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Monster Beverage Corp 10-Q 2008

Table of Contents

 

 

 

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

 

For the quarterly period ended September 30, 2008

 

Commission File Number 0-18761

 

HANSEN NATURAL CORPORATION

(Exact name of Registrant as specified in its charter)

 

Delaware

 

39-1679918

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

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.

 

Large Accelerated Filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o (Do not check if smaller reporting
company)

 

Smaller reporting company o

 

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.

 

 

 



Table of Contents

 

HANSEN NATURAL CORPORATION AND SUBSIDIARIES SEPTEMBER 30, 2008

 

INDEX

 

 

 

Page No.

 

 

 

Part I.

FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Condensed Consolidated Financial Statements (Unaudited)

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets as of
September 30, 2008 and December 31, 2007

3

 

 

 

 

 

 

Condensed Consolidated Statements of Income for the
Three- and Nine-Months Ended September 30, 2008 and 2007

4

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the
Nine-Months Ended September 30, 2008 and 2007

5

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

7

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial
Condition and Results of Operations

28

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

49

 

 

 

 

 

Item 4.

Controls and Procedures

50

 

 

 

 

 

Part II.

OTHER INFORMATION

 

 

 

 

 

 

Item 1.

Legal Proceedings

51

 

 

 

 

 

Item 1A.

Risk Factors

54

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

54

 

 

 

 

 

Item 4

Submission of Matters to a Vote of Security Holders

54

 

 

 

 

 

Item 5.

Other Information

55

 

 

 

 

 

Item 6.

Exhibits

55

 

 

 

 

 

 

Signatures

56

 

2



Table of Contents

 

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)

 

 

 

September 30,
2008

 

December 31,
2007

 

ASSETS

 

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

Cash and cash equivalents

 

$

256,436

 

$

12,440

 

Short-term investments

 

14,838

 

63,125

 

Accounts receivable, net

 

72,972

 

81,497

 

Inventories

 

110,466

 

98,140

 

Prepaid expenses and other current assets

 

9,181

 

3,755

 

Deferred income taxes

 

13,352

 

11,192

 

Total current assets

 

477,245

 

270,149

 

 

 

 

 

 

 

INVESTMENTS

 

109,530

 

227,085

 

PROPERTY AND EQUIPMENT, net

 

11,067

 

8,567

 

DEFERRED INCOME TAXES

 

16,208

 

14,006

 

INTANGIBLES, net

 

25,512

 

24,066

 

OTHER ASSETS

 

584

 

730

 

 

 

$

640,146

 

$

544,603

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

Accounts payable

 

$

60,724

 

$

56,766

 

Accrued liabilities

 

12,277

 

9,019

 

Accrued distributor terminations

 

3,841

 

4,312

 

Accrued compensation

 

5,100

 

5,827

 

Current portion of capital leases

 

673

 

663

 

Income taxes payable

 

5,740

 

6,294

 

Total current liabilities

 

88,355

 

82,881

 

 

 

 

 

 

 

DEFERRED REVENUE

 

37,656

 

39,555

 

 

 

 

 

 

 

COMMITMENTS AND CONTINGENCIES (Note 8)

 

 

 

 

 

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY:

 

 

 

 

 

Common stock - $0.005 par value; 120,000 shares authorized; 96,785 shares issued and 92,432 outstanding as of September 30, 2008; 95,849 shares issued and 93,191 outstanding as of December 31, 2007

 

484

 

479

 

Additional paid-in capital

 

110,352

 

96,749

 

Retained earnings

 

485,128

 

353,648

 

Accumulated other comprehensive loss

 

(3,201

)

(47

)

Common stock in treasury, at cost; 4,354 and 2,658 shares as of September 30, 2008 and December 31, 2007, respectively

 

(78,628

)

(28,662

)

Total stockholders’ equity

 

514,135

 

422,167

 

 

 

$

640,146

 

$

544,603

 

 

See accompanying notes to condensed consolidated financial statements.

 

3



Table of Contents

 

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)

 

 

 

Three-Months Ended

 

Nine-Months Ended

 

 

 

September 30

 

September 30

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

 

NET SALES

 

$

284,986

 

$

247,211

 

$

779,408

 

$

657,826

 

 

 

 

 

 

 

 

 

 

 

COST OF SALES

 

135,550

 

118,829

 

379,039

 

315,555

 

 

 

 

 

 

 

 

 

 

 

GROSS PROFIT

 

149,436

 

128,382

 

400,369

 

342,271

 

 

 

 

 

 

 

 

 

 

 

OPERATING EXPENSES

 

67,644

 

55,002

 

197,560

 

175,559

 

 

 

 

 

 

 

 

 

 

 

OPERATING INCOME

 

81,792

 

73,380

 

202,809

 

166,712

 

 

 

 

 

 

 

 

 

 

 

INTEREST AND OTHER INCOME, net

 

2,111

 

2,161

 

8,506

 

5,439

 

 

 

 

 

 

 

 

 

 

 

INCOME BEFORE PROVISION FOR INCOME TAXES

 

83,903

 

75,541

 

211,315

 

172,151

 

 

 

 

 

 

 

 

 

 

 

PROVISION FOR INCOME TAXES

 

31,466

 

29,744

 

79,835

 

67,845

 

 

 

 

 

 

 

 

 

 

 

NET INCOME

 

$

52,437

 

$

45,797

 

$

131,480

 

$

104,306

 

 

 

 

 

 

 

 

 

 

 

NET INCOME PER COMMON SHARE:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.57

 

$

0.50

 

$

1.42

 

$

1.15

 

Diluted

 

$

0.54

 

$

0.46

 

$

1.34

 

$

1.06

 

 

 

 

 

 

 

 

 

 

 

WEIGHTED AVERAGE NUMBER OF SHARES OF COMMON STOCK AND COMMON STOCK EQUIVALENTS:

 

 

 

 

 

 

 

 

 

Basic

 

92,337

 

91,572

 

92,852

 

90,589

 

Diluted

 

96,916

 

98,895

 

97,997

 

98,586

 

 

See accompanying notes to condensed consolidated financial statements.

 

4



Table of Contents

 

HANSEN NATURAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR NINE-MONTHS ENDED SEPTEMBER 30, 2008 AND 2007

(In Thousands) (Unaudited)

 

 

 

Nine-Months Ended

 

 

 

September 30, 2008

 

September 30, 2007

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

131,480

 

$

104,306

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Amortization of trademark

 

42

 

42

 

Depreciation and other amortization

 

2,559

 

1,488

 

Loss on disposal of property and equipment

 

87

 

25

 

Stock-based compensation

 

9,776

 

6,348

 

Deferred income taxes

 

(2,160

)

(9,632

)

Tax benefit from exercise of stock options

 

(2,198

)

(27,332

)

Provision for doubtful accounts

 

1

 

159

 

Effect on cash of changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

8,524

 

(35,581

)

Inventories

 

(12,326

)

(17,012

)

Prepaid expenses and other current assets

 

(5,324

)

(4,654

)

Prepaid income taxes

 

 

(9,210

)

Accounts payable

 

3,958

 

46,310

 

Accrued liabilities

 

3,259

 

(6,802

)

Accrued distributor terminations

 

(471

)

(1,240

)

Accrued compensation

 

(727

)

(201

)

Income taxes payable

 

1,644

 

23,341

 

Deferred revenue

 

(1,899

)

19,747

 

Net cash provided by operating activities

 

136,225

 

90,102

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Sales and maturities of held-to-maturity investments

 

 

3,528

 

Sales of available-for-sale investments

 

266,978

 

93,878

 

Purchases of available-for-sale investments

 

(106,685

)

(192,110

)

Purchases of property and equipment

 

(4,333

)

(2,995

)

Proceeds from sale of property and equipment

 

79

 

257

 

Additions to trademarks

 

(1,488

)

(2,762

)

Decrease in other assets

 

105

 

104

 

Net cash provided by (used in) investing activities

 

154,656

 

(100,100

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Principal payments on long-term debt

 

(842

)

(602

)

Tax benefit from exercise of stock options

 

2,198

 

27,332

 

Issuance of common stock

 

1,725

 

7,213

 

Purchases of common stock held in treasury

 

(49,966

)

 

Net cash (used in) provided by financing activities

 

(46,885

)

33,943

 

 

 

 

 

 

 

NET INCREASE IN CASH AND CASH EQUIVALENTS

 

243,996

 

23,945

 

CASH AND CASH EQUIVALENTS, beginning of period

 

12,440

 

35,129

 

CASH AND CASH EQUIVALENTS, end of period

 

$

256,436

 

$

59,074

 

 

 

 

 

 

 

SUPPLEMENTAL INFORMATION:

 

 

 

 

 

Cash paid during the year for:

 

 

 

 

 

Interest

 

$

33

 

$

33

 

Income taxes

 

$

80,839

 

$

63,436

 

 

5



Table of Contents

 

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.

 

6



Table of Contents

 

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

 

7



Table of Contents

 

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.

 

8



Table of Contents

 

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:

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Cash

 

$

15,355

 

$

 

$

 

$

15,355

 

Money market funds

 

180,877

 

 

 

180,877

 

U.S. Treasuries

 

60,204

 

 

 

60,204

 

Municipal securities

 

12,943

 

 

 

12,943

 

Auction rate securities

 

 

 

111,425

 

111,425

 

Total

 

$

269,379

 

$

 

$

111,425

 

$

380,804

 

 

 

 

 

 

 

 

 

 

 

Amounts included in:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

256,436

 

$

 

$

 

$

256,436

 

Short-term investments

 

12,943

 

 

1,895

 

14,838

 

Long-term investments

 

 

 

109,530

 

109,530

 

Total

 

$

269,379

 

$

 

$

111,425

 

$

380,804

 

 

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

 

9



Table of Contents

 

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.

 

10



Table of Contents

 

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:

 

 

 

Level 3
Auction Rate
Securities

 

Balance at December 31, 2007

 

$

 

Transfers to Level 3

 

227,089

 

Realized loss included in income

 

 

Unrealized loss included in other comprehensive loss

 

(5,366

)

Net settlements

 

(19,609

)

Balance at March 31, 2008

 

$

202,114

 

Transfers to Level 3

 

 

Realized loss included in income

 

 

Unrealized loss included in other comprehensive loss

 

(403

)

Net settlements

 

(77,655

)

Balance at June 30, 2008

 

$

124,056

 

Transfers to Level 3

 

 

Realized loss included in income

 

 

Unrealized gain included in other comprehensive loss

 

219

 

Net settlements

 

(12,850

)

Balance at September 30, 2008

 

$

111,425

 

 

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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:

 

September 30, 2008

 

Amortized
Cost

 

Gross
Unrealized
Holding
Gains

 

Gross
Unrealized
Holding
Losses

 

Fair
Value

 

Available-for-sale

 

 

 

 

 

 

 

 

 

Short-term:

 

 

 

 

 

 

 

 

 

Municipal securities

 

$

12,943

 

$

 

$

 

$

12,943

 

Auction rate securities

 

1,900

 

 

5

 

1,895

 

Long-term:

 

 

 

 

 

 

 

 

 

Auction rate securities

 

115,075

 

 

5,545

 

109,530

 

Total

 

$

129,918

 

$

 

$

5,550

 

$

124,368

 

 

December 31, 2007

 

Amortized
Cost

 

Gross
Unrealized
Holding
Gains

 

Gross
Unrealized
Holding
Losses

 

Fair
Value

 

Available-for-sale

 

 

 

 

 

 

 

 

 

Short-term:

 

 

 

 

 

 

 

 

 

Municipal securities

 

$

63,125

 

$

 

$

 

$

63,125

 

Long-term:

 

 

 

 

 

 

 

 

 

Auction rate securities

 

227,085

 

4

 

 

227,089

 

Total

 

$

290,210

 

$

4

 

$

 

$

290,214

 

 

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:

 

 

 

September 30,
2008

 

December 31,
2007

 

Raw materials

 

$

27,062

 

$

32,293

 

Finished goods

 

83,404

 

65,847

 

 

 

$

110,466

 

$

98,140

 

 

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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:

 

 

 

September 30,
2008

 

December 31,
2007

 

Land

 

$

1,417

 

$

 

Leasehold improvements

 

2,111

 

2,027

 

Furniture and office equipment

 

4,348

 

3,921

 

Equipment

 

3,093

 

1,937

 

Vehicles

 

6,896

 

5,333

 

 

 

17,865

 

13,218

 

Less: accumulated depreciation and amortization

 

(6,798

)

(4,651

)

 

 

$

11,067

 

$

8,567

 

 

7.             INTANGIBLES, Net

 

Intangibles consist of the following at:

 

 

 

September 30,
2008

 

December 31,
2007

 

Amortizing trademarks

 

$

1,169

 

$

1,169

 

Accumulated amortization

 

(443

)

(401

)

 

 

726

 

768

 

Non-amortizing trademarks

 

24,786

 

23,298

 

 

 

$

25,512

 

$

24,066

 

 

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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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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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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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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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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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:

 

 

 

Three-Months Ended

 

Nine-Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Net income, as reported

 

$

52,437

 

$

45,797

 

$

131,480

 

$

104,306

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Change in unrealized loss on available-for-sale securities, net of tax

 

28

 

 

(3,348

)

 

Foreign currency translation adjustments

 

200

 

 

194

 

 

Comprehensive income

 

$

52,665

 

$

45,797

 

$

128,326

 

$

104,306

 

 

The components of accumulated other comprehensive (loss) is as follows:

 

 

 

September 30, 2008

 

December 31, 2007

 

Accumulated net unrealized loss on available-for-sale securities, net of tax benefit of $2,203

 

$

(3,348

)

$

 

Foreign currency translation adjustments

 

147

 

(47

)

Total accumulated other comprehensive loss

 

$

(3,201

)

$

(47

)

 

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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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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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:

 

 

 

Three-Months Ended
September 30,

 

Nine-Months Ended
September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Dividend yield

 

0.0

%

0.0

%

0.0

%

0.0

%

Expected volatility

 

63

%

60

%

62

%

61

%

Risk free interest rate

 

3.5

%

4.7

%

3.5

%

4.8

%

Expected lives

 

6.0 Years

 

5.5 Years

 

5.6 Years

 

5.6 Years

 

 

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:

 

Options

 

Number of
Shares (In
Thousands)

 

Weighted-
Average
Exercise
Price Per
Share

 

Weighted-
Average
Remaining
Contractual
Term (In
Years)

 

Aggregate
Intrinsic
Value

 

Balance at Jaunuary 1, 2008

 

9,462

 

$

7.91

 

6.5

 

$

344,589

 

Granted 01/01/08 - 03/31/08

 

40

 

$

41.08

 

 

 

 

 

Granted 04/01/08 - 06/30/08

 

1,479

 

$

31.94

 

 

 

 

 

Granted 07/01/08 - 09/30/08

 

93

 

$

26.93

 

 

 

 

 

Exercised

 

(937

)

$

1.84

 

 

 

 

 

Cancelled

 

(121

)

$

21.57

 

 

 

 

 

Outstanding at September 30, 2008

 

10,016

 

$

12.16

 

6.6

 

$

189,475

 

Vested and expected to vest in the future at September 30, 2008

 

9,658

 

$

11.79

 

6.5

 

$

185,947

 

Exercisable at September 30, 2008

 

4,859

 

$

4.99

 

5.4

 

$

123,227

 

 

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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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):

 

 

 

Gross Unrealized Tax
Benefits

 

Balance at December 31, 2007

 

$

1,291

 

Additions for tax positions related to the current year

 

601

 

Balance at September 30, 2008

 

$

1,892

 

 

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:

 

 

 

Three-Months Ended

 

Nine-Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Weighted-average shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

92,337

 

91,572

 

92,852

 

90,589

 

Dilutive securities

 

4,579

 

7,323

 

5,145

 

7,997

 

Diluted

 

96,916

 

98,895

 

97,997

 

98,586

 

 

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:

 

 

 

Three-Months Ended September 30, 2008

 

 

 

DSD

 

Warehouse

 

Corporate and
Unallocated

 

Total

 

Net sales

 

$

257,698

 

$

27,288

 

$

 

$

284,986

 

Contribution margin

 

94,743

 

1,097

 

 

95,840

 

Corporate and unallocated expenses

 

 

 

(14,048

)

(14,048

)

Operating income

 

 

 

 

 

 

 

81,792

 

Interest and other income, net

 

(8

)

 

2,119

 

2,111

 

Income before provision for income taxes

 

 

 

 

 

 

 

83,903

 

Depreciation and amortization

 

516

 

8

 

496

 

1,020

 

Trademark amortization

 

 

11

 

3

 

14

 

 

 

 

Three-Months Ended September 30, 2007

 

 

 

DSD

 

Warehouse

 

Corporate and
Unallocated

 

Total

 

Net sales

 

$

221,888

 

$

25,323

 

$

 

$

247,211

 

Contribution margin

 

82,328

 

1,242

 

 

83,570

 

Corporate and unallocated expenses

 

 

 

(10,190

)

(10,190

)

Operating income

 

 

 

 

 

 

 

73,380

 

Interest and other income, net

 

(16

)

 

2,177

 

2,161

 

Income before provision for income taxes

 

 

 

 

 

 

 

75,541

 

Depreciation and amortization

 

238

 

8

 

324

 

570

 

Trademark amortization

 

 

11

 

3

 

14

 

 

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:

 

 

 

Nine-Months Ended September 30, 2008

 

 

 

DSD

 

Warehouse

 

Corporate and
Unallocated

 

Total

 

Net sales

 

$

705,974

 

$

73,434

 

$

 

$

779,408

 

Contribution margin

 

241,005

 

243

 

 

241,248

 

Corporate and unallocated expenses

 

 

 

(38,439

)

(38,439

)

Operating income

 

 

 

 

 

 

 

202,809

 

Interest and other income, net

 

(29

)

 

8,535

 

8,506

 

Income before provision for income taxes

 

 

 

 

 

 

 

211,315

 

Depreciation and amortization

 

1,091

 

24

 

1,444

 

2,559

 

Trademark amortization

 

 

33

 

9

 

42

 

 

 

 

Nine-Months Ended September 30, 2007

 

 

 

DSD

 

Warehouse

 

Corporate and
Unallocated

 

Total

 

Net sales

 

$

585,610

 

$

72,216

 

$

 

$

657,826

 

Contribution margin

 

204,645

 

2,929

 

 

207,574

 

Corporate and unallocated expenses

 

 

 

(40,862

)

(40,862

)

Operating income

 

 

 

 

 

 

 

166,712

 

Interest and other income, net

 

(33

)

 

5,472

 

5,439

 

Income before provision for income taxes

 

 

 

 

 

 

 

172,151

 

Depreciation and amortization

 

644

 

24

 

820

 

1,488

 

Trademark amortization

 

 

33

 

9

 

42

 

 

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:

 

 

 

Three-Months Ended

 

Nine-Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Energy drinks

 

$

258,110

 

$

222,649

 

$

707,482

 

$

588,599

 

Non-carbonated (primarily juice based beverages)

 

18,420

 

16,578

 

50,009

 

46,856

 

Carbonated (primarily soda beverages)

 

8,456

 

7,984

 

21,917

 

22,371

 

 

 

$

284,986

 

$

247,211

 

$

779,408

 

$

657,826

 

 

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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Table of Contents

 

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:

 

 

 

Three-Months Ended

 

Nine-Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

(In Thousands)

 

(In Thousands)

 

(In Thousands)

 

(In Thousands)

 

Included in Deferred Revenue:

 

 

 

 

 

 

 

 

 

Contributions from, net of reimbursements to AB Distributors

 

$

5

 

$

1,290

 

$

(360

)

$

21,136

 

 

 

 

 

 

 

 

 

 

 

Included in Net Sales:

 

 

 

 

 

 

 

 

 

Recognition of deferred revenue

 

$

523

 

$

453

 

$

1,539

 

$

1,389

 

 

 

 

 

 

 

 

 

 

 

Included in Operating Expenses:

 

 

 

 

 

 

 

 

 

Termination payments to prior distributors

 

$

(193

)

$

322

 

$

(43

)

$

15,023

 

Professional service fees (net of insurance proceeds) associated with the review of stock option grants and granting practices, related litigation and other related matters

 

$

 

$

95

(1)

$

(200

)

$

11,000

(1)

 


(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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Table of Contents

 

*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.

 

 

 

Three-Months Ended

 

Nine-Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Retail grocery, specialty chains and wholesalers

 

8

%

8

%

8

%

9

%

Club stores, drug chains & mass merchandisers

 

12

%

16

%

13

%

15

%

Full service distributors

 

75

%

72

%

74

%

72

%

Health food distributors

 

2

%

2

%

2

%

2

%

Other

 

3

%

2

%

3

%

2

%

 

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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Table of Contents

 

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.

 

 

 

Three-Months Ended
September 30,

 

Percentage
Change

 

Nine-Months Ended
September 30,

 

Percentage
Change

 

 

 

2008

 

2007

 

08 vs. 07

 

2008

 

2007

 

08 vs. 07

 

Gross sales, net of discounts & returns *

 

$

325,152

 

$

277,845

 

17.0

%

$

893,284

 

$

748,496

 

19.3

%

Less: Promotional and other allowances**

 

40,166

 

30,634

 

31.1

%

113,876

 

90,670

 

25.6

%

Net sales

 

284,986

 

247,211

 

15.3

%

779,408

 

657,826

 

18.5

%

Cost of sales

 

135,550

 

118,829

 

14.1

%

379,039

 

315,555

 

20.1

%

Gross profit

 

149,436

 

128,382

 

16.4

%

400,369

 

342,271

 

17.0

%

Gross profit margin as a percentage of net sales

 

52.4

%

51.9

%

 

 

51.4

%

52.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses(1)

 

67,644

 

55,002

 

23.0

%

197,560

 

175,559

 

12.5

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses as a percentage of net sales

 

23.7

%