What drove the revenue growth in 2007, and how sustainable is it?

Growth was driven mainly by higher volumes of Monster Energy® drinks, including Monster Energy, Lo-Carb, Assault, and Khaos, along with newer lines such as Java Monster™ coffee drinks, Monster M-80™, and Monster Heavy Metal™. Promotional allowances fell to 11.8% of gross sales from 13.0%, which helped net sales grow faster than gross sales. Sustainability depends on continued Monster demand, which the filing acknowledges is concentrated, and on the company's ability to respond to competition from Red Bull, Rockstar, and others, as well as to changing consumer preferences. The 7% to 8% fourth-quarter pull-forward ahead of the 2008 price increase may also weigh on early-2008 sales.

Why did margins decline even though sales grew so quickly?

Gross margin declined to 51.7% from 52.3% because the sales mix shifted toward DSD packages with lower gross margins, such as 8.3-ounce and 16-ounce cans, and because costs rose for certain sweeteners, containers, packaging materials, and juice concentrates. Higher inventory reserves for slow-moving and obsolete items also contributed. Operating expenses rose 50% to $237.0 million, including higher freight, sponsorships, commissions, payroll, and about $9.8 million of professional fees for the stock option review, so operating margin fell to 25.5% from 26.2%.

Are there risks to the company's cash and investment holdings?

Yes. Of the $290.2 million in short- and long-term investments, $227.1 million are long-term auction rate securities, which carry AAA ratings and are often backed by federal agencies or monoline insurers. In February 2008, a large portion of auctions failed, so these securities may not be sold at par in the near term. Holders may need to wait until the auctions succeed, the issuers call the notes, or the notes mature (up to 40 years). If issuers' credit deteriorates, the company may need to record impairment charges. Cash and cash equivalents were only $12.4 million at year-end.

What legal and regulatory issues could affect shareholders?

A shareholder class action alleging misleading statements related to stock option dating was dismissed with prejudice in October 2007, and the time to appeal has expired. Derivative lawsuits were settled in principle, with a February 25, 2008 stipulation requiring court approval at a May 5, 2008 hearing; the company committed to two years of corporate governance reforms and the insurer covers $0.4 million in plaintiffs' attorney fees. Other matters include trademark litigation against National Beverage (Freek), an Australian Monster trademark case, a Blue Sky labeling appeal, and a Gate City distributor arbitration seeking damages. Management believes the claims in aggregate will not have a material adverse effect, although outcomes cannot be predicted with certainty.

MNST 10-K FY2007 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed February 29, 2008. Cited figures are marked; the original filing is the authoritative source.

Hansen Natural Corporation (the registrant that later became Monster Beverage Corp., trading as MNST) reported a strong fiscal 2007.

Net sales rose 49.3% to $904.5 million^a, and net income increased 52.5% to $149.4 million, or $1.51 per diluted share, versus $0.99 in 2006. Growth was driven almost entirely by Monster Energy® drinks, which fueled the Direct Store Delivery (DSD) segment. DSD accounted for $809.8 million, or about 89.5%, of net sales, while case volume grew 35.3% to 98.5 million cases.

Gross margin slipped modestly to 51.7% from 52.3%, reflecting a richer mix of lower-margin packages and higher raw material, packaging, and freight costs. Operating margin fell to 25.5% from 26.2%, although operating income still grew 45.7% to $231.0 million^b. The balance sheet strengthened considerably.

Cash and investments totaled roughly $302.6 million^c, including $12.4 million in cash, $63.1 million in short-term investments, and $227.1 million in long-term auction rate securities. Stockholders' equity more than doubled to $422.2 million, and operating cash flow rose to $135.5 million from $76.4 million. The company carries no meaningful debt and pays no dividends.

Management flagged several risks: a 7%^d to 8% pull-forward of fourth-quarter sales ahead of a January 1, 2008 price increase, which could weigh on near-term sales; auction rate security failures in February 2008; and rising input costs for PET bottles, aluminum, sweeteners, and apple juice concentrate. The company also carries significant legal and governance overhang. Securities class action claims were dismissed with prejudice in October 2007, but a derivative settlement tied to historical stock option dating is pending court approval, with a hearing set for May 5, 2008.

Professional fees related to the option review totaled $9.8 million net of insurance reimbursements. Because of late filings in 2006 and early 2007, the company cannot use Form S-3 until about July 2008, which limits its capital-raising flexibility.

Concentration is also notable: Cadbury Schweppes Bottling Group accounted for about 16% of net sales and Wal-Mart about 12%. Co-packing arrangements are largely month-to-month, and sucralose comes from a single supplier.

02—Key points

Key Highlights

Record results: net sales of $904.5 million (+49.3%), gross profit of $468.0 million (+47.8%), operating income of $231.0 million (+45.7%), and net income of $149.4 million (+52.5%).
Monster Energy® is the growth engine: DSD segment net sales reached $809.8 million (about 89.5% of total) and energy drinks represented $813.5 million of product-line sales, with total case volume up 35.3% to 98.5 million cases.
Margin pressure: gross margin fell to 51.7% from 52.3% and operating margin to 25.5% from 26.2%, due to mix shift toward lower-margin packages and higher raw material, packaging, and freight costs; management expects these cost pressures to persist into 2008.
Strong liquidity and cash generation: $12.4 million in cash plus $290.2 million in short- and long-term investments; operating cash flow of $135.5 million (vs. $76.4 million in 2006); stockholders' equity up to $422.2 million from $225.1 million.
Auction rate securities risk: $227.1 million of long-term investments are auction rate securities, and a large portion of auctions failed in February 2008, limiting near-term liquidity and creating potential future impairment risk.
Concentrated customer base and pending pricing action: two customers represented about 16% and 12% of net sales; a January 1, 2008 price increase on Monster and Java Monster drinks led to an estimated 7% to 8% pull-forward of Q4 2007 gross sales into the prior quarter.
Governance and legal overhang: securities class action dismissed (October 2007), derivative settlement pending court approval (hearing May 5, 2008), ineligibility to use Form S-3 until about July 2008, and insiders (Sacks and Schlosberg) controlling up to 20.9% of shares.

03—Questions

Frequently Asked Questions

What drove the revenue growth in 2007, and how sustainable is it?
Growth was driven mainly by higher volumes of Monster Energy® drinks, including Monster Energy, Lo-Carb, Assault, and Khaos, along with newer lines such as Java Monster™ coffee drinks, Monster M-80™, and Monster Heavy Metal™. Promotional allowances fell to 11.8% of gross sales from 13.0%, which helped net sales grow faster than gross sales. Sustainability depends on continued Monster demand, which the filing acknowledges is concentrated, and on the company's ability to respond to competition from Red Bull, Rockstar, and others, as well as to changing consumer preferences. The 7% to 8% fourth-quarter pull-forward ahead of the 2008 price increase may also weigh on early-2008 sales.
Why did margins decline even though sales grew so quickly?
Gross margin declined to 51.7% from 52.3% because the sales mix shifted toward DSD packages with lower gross margins, such as 8.3-ounce and 16-ounce cans, and because costs rose for certain sweeteners, containers, packaging materials, and juice concentrates. Higher inventory reserves for slow-moving and obsolete items also contributed. Operating expenses rose 50% to $237.0 million, including higher freight, sponsorships, commissions, payroll, and about $9.8 million of professional fees for the stock option review, so operating margin fell to 25.5% from 26.2%.
Are there risks to the company's cash and investment holdings?
Yes. Of the $290.2 million in short- and long-term investments, $227.1 million are long-term auction rate securities, which carry AAA ratings and are often backed by federal agencies or monoline insurers. In February 2008, a large portion of auctions failed, so these securities may not be sold at par in the near term. Holders may need to wait until the auctions succeed, the issuers call the notes, or the notes mature (up to 40 years). If issuers' credit deteriorates, the company may need to record impairment charges. Cash and cash equivalents were only $12.4 million at year-end.
What legal and regulatory issues could affect shareholders?
A shareholder class action alleging misleading statements related to stock option dating was dismissed with prejudice in October 2007, and the time to appeal has expired. Derivative lawsuits were settled in principle, with a February 25, 2008 stipulation requiring court approval at a May 5, 2008 hearing; the company committed to two years of corporate governance reforms and the insurer covers $0.4 million in plaintiffs' attorney fees. Other matters include trademark litigation against National Beverage (Freek), an Australian Monster trademark case, a Blue Sky labeling appeal, and a Gate City distributor arbitration seeking damages. Management believes the claims in aggregate will not have a material adverse effect, although outcomes cannot be predicted with certainty.

04—Continue

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