DSHEA established a
new framework governing the composition and labeling of dietary supplements. With respect to composition, DSHEA defines "dietary supplements" as vitamins, minerals, herbs, other botanicals, amino
acids and other dietary substances for human use to supplement the diet, as well as concentrates, constituents, extracts or combinations of such dietary ingredients. Generally, under DSHEA, dietary
ingredients that were marketed in the United States before October 15, 1994 may be used in dietary supplements without notifying the FDA. However, a "new" dietary ingredient (a dietary
ingredient that was not marketed in the United States before October 15, 1994) must be the subject of a new dietary ingredient notification submitted to the FDA unless the ingredient has been
"present in the food supply as an article used for food" without being "chemically altered." A new dietary ingredient notification must provide the FDA evidence of a "history of use or other evidence
of safety" establishing that use of the dietary ingredient "will reasonably be expected to be safe." A new dietary ingredient notification must be submitted to the FDA at least 75 days before
the initial marketing of the new dietary ingredient. There can be no assurance that the FDA will accept the evidence of safety
9
for
any new dietary ingredients that we may want to market, and the FDA's refusal to accept such evidence could prevent the marketing of such dietary ingredients. The FDA is in the process of
developing guidance for the industry to clarify the FDA's interpretation of the new dietary ingredient notification requirements, and this guidance may raise new and significant regulatory barriers
for new dietary ingredients. In addition, increased FDA enforcement could lead the FDA to challenge dietary ingredients already on the market as "illegal" under the FDCA because of the failure to
submit a new dietary ingredient notification.
The
FDA generally prohibits the use in labeling for a dietary supplement of any "health claim" unless the claim is pre-approved by the FDA. DSHEA permits "statements of
nutritional support" to be included in labeling for dietary supplements without FDA pre-approval. Such statements may describe how a particular dietary ingredient affects the structure,
function or general well-being of the body, or the mechanism of action by which a dietary ingredient may affect body structure, function or well-being (but may not state that a
dietary supplement will diagnose, cure, mitigate, treat, or prevent a disease). A company that uses a statement of nutritional support in labeling must possess evidence substantiating that the
statement is truthful and not misleading. When such a claim is made on labels, it is necessary to disclose on the label that the FDA has not "evaluated" the statement, to disclose that the product is
not intended for use for a disease, and to notify the FDA about our use of the statement within 30 days of marketing the product. However, there can be no assurance that the FDA will not
determine that a particular statement of nutritional support that we want to use is an "unauthorized health or disease claim" or an unauthorized version of a "health claim." Such a determination might
prevent us from using the claim.
In
addition, DSHEA provides that certain so-called "third-party literature," such as a reprint of a peer-reviewed scientific publication linking a particular
dietary ingredient with health benefits, may be used "in connection with the sale of a dietary supplement to consumers" without the literature being subject to regulation as labeling. Such literature
must not be, among other things, false or misleading; the literature may not "promote" a particular manufacturer or brand of dietary supplement; and a balanced view of the available scientific
information on the subject matter must be presented. There can be no assurance, however, that all third-party literature that we would
like to disseminate in connection with our products will satisfy all the requirements, and failure to satisfy all requirements could prevent use of the literature or subject the product involved to
regulation as an unapproved drug.
As
authorized by DSHEA, the FDA adopted GMPs specifically for Dietary Supplements. These new GMP regulations, finalized in June 2007 and effective June 2008, are more
detailed than the GMPs that previously applied to dietary supplements and require, among other things, dietary supplements to be prepared, packaged and held in compliance with specific rules, and
require quality control provisions similar to those in the GMP regulations for drugs. We believe our manufacturing and distribution practices will timely comply with the new rules.
Although
the regulation of dietary supplements in some respects is less restrictive than the regulation of drugs, there can be no assurance that dietary supplements will continue to be
subject to less restrictive regulation. In December 2006, the Dietary Supplement and Nonprescription Drug Consumer Protection Act (the "AER Act") amended the FDCA to require that manufacturers,
packer, and distributors of dietary supplements report serious adverse events to FDA. The AER Act will take effect on December 22, 2007. We believe we will timely comply with the AER Act.
The
FDA regulates the formulation, manufacturing, packaging, labeling and distribution of OTC drug products under a "monograph" system that specifies active drug ingredients that are
generally recognized as safe and effective for particular uses. If an OTC drug is not in compliance with the applicable FDA monograph, the product generally cannot be sold without first obtaining the
FDA approval of a new drug application, a long and expensive procedure. There can be no assurance that, if more stringent statutes are enacted for dietary supplements, or if more stringent regulations
are
10
promulgated,
we will be able to comply with such statutes or regulations without incurring substantial expense.
The
FDA has broad authority to enforce the provisions of the FDCA applicable to dietary supplements and OTC drugs, including powers to issue a public "warning letter" to a company, to
publicize information about illegal products, to request a voluntary recall of illegal products from the market, and to request the Department of Justice to initiate a seizure action, an injunction
action, or a criminal prosecution in the US courts.
The
FTC exercises jurisdiction over the advertising of dietary supplements. In recent years, the FTC has instituted numerous enforcement actions against dietary supplement companies for
failure to adequately substantiate claims made in advertising or for the use of false or misleading advertising claims. These enforcement actions have often resulted in consent decrees and the payment
of civil penalties, restitution, or both, by the companies involved. We currently are subject to FTC consent decrees resulting from past advertising claims for certain of our products. Our subsidiary,
Rexall
Sundown, also is currently subject to FTC consent decrees resulting from past advertising claims for certain of its products. As a result, we are required to maintain compliance with these decrees and
are subject to an injunction and substantial civil monetary penalties if there should be any failure to comply. We and certain of our subsidiaries also are subject to consent judgments under the
California Safe Drinking Water and Toxic Enforcement Act of 1986 (also known as "Proposition 65"). Further, the Postal Service has issued cease and desist orders against certain mail order advertising
claims made by dietary supplement manufacturers, including us, and we are required to maintain compliance with the orders applicable to us, subject to civil monetary penalties for any noncompliance.
Violations of these orders could result in substantial monetary penalties. These civil penalty actions could have a material adverse effect on our consolidated financial position and results of
operations.
We
also are subject to regulation under various state, local, and international laws that include provisions governing, among other things, the formulation, manufacturing, packaging,
labeling, advertising and distribution of dietary supplements and OTC drugs. Government regulations in foreign countries may prevent or delay the introduction, or require the reformulation, of certain
of our products. Compliance with such foreign governmental regulations is generally the responsibility of our distributors in those countries. These distributors are independent contractors whom we do
not control.
In
addition, from time to time in the future, we may become subject to additional laws or regulations administered by the FDA or by other federal, state, local or foreign regulatory
authorities, to the repeal of laws or regulations that we consider favorable, such as DSHEA, or to more stringent interpretations of current laws or regulations. We are not able to predict the nature
of future laws, regulations, repeals or interpretations, and we cannot predict what effect additional governmental regulation, when and if it occurs, would have on our business in the future. Such
developments, however, 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, additional personnel, or other new requirements.
Any such development could have a material adverse effect on us.
Europe.
In Europe, the European Union Commission is responsible for developing legislation to
regulate foodstuffs and medicines. Although the government of each Member State may implement legislation governing these products, national legislation must be compatible with, and cannot be more
restrictive than, European requirements. Each Member State is responsible for its enforcement of the provisions of European and national legislation.
United Kingdom.
In the United Kingdom, the two main pieces of legislation that affect the operations
of Holland & Barrett and GNC (UK) are the Medicines Act 1968, which regulates the licensing and sale of medicines, and the Food Safety Act 1990, which provides for the safety of food
11
products.
A large volume of secondary legislation in the form of Statutory Instruments adds detail to the main provisions of the above Acts, governing composition, packaging, labeling and advertising
of products.
In
the UK regulatory system, a product intended to be taken orally will fall within either the category of food or the category of medicine. There is currently no special category of
dietary supplement as provided for in the United States by DSHEA. Some products which are intended to be applied externally, for example creams and ointments, may be classified as medicines and others
as cosmetics.
The
Medicines and Healthcare Products Regulatory Agency, or MHRA, now has responsibility for the implementation and enforcement of the Medicines Act, and is the licensing authority for
medicinal products. The MHRA directly employs enforcement officers from a wide range of backgrounds, including the police, and with a wide range of skills, including information technology. However,
the MHRA still relies heavily on competitor complaints to identify non-compliant products. The MHRA is an Executive Agency of the Department of Health. The MHRA decides whether a product
is a medicine or not and, if so, considers whether it can be licensed. It determines the status of a product by considering whether it is medicinal by "presentation" or by "function." Many, though not
all, herbal remedies are considered "medicinal" by virtue of these two criteria.
The
Food Standards Agency, or FSA, deals with legislation, policy and oversight of food products, with enforcement action in most situations being handled by local authority Trading
Standards Officers. The large number of local authorities in the UK can lead to an inconsistent approach to enforcement. Unlike the MHRA, local authorities regularly purchase products and analyze them
to identify issues of non-compliance. The FSA answers primarily to Ministers at the Department of Health and the Department of Environment Food and Rural Affairs. Most vitamin and mineral
supplements, and some products with herbal ingredients, are considered to be food supplements and fall under general food law which requires them to be safe. Despite the differences in approaches in
identifying non-compliant products, both the MHRA and local authorities can, and do, prosecute where issues of non-compliance are identified.
In
July 2002, the European Union, or EU, published in its Official Journal the final text of a Food Supplements Directive which became effective in the EU at that time, and which
sets out a process and timetable by which the Member States of Europe must bring their domestic legislation in line with its provisions. The Directive seeks to harmonize the regulation of the
composition, labeling and marketing of food supplements (at this stage only vitamins and minerals) throughout the EU. It does this by specifying what nutrients and nutrient sources may be used (and by
interpretation the rest which may not), and the labeling and other information which must be provided on packaging. In addition, this
Directive is intended to regulate the levels at which these nutrients may be present in a supplement. These maximum permitted levels are due to be announced shortly.
By
harmonizing Member State legislation, the Food Supplements Directive should provide opportunities for businesses to market one product or a range of products to a larger number of
potential customers without having to reformulate or repackage it. This development may lead to some liberalizing of the more restrictive regimes in France and Germany, providing new business
opportunities. Conversely, however, it may limit the range of nutrients and nutrient sources substantially, and eventually the potencies at which some nutrients may be marketed by us in the more
liberal countries, such as the UK, which may lead to some reformulation costs and loss of some specialty products.
Following
the publication of the Food Supplements Directive, two challenges were brought in the UK Courts attacking its validity. Subsequently, the matters were referred to the European
Court of Justice, or ECJ, for resolution. The ECJ upheld the validity of the Directive, ruling that its contents were legal under European Law. However, due to the ECJ's comments on procedure, the EU
Commission has undertaken to look at ways to ensure the Directive is implemented in a transparent and timely manner.
12
The provisions of the Food Supplements Directive have been incorporated into UK domestic law (which includes England & Wales, Scotland and Northern Ireland) by Statutory
Instrument and apply from August 2005.
On
April 30, 2004, the EU published the Traditional Herbal Medicinal Products Directive, or THMPD, which requires traditional herbal medicines to be registered in each Member
State in which they are intended to be marketed. A registration requires a product be manufactured to pharmaceutical GMP standards; however, generally, there is no need to demonstrate efficacy,
provided that the product is safe, is manufactured to high standards, and has a history of supply on the market for 30 years, 15 years of which must be in the EU. The THMPD is intended
to provide a safe harbor in EU law for a number of categories of herbal remedies, which may otherwise be found to fall outside EU law. However, it does not provide a mechanism for new product
development, and would entail some compliance costs in registering the many herbal products already on the market. Member States had to put into place the provisions for national compliance by
October 2005, the date on which Traditional Herbal Medicinal products could begin to be registered. A transitional period of seven years has been granted in the UK to allow all relevant
products to be registered. Full compliance is required by April 2011. We currently believe that we will comply with this Directive.
On
December 30, 2006, the EU published the Nutrition and Health Claim Regulation to apply from July 1, 2007. The Regulation controls nutrition and health claims by means of
positive lists of authorized claims that can be made in advertising, labeling and presentation of all foods, including food supplements, together with the criteria a product must meet to use them.
Under transitional arrangements in the Regulation, claims already in use before January 1, 2006, and complying with existing national legislation can continue to be made for up to three years.
Industry has worked together to submit over 700 claims and the European Food Safety Authority will produce a community list of accepted claims in 2010.
Additional
European legislation is being developed to regulate sports nutrition products, including the composition of such products. In particular, such legislation could restrict the
type of nutrients we may use in our products. Legislation introducing maximum permitted levels for nutrients in fortified foods is also under discussion together with legislation introducing a
positive list for enzymes. These proposals, if implemented, could require us to reformulate our existing products. Also, proposals to amend medicine legislation will impact traditional herbal
medicines and introduce new requirements, such as Braille labeling, which may lead to higher associated costs.
The
EU has established a European Food Safety Authority, which will have an important role to play in focusing attention on food standards in Europe. Its Executive Director is
Mr. Geoffrey Podger, who, until 2003, was the Chief Executive of the UK's Food Standards Agency.
Ireland.
The legislative and regulatory situation in the Republic of Ireland is similar, but not
identical, to that in the UK. The Irish Medicines Board has a similar role to that of the UK's MHRA and the Food Safety Authority of Ireland is analogous to the UK's FSA. Like the UK, Ireland will be
required to bring its domestic legislation into line with the provisions of the Food Supplements Directive and the THMPD when the latter is finalized, and, indeed, with the other forthcoming EU
legislation mentioned above. Thus the market prospects for Ireland, in general, are similar to those outlined in the UK.
Netherlands.
The regulatory environment in the Netherlands is similar to the UK in terms of
availability of products. The Netherlands currently has the same liberal market, with no restrictions on potency of nutrients. Licensed herbal medicines are available. However, there are some herbal
medicines which are sold freely as in the UK without the need to be licensed, depending on the claims made for them. The Netherlands also is more liberal regarding certain substances, for which
unlicensed sales are allowed. The government department dealing with this sector is the Ministry for Health, Welfare and Sport.
13
Responsibility
for food safety falls to the Keuringsdienst van Waren (Inspectorate for Health Protection and Veterinary Public Health). This authority deals with all nutritional
products. The Medicines Evaluation Board, which is the equivalent of the UK's MHRA, is charged with responsibility for the safety of medicines which are regulated under the Supply of Medicines Act.
The
overall market prospects for the Netherlands, in general, are similar to those outlined for the UK above, with the exception of only a four-year transitional period
granted for the registration of Traditional Herbal Medicinal products which are currently on sale in the Netherlands and which fall within the scope of the THMPD.
Canada.
The product safety and quality, manufacturing, packaging, labeling, storage, importation,
advertising, distribution, sale and clinical trials of natural health products, called NHPs, and hybrid NHPs, are subject to regulation primarily under provisions under the Canadian Food and Drugs
Act, the Canadian Food and Drug Regulations, the Natural Health Product Regulations and related Health Canada Guidance Documents and Policies. Health Canada, the public health agency of Canada,
including, specifically, the Therapeutic Products Directorate, the Natural Health Products Directorate and the Health Protection and Food Branch Inspectorate, is primarily responsible for
administering the Act and Regulations. NHPs include, vitamins and minerals, herbal remedies, homeopathic medicines, traditional medicines (such as traditional Chinese medicines), probiotics and
products like amino acids and essential fatty acids and hybrid NHPs. With the exception of homeopathic medicines, products with ingredients required to be sold under prescription are not NHPs and are
regulated as drugs though the regular drug approval process. Similarly, hybrid products comprising drugs are regulated as such under the Canadian Food and Drugs Act and the Canadian Food and Drug
Regulations.
Before
January 1, 2004, NHPs for which therapeutic claims were made were regulated as drugs requiring a Drug Identification Number, or DIN. Effective January 1, 2004, NHPs
in Canada became subject to new requirements under the Natural Health Product Regulations. Under these regulations, all NHPs must have a product license before sale. An application for a product
license must provide specific information including quality of medicinal ingredients, including a list of medicinal and non-medicinal ingredients and their source and potency, use and purpose of the
NHPs, and the supporting safety and efficacy data. These regulations also set out a regime for site licensing of buildings or locations in which NHPs are imported, distributed, manufactured, packaged,
labeled or stored. One of the prerequisites of a site license is that GMP's be employed. The regulations require all manufacturers, packagers, labelers and importers of NHPs to have site licenses.
Further, the regulations set out requirements for adverse reaction reporting.
As
of January 1, 2004, all NHPs must comply with the NHP Regulations. For products already marketed in Canada as of that date, the regulations provide transition periods for
compliance with the site license and product license requirements. The transition period for obtaining site licenses expired December 31, 2005, so all manufacturers, packagers, labelers and
importers of NHPs must now have site licenses. For product licenses, the requirements for products that were marketed in Canada as of January 1, 2004 are as follows: (i) for NHPs that
had a DIN prior to January 1, 2004, a NHP product license must be obtained by December 31, 2009; (ii) for NHP's without a prior DIN, products can continue to be marketed and sold
in Canada if a product license application was filed on or before June 30, 2004. However, if the product license eventually is refused, subject to Health Canada's compliance procedures, the NHP
could not be sold in Canada until a product license is obtained.
Health
Canada has adopted a phased-in approach to comply with the NHP Regulations, based on perceived level of risk of the product. All NHP's must comply will all the
regulations by January 1, 2010. We have adopted a phased-in compliance strategy in accordance with the prescribed transition periods.
14
In
addition, advertising of NHPs are regulated under the aforementioned Act and Regulations. Guidelines adopted October 18, 2007, were prepared by Advertising Standards Canada
(ASC) and Health Canada.
The
overall risk factors and market prospects for Canada, in general, are similar to those outlined in the US. Health Canada can suspend or revoke licenses for lack of compliance or if
they perceive the product to present an unacceptable level of risk.
International Operations
In addition to Canada, the UK, Ireland and the Netherlands, we market nutritional supplement products through subsidiaries, distributors, retailers and direct
mail in more than 75 countries throughout Europe, Central America, South America, Asia, the Pacific Rim countries, Africa and the Caribbean Islands.
We
conduct our international operations to conform to local variations, economic realities, market customs, consumer habits and regulatory environments. Our products (including labeling
of such products) and our distribution and marketing programs are modified in response to local and foreign legal requirements and customer preferences.
Our
international operations are subject to many of the same risks our domestic operations face. These include competition and the strength of the relevant economy. In addition,
international operations are subject to certain risks inherent in conducting business abroad, including foreign regulatory restrictions, fluctuations in monetary exchange rates, import-export controls
and the economic and political policies of foreign governments. The importance of these risks increases as our international operations grow and expand. Virtually all our international operations are
affected by foreign currency fluctuations, and, more particularly, changes in the value of the British pound, the euro and the Canadian dollar as compared to the US dollar.
See
Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operation," and the notes to our consolidated financial statements contained in this Annual
Report for additional information regarding financial information about the geographic areas in which we conduct our business.
Trademarks and Patents
United States.
We have developed many brand names and trademarks for products in all areas. We
consider the overall protection of our patent, trademark, license and other intellectual property rights to be of material value and we vigorously protect these rights from infringement. We have
applied for or registered more than 2,200 trademarks with the United States Patent and Trademark Office, or the PTO, for our Nature's Bounty®, Vitamin World®, Puritan's
Pride®, Holland & Barrett®, Rexall®, Sundown®, Solgar®, MET-Rx®, WORLDWIDE Sport Nutrition®,
American Health®, SISU® and Ester-C® trademarks, among others. We also
have rights to use other names essential to our business. Federally registered trademarks have a perpetual life, as long as they are maintained and renewed on a timely basis and used properly as
trademarks, subject to the rights of third parties to seek cancellation of the trademarks if they claim priority or confusion of usage.
We
hold 70 patents, including 41 patents for Ester-C®, in the US and internationally. We also are prosecuting patent applications actively on a
world-wide basis for a number of products, particularly products that include ESTER-C® as an active ingredient. We regard our trademarks and other proprietary
rights as valuable assets and believe they have significant value in marketing our products. We vigorously protect our trademarks and patents against infringement.
Canada.
Each of our Solgar, Le Naturiste and SISU subsidiaries owns the trademarks registered in
Canada for its respective names.
15
UK/Ireland.
Our Holland & Barrett subsidiary owns trademarks registered in the UK and
throughout the EU for its Holland & Barrett® and Nature's Way® trademarks, and has rights to use other names essential to its business. Holland & Barrett is the
exclusive licensee of the trademarks essential to the GNC (UK) business in the UK. Our Solgar subsidiary also owns trademarks in the UK and throughout the EU.
Netherlands.
Our De Tuinen subsidiary owns trademarks registered in the Netherlands or throughout the
EU for its DeTuinen® trademarks and has rights to use other names essential to its business.
Raw Materials
In fiscal 2007, we spent approximately $350 million on raw materials. The principal raw materials required in our operations are vitamins, minerals, herbs,
gelatin and packaging components. We purchased the majority of our vitamins, minerals and herbs from raw material manufacturers and distributors in the United States, Japan, China, Europe, India,
Canada, Australia and South America. We believe that there are adequate sources of supply for all our principal raw materials. From time to time, weather or unpredictable fluctuations in the supply
and demand may affect price, quantity, availability or selection of raw materials. We believe that our strong relationships with our suppliers yield high-quality, competitive pricing and
overall good service to our customers. Although we cannot be sure that our sources of supply for our principal raw materials will be adequate
in all circumstances, we believe that we can develop alternate sources in a timely and cost effective manner if our current sources become inadequate. During fiscal 2007, no one supplier accounted for
more than 10% of our raw material purchases. Due to the availability of numerous alternative suppliers, 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.
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. We believe that 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.
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 currently known to us, or that we currently deem immaterial, also may materially adversely affect our
business, financial condition, operating results and cash flows.
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
16
distributed
specifically by us. Consumer perception of our products can be significantly influenced by scientific research or findings, national media attention and other publicity regarding the
consumption of nutritional supplements. There can be no assurance that future scientific research, findings or publicity will be favorable to the nutritional supplement market or any particular
product, or consistent with earlier favorable research, findings or publicity. Future research reports, findings or publicity that are perceived as less favorable than, or that question, such 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. Because of our
dependence upon consumer perceptions, adverse scientific research reports, findings or publicity, whether or not accurate, 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 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 could arise even if the adverse effects
associated with such products resulted from consumers' failure to consume such products appropriately or as directed.
Complying with new and existing government regulation, both in the US and abroad, could increase our costs significantly 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 US
federal agencies, including the FDA, the FTC, the Consumer Product Safety Commission, the Department of Agriculture 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 in Canada, the Food Standards Agency and the Department of Health in the UK and similar regulators in Ireland and the
Netherlands. Government regulations may prevent or delay the introduction, or require the reformulation, 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 could also lead to
liability, substantial costs and reduced growth prospects. 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. In addition, complying with the new adverse event reporting requirements will impose additional costs on us, which could be significant.
We
currently are subject to FTC consent decrees and a US Postal Service consent order, prohibiting certain advertising claims for certain of our products. We also are subject to
Proposition 65 consent judgments. A determination that we have violated of 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.
Additional
or more stringent regulations of dietary supplements and other products have been considered from time to time. 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. For
example, the FDA issued rules in 2007, which imposed substantial new regulatory requirements for dietary supplements, including good manufacturing practices. Congress also passed legislation requiring
adverse event reporting and related record keeping which imposed additional costs on us. We believe our manufacturing, distribution and reporting practices will timely comply with the recently-enacted
rules;
17
nevertheless,
we may not be able to comply with the new rules without incurring additional expenses, which could be significant. See Item 1, "BusinessGovernment Regulation" for
additional information.
In
Europe, the enactment of legislation that could significantly impact the formulation and marketing of our products is anticipated. For example, in accordance with the Nutritional
Supplements Directive, maximum permitted levels for vitamin and mineral supplements are likely to be introduced shortly. European legislation regulating food supplements other than vitamins and
minerals is also expected to be introduced by the end of calendar 2007. The introduction of these anticipated legislations 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 to use the claims. The Regulation has impacted the claims that can be made for our products, and may impact our sales in Europe. See Item 1,
"BusinessGovernment Regulation;
Europe
" for additional information.
In
addition, an EU Directive governing product safety came into force 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 European Member State the power to order a product recall and, if necessary, instigate the product recall themselves. As a result, the number of product
recalls in Europe has increased substantially and the likelihood that we will be subject to a product recall in Europe has
increased. A product 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.
We may be exposed to legal proceedings instigated by regulators abroad which could increase our costs and adversely affect our reputation, revenues and operating income.
In Europe, non-compliance with relevant legislation can result in regulators bringing administrative or, in some cases, criminal proceedings. In the
UK, it is common for regulators to prosecute retailers and manufacturers for non-compliance with legislation governing foodstuffs and medicines. Failures by us or our subsidiaries 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, "BusinessGovernment Regulation," for additional information.
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 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 or dietary supplements and, in most cases, are not necessarily
subject to pre-market regulatory approval in the United States. Our products could contain contaminated substances, and 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. For example, we have been named in certain pending cases involving the sale of certain nutrition bars, products that contain certain
prohormone ingredients and our sales of products containing ephedra. A product liability claim against us could result in increased costs and could adversely affect our
18
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.
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 out of 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.
Our
estimate of retained-insurance liabilities is subject to change as new events or circumstances develop that might materially impact the ultimate cost to settle these losses. We
cannot assure you that our insurance will be sufficient to cover our losses. Any losses that are not completely covered by our insurance 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 ("D&O"). We were able to obtain these insurance coverages through July 15, 2008 and our current insurance program is consistent with both our past level of
coverage and our risk management policies. However, we cannot assure you that we will be able to obtain comparable insurance coverage at favorable terms, or at all, in the future.
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 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 US and abroad, could increase our costs significantly and adversely affect our financial results" and other risks summarized above.
Our operations in international markets expose us to certain risks.
We may experience difficulty entering new international markets due to greater regulatory barriers, the necessity of adapting to new regulatory systems and
problems related to entering new markets with different cultural bases and political systems. As of September 30, 2007, we operated 706 retail stores outside of the United States. In addition,
we had significant wholesale sales outside of the United States. For fiscal 2007, approximately 36% of our net sales were generated in international markets. These international operations expose us
to certain risks, including, among other things:
-
-
local
economic conditions;
19
-
-
changes
in or interpretations of foreign regulations that may limit our ability to sell certain products or repatriate profits to the United States;
-
-
exposure
to currency fluctuations;
-
-
potential
imposition of trade or foreign exchange restrictions or increased tariffs;
-
-
difficulty
in collecting international accounts receivable;
-
-
difficulty
in staffing, developing and managing foreign operations as a result of distance, languages and cultural differences;
-
-
potentially
longer payment cycles;
-
-
difficulties
in enforcement of contractual obligations and intellectual property rights;
-
-
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.
-
-
geographic
time zone, language and cultural differences between personnel in different areas of the world; and
-
-
political
instability.
As
we continue to expand our international operations, these and other risks associated with international operations are likely to increase. See Item 1,
"BusinessBusiness Strategy" and "BusinessGovernment Regulation."
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 would 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. 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:
-
-
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;
-
-
unknown
risks; and
-
-
the
potential loss of key employees, customers and strategic partners of acquired companies.
We
may not integrate successfully any businesses or technologies we acquire in the future 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.
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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. Our ability to manage our
operations and meet our business objectives could be affected adversely if, for any reason, these officers or employees do not remain with us.
Two of our customers account for a substantial portion of our Wholesale/US Nutrition division's revenue, and the loss of one or both of these customers would have a material
adverse effect on the results of operations of that division.
Two of our customers accounted for, individually, 18% and 8%, respectively, of our Wholesale/US Nutrition segment's net sales in fiscal 2007 and 14% and 7% of our
Wholesale/US Nutrition segment's total gross accounts receivable as of September 30, 2007. We do not have long-term contracts with these customers. One customer is primarily a
supplier to the other customer; therefore, adverse changes in our business relationship with either may result in the loss of most of the net sales to both customers. While no one customer represented
individually more than 10% of our consolidated net sales or total gross accounts receivable, the loss of either one of these customers would have a material adverse effect on our Wholesale/US
Nutrition segment if we were unable to replace that customer. In addition, our results of operations and ability to service our debt obligations would be impacted negatively to the extent that one or
both of the customers are unable to make payments or does not make timely payments on outstanding accounts receivables.
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 herbs from bulk manufacturers and distributors in the US, Japan, China, Europe, India, Canada,
Australia and South America. 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 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 further decline in the value of the US dollar, could result in
higher costs for raw materials purchased abroad. In addition, we rely on 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.
We manufacture the vast majority of the nutritional supplements that we sell. We currently have manufacturing facilities in Arizona, California, Florida,
Illinois, New Jersey, and New York in the US, and in Canada and the UK. All our domestic manufacturing operations are subject to GMPs promulgated by the FDA and other applicable regulatory standards.
We are subject to similar regulations and standards in Canada. 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.
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We operate in a highly competitive industry, and our failure to compete effectively could adversely affect our market share, financial condition and growth prospects.
The vitamin and nutritional supplements industry is a large and growing industry, which 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 which may have broader product lines
or larger sales volumes, or both, than we do, and our products also compete with nationally advertised brand name products. Most 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 America 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, usually less geographically diverse,
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. Increased competition from companies that distribute through the wholesale channel 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. See Item 1, "BusinessCompetition; Customers."
We
may not be able to compete effectively in one of, 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.
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 relationship 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.
If
we do not introduce new products or make enhancements to meet the changing need 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, particularly oil. Acts of God, war and risk of war also have an adverse effect on
the economy. Instability in the financial markets as a result of war, sabotage or terrorism could adversely affect our ability to raise capital, as
22
well
as adversely affect the retail and vitamin and dietary supplement industries and restrict their future growth.
We may be affected adversely by increased utility and fuel costs.
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. 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,
which may have a significant impact on our financial results. For the fiscal year ended September 30, 2007, 36% of our sales were denominated in a currency other than the US dollar, and as of
September 30, 2007, 32% of our assets and 21% of our total liabilities were denominated in a currency other than the US dollar. As of September 30, 2007, we had not entered into any
hedging arrangements to mitigate our exposure to foreign currency exchange rate risk.
System interruption and security breaches may affect sales.
Customer access to, and ability to use, our websites affect our Direct Response sales. 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. 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 affect our operating results negatively.
Our inability to protect our intellectual property rights could adversely affect our business.
We own trademarks registered with the US Patent and Trademark Office and many foreign jurisdictions for our Nature's Bounty®, Vitamin
World®, Puritan's Pride®, Rexall®, Sundown®, Ester-C®, Solgar®, MET-Rx®, WORLDWIDE Sport
Nutrition®, American Health® trademarks, among others, and with the appropriate UK, Dutch and Canadian authorities for our Holland & Barrett®, Nature's
Way®, De Tuinen®, Le Naturiste® and SISU® trademarks, among others, and have rights to use other names essential to our business. Our policy is to
pursue registrations for all trademarks associated with our key products. US registered trademarks have a perpetual life, as long as they are renewed on a timely basis and used properly as trademarks,
subject to the rights of third parties to seek cancellation of the trademarks if they claim priority or confusion of usage. We regard our trademarks and other proprietary rights as valuable assets and
believe they have significant value in marketing our products. However, we hold patents for certain products, including 41 patents worldwide for Ester-C products. There can be no assurance
that infringing goods could not be manufactured in foreign jurisdictions without our knowledge and consent. In addition, many types of Vitamin C products are available on the worldwide market, which
may affect sales of our unique Ester-C® brand products. We vigorously protect our patents and trademarks against infringement. Our products generally are not subject to patent
protection. There can be no assurance that, to the extent we do not have patents or trademarks on our products, another company will not replicate one or more of our products. Further, there can be no
assurance that in those foreign jurisdictions in which we conduct business the protection available to the us will be as extensive as the protection available to us in the United States. See
Item 1, "BusinessTrademarks and Patents."
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Intellectual property litigation and infringement claims against us could cause us to incur significant expenses or prevent us from manufacturing, selling or using 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 using our products. 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 could be costly, 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.
Item 1B. Unresolved Staff Comments
None.