HAWKINS INC FORM 8-K/A. (Amended Current report filing) Filed 03/03/16 for the Period Ending 12/23/15

Transcription

1 HAWKINS INC FORM 8-K/A (Amended Current report filing) Filed 03/03/16 for the Period Ending 12/23/15 Address 3100 E HENNEPIN AVE MINNEAPOLIS, MN Telephone CIK Symbol HWKN SIC Code Chemicals And Allied Products Industry Chemical Manufacturing Sector Basic Materials Fiscal Year 03/29 Copyright 2016, EDGAR Online, Inc. All Rights Reserved. Distribution and use of this document restricted under EDGAR Online, Inc. Terms of Use.

2 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C FORM 8-K/A CURRENT REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Date of Report (Date of earliest event reported) December 23, 2015 HAWKINS, INC. (Exact name of registrant as specified in charter) Minnesota (State of Incorporation) (Commission File Number) (IRS Employer Identification No.) 2381 Rosegate Roseville, MN (Address of Principal Executive Offices) (Zip Code) ( (Registrant s telephone number, including area code) Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions: Written communications pursuant to Rule 425 under the Securities Act (17 CFR ) Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR a-12) Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR d-2(b)) Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR e-4(c))

3 EXPLANATORY NOTE On December 23, 2015, Hawkins, Inc. (the Company ) acquired SPH Holdings, Inc. pursuant to a Stock Purchase Agreement by and among the Company, SPH, the selling stockholders of SPH (the SPH Stockholders ), and ICV Manager, LLC, as the representative of the SPH Stockholders. This Amendment No. 1 on Form 8-K/A is being filed by Hawkins, Inc. to amend the current report on Form 8-K filed with the Securities and Exchange Commission ( SEC ) on December 23, 2015 (the Original Report ), solely to provide the disclosures required by Item 9.01 of Form 8-K that were not previously filed with the Original Report, including the required financial statement of SPH Holdings, Inc. and the required pro forma financial information. Except as otherwise provided herein, the disclosures made in the Original Report remain unchanged. Item Financial Statements and Exhibits. (a) Financial Statements of Business Acquired. The consolidated financial statements of SPH Holdings, Inc. and subsidiaries ( SPH ) required by Item 9.01(a) of Form 8-K are attached as Exhibit 99.1 hereto and incorporated herein by reference. (b) Pro Forma Financial Information. The unaudited pro forma condensed combined statements of operations of Hawkins, Inc. and SPH for the fiscal year ended March 29, 2015, and for the nine months ended December 27, 2015, are attached as Exhibit 99.2 hereto and incorporated herein by reference. Because the acquisition was completed within Hawkins quarter ended December 27, 2015, the unaudited condensed consolidated balance sheet included in its quarterly report on Form 10-Q for the quarter ended December 27, 2015, and filed with the SEC on February 5, 2016, gives effect to the acquisition of SPH and the related debt. As a result, an unaudited pro forma condensed combined balance sheet is not required to be presented. (d) Exhibits. 2.1 Stock Purchase Agreement, dated November 23, 2015, by and among Hawkins, Inc., SPH Holdings, Inc., the stockholders of SPH Holdings, Inc. listed therein, and ICV Manager, LLC (incorporated by reference to Exhibit 2.1 to Current Report on Form 8-K filed November 23, 2015) Credit Agreement dated as of December 23, 2015, among Hawkins, Inc., the lenders party thereto, and U.S. Bank National Association, as an LC Issuer, Swing Line Lender and Administrative Agent.* 23.1 Consent of BDO USA, LLP, Independent Auditors Audited consolidated financial statements of SPH Holdings, Inc. and subsidiaries as of and for the three years ended December 31, Unaudited consolidated financial statements of SPH Holdings, Inc. and subsidiaries as of and for the nine months ended September 30, 2015 and Unaudited pro forma condensed combined statements of operations of Hawkins, Inc. and SPH Holdings, Inc. for the fiscal year ended March 29, 2015, and for the nine months ended December 27, * Filed with Original Report.

4 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. HAWKINS, INC. Date: March 3, 2016 By: /s/ Kathleen P. Pepski Kathleen P. Pepski VicePresident,ChiefFinancialOfficer,andTreasurer

5 EXHIBIT INDEX Exhibit No. Description Method of Filing 2.1 Stock Purchase Agreement, dated November 23, 2015, by and among Hawkins, Inc., SPH Holdings, Inc., the stockholders of SPH Holdings, Inc. listed therein, and ICV Manager, LLC Credit Agreement dated as of December 23, 2015, among Hawkins, Inc., the lenders party thereto, and U.S. Bank National Association, as an LC Issuer, Swing Line Lender and Administrative Agent. Incorporated by Reference Previously Filed 23.1 Consent of BDO USA, LLP, Independent Auditors. Filed Electronically 99.1 Audited consolidated financial statements of SPH Holdings, Inc. and subsidiaries as of and for the three years ended December 31, Unaudited consolidated financial statements of SPH Holdings, Inc. and subsidiaries as of and for the nine months ended September 30, 2015 and Unaudited pro forma condensed combined statements of operations of Hawkins, Inc. and SPH Holdings, Inc. for the fiscal year ended March 29, 2015, and for the nine months ended December 27, Filed Electronically Filed Electronically

6 Exhibit 23.1 Consent of Independent Auditors Hawkins, Inc. Minneapolis, Minnesota We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No , , and ) of Hawkins, Inc. of our report dated April 30, 2015, except for the Goodwill paragraph in Note 2, which is as of March 3, 2016, relating to the consolidated financial statements of SPH Holdings, Inc. and Subsidiaries for the years ended December 31, 2014 and 2013 and our report dated April 30, 2014, except for the Recently Adopted Accounting Pronouncements and Goodwill paragraphs in Note 2, which are as of March 3, 2016, relating to the consolidated financial statements of SPH Holdings, Inc. and Subsidiaries for the years ended December 31, 2013 and 2012 which appear in this Form 8-K. /s/ BDO USA, LLP Los Angeles, California March 3, 2016

7 Exhibit 99.1 SPH Holdings, Inc. and Subsidiaries Consolidated Financial Statements As of and for Years Ended December 31, 2013 and 2012

8 Consolidated Financial Statements As of and for the Years Ended December 31, 2013 and 2012

9 Contents Independent Auditor s Report 3-4 Consolidated Financial Statements Consolidated Balance Sheets as of December 31, 2013 and Consolidated Statements of Operations for the Years Ended December 31, 2013 and Consolidated Statements of Stockholders Equity for the Years Ended December 31, 2013 and Consolidated Statements of Cash Flows for the Years Ended December 31, 2013 and Notes to Consolidated Financial Statements

10 Independent Auditor s Report Board of Directors SPH Holdings, Inc. and Subsidiaries Fullerton, California We have audited the accompanying consolidated financial statements of SPH Holdings, Inc. and Subsidiaries, which comprise the consolidated balance sheets as of December 31, 2013 and 2012 and the related consolidated statements of operations, stockholders equity, and cash flows for the years then ended, and the related notes to the consolidated financial statements. Management s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor s Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms. 3

11 Opinion In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of SPH Holdings, Inc. and Subsidiaries as of December 31, 2013 and 2012, and the results of their operations and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. Emphasis of a Matter As discussed in Note 2 to the consolidated financial statements, the Company has changed its method of accounting for goodwill in the consolidated financial statements for the year ended December 31, 2013 due to unwinding the effects of the adoption of Accounting Standards Update No , Accountingfor Goodwill,aconsensusofthePrivateCompanyCouncilas the Company meets the definition of a public business entity. Our opinion is not modified with respect to this matter. /s/ BDO USA, LLP Los Angeles, California April 30, 2014, except for the Recently Adopted Accounting Pronouncements and Goodwill paragraphs in Note 2, which are as of March 3, 2016 BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms. 4

12 Consolidated Financial Statements

13 Consolidated Balance Sheets December31, Assets Current assets Cash and cash equivalents $ 850,900 $ 578,300 Accounts receivable, net of allowance of $596,500 and $583,600, respectively 14,200,200 11,379,000 Inventories 11,987,800 13,788,700 Prepaid expenses 539, ,000 Income taxes receivable 207,000 Deferred income taxes 1,432, ,600 Total current assets 29,010,200 27,057,600 Property and equipment, net 6,153,100 5,043,400 Prepaid expenses, net of current portion 1,200 Debt issuance costs 147, ,000 Intangible assets, net 19,204,400 24,653,600 Goodwill 22,561,800 22,561,800 Total assets $77,076,600 $79,546,600 Liabilities and Stockholders Equity Current liabilities Accounts payable $ 8,285,700 $ 5,765,800 Current portion of debt 1,764,800 1,472,900 Other accrued expenses 1,714,000 1,586,000 Interest payable Income taxes payable 327,000 Total current liabilities 12,092,100 8,825,600 Long-term liabilities Debt, net of current portion and discount 30,534,800 36,635,400 Deferred tax liability 7,544,500 8,953,900 Total long-term liabilities 38,079,300 45,589,300 Total liabilities 50,171,400 54,414,900 Commitments and Contingencies (see Note 9) Stockholders equity Series A convertible preferred stock, 296,880 and 293,249 shares issued and outstanding, respectively 29,762,800 29,322,000 Stockholder notes receivable (301,800) (133,700) Accumulated deficit (2,555,800) (4,056,600) Total stockholders equity 26,905,200 25,131,700 Total liabilities and stockholders equity $77,076,600 $79,546,600 6 Seeaccompanyingnotestoconsolidatedfinancialstatements.

14 Consolidated Statements of Operations YearsendedDecember31, Revenues, net $101,961,200 $83,678,100 Cost of sales 79,016,300 63,294,400 Gross profit 22,944,900 20,383,700 Selling, general and administrative expenses 11,600,300 13,014,700 Amortization of intangibles 5,449,200 4,864,100 Total operating expenses 17,049,500 17,878,800 Income from operations 5,895,400 2,504,900 Interest expense, net (3,396,100) (3,423,800) Other expense (769,800) (108,200) Income before provision for income taxes 1,729,500 (1,027,100) Provision for income taxes (228,700) (519,000) Net income (loss) $ 1,500,800 $ (1,546,100) 7 Seeaccompanyingnotestoconsolidatedfinancialstatements.

15 Consolidated Statements of Stockholders Equity PreferredStock SeriesA Stockholder Notes Accumulated Shares Amount Receivable Deficit Total Balance, December 31, ,620 $22,062,000 $(209,100) $(2,001,100) $19,851,800 Issuance of preferred stock 73,629 7,360,000 7,360,000 Retirement of preferred stock and shareholder note (1,000) (100,000) 80,000 (20,000) Stockholder notes accrued interest (4,600) (4,600) Dividend declared and paid (509,400) (509,400) Net loss (1,546,100) (1,546,100) Balance, December 31, ,249 29,322,000 (133,700) (4,056,600) 25,131,700 Issuance of preferred stock 3, , ,800 Issuance of stockholder note receivable (157,800) (157,800) Stockholder notes accrued interest (10,300) (10,300) Net income 1,500,800 1,500,800 Balance, December 31, ,880 $29,762,800 $(301,800) $(2,555,800) $26,905,200 8 Seeaccompanyingnotestoconsolidatedfinancialstatements.

16 Consolidated Statements of Cash Flows YearsendedDecember31, Cash flows from operating activities Net income (loss) $ 1,500,800 $ (1,546,100) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation 473, ,600 Amortization of intangible assets 5,449,200 4,864,100 Amortization of debt issuance and debt discount costs 261, ,100 Shareholder accrued interest (10,300) (4,600) Loss on sale of equipment 153,800 10,000 Bad debt expense 35, ,000 (Recovery) provision for obsolete inventory (301,600) 162,000 Deferred income taxes, net (2,125,800) 693,000 Changes in operating assets and liabilities: Accounts receivable (2,856,400) 5,020,400 Inventories 2,102,500 (400,700) Prepaid expenses (149,100) 273,100 Income taxes payable/receivable 534,000 (174,200) Accounts payable 2,519,900 (3,915,300) Other accrued expenses 128,000 1,134,300 Interest payable (300) (4,100) Net cash provided by operating activities 7,715,200 6,741,600 Cash flows from investing activities Purchases of property and equipment (1,736,900) (536,300) Payment for purchase of the outstanding stock of Pharmline, Inc. (28,000,000) Net cash used in investing activities (1,736,900) (28,536,300) 9

17 Consolidated Statements of Cash Flows (Continued) YearsendedDecember31, Cash flows from financing activities Proceeds from debt 23,888,300 Repayment of debt (5,988,700) (8,122,400) Payment of debt issuance and debt discount costs (471,300) Proceeds from issuance of preferred stock 283,000 7,360,000 Repurchase of preferred stock (20,000) Dividends paid to stockholders (509,400) Net cash (used in) provided by financing activities (5,705,700) 22,125,200 Net increase in cash and cash equivalents 272, ,500 Cash and cash equivalents, beginning of period 578, ,800 Cash and cash equivalents, end of period $ 850,900 $ 578,300 Supplemental disclosures of cash flow information Cash paid during the year for: Interest $ 3,145,100 $ 3,221,300 Income taxes 1,823,400 Supplemental disclosures of noncash investing and financing activities Issuance of shareholder note $ 157,800 $ Conversion of accounts receivable, accounts payable and working capital adjustment in settlement of Pharmline Inc. s closing cash 1,348, Seeaccompanyingnotestoconsolidatedfinancialstatements.

18 1. General Description SPH Holdings, Inc. and Subsidiaries Notes to Consolidated Financial Statements SPH Holdings, Inc. ( SPHHI ), which was incorporated on November 1, 2010 under the General Corporation Law of the State of Delaware, is the sole stockholder of Stauber Holdings, Inc. ( Holdings ), which is the sole stockholder of Stauber Performance Ingredients, Inc. dba Stauber California ( SCA ), which is the sole member of Stauber Performance Ingredients, LLC ( SPILLC ) (together, the Company ). SCA is the only active operating company; SPHHI and Holdings are passive holding companies that may generate interest income or transaction costs. SPHHI is a holding company which monitors the operating company and may engage in strategic acquisitions for the Company. SCA distributes food ingredients, nutrients, and fine chemicals in bulk to processors and manufacturers in the food, nutritional supplement, and pharmaceutical industries. On May 21, 2012, SPHHI acquired all of the outstanding equity securities of Gadot USA, Inc. ( Gadot ), the parent and sole stockholder of Pharmline, Inc. dba Stauber New York ( SNY ), a value-added manufacturer and distributor of nutraceutical products located in Florida, New York. SNY was acquired to expand the Company s geographic presence and manufacturing capabilities. Gadot was purchased for approximately $29,500,000, including transaction expenses of approximately $1,500,000, which was funded through $7,300,000 from the issuance of additional Series A convertible preferred stock to existing stockholders and additional borrowings from existing lenders under amended term and revolving credit facilities totaling $10,500,000 and $11,700,000, respectively. The acquisition of SNY was accounted for using the acquisition method. Assets acquired and liabilities assumed were recorded at their estimated fair values as of the acquisition date. The fair values of identifiable intangible assets were based on valuations using the income approach and estimates provided by management. The excess of the purchase price over the tangible assets, identifiable intangible assets and assumed liabilities was recorded as goodwill. The allocation of the purchase price was based upon the fair value of certain assets acquired and liabilities assumed as of the date of acquisition. The purchase price was allocated as follows: Theremainderofthispageintentionallyleftblank. 11

19 Notes to Consolidated Financial Statements Cash $ 2,153,200 Accounts receivable 7,245,300 Other current assets 297,300 Inventory 5,380,200 Deferred tax asset 750,000 Property and equipment 4,659,800 Identifiable intangible assets 9,990,000 Goodwill 8,701,100 Total assets acquired 39,176,900 Accounts payable, accrued expenses and other current liabilities (5,560,500) Debt (34,200) Deferred tax liabilities (4,777,800) Total liabilities assumed (10,372,500) Total allocation of purchase price 28,804,400 Less: net cash acquired (804,400) Total purchase price, net of cash acquired $ 28,000,000 For financial reporting purposes, the assets acquired were recorded at their fair values. This resulted in recording certain intangible assets including goodwill. Goodwill arose from the expected synergies of acquiring SNY and the workforce in place at SNY. Any goodwill or intangible assets resulting from the transaction were not deductible for tax purposes. For federal and state income tax purposes, assets were not adjusted to their fair values, but were instead carried forward at their original tax basis. However, any existing intangibles that were tax deductible prior to the transaction continue to be tax deductible (see Notes 2, 5, and 7). 2. Summary of Significant Accounting Policies Principles of Consolidation The accompanying consolidated financial statements include the accounts of SPHHI, Holdings, SCA, SNY and SPILLC from January 1, 2013 through December 31, Prior year consolidated financial statements include the accounts of SPHHI, Holdings, SCA and SPILLC from January 1, 2012 through December 31, 2012 and SNY from May 21, 2012, the date of the acquisition, through December 31, All intercompany accounts and transactions have been eliminated in consolidation. Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ( GAAP ). 12

20 Recently Adopted Accounting Pronouncements SPH Holdings, Inc. and Subsidiaries Notes to Consolidated Financial Statements In January 2014, the Financial Accounting Standards Board issued Accounting Standards Update ( ASU ) related to the accounting for goodwill by private companies. Under this guidance, private companies may elect to amortize goodwill over 10 years, or less than 10 years if the entity can demonstrate that another useful life is more appropriate, and to test goodwill for impairment only upon occurrence of a triggering event that indicates that the book value of the entity may exceed the fair value of the entity, as opposed to testing goodwill for impairment annually under prior accounting guidance. The accounting guidance is effective for the fiscal year beginning after December 15, 2014 and early adoption is permitted. On January 1, 2013, the Company had adopted ASU related to the accounting for goodwill by private companies. However, these financial statements are being revised as the Company now meets the definition of a public business entity and is precluded from adopting ASU Reclassifications Certain 2012 amounts have been reclassified to conform to the 2013 presentation. These classifications had no impact on net loss or stockholders equity. Revenue Recognition The Company recognizes revenue when products are shipped to customers and title has passed, the price is fixed and determinable, and collectability is reasonably assured. Shipping and Handling Amounts billed to customers for shipping and handling are recorded as revenue. Freight costs associated with shipping goods to customers are not included in cost of sales. Shipping and handling costs of $885,600 and $709,200 are included in selling, general, and administrative expenses for the years ended December 31, 2013 and 2012, respectively. Concentration of Credit Risk Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of accounts receivable. The Company performs ongoing credit evaluations of its customers financial condition and limits the amount of credit extended when deemed necessary but generally requires no collateral. The Company maintains allowances for estimated credit losses, and historically such losses have been within management s estimates. In addition, the Company is subject to counterparty risk on certain cash and investments balances held at a financial institution. The Company places its cash with high credit quality financial institutions. The Company maintains bank accounts at financial institutions, which at times may exceed amounts insured by the Federal Deposit Insurance Corporation ( FDIC ). The Company has never experienced any losses related to these balances. Non-interest bearing cash balances are insured up to $250,000 per depositor at each financial institution. At December 31, 2013, the Company s cash balance exceeded the insured amount. 13

21 Cash and Cash Equivalents SPH Holdings, Inc. and Subsidiaries Notes to Consolidated Financial Statements The Company s cash and cash equivalents consist principally of demand deposit accounts and sweep accounts linked to an off-shore investment account held in U.S. dollars with a U.S. financial institution. The off-shore investment account invests in time deposits with maturities of 1-3 days. Accounts Receivable and Allowance for Bad Debts Accounts receivable are customer obligations due under normal trade terms. The Company performs continuing credit evaluations of the customers financial condition and generally does not require collateral. The allowance for bad debts is maintained at a level that, in management s opinion, is adequate to absorb potential losses related to trade receivables. The allowance for bad debts is based upon management s continuous evaluation of the collectability of outstanding receivables. Management s evaluation takes into consideration such factors as past bad debt experience, economic conditions, and information about specific receivables. The allowance for bad debts is based on estimates and ultimate losses may vary from current estimates. As adjustments to these estimates become necessary, they are reported in earnings in the periods that they become known. The allowance is increased by bad debt provisions charged to operating expense and reduced by direct write-offs, net of recoveries. Inventories Inventories consist substantially of raw materials, work-in-process and finished goods and are stated at the lower of cost or market. Cost is determined using the first-in, first-out method (see Note 3). Property and Equipment Property and equipment are stated at cost less accumulated depreciation. Expenditures for major additions and improvements are capitalized, while minor replacements, maintenance and repairs are charged to expense as incurred. Depreciation is provided over the estimated useful lives of the assets involved using the straight-line method. The range of estimated useful lives is as follows: Y ears Buildings 15 Leasehold improvements 3 to 5 Machinery and equipment 5 to 12 Transportation equipment 5 Computers 5 Furniture and fixtures 3 to 5 Leasehold improvements are depreciated over the lesser of the useful life or the remaining term of the lease (see Note 4). 14

22 Long-Lived Assets SPH Holdings, Inc. and Subsidiaries Notes to Consolidated Financial Statements The Company reviews long-lived assets, including intangible assets, for impairment whenever events or circumstances indicate that the carrying amount of any such asset may not be fully recoverable. The determination of recoverability is based on an estimate of the undiscounted cash flows expected to result from the use of an asset and its eventual disposition. If the sum of the undiscounted cash flows, excluding interest, is less than the carrying value, the Company recognizes an impairment loss, measured as the amount by which the carrying value exceeds the fair value of the asset. No impairment charges were recorded during the years ended December 31, 2013 and The range of estimated useful lives for intangible assets is as follows: Years Supplier relationships 3 to 5 Customer relationships 10 to 15 Trademarks and trade names 7 to 10 Non-competition agreements 3 Goodwill The Company tests goodwill for impairment on an annual basis or upon the occurrence of a triggering event that indicates that the fair value of the Company may be below its carrying amount. Upon occurrence of a triggering event the Company may first assess qualitative factors to determine whether further quantitative analysis is necessary. If the qualitative assessment indicates that it is more likely than not that goodwill is impaired, the Company will perform a quantitative test to compare the Company s estimated fair value to its book value. If the estimated fair value exceeds book value, goodwill is considered not to be impaired and no additional steps are necessary. If the book value of the Company exceeds estimated fair value, the difference is recorded as goodwill impairment. No impairment charges were recorded during the years ended December 31, 2013 and Accounting Estimates The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts 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 period. The Company s significant estimates include allowances for doubtful accounts, reserve for inventory obsolescence, realizability of deferred tax assets and liabilities, useful lives for depreciation and amortization and assessing the need for impairment charges (intangible assets and goodwill). Actual results could differ materially from those estimates. 15

23 Income Taxes SPH Holdings, Inc. and Subsidiaries Notes to Consolidated Financial Statements The Company files tax returns for federal and state purposes at the SPHHI level. Deferred income tax assets and liabilities are computed annually for differences between the financial statement and income tax bases of assets and liabilities. Such deferred income tax asset and liability computations are based on enacted tax laws and rates applicable to periods in which the differences are expected to reverse. A valuation allowance is established, when necessary, to reduce deferred income tax assets to the amount expected to be realized. Income tax expense is the tax payable or refundable for the period, plus or minus the change during the period in deferred income tax assets and liabilities. The Company follows the recognition and disclosure provisions under guidance contained in Accounting Standards Codification ( ASC ) 740. Under this guidance, tax positions are evaluated for recognition using a more-likely-than-not threshold, and those tax positions requiring recognition are measured as the largest amount of tax benefit that is greater than fifty percent likely of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. The Company does not have any material accrued interest or penalties associated with any unrecognized tax benefits. As of December 31, 2013 and 2012, the Company recorded $145,000 and $0, respectively, related to uncertain tax positions in connection with ASC 740. The following is a rollforward of the Company s total unrecognized tax liabilities for the year ended December 31, 2013: GrossUnrecognizedTax Liabilities Balance at December 31, 2012 $ Additions for tax positions related to the current year 145,000 Balance at December 31, 2013 $ 145,000 Debt Issuance Costs and Debt Discount Financing costs were incurred in connection with the issuance and amendment of the Company s financing arrangements (see Note 6). These costs have been capitalized and are reflected as debt issuance costs on the balance sheet or as a discount to the related debt, depending upon whether the financing costs have been paid to lenders or third parties. Debt issuance costs and the debt discount are being amortized using the effective interest rate method over the term of the loans and are included as a component of interest expense on the accompanying consolidated statements of operations. Amortization expense related to debt issuance and debt discount costs were $81,900 and $180,000, respectively, for the year ended December 31, Amortization expense related to debt issuance and debt discount costs were $51,500 and $155,600, respectively, for the year ended December 31,

24 Fair Value SPH Holdings, Inc. and Subsidiaries Notes to Consolidated Financial Statements The Company s financial instruments are primarily composed of cash and cash equivalents, trade accounts receivable, accounts payable, accrued expenses and debt. The fair value of cash and cash equivalents, trade accounts receivable, accounts payable and accrued expenses closely approximate their carrying value due to their short maturities. The fair value of debt closely approximates its carrying value because the terms of the debt approximate terms available in the market for debt of a similar credit risk profile for a similar duration. The fair value of related party transactions is not determinable due to the nature of these transactions. 3. Inventory Inventory as of December 31, 2013 and 2012 consisted of the following: Raw materials $11,133,800 $10,528,800 Work in process 219,800 68,200 Finished goods 1,892,500 4,751,600 13,246,100 15,348,600 Reserve for obsolescence (1,258,300) (1,559,900) Total $11,987,800 $13,788, Property and Equipment Property and equipment as of December 31, 2013 and 2012 consisted of the following: Land $ 550,000 $ 550,000 Building and improvements 2,089,200 1,918,700 Machinery and equipment 2,524,800 2,327,200 Computers and equipment 1,008, ,500 Furniture and fixtures 132,400 42,700 Transportation equipment 75,700 30,800 Construction in progress 735, ,200 7,116,400 5,557,100 Accumulated depreciation (963,300) (513,700) $6,153,100 $5,043,400 For the years ended December 31, 2013 and 2012, the Company recorded $473,400 and $301,600, respectively, in depreciation expense, which is included in cost of goods sold and selling, general, and administrative expenses in the accompanying consolidated statements of operations. 17

25 5. Intangible Assets Intangible assets as of December 31, 2013 consisted of the following: SPH Holdings, Inc. and Subsidiaries Notes to Consolidated Financial Statements Gross Carrying Value Net Carrying Value Accumulated Amortization Supplier relationships $12,120,000 $ (8,259,100) $ 3,860,900 Backlog 310,000 (310,000) Customer relationships 12,610,000 (2,624,100) 9,985,900 Trademarks/trade names 7,300,000 (1,955,600) 5,344,400 Non-competition agreement 700,000 (686,800) 13,200 $33,040,000 $(13,835,600) $19,204,400 Intangible assets as of December 31, 2012 consisted of the following: Gross Carrying Value Net Carrying Value Accumulated Amortization Supplier relationships $12,120,000 $(4,953,200) $ 7,166,800 Backlog 310,000 (310,000) Customer relationships 12,610,000 (1,572,700) 11,037,300 Trademarks/trade names 7,300,000 (1,097,100) 6,202,900 Non-competition agreement 700,000 (453,400) 246,600 $33,040,000 $(8,386,400) $24,653,600 Intangible assets are amortized over estimated useful lives ranging from less than one year to fifteen years, with no residual values. Consolidated amortization expense during the years ended December 31, 2013 and 2012 pertaining to long-lived intangible assets was $5,449,200 and $4,864,100, respectively. 18

26 Notes to Consolidated Financial Statements As of December 31, 2013, the estimated aggregate amortization expense for the next five years is as follows: YearsendingDecember31, Amount 2014 $ 5,229, ,465, ,910, ,910, ,910,000 Thereafter 5,780,100 $19,204,400 Changes in the carrying values of intangible assets are outlined in the table below: Amount Balance, December 31, 2011 $19,527,700 Additions 9,990,000 Amortization (4,864,100) Balance, December 31, ,653,600 Amortization (5,449,200) Balance, December 31, 2013 $19,204, Debt Senior Term Loan The Company has a senior secured term loan agreement (the Loan Agreement ) with a senior lender, collateralized by substantially all of the Company s assets. The Loan Agreement provides for a senior secured long term loan in the aggregate principal amount of $25,700,000. The Loan Agreement requires the Company to make scheduled payments of interest and principal and allows prepayment of principal under specific conditions. Interest accrues at the greater of LIBOR plus 7.5% or 10.5%. During the years ended December 31, 2013 and 2012, the Company made advance payments of $5,000,000 and $2,000,000, respectively, in addition to its obligatory principal and interest payments. The Loan Agreement expires in January In 2012, the Loan Agreement was amended (the Amendment ) and the Company borrowed an additional principal amount of $10,500,000. The Amendment requires the Company to make scheduled payments of interest and principal and allows prepayment of principal under specific conditions. Interest accrues at the greater of LIBOR plus 7.5% or 10.5%. The Amendment expires in May

27 Notes to Consolidated Financial Statements As of December 31, 2013 and 2012, the principal balance on the senior term loan was $23,557,500 and $29,944,400, respectively, and carried an interest rate of 10.5% per annum. Revolving Credit Facility The Company s revolving credit facility (the Credit Agreement ) was amended and restated on May 21, 2012 to provide for revolving borrowings up to $20,000,000 with a priority interest on the Company s accounts receivable and inventory. The credit facility expires on May 31, 2015, carries a variable interest rate based on LIBOR plus a defined margin and a commitment fee of 0.25% on any unused balance. As of December 31, 2013 and 2012, $7,403,900 and $6,919,700, respectively, was outstanding on the revolving credit facility with interest rates ranging from 2.66% to 3.25% per annum. Real Estate Loan On July 20, 2012, the Company entered into a real estate loan agreement (the Real Estate Loan Agreement ) with a senior lender. The real estate loan provides for a term loan in the aggregate principal amount of $1,720,000, with principal payments of $7,167 due each calendar month end commencing on July 31, 2012 with a maturity date of July 20, The interest rate is computed over 360 days at the one-month LIBOR plus a 2.5% margin. At December 31, 2013 and 2012, $1,591,000 and $1,677,000, respectively, was outstanding on the real estate loan and the interest rate was 2.67% and 2.77%, respectively. The terms of the Loan and Credit Agreements require the Company to maintain a certain fixed-charge coverage ratio and minimum earnings before interest, taxes, depreciation, and amortization ( EBITDA ). The Loan Agreement also contains certain restrictive covenants, including limitations on additional debt; acquisition by the Company of the stock of, or merger with other corporations; dividend payments; and asset sales. The Company was in compliance with all such covenants and ratios as of December 31, 2013 and Debt as of December 31, 2013 and 2012 consists of the following: Senior term loan $23,557,500 $29,944,400 Revolving credit facility 7,403,900 6,919,700 Real estate loan 1,591,000 1,677,000 Total debt 32,552,400 38,541,100 Less: Unamortized debt discount (252,800) (432,800) 32,299,600 38,108,300 Less: Current portion of debt (1,764,800) (1,472,900) $30,534,800 $36,635,400 20

28 Notes to Consolidated Financial Statements Scheduled annual maturities of debt, including the current portion, as of December 31, 2013 is as follows: YearsendingDecember31, Amount 2014 $ 1,764, ,781, ,141, ,864,200 Total debt $32,552,400 Interest expense, including amortization of debt issuance costs and debt discounts was $3,406,800 and $3,429,400 for the years ended December 31, 2013 and 2012, respectively. Unamortized debt discount for the years ended December 31, 2013 and 2012 was $252,800 and $432,800, respectively. 7. Income Taxes The provision for income taxes consists of the following: YearsendedDecember31, Current: Federal $ 1,571,200 $ 12,400 State 783,300 (69,400) Total current 2,354,500 (57,000) Deferred: Federal (584,000) (377,400) State (1,541,800) 953,400 Total deferred (2,125,800) 576,000 Total $ 228,700 $ 519,000 21

29 Notes to Consolidated Financial Statements The major elements contributing to the difference between the federal statutory rate and the effective tax rate are as follows: YearsendedDecember31, Federal statutory rate 34.00% 34.00% State and local income taxes - net of federal benefit (30.61) Nondeductible (3.22) 0.00 Transaction fees 0.94 (39.88) Change in state tax rate (20.20) (93.97) Other % (54.32)% As of December 31, 2013 and 2012, the tax effects of temporary differences that give rise to deferred income taxes are as follows: Current: State income taxes $ (90,700) $ (123,400) Bad debt reserve 259, ,800 Inventory reserve 546, ,400 Capitalized inventory costs 245, ,600 Vacation accrual 114,100 58,700 Bonus accrual 321,800 28,800 Other accruals and reserves 36,400 25,700 Total current 1,432, ,600 Long-term: State income taxes 517,500 1,113,600 Intangible asset amortization (8,316,600) (11,683,300) Property and equipment depreciation (117,600) (177,700) Net operating loss carry forwards 261,800 1,591,300 Other-net 110, ,200 Total long-term (7,544,500) (8,953,900) Total $(6,112,500) $ (8,238,300) As of December 31, 2013, the Company does not have any available net operating loss carry forwards for federal and for state purposes. For the year ended December 31, 2012, the Company had available net operating loss carry forwards for federal purposes of approximately $3,415,700 and for state purposes of approximately $445,

30 Notes to Consolidated Financial Statements The Company is not subject to examination by U.S. federal tax authorities tax years before 2010 and by state tax authorities for tax years before The Company s policy is to recognize interest and penalties on unrecognized tax benefits in income tax expense in the consolidated statements of operations. To the extent accrued interest and penalties do not ultimately become payable, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision in the period that such determination is made. 8. Related Party Transactions At December 31, 2013 the Company held two promissory notes from minority stockholders that accrue interest at 5% per annum. The interest is added to the principal if unpaid. At December 31, 2013 and 2012, the notes had outstanding unpaid principal in the amount of $301,800 and $133,700, respectively, which is included as a reduction to stockholders equity in the accompanying consolidated balance sheets and statements of stockholders equity. Such amounts represent a portion of the purchase consideration for preferred stock of the Company. During 2012, the Company repurchased and retired 1,000 shares from a former minority stockholder, thereby extinguishing an outstanding promissory note of $80,000 and accrued interest of $3,000. The Company leases its corporate office building from a stockholder. For each year ended December 31, 2013 and 2012, rental expense was $55,600 that was attributed to the stockholder and included in selling, general, and administrative expenses in the accompanying consolidated statements of operations. Under a management agreement, during the years ended December 31, 2013 and 2012 the Company incurred and paid $704,600 and $591,600, respectively, in monitoring fees and reimbursable expenses to ICV Partners, LLC, and the investment manager of the majority stockholder of the Company. Under this agreement, the Company shall incur and pay ICV Partners, LLC an annual monitoring fee equal to the greater of 5% of consolidated adjusted EBITDA as defined in the Purchase Agreement or $400,000, paid quarterly. 9. Commitments and Contingencies Operating Leases The Company leases its corporate office building under a non-cancelable and long-term operating lease from individuals, one of whom is a stockholder in the Company. The lease expires on January 21, 2016 with an option to renew the term of the lease for a subsequent five year period. The monthly base rent is $39,300 per month, of which 11.8% is attributable to a stockholder of the Company. SNY leases a warehouse building under a non-cancelable and long-term operating lease from a third party. The lease expires December 31, 2014 with an option to renew the term of the lease for an additional two year period. The monthly base rent is $15,750. The Company has various operating leases on certain operating equipment, which are in place through July

31 Notes to Consolidated Financial Statements As of December 31, 2013, future minimum rental payments under these non-cancelable operating leases for the next five years are as follows: YearsendingDecember31, Amount 2014 $ 732, , , ,000 Total $1,280,400 Rent expense incurred and charged to operations was approximately $645,600 and $525,500 for each year ended December 31, 2013 and 2012 and is included in selling, general, and administrative expenses in the accompanying consolidated statements of operations. Litigation The Company is involved from time to time in certain legal actions and claims arising in the ordinary course of business. Management believes that the outcome of such litigation and claims, should they arise in the future, is not likely to have a material effect on the Company s consolidated financial position or results of operations. In February 2012, the Company and SNY were named in several lawsuits pending in the State of California and Orange County Superior Court concerning personal injuries allegedly suffered by users of Hydroxycut brand products ( Hydroxycut Lawsuit ). In January 2013, a master settlement agreement (the MSA ) was reached in its entirety between the defendants and all claimants in the Hydroxycut Lawsuit. The Company s and SNY s damages were $30,000 and $45,000, respectively which were paid by the Company s insurance carrier less deductibles. The MSA is contingent upon the completion of a master release and the execution of the individual releases is still under review. In December 2013, the Company received separate pre-litigation claims from two of its customers for damages allegedly sustained from a contaminated enzyme supplied by the Company. The Company purchased the enzyme from a third party manufacturer who purchased the product from the enzyme supplier. The customers claims request reimbursement for alleged damages sustained. Management is evaluating the basis for the claims and as of the date of these financial statements has not received requested evidence to establish the basis for the alleged damages. Accordingly, management cannot reasonably estimate any loss related to these claims. The Company s insurers are participating in the claim investigation process and should there be any loss to the Company, management will pursue recovery from its insurers and indemnification separately from the enzyme third party manufacturer and supplier. No accrual for loss has been recorded in connection with these claims as of December 31,

32 Indemnities and Guarantees SPH Holdings, Inc. and Subsidiaries Notes to Consolidated Financial Statements During the normal course of business, the Company has made certain indemnities and guarantees under which they may be required to make payments in relation to certain transactions. These indemnities include (i) certain real estate leases, under which the Company may be required to indemnify property owners for environmental and other liabilities, and (ii) certain agreements with the Company s officers under which the Company may be required to indemnify officers for liabilities arising out of their employment relationship. The duration of these indemnities and guarantees varies and in certain cases is indefinite. The majority of these indemnities and guarantees do not provide for any limitation of the maximum potential future payments the Company could be obligated to make. Historically, the Company has not been obligated to make significant payments for these obligations, and no liabilities have been recorded for these indemnities and guarantees in the accompanying consolidated balance sheets. 10. Employee Benefit Plan The Company sponsors a profit-sharing plan (the 401(k) Plan ) under the provisions of Section 401(k) of the Internal Revenue Code. The 401(k) Plan covers all employees who were employed on the effective date of the 401(k) Plan and subsequent eligible employees. The Company can make discretionary contributions to the 401(k) Plan. Under the 401(k) Plan, participating employees may defer a percentage of their pretax salary, but not more than the statutory limits. The Company matches 50% of participating employee s elective deferral, up to a maximum contribution of 2.5% of their compensation. Maximum compensation for plan purposes for 2013 and 2012 was $255,000 and $250,000, respectively. The Company s matching contributions to the 401(k) Plan were approximately $69,500 and $70,100 for the years ended December 31, 2013 and 2012, respectively, which is included in selling, general, and administrative expenses in the accompanying consolidated statements of operations. SNY sponsors a safe harbor profit-sharing plan (the safe harbor 401(k) Plan ) under the provisions of Section 401(k) of the Internal Revenue Code. The safe harbor 401(k) Plan covers all employees who were employed on the effective date of the safe harbor 401(k) Plan and employees hired subsequent to the effective date. SNY makes contributions equal to the sum of 100% of the amount of the participating employee s elective deferrals that do not exceed 3% of their compensation, plus 50% of the amount of their elective deferrals that exceed 3% up to a maximum of 5% of their compensation. This contribution is 100% vested. SNY s matching contribution to the safe harbor Plan for the year ended December 31, 2013 and for the period from May 21, 2012 through December 31, 2012 was approximately $67,000 and $42,500, respectively, which is included in cost of goods sold, selling, general and administrative expenses in the accompanying consolidated statements of operations. 11. Stockholders Equity During the year ended December 31, 2013, the Company s Board of Directors authorized and approved the issuance of 3,631 shares of the Company s Series A preferred stock for approximately $121 per share resulting in gross proceeds of $440,