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Monster Beverage Corp 10-Q 2008 Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
Form 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
HANSEN NATURAL CORPORATION (Exact name of Registrant as specified in its charter)
550 Monica Circle, Suite 201 Corona, California 92880 (Address of principal executive offices) (Zip code)
(951) 739 – 6200 (Registrant’s telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the Registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).
Yes o No x
The Registrant had 92,431,568 shares of common stock, par value $0.005 per share, outstanding as of October 27, 2008.
HANSEN NATURAL CORPORATION AND SUBSIDIARIES SEPTEMBER 30, 2008
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PART I – FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
HANSEN NATURAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 2008 AND DECEMBER 31, 2007 (In Thousands, Except Par Value) (Unaudited)
See accompanying notes to condensed consolidated financial statements.
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE- AND NINE-MONTHS ENDED SEPTEMBER 30, 2008 AND 2007 (In Thousands, Except Per Share Amounts) (Unaudited)
See accompanying notes to condensed consolidated financial statements.
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR NINE-MONTHS ENDED SEPTEMBER 30, 2008 AND 2007 (In Thousands) (Unaudited)
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE-MONTHS ENDED SEPTEMBER 30, 2008 AND 2007 (In Thousands) (Unaudited) (Continued)
SUPPLEMENTAL DISCLOSURE OF NON-CASH ITEMS
The Company entered into capital leases for the acquisition of promotional vehicles of $0.9 million and $1.0 million for the nine-months ended September 30, 2008 and 2007, respectively.
The Company purchased $0.05 million and $0.5 million of property, plant and equipment which was included in accounts payable as of September 30, 2008 and 2007, respectively.
See accompanying notes to condensed consolidated financial statements.
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Thousands, Except Per Share Amounts) (Unaudited)
1. BASIS OF PRESENTATION
Reference is made to the Notes to Consolidated Financial Statements, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007 (“Form 10-K”), for a summary of significant accounting policies utilized by Hansen Natural Corporation (“Hansen” or the “Company”) and its wholly-owned subsidiaries, Hansen Beverage Company (“HBC”), Monster LDA Company, formerly known as Hard e Beverage Company and previously known as Hard Energy Company and as CVI Ventures, Inc., Monster Energy UK Limited (Incorporated in the United Kingdom), a direct wholly owned subsidiary of HBC and Monster Energy Limited (incorporated in Ireland), a direct wholly owned subsidiary of HBC, Monster Energy AU Pty, Ltd. (incorporated in Australia), a direct wholly owned subsidiary of HBC, Blue Sky Natural Beverage Co. (“Blue Sky”), a direct wholly owned subsidiary of HBC, Hansen Junior Juice Company (“Junior Juice”), a direct wholly owned subsidiary of HBC, and other disclosures, which should be read in conjunction with this Quarterly Report on Form 10-Q (“Form 10-Q”).
The Company’s financial statements included in this Form 10-Q have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and Securities and Exchange Commission (“SEC”) rules and regulations applicable to interim financial reporting. They do not include all the information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP. The information set forth in these interim condensed consolidated financial statements for the three- and nine-months ended September 30, 2008 and 2007 is unaudited and reflects all adjustments, which include only normal recurring adjustments and which in the opinion of management are necessary to make the interim condensed consolidated financial statements not misleading. Results of operations for periods covered by this report may not necessarily be indicative of results of operations for the full year.
The preparation of financial statements in conformity with GAAP necessarily requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates.
The Company has reclassified $0.1 million of customer deposit liabilities in the accompanying condensed consolidated balance sheet as of December 31, 2007 from customer deposit liabilities to accrued liabilities to conform to the current period presentation.
2. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
On January 1, 2008, the Company adopted Statement of Financial Accounting Standard (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS No. 157”), for its financial assets and liabilities. The Company’s adoption of SFAS No. 157 did not have a material impact on its financial position, results of operations or liquidity. In accordance with Financial Accounting Standards Board (“FASB”) Staff Position (“FSP”) No. FAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP 157-2”), the Company elected to defer until January 1, 2009 the adoption of SFAS
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Thousands, Except Per Share Amounts) (Unaudited)
No. 157 for all nonfinancial assets and liabilities that are not recognized or disclosed at fair value in the financial statements on a recurring basis. The adoption of SFAS No. 157 for those assets and liabilities within the scope of FSP 157-2 is not expected to have a material impact on the Company’s financial position, results of operations or liquidity.
In October 2008, the FASB issued FSP FAS No. 157-3, “Determining the Fair Value of a Financial Asset When the Market for that Asset is Not Active” (“FSP 157-3”), that clarifies the application of SFAS No. 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. FSP 157-3 is effective upon issuance, including prior periods for which the financial statements have not been issued. The adoption of FSP 157-3 did not have a material impact on the Company’s financial position, results of operations or liquidity.
SFAS No. 157 provides a framework for measuring fair value and requires expanded disclosures regarding fair value measurements. SFAS No. 157 defines fair value as the price that would be received for an asset or the exit price that would be paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants on the measurement date. SFAS No. 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs, where available. The following summarizes the three levels of inputs required by the standard that the Company uses 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 related 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.
SFAS No. 157 requires the use of observable market inputs (quoted market prices) when measuring fair value and requires a Level 1 quoted price to be used to measure fair value whenever possible.
On January 1, 2008, the Company adopted SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement No. 115” (“SFAS No. 159”), which permits entities to choose to measure many financial instruments and certain other items at fair value. The adoption of SFAS No. 159 did not have an impact on the Company’s condensed consolidated financial statements as management did not elect the fair value option for any other financial instruments.
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Thousands, Except Per Share Amounts) (Unaudited)
In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS No. 162”). This standard is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with GAAP for non-governmental entities. SFAS No. 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board’s amendments to Interim Auditing Standards Section 411, “The Meaning of Present Fairly in Conformity with GAAP.” The Company does not expect the adoption of SFAS No. 162 to have a material impact on its condensed consolidated financial statements.
In April 2008, the FASB issued FSP No. FAS 142-3, “Determination of Useful Life of Intangible Assets” (“FSP 142-3”). FSP 142-3 amends the factors that should be considered in developing the renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No.142, “Goodwill and Other Intangible Assets.” FSP 142-3 also requires expanded disclosure related to the determination of intangible asset useful lives. FSP 142-3 is effective for fiscal years beginning after December 15, 2008. Earlier adoption is not permitted. The Company does not expect the adoption of FSP 142-3 to have a material impact on its condensed consolidated financial statements.
3. FAIR VALUE OF CERTAIN FINANCIAL ASSETS AND LIABILITIES
In accordance with SFAS No. 157, the following represents the Company’s fair value hierarchy for its financial assets (cash equivalents and investments) measured at fair value on a recurring basis as of September 30, 2008:
The Company’s Level 3 assets are comprised of municipal or educational related or other public body notes with an auction reset feature (“auction rate securities”). The majority of these notes carry an investment grade or better credit rating and certain of the notes are additionally backed by various federal agencies and/or monoline insurance companies. The applicable interest rate is reset at pre-determined intervals, usually every 7 to 35 days. Liquidity for these auction rate securities was typically provided by an auction process which allowed holders to sell their notes. During the nine-months
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Thousands, Except Per Share Amounts) (Unaudited)
ended September 30, 2008, a large portion of the auctions for these auction rate securities failed. There is no assurance that auctions on the remaining auction rate securities in the Company’s investment portfolio will succeed. The auction failures appear to have been attributable to inadequate buyers and/or buying demand and/or the lack of support from financial advisors and sponsors. In the event that there is a failed auction, the indenture governing the security generally requires the issuer to pay interest at a default rate that is generally above market rates for similar instruments. The securities for which auctions have failed will continue to accrue and/or pay interest at their predetermined rates and be auctioned every 7 to 35 days until their respective auction succeeds, the issuer calls the securities, they mature or the Company is able to sell the securities to third parties. As a result, the Company’s ability to liquidate and fully recover the carrying value of its auction rate securities in the near term may be limited. Consequently, certain of these securities are classified as long-term investments in the accompanying consolidated balance sheets.
A Level 3 valuation was performed for the Company’s auction rate securities as of September 30, 2008, which indicated a fair value of $111.4 million. The valuation utilized a mark to model approach which included estimates for interest rates, timing and amount of cash flows, credit and liquidity premiums, and expected holding periods for the auction rate securities. These assumptions are typically volatile and subject to change as the underlying data sources and market conditions evolve. They represent the Company’s current estimates given available data as of September 30, 2008.
Based on the Level 3 valuation performed as of September 30, 2008 for the purpose of complying with GAAP, the Company determined that there was a decline in fair value of its auction rate securities of $5.6 million, which was deemed temporary. This amount has been recorded net of a tax benefit of $2.2 million, as a component of other comprehensive loss for the nine-months ended September 30, 2008. Factors considered in determining whether a loss is temporary include length of time and the extent to which the investment’s fair value has been less than the cost basis, the financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer and the Company’s intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery of fair value.
These auction rate securities will continue to accrue and/or pay interest at their contractual rates until their respective auctions succeed. Based on the Company’s ability to access cash and other short-term investments and based on the Company’s expected operating cash flows, the Company does not anticipate that the current lack of liquidity of these investments will have a material effect on its liquidity or working capital. If uncertainties in the credit and capital markets continue or there are ratings downgrades on the auction rate securities held by the Company, the Company may be required to recognize other-than-temporary impairments on these long-term investments.
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Thousands, Except Per Share Amounts) (Unaudited)
The following table provides a summary of changes in fair value of the Company’s Level 3 financial assets as of September 30, 2008:
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Thousands, Except Per Share Amounts) (Unaudited)
4. INVESTMENTS
The following table summarizes the Company’s investments at September 30, 2008 and December 31, 2007:
The Company’s short-term investments as of December 31, 2007 included variable rate demand notes of $60.6 million. Although the underlying maturities of these securities are long-term in nature, the investments are classified as short-term because they contain a ‘put’ feature which allows the holder to tender the securities at par value on seven days notice. The ‘put’ feature is supported by a letter of credit or standby purchase agreement provided by a highly-rated commercial bank. The notes are issued by municipalities and other tax-exempt entities and the interest rate payable on these investments resets on a weekly basis. Subsequent to December 31, 2007, the Company redeemed all its holdings of variable rate demand notes at par value.
5. INVENTORIES
Inventories consist of the following at:
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Thousands, Except Per Share Amounts) (Unaudited)
6. PROPERTY AND EQUIPMENT, Net
Property and equipment consist of the following at:
7. INTANGIBLES, Net
Intangibles consist of the following at:
All amortizing trademarks have been assigned an estimated useful life and such trademarks are amortized on a straight-line basis over the number of years that approximate their respective useful lives ranging from one to 25 years (weighted-average life of 19 years). Amortization expense recorded was $0.01 million for both the three-months ended September 30, 2008 and 2007, respectively. Amortization expense recorded was $0.04 million for both the nine-months ended September 30, 2008 and 2007, respectively. As of September 30, 2008, future estimated amortization expense related to amortizing trademarks through September 30, 2013 is approximately $0.05 million per year.
8. COMMITMENTS AND CONTINGENCIES
Purchase Commitments – The Company has purchase commitments aggregating approximately $52.5 million, which represent commitments made by the Company and its subsidiaries to various suppliers of raw materials for the manufacturing and packaging of its products. These obligations vary in terms and are due within the next twelve months.
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Thousands, Except Per Share Amounts) (Unaudited)
In addition to the above obligations, pursuant to a can supply agreement between the Company and Rexam Beverage Can Company (“Rexam”) dated as of January 1, 2006, as amended, the Company has undertaken to purchase a minimum volume of 24-ounce resealable aluminum beverage cans over the four year period commencing from January 1, 2006 through December 31, 2009. Under the terms of the agreement, if the Company fails to purchase the minimum volume, the Company will be obligated to reimburse Rexam for certain capital reimbursements on a pro-rated basis. The Company’s maximum liability under this agreement as of September 30, 2008 is $4.7 million subject to compliance by Rexam with certain conditions.
Litigation – In August 2006, HBC filed a lawsuit against National Beverage Company, Shasta Beverages, Inc., Newbevco Inc. and Freek’N Beverage Corp. (collectively “National”) seeking an injunction and damages for trademark infringement, trademark dilution, unfair competition and deceptive trade practices based on National’s unauthorized use of HBC’s valuable and distinctive Monster Energy® trade dress in connection with a line of energy drinks it launched under the “Freek” brand name. In June 2007, the parties entered into a confidential settlement agreement resolving the parties’ disputes in the litigation. National subsequently repudiated the settlement agreement and HBC responded by filing a motion in the United States District Court for the Central District of California to enforce the terms of the confidential settlement agreement. On August 14, 2007, the United States District Court entered an Order enforcing the settlement agreement and permanently enjoining National from manufacturing, distributing, shipping, marketing, selling and offering to sell “Freek” energy drinks in containers using the original “Freek” trade dress that was subject to the District Court’s preliminary injunction. National filed a notice of appeal with the Ninth Circuit Court of Appeals of the United States. National requested that the District Court stay this Order pending its appeal to the Ninth Circuit Court of Appeals, which was subsequently denied by the District Court. The Ninth Circuit Court of Appeals has scheduled oral arguments for December 11, 2008.
In August 2006, HBC filed an action in the Federal Courts of Australia, Victoria District Registry against Bickfords Australia (Pty) Limited and Meak (Pty) Ltd. (collectively “Bickfords”), in which HBC is seeking an injunction restraining Bickfords from selling or offering for sale or promoting for sale in Australia any energy drink or beverage under the Monster Energy or Monster marks or any similar marks and for damages and costs. The defendants cross-claimed seeking an order to restrain HBC from selling, or offering for sale, or promoting in Australia any drink product under the Monster EnergyÒ or MonsterÒ trademarks or any similar trademarks and for costs. The trial took place in February 2007 and closing oral submissions took place in June 2007. The Court handed down its decision on March 31, 2008, in which the Court dismissed both parties’ actions. As a result, neither HBC nor Bickfords are restrained from using the Monster or Monster Energy marks in Australia. HBC is appealing the Court’s decision. The appeal hearing took place on August 4 and 5, 2008 and HBC is awaiting the decision of the Court.
In September 2006, Christopher Chavez purporting to act on behalf of himself and a class of consumers yet to be defined filed an action in the Superior Court, of the State of California, City and County of San Francisco, against the Company and its subsidiaries for unfair business practices, false advertising, violation of California Consumers Legal Remedies Act, fraud, deceit and/or misrepresentation alleging that the Company misleadingly labels its Blue Sky beverages as
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Thousands, Except Per Share Amounts) (Unaudited)
originating in and/or being canned under the authority of a company located in Santa Fe, New Mexico. Defendants removed this Superior Court action to the United States Court for the Northern District of California under the Class Action Fairness Act, and filed motions for dismissal or transfer. On June 11, 2007, the United States District Court, Northern District of California granted the Company’s motion to dismiss Chavez’s complaint with prejudice. On June 21, 2007, Mr. Chavez noticed an appeal in the United States Court of Appeal for the Ninth Circuit. Mr. Chavez, as the appellant, has filed his opening brief and Hansen’s response has also been filed. The appeal has not been scheduled for hearing.
In January 2007, the Company’s distributor for the Riverside and San Bernardino, California territories, Gate City Beverage Company (“Gate City”), notified the Company of its intention to sell its business and requested the Company consent to the assignment of the distribution agreement with the Company. The Company declined its consent and exercised its contractual right to terminate the Gate City distribution agreement upon thirty days prior written notice. Gate City threatened to take “appropriate action” against the Company and third parties for what it contended was an improper termination of the distribution agreement. The Company denied Gate City’s assertion regarding improper termination of the applicable distribution agreement. On February 6, 2008, Gate City filed a demand for arbitration with the American Arbitration Association to be held in Orange County, California, claiming damages in an amount exceeding $5.0 million, plus attorneys’ fees and costs. The Company disputes liability and is defending the claim. The parties are presently conducting discovery and the arbitration hearing has been set for March 30, 2009 through April 3, 2009.
On July 3, 2008, the Company filed a lawsuit in the Superior Court for the State of California for Los Angeles County against St. Paul Mercury Insurance Company (“St. Paul”) due to St. Paul’s failure to reimburse the Company for certain costs and expenses incurred and paid by the Company for and in connection with the investigation and defense of various proceedings relating to certain stock option grants made by the Company (the “St. Paul Complaint”). St. Paul sold the Company a directors and officers insurance policy that covered such expenses during the pertinent time period. St. Paul has reimbursed the Company for certain of the costs and expenses associated with the Company’s successful defense against the proceedings, but has refused to pay the remainder of the limits of its policy. The St. Paul Complaint alleges that St. Paul is liable to the Company for the difference. The St. Paul Complaint seeks a declaration concerning the amount the Company is owed by St. Paul and asserts claims for breach of contract and tortuous breach of the implied covenants of good faith and fair dealing. The Company seeks damages arising from St. Paul’s breach of the policy, punitive damages, and reimbursement of the attorneys’ fees expended in the investigation and litigation. On August 1, 2008, St. Paul removed the lawsuit to the United States District Court for the Central District of California. On August 8, 2008, St. Paul answered the St. Paul Complaint and denied that it has any further responsibility to the Company beyond the amount for which it had previously reimbursed the Company. A trial has been preliminarily scheduled in this litigation for November 17, 2009. The parties are presently engaged in the preliminary phases of pre-trial discovery.
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Thousands, Except Per Share Amounts) (Unaudited)
On July 11, 2008, the Company initiated an action against Citigroup Inc., Citigroup Global Markets, Inc. and Citi Smith Barney, in the United States District Court, Central District of California, for violations of federal securities laws and the Investment Advisors Act, arising out of the Company’s purchase of auction rate securities. The Court has granted defendants’ motion to compel arbitration before the Financial Industry Regulatory Authority.
On August 28, 2008, the Company initiated an action against Oppenheimer Holdings Inc.; Oppenheimer & Co. Inc.; and Oppenheimer Asset Management Inc., in the United States District Court, Central District of California, for violations of federal securities laws and the Investment Advisors Act, arising out of the Company’s purchase of auction rate securities. The defendants answered the complaint on October 14, 2008 denying the allegations set forth therein.
The Company is subject to litigation from time to time in the normal course of business, including claims from terminated distributors. Although it is not possible to predict the outcome of such litigation, based on the facts known to the Company and after consultation with counsel, management believes that such litigation in the aggregate will likely not have a material adverse effect on the Company’s financial position or results of operations.
Securities Litigation – On September 11, 2008, a federal securities class action complaint styled Cunha v. Hansen Natural Corp., et al. was filed in the United States District Court for the Central District of California (the “District Court”). On September 17, 2008, a second federal securities class action complaint styled Brown v. Hansen Natural Corp., et al. was also filed in the District Court.
Both actions, filed by single individual shareholders purportedly on behalf of a class of purchasers of the Company’s stock during the period May 23, 2007 through November 8, 2007 (the “Class Period”), name as defendants the Company, Rodney C. Sacks, and Hilton H. Schlosberg. The allegations of both complaints are substantially similar. Plaintiffs allege violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Plaintiffs allege, among other things, that during the Class Period, the defendants issued materially false and misleading statements that failed to disclose that: (i) the Company’s second quarter sales results were “materially impacted by inventory loading as customers were induced to purchase more product before the Company raised its prices in its Monster Energy drink line and its Java Monster drink line”; (ii) the Company was “experiencing declining sales in its non-core drink lines”; (iii) the Company was “experiencing production shortfalls with its Java Monster drink line”; and (iv) as a result of the foregoing, defendants “lacked a reasonable basis for their positive statements about the Company and its prospects.” The complaints seek an unspecified amount of damages.
Plaintiffs’ motions for appointment of Lead Plaintiff are due by November 10, 2008. After Lead Plaintiff is appointed, if a motion for consolidation is granted, defendants must respond within forty-five days from the date of service of any consolidated complaint or the designation of one complaint as the operative complaint in the consolidated class actions. If a motion for consolidation is denied, then defendants must respond to the complaint forty-five days from the date on which the denial of such motion is entered on the Court’s docket.
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Thousands, Except Per Share Amounts) (Unaudited)
Derivative Litigation – On September 15, 2008, a derivative complaint was filed in the Superior Court of the State of California, County of Riverside, styled Stueve v. Sacks, et al. (RIC508262). On October 15, 2008, a second derivative complaint was filed in the United States District Court for the Central District of California, styled Merckel v. Sacks, et al. The derivative suits were each brought, purportedly on behalf of the Company, by a shareholder of the Company who made no prior demand on the Company’s Board of Directors.
Stueve has decided to voluntarily withdraw his complaint, which was based on factual allegations that were substantially similar to those set forth in the two securities class action complaints described above. On October 31, 2008, the parties entered into and submitted for the Court’s approval a stipulation providing for the dismissal of the Stueve action in its entirety and without prejudice.
The Merckel complaint names as defendants certain current and former officers, directors, and employees of the Company and HBC, including Rodney C. Sacks, Hilton H. Schlosberg, Harold C. Taber, Jr., Benjamin M. Polk, Norman C. Epstein, Mark S. Vidergauz, Sydney Selati, Thomas J. Kelly, Mark J. Hall, and Kirk S. Blower, as well as the administrator of the Estate of Michael B. Schott and Hilrod Holdings, L.P. The Company is named as a nominal defendant. The factual allegations of the Merckel complaint are also substantially similar to those set forth in the two securities class action complaints described above. The Merckel complaint alleges, among other things, that between May 2007 and the present, the defendants directed the Company to issue a series of improper statements concerning its business prospects. The complaint further alleges that while the Company’s shares were purportedly artificially inflated because of those improper statements, certain defendants sold Company stock while in possession of material non-public information regarding the Company’s “true” business prospects. The complaint asserts causes of action for breaches of fiduciary duties, aiding and abetting breaches of fiduciary duty, violations of Cal. Corp. Code §§ 25402 and 25403 for insider selling, and unjust enrichment. The suit seeks an unspecified amount of damages to be paid to the Company, adoption of corporate governance reforms, and equitable and injunctive relief.
Although the ultimate outcome of these matters cannot be determined with certainty, the Company believes that the complaints are without merit. The Company intends to vigorously defend against these lawsuits.
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Thousands, Except Per Share Amounts) (Unaudited)
9. COMPREHENSIVE INCOME
The components of comprehensive income are as follows:
The components of accumulated other comprehensive (loss) is as follows:
10. TREASURY STOCK PURCHASE
During the nine-months ended September 30, 2008 the Company purchased 1.7 million shares of common stock at an average purchase price of $29.46 per share which the Company holds in treasury.
11. STOCK-BASED COMPENSATION
The Company has two stock option plans under which shares were available for grant at September 30, 2008: the Hansen Natural Corporation Amended and Restated 2001 Stock Option Plan (the “2001 Option Plan”) and the 2005 Hansen Natural Corporation Stock Option Plan for Non-Employee Directors (the “2005 Directors Plan”).
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Thousands, Except Per Share Amounts) (Unaudited)
The 2001 Option Plan permits the granting of options to purchase up to 22,000,000 shares of the common stock of the Company to certain key employees or non-employees of the Company and its subsidiaries. Options granted under the 2001 Option Plan may be incentive stock options under Section 422 of the Internal Revenue Code, as amended, non-qualified stock options or stock appreciation rights. Stock options are exercisable at such time and in such amounts as determined by the Compensation Committee of the Board of Directors of the Company up to a ten-year period after their date of grant. As of September 30, 2008, options to purchase 17,397,700 shares of the Company’s common stock had been granted, net of cancellations, and options to purchase 4,602,300 shares of the Company’s common stock remain available for grant under the 2001 Option Plan.
The 2005 Directors Plan permits the granting of options to purchase up to an aggregate of 800,000 shares of common stock of the Company to non-employee directors of the Company. On the date of the annual meeting of stockholders at which an eligible director is initially elected, each eligible director is entitled to receive a one-time grant of an option to purchase 24,000 shares of the Company’s common stock exercisable at the closing price for a share of common stock on the date of grant. Additionally, on the fifth anniversary of the election of eligible directors elected or appointed to the Board of Directors, and each fifth anniversary thereafter, each eligible director shall receive an additional grant of an option to purchase 19,200 shares of the Company’s common stock. Options become exercisable in four equal installments, with the grant immediately vested with respect to 25% of the grant and the remaining installments vesting on the three successive anniversaries of the date of grant; provided that all options held by an eligible director become fully and immediately exercisable upon a change in control of the Company. Options granted under the 2005 Directors Plan that are not exercised generally expire ten years after the date of grant. Option grants may be made under the 2005 Directors Plan for ten years from the effective date of the 2005 Directors Plan. The 2005 Directors Plan is a “formula plan” so that a non-employee director’s participation in the 2005 Directors Plan does not affect his status as a “disinterested person” (as defined in Rule 16b-3 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). As of September 30, 2008, options to purchase 76,800 shares of the Company’s common stock had been granted under the 2005 Directors Plan, and options to purchase 723,200 shares of the Company’s common stock remained available for grant.
Under the Company’s stock option plans, all grants are made at prices based on the fair market value of the options on the date of grant. Outstanding options generally vest over five years from the grant date and generally expire up to ten years after the grant date. The Company recorded $4.0 million and $2.2 million of compensation expense relating to outstanding options during the three-months ended September 30, 2008 and 2007, respectively. The Company recorded $9.8 million and $6.3 million of compensation expense relating to outstanding options during the nine-months ended September 30, 2008 and 2007, respectively.
The Company records compensation expense for employee stock options based on the estimated fair value of the options on the date of grant using the Black-Scholes-Merton option pricing formula with the assumptions included in the table below. The Company records compensation expense for non-employee stock options based on the estimated fair value of the options as of the earlier of (1) the date at which a commitment for performance by the non-employee to earn the stock option is reached, or (2) the date at which the non-employee’s performance is complete, using the Black-Scholes-Merton option pricing formula with the assumptions included in the table below. The Company uses historical data to determine the exercise behavior, volatility and
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Thousands, Except Per Share Amounts) (Unaudited)
forfeiture rate of the options. The following weighted-average assumptions were used to estimate the fair value of options granted during the three- and nine-months ended September 30, 2008 and 2007:
The following table summarizes the Company’s activities with respect to its stock option plans for the nine-months ended September 30, 2008 as follows:
The weighted-average grant-date fair value of options granted during the three-months ended September 30, 2008 and 2007 was $16.31 per share and $26.89 per share, respectively. The weighted-average grant-date fair value of options granted during the nine-months ended September 30, 2008 and 2007 was $18.57 per share and $23.56 per share, respectively. The total intrinsic value of options exercised during the three-months ended September 30, 2008 and 2007 was $5.7 million and $72.9 million, respectively. The total intrinsic value of options exercised during the nine-months ended September 30, 2008 and 2007 was $28.4 million and $110.0 million, respectively.
Cash received from option exercises under all plans for the three-months ended September 30, 2008 and 2007 was approximately $0.5 million and $3.3 million, respectively. Cash received from option exercises under all plans for the nine-months ended September 30, 2008 and 2007 was approximately $1.7 million and $7.2 million, respectively. The actual tax benefit realized for tax
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Thousands, Except Per Share Amounts) (Unaudited)
deductions from non-qualified stock option exercises and disqualifying dispositions of incentive stock options for the three-months ended September 30, 2008 and 2007 was $0.02 million and $18.0 million, respectively. The actual tax benefit realized for tax deductions from non-qualified stock option exercises and disqualifying dispositions of incentive stock options for the nine-months ended September 30, 2008 and 2007 was $2.2 million and $27.3 million, respectively.
At September 30, 2008, there was $41.4 million of total unrecognized compensation expense related to nonvested shares granted to both employees and non-employees under the Company’s share-based payment plans. That cost is expected to be recognized over a weighted-average period of 2.5 years.
12. INCOME TAXES
Effective January 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes (“FIN No. 48”). FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. This pronouncement also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.
Upon adoption of FIN No. 48 as of January 1, 2007, the Company’s reassessment of its tax positions did not have a material impact on the consolidated financial statements. The following is a rollforward of the Company’s total gross unrecognized tax benefits for the nine-months ended September 30, 2008 (in thousands):
The gross unrealized tax benefits, if recognized, would result in a reduction of the Company’s provision and effective tax rate. With the adoption of FIN No. 48, the Company has decided to classify interest and penalties as a component of tax expense. No interest and penalties on unrecognized tax benefits were accrued as of September 30, 2008. The Company believes that the uncertainty which gives rise to the total amount of unrecognized tax benefit at September 30, 2008, will be resolved within the next 12 months.
On August 9, 2007, the Internal Revenue Service began its examination of the Company’s U.S. federal income tax return for the period ended December 31, 2005. The examination is expected to be completed within the next twelve months.
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Thousands, Except Per Share Amounts) (Unaudited)
13. EARNINGS PER SHARE
A reconciliation of the weighted average shares used in the basic and diluted earnings per common share computations for the three- and nine-months ended September 30, 2008 and 2007 is presented below:
For the three-months ended September 30, 2008 and 2007, options outstanding totaling 2.1 million and 0.3 million shares, respectively, were excluded from the calculations as their effect would have been antidilutive. For the nine-months ended September 30, 2008 and 2007, options outstanding totaling 1.2 million and 0.2 million shares, respectively, were excluded from the calculations as their effect would have been antidilutive.
14. SEGMENT INFORMATION
The Company has two reportable segments, namely Direct Store Delivery (“DSD”), whose principal products comprise energy drinks, and Warehouse, whose principal products comprise juice based and soda beverages. The DSD segment develops, markets and sells products primarily through an exclusive distributor network, whereas the Warehouse segment develops, markets and sells products primarily direct to retailers. Corporate and unallocated amounts that do not relate to DSD or Warehouse segments have been allocated to “Corporate & Unallocated.”
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Thousands, Except Per Share Amounts) (Unaudited)
The net revenues derived from DSD and Warehouse segments and other financial information related thereto for the three-months ended September 30, 2008 and 2007 are as follows:
Revenue is derived from sales to external customers. Operating expenses that pertain to each segment are allocated to the applicable segment.
Contribution margin for the DSD segment recognizes termination costs of ($0.2) million and $0.3 million in aggregate during the three-months ended September 30, 2008 and 2007, respectively, to certain of the Company’s distributors.
Corporate and unallocated expenses were $14.0 million for the three-months ended September 30, 2008 and included $8.8 million of payroll costs, of which $4.0 million was attributable to stock-based compensation expense (see Note 11, “Stock-Based Compensation”), and $2.7 million attributable to professional service expenses, including accounting and legal costs. Corporate and unallocated expenses were $10.2 million for the three-months ended September 30, 2007 and included $6.7 million of payroll costs, of which $2.2 million was attributable to stock based compensation expense (see Note 11, “Stock-Based Compensation”), and $1.8 million of professional service expenses, including accounting and legal costs. Certain items, including operating assets and income taxes, are not allocated to individual segments and therefore are not presented above.
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Thousands, Except Per Share Amounts) (Unaudited)
One customer made up approximately 14% of the Company’s net sales for the three-months ended September 30, 2008. Two customers made up approximately 15% and 13% respectively, of the Company’s net sales for the three-months ended September 30, 2007.
The net revenues derived from DSD and Warehouse segments and other financial information related thereto for the nine-months ended September 30, 2008 and 2007 are as follows:
Revenue is derived from sales to external customers. Operating expenses that pertain to each segment are allocated to the applicable segment.
Contribution margin for the DSD segment recognizes termination costs of ($0.04) million and $15.0 million in aggregate during the nine-months ended September 30, 2008 and 2007, respectively, to certain of the Company’s distributors.
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Thousands, Except Per Share Amounts) (Unaudited)
Corporate and unallocated expenses were $38.4 million for the nine-months ended September 30, 2008 and included $24.6 million of payroll costs, of which $9.8 million was attributable to stock-based compensation expense (see Note 11, “Stock-Based Compensation”), and $7.2 million attributable to professional service expenses, including accounting and legal costs. Corporate and unallocated expenses were $40.9 million for the nine-months ended September 30, 2007 and included $18.5 million of payroll costs, of which $6.3 million was attributable to stock based compensation expense (see Note 11, “Stock-Based Compensation”), and $15.8 million of professional service expenses, including accounting and legal costs. Certain items, including operating assets and income taxes, are not allocated to individual segments and therefore are not presented above.
Two customers made up approximately 16% and 11% respectively, of the Company’s net sales for the nine-months ended September 30, 2008. Two customers made up approximately 16% and 13% respectively, of the Company’s net sales for the nine-months ended September 30, 2007.
The Company’s net sales by product line for the three- and nine-months ended September 30, 2008 and 2007, respectively, were as follows:
15. AB DISTRIBUTION COORDINATION AGREEMENTS
On May 8, 2006, HBC entered into the Monster Beverages Off-Premise Distribution Coordination Agreement and the Allied Products Distribution Coordination Agreement (jointly, the “AB Off-Premise Agreements”) with Anheuser-Busch, Inc., a Missouri corporation (“AB”). Under the AB Off-Premise Agreements, select Anheuser-Busch Distributors (the “AB Distributors”) distribute and sell, in markets designated by HBC, HBC’s Monster Energy® and Lost® Energy™ brands non-alcoholic energy drinks, Rumba™, Samba and Tango brand energy juice and Unbound Energy® brand energy drinks, as well as additional products that may be agreed between the parties.
Pursuant to the AB Distribution Agreements (the “AB Distribution Agreements”) entered into with AB Distributors, net reimbursements of $0.4 million to such AB Distributors and net contributions of $21.1 million from such AB Distributors relating to the costs of terminating the Company’s prior distributors were recorded by the Company for the nine-months ended September 30, 2008 and 2007, respectively. Such amounts have been accounted for as deferred revenue in the accompanying condensed consolidated balance sheets, and will be recognized as revenue ratably over the anticipated 20 year life of the respective AB Distribution Agreements. Revenue recognized
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Thousands, Except Per Share Amounts) (Unaudited)
was $0.5 million for both the three-months ended September 30, 2008 and 2007, respectively. Revenue recognized was $1.5 million and $1.4 million for the nine-months ended September 30, 2008 and 2007, respectively. Related distributor receivables of $0.6 million and $4.5 million are included in accounts receivable, net, in the accompanying condensed consolidated balance sheets as of September 30, 2008 and December 31, 2007, respectively.
As of September 30, 2008 and December 31, 2007, amounts totaling $0.1 million, respectively, were received by the Company from certain other AB Distributors in anticipation of executing AB Distribution Agreements with the Company. Such receipts have been accounted for as customer deposit liabilities and are included in accrued liabilities in the accompanying condensed consolidated balance sheets.
The Company incurred termination costs amounting to ($0.2) million and $0.3 million in aggregate during the three-months ended September 30, 2008 and 2007, respectively, to certain of its prior distributors. The Company incurred termination costs amounting to ($0.04) million and $15.0 million in aggregate during the nine-months ended September 30, 2008 and 2007, respectively, to certain of its prior distributors. Such termination costs have been expensed in full and are included in operating expenses for the three- and nine-months ended September 30, 2008 and 2007. Accrued distributor terminations in the accompanying condensed consolidated balance sheets as of September 30, 2008 and December 31, 2007 were $3.8 million and $4.3 million, respectively.
On February 8, 2007, HBC entered into an On-Premise Distribution Coordination Agreement (the “On-Premise Agreement”) with AB. Under the On-Premise Agreement, AB will manage and coordinate the sales, distribution and merchandising of Monster Energy® energy drinks to on-premise retailers including bars, nightclubs and restaurants in territories approved by HBC.
16. RELATED PARTY TRANSACTIONS
A director of the Company is a partner in a law firm that serves as counsel to the Company. Expenses incurred in connection with services rendered to the Company during the three-months ended September 30, 2008 and 2007 were $0.2 million and $1.2 million, respectively. Expenses incurred in connection with services rendered to the Company during the nine-months ended September 30, 2008 and 2007 were $1.9 million and $4.8 million, respectively.
Two directors and officers of the Company and their families are principal owners of a company that provides promotional materials to the Company. Expenses incurred with such company in connection with promotional materials purchased during the three-months ended September 30, 2008 and 2007 were $0.2 million and $0.09 million, respectively. Expenses incurred with such company in connection with promotional materials purchased during the nine-months ended September 30, 2008 and 2007 were $0.6 million and $0.5 million, respectively.
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HANSEN NATURAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Tabular Dollars in Thousands, Except Per Share Amounts) (Unaudited)
17. SUBSEQUENT EVENTS
On October 3, 2008, the Company entered into the Monster Energy Distribution Coordination Agreement (the “TCCC North American Coordination Agreement”) with The Coca-Cola Company (“TCCC”). Pursuant to the TCCC North American Coordination Agreement, the Company has designated, and in the future may designate, territories in which it wishes distributors from TCCC’s network of partially owned and independent bottlers (the “TCCC North American Bottlers”) to distribute and sell primarily the Company’s Monster Energy® beverages (the “Products”) in the United States and Canada.
Coca-Cola Enterprises Inc. (“CCE”) has been appointed to distribute, directly and through certain sub-distributors, the Products in portions of twenty-three U.S. states (the “U.S. Territories”), commencing in November, 2008. The Company may designate additional territories within reasonable proximity to the U.S. Territories and CCE will use reasonable good faith efforts to add the additional territories. Under the Monster Energy Canadian Distribution Agreement with the Coca-Cola Bottling Company (“CCBC”), CCBC has been appointed to distribute, directly and through certain sub-distributors, the Products in Canada, with performance to commence on January 1, 2009.
On October 3, 2008, the Company entered into the Monster Energy International Coordination Agreement (the “TCCC International Coordination Agreement”) with TCCC. Pursuant to the TCCC International Coordination Agreement, the Company has designated, and in the future may designate, countries in which it wishes to appoint TCCC distributors to distribute and sell the Products.
The Company entered into the Monster Energy International Distribution Agreement and the Monster Energy Belgium Distribution Agreement with CCE pursuant to which CCE has been appointed to distribute, directly and through certain sub-distributors, the Products in Great Britain, France, Belgium, the Netherlands, Luxembourg and Monaco.
As a result, the Company will transition certain of its existing distribution arrangements to newly appointed distributors, including TCCC North American Bottlers and new AB Distributors. In connection with the transition, the Company will make termination payments to certain existing distributors who will be terminated. Such termination costs will be expensed in full and included in operating expenses. Non-refundable contributions were previously received by the Company from certain of these existing distributors, who will be terminated. Such contributions were previously treated as deferred revenue. Upon termination, the associated balance in deferred revenue will be recognized as revenue. The impact of the above amounts is currently estimated to be a charge in the range of $110 million to $130 million in the aggregate, but could be higher or lower. The actual termination payments could differ significantly from current estimates because the estimates are largely based on the Company’s estimate of each affected distributor’s contractual termination rights. These estimates include assumptions related to each distributor’s own sales and gross profit levels, net of certain allowances. The actual termination costs and related revenue will be recorded in the period in which the terminations become effective, which will primarily be in the fourth fiscal quarter of 2008.
The Company will receive from newly appointed distributors non-refundable contributions estimated to be in the range of $110 million to $130 million for the purpose of covering the costs of terminating the affected distributors, but could be higher or lower. The non-refundable contributions could differ significantly from current estimates because the estimates are based largely on the Company’s estimate of each affected terminated distributor’s own sales. These contributions will be recorded as deferred revenue, which will be recognized as revenue ratably over the anticipated 20-year life of the distribution agreements.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Our Business
Overview
We develop, market, sell and distribute “alternative” beverage category natural sodas, fruit juices and juice drinks, energy drinks and energy sports drinks, fruit juice smoothies and “functional drinks,” non-carbonated ready-to-drink iced teas, children’s multi-vitamin juice drinks, Junior Juice® juices, Junior Juice Water and flavored sparkling beverages under the Hansen’s® brand name. We also develop, market, sell and distribute energy drinks under the following brand names; Monster Energy®, Monster Hitman Energy Shooter™, Lost® Energy™, Joker Mad Energy™, Unbound Energy® and Ace™ brand names as well as Rumba™, Samba and Tango brand energy juices. We also market, sell and distribute the Java Monster™ line of non-carbonated dairy based coffee drinks. We also market, sell and distribute natural sodas, premium natural sodas with supplements, organic natural sodas, seltzer waters, sports drinks and energy drinks under the Blue Sky® brand name. We have also commenced to market, sell and distribute enhanced water beverages under the Vidration™ brand name.
Our Monster Energy® brand energy drinks include Monster Energy® drinks (introduced in April 2002), lo-carb Monster Energy® drinks (introduced in August 2003), Monster Energy® Assault™ energy drinks (introduced in September 2004), Monster Energy® Khaos™ energy drinks (introduced in August 2005), Monster M-80™ energy drinks (introduced in March 2007), Monster Heavy Metal™ energy drinks (introduced in November 2007) and Monster MIXXD™ energy drinks (introduced in December 2007).
We have two reportable segments, namely DSD, whose principal products comprise energy drinks, and Warehouse, whose principal products comprise juice based and soda beverages. The DSD segment develops, markets and sells products primarily through an exclusive distributor network, whereas the Warehouse segment develops, markets and sells products primarily direct to retailers.
Our sales and marketing strategy for all our beverages is to focus our efforts on developing brand awareness and trial through sampling both in stores and at events. We use our branded vehicles and other promotional vehicles at events where we sample our products to consumers. We utilize “push-pull” methods to achieve maximum shelf and display space exposure in sales outlets and maximum demand from consumers for our products, including advertising, in-store promotions and in-store placement of point-of-sale materials and racks, prize promotions, price promotions, competitions, endorsements from selected public and extreme sports figures, coupons, sampling and sponsorship of selected causes such as cancer research and SPCAs, as well as extreme sports teams such as the Pro Circuit – Kawasaki Motocross and Supercross teams, Kawasaki Factory Motocross and Supercross teams, Robby Gordon Racing Team, Kawasaki Factory International Moto GP Team, Kenny Bernstein Drag Racing Team, Ken Block Rally Racing Team, Ricky Carmichael NASCAR Camping World East Series, Iron Horse Mountain Bike Team, extreme sports figures and athletes, sporting events such as the Monster Energy® Supercross Series, the Monster Energy® Outdoor Motocross Series, the Monster Energy® Pro Pipeline surfing competition, Winter and Summer X-Games, Canadian Outdoor Motocross Series, CORR Short Course Off-Road Truck Racing, ski and
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snowboard competitions and other health and sports related activities, including extreme sports, particularly supercross, motocross, freestyle, surfing, skateboarding, wakeboarding, skiing, snowboarding, BMX, mountain biking, snowmobile racing, etc., and we also participate in product demonstrations, food tasting and other related events. In store posters, outdoor posters, print, radio and television advertising, together with price promotions and coupons, may also be used to promote our brands.
We believe that one of the keys to success in the beverage industry is differentiation, such as making Hansen’s® products visually distinctive from other beverages on the shelves of retailers. We review our products and packaging on an ongoing basis and, where practical, endeavor to make them different, better and unique. The labels and graphics for many of our products are redesigned from time to time to maximize their visibility and identification, wherever they may be placed in stores, and we will continue to reevaluate the same from time to time.
During the second quarter of 2006, we entered into the Monster Beverages Off-Premise Distribution Coordination Agreement and the Allied Products Distribution Coordination Agreement (jointly, the “AB Off-Premise Agreements”) with Anheuser-Busch, Inc., a Missouri corporation (“AB”). Under the AB Off-Premise Agreements, select Anheuser-Busch Distributors (the “AB Distributors”) distribute and sell, in markets designated by HBC, HBC’s Monster Energy® and Lost® Energy™ brands non-alcoholic energy drinks, Rumba™, Samba and Tango brand energy juice and Unbound Energy® brand energy drinks, as well as additional products that may be agreed between the parties.
Pursuant to the AB Distribution Agreements (the “AB Distribution Agreements”) entered into with AB Distributors, net reimbursements of $0.4 million to such AB Distributors and net contributions of $21.1 million from such AB Distributors relating to the costs of terminating our prior distributors were recorded by us for the nine-months ended September 30, 2008 and 2007, respectively. Such amounts have been accounted for as deferred revenue in the accompanying condensed consolidated balance sheets and will be recognized as revenue ratably over the anticipated 20 year life of the respective AB Distribution Agreements. Revenue recognized was $0.5 million for both the three-months ended September 30, 2008 and 2007, respectively. Revenue recognized was $1.5 million and $1.4 million for the nine-months ended September 30, 2008 and 2007, respectively. Related distributor receivables of $0.6 million and $4.5 million are included in accounts receivable net, in the accompanying condensed consolidated balance sheets as of September 30, 2008 and December 31, 2007, respectively.
As of September 30, 2008 and December 31, 2007, amounts totaling $0.1 million, respectively, were received by us from certain other AB Distributors in anticipation of executing AB Distribution Agreements with us. Such receipts have been accounted for as customer deposit liabilities and are included in accrued liabilities in the accompanying condensed consolidated balance sheets.
We incurred termination costs amounting to ($0.2) million and $0.3 million in aggregate during the three-months ended September 30, 2008 and 2007, respectively, to certain of our prior distributors. We incurred termination costs amounting to ($0.04) million and $15.0 million in aggregate during the nine-months ended September 30, 2008 and 2007, respectively, to certain of our prior distributors. Such termination costs have been expensed in full and are included in operating expenses for the three- and nine-months ended September 30, 2008 and 2007. Accrued distributor terminations in the accompanying condensed consolidated balance sheets as of September 30, 2008 and December 31, 2007 were $3.8 million and $4.3 million, respectively.
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On October 3, 2008, we entered into the Monster Energy Distribution Coordination Agreement (the “TCCC North American Coordination Agreement”) with The Coca-Cola Company (“TCCC”). Pursuant to the TCCC North American Coordination Agreement, we have designated, and in the future may designate, territories in which we wish distributors from TCCC’s network of partially owned and independent bottlers (the “TCCC North American Bottlers”) to distribute and sell primarily our Monster Energy® beverages (the “Products”) in the United States and Canada.
Coca-Cola Enterprises Inc. (“CCE”) has been appointed to distribute, directly and through certain sub-distributors, the Products in portions of twenty-three U.S. states (the “U.S. Territories”), commencing in November, 2008. We may designate additional territories within reasonable proximity to the U.S. Territories and CCE will use reasonable good faith efforts to add the additional territories. Under the Monster Energy Canadian Distribution Agreement with the Coca-Cola Bottling Company (“CCBC”), CCBC has been appointed to distribute, directly and through certain sub-distributors, the Products in Canada, with performance to commence on January 1, 2009.
On October 3, 2008, we entered into the Monster Energy International Coordination Agreement (the “TCCC International Coordination Agreement”) with TCCC. Pursuant to the TCCC International Coordination Agreement, we have designated, and in the future may designate, countries in which we wish to appoint TCCC distributors to distribute and sell the Products.
We entered into the Monster Energy International Distribution Agreement and the Monster Energy Belgium Distribution Agreement with CCE pursuant to which CCE has been appointed to distribute, directly, and through certain sub-distributors, the Products in Great Britain, France, Belgium, the Netherlands, Luxembourg and Monaco.
As a result, we will transition certain of our existing distribution arrangements to newly appointed distributors, including TCCC North American Bottlers and new AB Distributors. In connection with the transition, we will make termination payments to certain existing distributors who will be terminated. Such termination costs will be expensed in full and included in operating expenses. Non-refundable contributions were previously received by us from certain of these existing distributors, who will be terminated. Such contributions were previously treated as deferred revenue. Upon termination, the associated balance in deferred revenue will be recognized as revenue. The impact of the above amounts is currently estimated to be a charge in the range of $110 million to $130 million in the aggregate, but could be higher or lower. The actual termination payments could differ significantly from current estimates because the estimates are largely based on our estimate of each affected distributor’s contractual termination rights. These estimates include assumptions related to each distributor’s own sales and gross profit levels, net of certain allowances. The actual termination costs and related revenue will be recorded in the period in which the terminations become effective, which will primarily be in the fourth fiscal quarter of 2008.
We will receive from newly appointed distributors non-refundable contributions estimated to be in the range of $110 million to $130 million for the purpose of covering the costs of terminating the affected distributors, but could be higher or lower. The non-refundable contributions could differ significantly from current estimates because the estimates are based largely on our estimate of each affected terminated distributor’s own sales. These contributions will be recorded as deferred revenue, which will be recognized as revenue ratably over the anticipated 20-year life of the distribution agreements.
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As discussed under Review of Historic Stock Option Granting Practices in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, included in our Form 10-K for the fiscal year ended December 31, 2006, and Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, included in our Form 10-Q for the quarter ended March 31, 2007, a special committee of our Board of Directors concluded its review of our stock option grants and granting practices. In connection with this review, and with respect to related litigation and other related matters, we incurred professional service fees, net of insurance proceeds of $0.1 million for the three-months ended September 30, 2007. There were no professional service fees in connection with our special investigation of stock option grants and granting practices, related litigation and other related matters during the three-months ended September 30, 2008. In connection with this review, and with respect to related litigation and other related matters, we incurred professional service fees, net of insurance proceeds, of ($0.2) million, and $11.0 million for the nine-months ended September 30, 2008 and 2007, respectively.
The following table summarizes the selected items discussed above for the three- and nine-months ended September 30, 2008 and 2007:
(1) net of $0.8 million insurance reimbursements
We again achieved record gross sales* of $325.2 million in the third quarter of 2008. The increase in gross sales for the three-months ended September 30, 2008 was primarily attributable to increased sales of our Monster Energy® brand energy drinks. The percentage increase in gross sales was slightly higher than the percentage increase in net sales, primarily due to an increase in promotional and other allowances as a percentage of gross sales, which increased from 11.0% for the three-months ended September 30, 2007 to 12.4% for the three-months ended September 30, 2008. The actual amount of promotional and other allowances increased to $40.2 million from $30.6 million for the three-months ended September 30, 2008 and 2007, respectively.
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*Gross sales, although used internally by management as an indicator of operating performance, should not be considered as an alternative to net sales, which is determined in accordance with accounting principles generally accepted in the United States of America (“GAAP”), and should not be used alone as an indicator of operating performance in place of net sales. Additionally, gross sales may not be comparable to similarly titled measures used by other companies as gross sales has been defined by our internal reporting requirements. However, gross sales is used by management to monitor operating performance including sales performance of particular products, salesperson performance, product growth or declines and our overall performance. The use of gross sales allows evaluation of sales performance before the effect of any promotional items, which can mask certain performance issues. Management believes the presentation of gross sales allows a more comprehensive presentation of our operating performance. Gross sales may not be realized in the form of cash receipts as promotional payments and allowances may be deducted from payments received from customers.
A substantial portion of our gross sales are derived from our Monster Energy® brand energy drinks. Any decrease in sales of our Monster Energy® brand energy drinks could cause a significant adverse affect on our future revenues and net income. Competitive pressure in the “energy drink” category could adversely affect our operating results.
Gross sales shipped outside of California represented 75.6% and 72.1% of our gross sales, for the three-months ended September 30, 2008 and 2007, respectively. Gross sales shipped outside of California represented 77.0% and 72.2% of our gross sales for the nine-months ended September 30, 2008 and 2007, respectively. Gross sales to customers outside the United States amounted to $31.1 million and $13.9 million for the three-months ended September 30, 2008 and 2007, respectively. Such sales were approximately 9.7% and 4.9% of gross sales for the three-months ended September 30, 2008 and 2007, respectively. Gross sales to customers outside the United States amounted to $79.4 million and $40.4 million for the nine-months ended September 30, 2008 and 2007, respectively. Such sales were approximately 8.9% and 5.4% of gross sales for the nine-months ended September 30, 2008 and 2007, respectively.
Our customers are typically retail grocery and specialty chains, wholesalers, club stores, drug chains, mass merchandisers, convenience chains, full service beverage distributors, health food distributors and food service customers. Gross sales to our various customer types for the three- and nine-months ended September 30, 2008 and 2007 are reflected below. The allocations below reflect changes made by us to the categories historically reported.
Our customers include Dr Pepper Snapple Group, Inc., Wal-Mart, Inc. (including Sam’s Club), AB Distributors, Kalil Bottling Group, Trader Joe’s, John Lenore & Company, Pepsi Canada, Swire Coca-Cola, Costco, The Kroger Co., Safeway Inc. and Albertsons. A decision by any large customer to decrease amounts purchased from us or to cease carrying our products could have a material negative effect on our financial condition and consolidated results of operations. Dr Pepper
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Snapple Group, Inc., a customer of the DSD division, accounted for approximately 16% of our net sales for both the nine-months ended September 30, 2008 and 2007, respectively. Wal-Mart, Inc. (including Sam’s Club), a customer of both the DSD and Warehouse divisions, accounted for approximately 11% and 13% of our net sales for the nine-months ended September 30, 2008 and 2007, respectively.
We continue to incur expenditures in connection with the development and introduction of new products and flavors.
Results of Operations
The following table sets forth key statistics for the three- and nine-months ended September 30, 2008 and 2007, respectively.
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