U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[X] Annual report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended December 31, 2003
Transition report under section 13 or 15(d) of the Securities Exchange Act
of 1934 for the transition period
from _____________________ to _____________________
Commission file number 0-29245
Health & Nutrition Systems International, Inc.
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(Name of small business issuer in its charter)
FLORIDA 65-0452156
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(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
3750 INVESTMENT LANE, SUITE 5
WEST PALM BEACH, FLORIDA 33407
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (561) 863-8446
Securities registered under Section 12(b) of the Exchange Act:
NONE
Name of each exchange on which registered:
NONE
Securities registered under Section 12(g) of the Exchange Act:
COMMON STOCK, PAR VALUE $.001 PER SHARE
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(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 [ ]
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B is not contained in this form, and no disclosure will
be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference to Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [ ]
State issuer's revenues for its most recent fiscal year. $6,552,206.00
State the aggregate market value of the voting and non-voting common
equity held by non-affiliates computed by reference to the price at which the
common equity was sold, or the average bid and asked price of such common
equity, as of a specified date within the past 60 days. The aggregate market
value of the voting stock held by non-affiliates on December 31, 2003 was
$372,062.50 (computed at the closing price of the common stock of the issuer
outstanding which was $.13 on December 31, 2003).
As of April 9, 2004, 3,832,813 shares of the registrant's Common Stock
were outstanding.
Transitional Small Business Disclosure Format: Yes [ ] No [X]
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's proxy statement for its 2004 annual
shareholders' meeting are incorporated by reference in Part III of this report.
The registrant's proxy statement will be filed within 120 days after December
31, 2003.
TABLE OF CONTENTS
PAGE
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PART I........................................................................1
ITEM 1. DESCRIPTION OF BUSINESS.............................................1
ITEM 2. DESCRIPTION OF PROPERTY............................................11
ITEM 3. LEGAL PROCEEDINGS..................................................12
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................12
PART II......................................................................13
ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES...............13
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION..........14
ITEM 7. FINANCIAL STATEMENTS...............................................28
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE...............................................29
ITEM 8A. CONTROLS AND PROCEDURES............................................29
PART III.....................................................................29
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT .................29
ITEM 10. EXECUTIVE COMPENSATION.............................................29
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS.........................30
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.....................30
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K...................................30
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.............................34
SIGNATURES...................................................................35
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FORWARD-LOOKING INFORMATION MAY PROVE INACCURATE
This annual report on Form 10-KSB contains forward-looking statements.
These forward looking statements concern our operations, economic performance,
and financial condition, including but not limited to, the information under the
caption "Management's Discussion and Analysis or Plan of Operation." These
statements are based on management's beliefs as well as assumptions made by and
information currently available to management, including statements regarding
future economic performance and financial condition, liquidity and capital
resources, and management's plans and objectives. Any statements that are not
statements of historical fact should be regarded as forward-looking statements.
For example, the words "intends," "believes," "anticipates," "plans," and
"expects" are intended to identify forward-looking statements. There are a
number of important factors that could cause our actual results to differ
materially from those indicated by such forward-looking statements. These
factors include, without limitation, those factors described under "Certain
Factors Which May Affect Future Results" in this annual report. In addition,
actual and potential terrorist attacks on the United States, current and future
responses by the U.S. government, the war in the Persian Gulf, the effects of
these events on consumer confidence and demand, the introduction of products
that compete with the Company's products, the loss of significant customers, and
the deployment by the Company of capital, increase the uncertainty inherent in
forward-looking statements. In addition, the announcement by the Food and Drug
Administration that it was considering the ban of the ingredient ephedra in
neutraceutical products (a subsequent FDA announcement in December 2003 banned
ephedra effective April, 2004) and the surrounding negative publicity regarding
ephedra-containing products caused us to discontinue selling products containing
ephedra in March 2003. These factors, among others, could cause our actual
results to differ materially from those indicated by such forward-looking
statements.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Health & Nutrition Systems International, Inc. (the "Company," "HNS,"
"we" or "us") was organized as a Florida corporation on October 25, 1993. Our
fiscal year end is December 31. Our corporate offices are located at 3750
Investment Lane Building, Building #5, West Palm Beach, FL 33404. Our phone
number is (561) 863-8446.
We develop, market and sell weight management, energy and sport
nutrition products to national and regional, food, drug, health, pharmacy,
mass-market accounts, and independent health and pharmacy accounts. Our product
formulations are not proprietary. As a result, our strategy is to create market
awareness and sales through the name branding of each of our products as well as
the name "Health and Nutrition Systems."
RECENT DEVELOPMENTS
In July of 2003, the Board of Directions determined to consider
strategic alternatives to either enhance or replace our neutraceutical business.
The Board intends to continue to assess what steps can be taken to realize
greater value for our shareholders. These include the possibility of acquiring
additional businesses for stock and/or the sale of the Company or substantially
all of its assets, including the ongoing possibility of such a sale to Mr. Tisi,
our Chief Executive Officer and President, or an entity controlled by him.
On November 26, 2003, we entered into an agreement with TeeZee, Inc., a
Company wholly owned by Mr. Tisi, to sell substantially all of our assets,
subject to approval by our shareholders, for $411,000 in cash and notes and the
assumption of substantially all of our liabilities. Prior to entering into the
definitive agreement, the Board of Directors considered strategic alternatives
with particular attention to the risks associated with our diet-related
nutraceuticals business and the increasingly challenging regulatory, legal and
insurance environment for the nutraceuticals industry, and weighed them against
the offer from TeeZee, Inc. and determined that, at that time, the proposed sale
was in the best interests of our shareholders. The Board also hired an
investment advisory firm, Capitalink, to render an opinion as to the fairness of
the transaction, from a financial point of view. Mr. Tisi subsequently informed
us that based upon the expiration of his employment agreement on December 31,
2003, if the sale was not approved by our shareholders, he would terminate his
employment with us. In February, we restated our earnings for the third quarter
of 2003, which lowered our reported earnings for the period. At that time, Mr.
Tisi also told the Board he was willing to continue to serve as our chief
executive officer - subject to the execution of a definitive agreement - even if
the Board decided not to accept his offer. Capitalink thereafter rescinded its
fairness opinion which was based in part on the third quarter results. As a
result, on February 23, 2004, we terminated the agreement with Tee Zee, Inc. Tee
Zee, Inc. has left open its offer to purchase substantially all of our assets.
The Board of Directors is continuing to review Mr. Tisi's offer, in light of
developments subsequent to the termination of the agreement, principally with
reference to our future prospects and Mr. Tisi's new agreement to remain as our
CEO through December 31, 2005.
On April 9, 2004, Mr. Tisi entered into a new two-year employment
contract effective as of January 1, 2004. The contract
o increases his base salary from $147,000 to $164,000;
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o provides for a quarterly bonus of the sum of 5% of the increase
in net revenues compared to the comparable quarter for the prior
year and 10% of the increase in net income over the prior year's
comparable quarter. One third of the bonus is payable at the
conclusion of the applicable quarter; one third is payable on
the conclusion of the following quarter based on cumulative
results for the year through the end of such quarter compared to
the prior year's year to date results, and one third is payable
at year-end based on a comparison to the prior years results;
o provides for the payment of the unpaid portion of his 2003 bonus
($162,271) and the incremental increase in his annual salary in
12 equal monthly installments beginning April 1, 2004;
o provides for an annual grant of options to purchase 50,000
shares of our common stock under the 1998 Stock Option Plan;
o provides for the payment of $275,000 in severance upon a change
in control of the Company if we terminate the agreement other
than for cause, unless we enter into an agreement regarding his
continued employment;
o provides that he will not compete with us for a one year period
after the termination of the contract (other than termination
without cause) in the wholesale distribution of sale in the
United States to retailers or intermediaries of products which
directly or otherwise significantly compete with products sold
or distributed by the Company.
To partially mitigate our sole reliance or Mr. Tisi, the Board has
expanded the role of our Chairman, James Brown. Mr. Brown, who has to-date
focused primarily on opportunities that might strategically enhance shareholder
value, will have more day-to-day interaction in areas such as financial
management and strategic direction. For these services, Mr. Brown's compensation
was increased in February 2004 from $3,000 per month to $8,000 per month through
July 31, 2004.
PRODUCTS
We market and sell the following products:
o THIN TAB(R) MAHUANG FREE -- Thin Tab(R) Mahuang Free helps
stimulate the metabolism without ephedra and helps break through
weight loss "plateaus." Introduced in the fourth quarter of
1999.
o ORIGINAL CARB CUTTER(R) -- The Original Carb Cutter(R), is a
supplement formulated to support the controlled carb lifestyle.
It contains natural substances that can help to accelerate the
body's natural ability to metabolize excess glucose from refined
carbohydrates and sugars so they are burned as energy - not
stored as fat. Introduced in the fourth quarter of 1999.
o EAT LESS(R) -- Low carbohydrate diets are one of the most
effective ways to lose weight. However, they often lack fiber,
which can slow weight loss. Eat Less(R) is helpful for low
carbohydrate diets by reducing caloric intake, and supplemental
fiber, while still successfully maintaining a low carbohydrate
diet. Introduced in the fourth quarter of 2002.
o CARB CUTTER(R) PHASE2 -- Carb Cutter(R) "Phase 2" may be used as
an adjunct to the Original Carb Cutter(R). It contains a natural
substance -- "Phaseolamin 2250" that can help to neutralize
excess starch from complex carbohydrates by binding with a key
enzyme - alpha-amylase -without affecting nutrients and fiber in
foods. Introduced in the third quarter of 2002.
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o FAT CUTTER(TM) EPHEDRA FREE - Excess fats are still a concern
for low carb dieters. Fat Cutter targets the absorption of
excess fats, allowing some of the fats to pass through
undigested. Fat Cutter also provides quality minerals such as
calcium which are often lacking in low carbohydrate dieters
because of increased protein intake. Introduced in the first
quarter of 2003.
o ZOOM(R) -- Zoom(R) is a carbohydrate free, calorie free, sugar
free alternative to popular energy drinks and contains a blend
of natural herbs. It is enhanced with nutrients found naturally
in the body and everyday foods. It contains Taurine, which is an
important metabolic transmitter. Taurine increases the heart
function and boosts energy. Zoom(R) also includes natural
caffeine and a triple ginseng blend all of which play an
important role. These ingredients go into the blood and nervous
system within 10 minutes resulting in an energy boost.
Introduced in the fourth quarter of 2003.
o DIET A DAY(TM) "PHASE 2" -- Diet A Day "Phase 2" contains
"Phaseolamin 2250" which helps neutralize excess starch from
complex carbohydrates by binding with a key enzyme -
alpha-amylase -without affecting nutrients and fiber in foods.
It also contains natural ingredients to support healthy blood
sugar levels following high starch meals. Introduced in the
fourth quarter of 2003.
As of March 15, 2003, we stopped selling any products that contain
ephedra because of negative publicity surrounding the ingredient, including the
Food and Drug Administration's announcement that it was considering a ban on
ephedra. In December 2003 the FDA announced that it was banning the use of
ephedra. Prior to March 15, 2003, we sold ThinTab(R), Fat Cutter Plus(R), and
Carbolizer(TM), all of which contained ephedra.
In 2003, sales of ThinTab(R) and Fat Cutter Plus(R) totaled $61,843.
Our third ephedra-containing product, Carbolizer(TM), was assigned to
KMS-Thin Tab 100, Inc. in September 2002 as part of a larger general settlement
of pending litigation with KMS and J.C. Herbert Bryant, III.
In 2002, sales of ephedra-containing products were approximately
$965,608; however, a significant amount of these products were returned to us by
our customers. Although retailers who purchased those products from us may
continue to sell them from their inventory until April, 2004 when the FDA's ban
becomes effective, we believe that substantially all sales of these products
have ceased.
Acutrim(R) Natural was introduced into our product line in 2001. We
purchased The Acutrim(R) trademark in the first quarter of 2001. After we
purchased the trademark, we reformulated and repositioned the marketing of the
Acutrim(R) product. We sold this trademark in 2003 for $300,000.
CERTIFICATES OF ANALYSIS
Garden State Nutritional, a division of Vitaquest International Inc.,
is the only manufacturer of our products. See "Manufacturing and Shipping." GSN
provides a certificate of analysis for each of our products which gives
laboratory test results performed by GSN that verify product quality and
ingredients. We deliver these certificates to our customers, and to consumers,
upon request.
CLINICAL TESTING
No regulatory agency specifically requires that a marketer of dietary
supplements perform clinical testing. However, the claims that are made with
respect to our products' performance are subject to
3
review by various state and local authorities, including, the Federal Trade
Commission. As a result, in 2001, we initiated a practice of performing
independent clinical trials of our principal products. To date, Carb Cutter(R)
has been tested, and Eat Less(R) is currently under review. These trials are
meant to substantiate that our products work as described in our advertising,
labeling, or other consumer-directed communications. These double blind placebo
trials are conducted by Marshall-Blum LLC, an independent research company with
twenty years of experience in product testing. Marshall-Blum follows strict
clinical guidelines to assist with product compliance with applicable
regulations and scientific standards. The FDA has recently required that
products like ours receive an Investigational New Drug number before clinical
testing can be conducted. We are considering whether we will continue to conduct
clinical testing of our products in light of the additional expense and legal
uncertainties attendant to this new requirement.
MARKETING
We currently design and develop all of our products, marketing and
advertising in house. We try to create market awareness and sales through
name-brand recognition of our trademarked products.
We target our own print advertising to develop brand awareness and
recognition in consumer magazines, The National Enquirer, and The Globe. We
intend to continue directly promoting our products through the print media.
In addition to our own national print advertising program, we have
ongoing "co-op" programs with most of the major retailers who sell our products.
These programs require us to spend a certain percentage of projected revenue to
be generated by our customers' sales of our products on targeted advertising for
that retailer through marketing vehicles such as Sunday newspaper inserts and
promotional "10-30" day price specials. We are obligated to spend these co-op
dollars irrespective of the actual revenue generated by the sales of our
products with that retailer. These co-op programs target several million
consumers and are intended to drive sales to the specific retailer.
In connection with our marketing efforts, we sometimes offer, or are
required to grant, cash discounts, new store discounts and pay slotting fees for
inclusion of our products in the customer's "Plan-O-Gram." We also sometimes
give allowances based on factors such as volume.
All of our products are included in the "plan-o-gram" marketing
programs of the major retailers who sell our products. These programs give our
products identical shelf and aisle positions in all locations in a particular
chain of stores using a pre-planned, in-store display format. The plan-o-gram
program guarantees consistent distribution and location of our products in all
stores. The major retailers periodically review the products that participate in
their plan-o-gram programs, sometimes as often as quarterly. There can be no
assurance that our products will remain in any given retailer's plan-o-gram
program. If one of our products is removed from a retailer's plan-o-gram
program, it is likely that the sales volume of that product by that retailer
would decline.
We report our net revenue after subtracting
o co-op advertising and promotions given to the customers to
promote the product and improve sales;
o cash discounts;
o slotting fees and new store discounts; and
o returns and allowances.
In 2003 those expenses totaled $1,837,460, compared with $1,514,299 in
2002.
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MANUFACTURING AND SHIPPING
Garden State Nutritional, a division of Vitaquest International Inc.,
manufactures all of our products. GSN is a state-of-the-art supplement, liquid,
and powder manufacturer, which owns a 200,000 square foot manufacturing facility
in West Caldwell, New Jersey. GSN has been known as an industry leader for more
than 25 years. GSN has the capacity to support the production of all of HNS's
product needs for the foreseeable future. During 2001, we did not have a term
contract with GSN, but acquired our needed inventory on a purchase order basis.
In early April 2002, we entered into a two year exclusive manufacturing contract
with GSN under which we purchase all of our products from GSN. Although back-up
suppliers are identified and available, the loss of this supplier would have a
material adverse affect on us. GSN's research and development personnel, in
conjunction with our in-house team, develop our product formulations. Pursuant
to the terms of our exclusive manufacturing agreement with GSN, we have a
$450,000 line of credit with GSN with 60 day terms. GSN informally has allowed
the Company to purchase up to $1,000,000 on the line of credit. At December 31,
2003, the balance owed to GSN under this line of credit was $502,424.
At December 31, 2003 we also owed GSN $778,000 under the terms of an
amended promissory note.
Our production/assembly personnel package products once they are
received from GSN. Our production/assembly personnel fill out shipping documents
and oversee quality control and inventory flow. Our orders from large retailers
are shipped on pallets using the preferred freight company of the retailer's
choice.
INTELLECTUAL PROPERTY
Our policy is to pursue registration of all of the trademarks
associated with our key products. We currently own federal registrations, have
pending federal applications, or hold common law rights on all of our products.
We have also registered several of our advertising slogans, including "I
cheat(R)," and "We cheat(R)." Federally registered trademarks have a perpetual
life, provided that they are renewed on a timely basis and are used properly as
trademarks, subject to certain rights of third parties to seek cancellation of
the marks.
We also rely on common law trademark rights to protect our unregistered
trademarks. Common law trademark rights do not provide us with the same level of
protection as afforded by a United States federal registration of a trademark.
In addition, common law trademark rights are limited to the geographic area in
which the trademark is actually used.
We regard our trademarks and other proprietary rights as valuable
assets and believe that such rights have significant value in the marketing of
our products. We have in the past, and intend to continue in the future to,
vigorously protect our trademarks against infringement, both in the United
States and in foreign countries.
EMPLOYEES
We currently have twelve (12) full-time employees; four (4) are
managerial, four (4) are engaged in sales and marketing, two (2) are
administrative personnel and two (2) are assembly personnel. We believe our
relationship with our employees is good.
Mr. Tisi, our Chief Executive Officer and President has developed
relationships with our customers, vendors and other industry participants that
have enabled us to maintain our operations, and, in the last year, grow our
business. The loss of his services would severely impair our ability to function
as
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we currently do. In addition to being our CEO, Mr. Tisi is responsible for our
product development, marketing, operations and finance. We have reviewed, and
continue to review, supplementing Mr. Tisi's activities with additional
executive capacity, but working capital limitations limit our ability to
identify and recruit appropriate candidates.
The Board has recently expanded the role of our Chairman, James Brown.
Mr. Brown, who has to date focused primarily on opportunities that might
strategically enhance shareholder value, will have more day-to-day interaction
on areas such as financial management and strategic direction.
PRODUCT DISTRIBUTION
GENERAL
Our customers are predominantly drug, health food, and mass retailers
who sell our products to the retail consumer. Although we may have contracts
with our customers which generally outline certain aspects of our relations with
them, these contracts do not obligate them to purchase any of our products. Our
customers purchase our products on a purchase order basis.
DRUG, HEALTH FOOD AND MASS RETAILERS
During 2003, we continued to diversify our customer base by
establishing one or more of our products in more than seventeen different drug,
health food, and mass retailers. We estimate that Carb Cutter(R) is now
available in more than 25,000 store locations nationwide. Because our customers
purchase our products on a purchase order basis, there can be no assurance that
our products will continue to have "full distribution" (or any distribution) by
the retailers that carry them.
One or more of our products are currently sold by the following mass
retailers: Wal-Mart approximately (2,000 locations), Walgreens approximately
(3,500 locations), Rite-Aid approximately (3,600 locations), CVS approximately
(4,100 locations), Brooks (Maxi Drug) approximately (330 locations), Vitamin
World approximately (600 locations), H. E. Butt Grocery Co. approximately (250
locations), Wakefern approximately (200 locations), Sav-On approximately (1,300
locations), Giant Landover approximately (180 locations), Giant Eagle
approximately (188 locations), Eckerd's approximately (2,600 locations), GNC
approximately (4,000 locations), Albertsons approximately (2,000 locations),
Duane Reade approximately (190 locations), Long's approximately (400 locations)
and Vitamin Shoppe approximately (80 locations).
In 2003, we derived approximately 92% of our net revenues from these
customers.
INDEPENDENT RETAIL HEALTH AND PHARMACY STORES
In 1999, we began selling our products through independent retail
health and pharmacy stores through in house tele-mareketing. In 2003, $167,135
(or 2.5%) of net revenues came from independent health and pharmacy accounts. In
2002, $246,456 (or 6.9%) of net revenues came from independent health and
pharmacy accounts.
We believe that our revenue from the independent customers declined in
2003 mostly because with many independents going out of business, we
concentrated our distribution efforts on our mass retailer distribution network,
and our focus only on re-orders with existing independent customers instead of
trying to generate new accounts through special promotions.
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SIGNIFICANT CUSTOMERS
We depend on several significant customers for a large percentage of
our sales. Our six largest customers are GNC, Wal-Mart, Walgreens, Rite Aid, CVS
and Eckerd Drugs. These six customers, combined, accounted for 83% of our net
revenues in 2003. In 2002, these same six customers accounted for 64.8% of our
net revenues. The loss of one or more of these customers could have a material
adverse effect on the Company.
GOVERNMENT REGULATIONS
The processing, formulation, packaging, labeling, and advertising of
our products are subject to regulation by one or more federal agencies,
including the Food and Drug Administration, the Federal Trade Commission, the
Consumer Product Safety Commission, the United States Department of Agriculture
and the United States Environmental Protection Agency. These activities are also
regulated by various agencies of the states, localities, and countries in which
its products are sold. In addition, we manufacture and market certain of our
products in substantial compliance with the guidelines promulgated by the United
States Pharmacopoeia Convention, Inc. and other voluntary standard
organizations.
The Dietary Supplemental Health and Education Act recognizes the
importance of good nutrition and the availability of safe dietary supplements in
preventive health care. DSHEA amends the Federal Food, Drug and Cosmetic Act by
defining dietary supplements, which include vitamins, minerals, nutritional
supplements and herbs, as a new category of food, separate from conventional
food. Under DSHEA, the FDA is generally prohibited from regulating such dietary
supplements as food additives or drugs. It requires the FDA to regulate dietary
supplements so as to guarantee consumer access to beneficial dietary
supplements, allowing truthful and proven claims. Generally, dietary ingredients
that were on the market before October 15, 1994 may be sold without FDA
pre-approval and without notifying the FDA. However, new dietary ingredients
(those not used in dietary supplements marketed before October 15, 1994) require
pre-market submission to the FDA of evidence of a history of their safe use, or
other evidence establishing that they are reasonably expected to be safe. There
can be no assurance that the FDA will accept the evidence of safety for any new
dietary ingredient that we may decide to use, and the FDA's refusal to accept
such evidence could result in regulation of such dietary ingredients as food
additives, requiring the FDA pre-approval based on newly conducted and costly
safety testing. Also, while DSHEA authorizes the use of statements of
nutritional support in the labeling of dietary supplements, the FDA is required
to be notified of such statements, and there can be no assurance that the FDA
will not consider particular labeling statements we use to be drug claims rather
than acceptable statements of nutritional support, necessitating approval of a
costly new drug application, or re-labeling to delete such statements. It is
also possible that FDA could allege false statements were submitted to it if
structure/function claim notifications was either non-existent or so lacking in
scientific support as to be plainly false.
FFD&CA also authorizes the FDA to promulgate good manufacturing
practice regulations for dietary supplements, which would require special
quality controls for the manufacture, packaging, storage, and distribution of
supplements. Although the final version of the GMP rules has not yet been
issued, we anticipate we will be in substantial compliance with the proposed
regulations once they are enacted. FFD&CA further authorizes the FDA to
promulgate regulations governing the labeling of dietary supplements. Such
rules, which were issued on September 23, 1997, entail specific requirements
relative to the labeling of our dietary supplements. The rules, which took
effect in March 1999, also require additional record keeping and claim
substantiation, reformulation, or discontinuance of certain products. We believe
we are in substantial compliance with these new requirements.
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All of our products are classified as dietary supplements under the
FFD&CA. In September 1997, the FDA issued regulations governing the labeling and
marketing of dietary supplement products. These regulations cover:
o the identification of dietary supplements and their nutrition
and ingredient labeling;
o the wording used for claims about nutrients, health claims and
statements of nutritional support;
o labeling requirements for dietary supplements for which "high
potency" and "anti-oxidant" claims are made;
o notification procedures for statements on dietary supplements;
and
o pre-market notification procedures for new dietary ingredients
in dietary supplements.
The notification procedures became effective in October 1997. The
labeling requirements became effective on March 23, 1999. Where required, we
revised our product labels as necessary to reflect the requirements. We believe
we substantially comply with these requirements. In addition, we are required to
continue our ongoing program of providing evidence for our product performance
claims, and notify the FDA of certain types of performance claims made for our
products. Our substantiation program involves ongoing compilation and review of
scientific literature pertinent to the ingredients contained in our products and
the claims we make about them.
In certain markets, including the United States, claims made with
respect to dietary supplements, personal care or any of our other products may
change the regulatory status of our products. For example, in the United States,
the FDA could possibly take the position that claims made for some of our
products make those products new drugs requiring preliminary approval. The FDA
could also place those products within the scope of its a Food and Drug
Administration over-the-counter drug regulations and require it to comply with a
published FDA OTC monograph. OTC monographs dictate permissible ingredients,
appropriate labeling language, and require the marketer or supplier of the
products to register and file annual drug listing information with the Food and
Drug Administration. We do not at present sell OTC drug products. If the FDA
were to assert that our product claims cause them to be considered new drugs or
fall within the scope of over-the-counter regulations, we would be required to
either file a new drug application, comply with the applicable monographs, or
change the claims made in connection with our products. The FDA has recently
required that products like ours secure an Investigational New Drug number prior
to being eligible for human clinical trials. This will make such trials
significantly more expensive and may subject the Company to additional
regulation. We are considering whether we will continue to conduct clinical
testing of our products in light of the additional expense and legal
uncertainties attendant to this new requirement.
Additionally, dietary supplements are subject to the Nutrition,
Labeling and Education Act (NLEA), which regulates health claims, ingredient
labeling and nutrient content claims characterizing the level of a nutrient in a
product. NLEA prohibits the use of any health claim for dietary supplements
unless the health claim is supported by significant scientific agreement and is
pre-approved by the FDA.
The FTC regulates the marketing practices and advertising of all our
products. In the past several years, the FTC instituted enforcement actions
against several dietary supplement companies for false and misleading marketing
practices and advertising of certain products. These enforcement actions have
resulted in consent decrees and monetary payments by the companies involved.
Under FTC standards, the dissemination of any false advertising constitutes an
unfair or deceptive act or practice actionable under Section 45 of the Fair
Trade Commission Act and a false advertisement actionable under Section 52 of
that act. A false advertisement is one that is "misleading in a material
respect." In determining
8
whether an advertisement or labeling information is misleading in a material
respect, FTC determines not only whether overt representations and implied
representations are false, but also whether the advertisement fails to reveal
material facts. Under FTC's standard, any health benefit representation made in
advertising must be backed by "competent and reliable scientific evidence" by
which FTC means:
tests, analyses, research studies, or other evidence based upon the
expertise of professionals in the relevant area, that have been
conducted and evaluated in an objective manner by persons qualified to
do so, using procedures generally accepted by the profession to yield
accurate and reliable results.
The FTC has increased its review of the use of the type of testimonials
we use in our business. The Federal Trade Commission requires competent and
reliable evidence substantiating claims and testimonials at the time that such
claims of health benefit are first made. The failure to have this evidence when
product claims are first made violates the Federal Trade Commission Act.
Although the FTC has never threatened an enforcement action against us for the
advertising of our products, there can be no assurance that the FTC will not
question our advertising or other operations in the future.
We may be required to obtain an approval, license, or certification
from a foreign country's ministry of health or comparable agency prior to
entering a new foreign market. We work with local authorities in order to obtain
the requisite approvals, license, or certification before entering a foreign
market. The approval process generally requires us to present each of our
products and product ingredients to appropriate regulators and, in some
instances, arrange for testing of our products by local technicians for
ingredient analysis. Such approvals may be conditioned on reformulation of our
products or may be unavailable with respect to certain of our products or
certain ingredients contained in our products. We must also comply with product
labeling and packaging regulations that are different from country to country.
In markets where a formal approval license or certification is not required, we
will rely upon the advice of local counsel in each country, to help us ensure we
comply with the law.
We cannot predict what new legislation or regulations governing our
activities will be enacted by legislative bodies or promulgated by agencies
regulating our activities. We do know that our industry has come under increased
scrutiny, principally because of the FDA's investigation of the use of ephedra.
In February, 2004, the FDA published a final rule, effective in April 2004,
prohibiting the sale of dietary supplements that contain ephedrine alkaloids
(ephedra). The FDA took that action based on its determination that such
supplements present an "unreasonable risk of illness or injury." We stopped
selling products containing ephedra in March 2003.
Moreover, the FDA is expected to increase its enforcement activity
against dietary supplements that the agency considers violative of FFD&CA. In
particular, the FDA is increasing its enforcement of DSHEA provisions. Those
enforcement activities will be enhanced by the passage in January, 2004, of the
Agriculture Appropriations, FY 2004 (Public Law: 108-199), which appropriated to
the FDA an additional $11, 400,000 for enforcement of dietary supplement
regulations. That appropriation was over and above the increased enforcement
budget FDA received for FY 2004.
We believe we will become subject to additional laws or regulations
administered by the FDA or other federal, state, or foreign regulatory
authorities. We also believe the laws or regulations which we consider favorable
may be repealed, or more stringent interpretations of current laws or
regulations will be implemented in the future. The FDA may restrict or prohibit
the sale and marketing of additional dietary supplement ingredients. Any or all
of such requirements could be a burden and costly, to us. Future regulations
could:
o require us to change the way we conduct business;
9
o require us to change the contents of our products;
o make us keep additional records;
o make us increase the available documentation of the properties
of our products; or
o make us increase or use different labeling and scientific proof
of product ingredients, safety or usefulness.
COMPETITION
The diet industry is highly competitive. We compete directly with the
following companies: Atkins Nutritional, Twinlabs, Metabolife International,
Inc, Rexall Sundown, Dexatrim, Natures Bounty (NBTY) and Slim Fast. We also
compete indirectly with companies that use direct marketing to distribute diet
products directly to the retail consumer without the use of an intermediary such
as a mass retailer. These companies use television and radio advertising which
can range from thirty second commercials to full length thirty minute
infomercials. Many of these companies also attempt to bring their best selling
brands to the retail market. When they do, the products then compete directly
with our's.
Our product formulae are not proprietary. Similar formulations are
currently being developed and marketed by our competitors. Substantially all of
our competitors have greater resources and name recognition than we do. Many of
our competitors sell, in addition to diet products, a broad range of health and
nutrition products. In addition, many of our competitors sell to the same
customers as we do. In addition, GSN, our sole manufacturer, sells similar
products to our competitors, often with similar formulations. We strive to
differentiate our products through the mixture of ingredients in our products
and the amounts of such ingredients contained in our products. We believe that
this allows us to maintain consumer loyalty to our brand rather than to a
specific ingredient or combination of ingredients. We also strive to
differentiate our products by providing distinctive packaging.
The most significant barrier to entry within our industry is the
difficulty of establishing a new product. This involves a significant capital
commitment to advertise the product, participate in trade shows, build
inventory, and pay the cost of entry with slotting fees and or free merchandise.
Test marketing also requires a significant commitment of time and capital. These
barriers effect us as well as our competition. Many of our competitors are
significantly better capitalized and have significantly more human resources
than us.
FINANCING
GSN FINANCING
In early April 2002, we entered into an agreement with GSN, our sole
manufacturer, pursuant to which we agreed to repay to GSN amounts owed to them
as of the date of the agreement. The amount was represented by a promissory note
of approximately $700,000. Our repayment schedule required equal monthly
payments over the next twenty four months, without interest. In connection with
this agreement, we granted a blanket lien on our assets to GSN. The occurrence
of any of the following events constitute a default under this promissory note:
o the failure of the Company to pay when due any payment of
principal and such failure continues for fifteen (15) days after
Lender notifies the Company in writing;
10
o the Company files for or is granted certain relief pursuant to
or within the meaning of the United States Bankruptcy Code, or
any other federal or state law relating to insolvency or relief
of debtors, and
o Christopher Tisi ceases to be the President and Chief Executive
Officer of the Company (unless a replacement reasonably
acceptable to GSN is obtained within thirty days).
In July 2003 the Company issued an amended promissory note to Garden
State Nutrition in the principal amount of $1,300,000.
The new note provided for $300,000 to be paid before December 31, 2003,
with the balance due in quarterly installments of $131,410 commencing November
1, 2003 at 4.5% per annum. At December 31, 2003, the balance owed to GSN for the
note is $778,579. We met the obligation with respect to the $300,000 by using
the proceeds from the sale of Acutrim(R) that we received in August 2003.
In early April 2002, we entered into an exclusive manufacturing
agreement with GSN that provided us with a $450,000 line of credit on current
invoices, with 60 day terms. GSN has allowed us to have as much as $1,000,000
outstanding at certain times under the line of credit. At December 31, 2002, the
balance owed to GSN under this line of credit was $892,878. Under our line of
credit, the balance owed on December 31, 2003 was $502,424.
GSN has allowed us to exceed our line of credit terms in the past. If
they do not continue to allow us to exceed our credit line with them, we may not
have adequate working capital to respond to demand by our customers, new
opportunities that are presented to us. We believe that the terms of the GSN
financing are significantly better than those which any other source of
financing may provide to us.
VENDOR FINANCING
We consider our relationships with our vendors to be good. During 2003,
we were able to increase our credit limits as well as improve our payment terms
with certain vendors.
PRODUCTS LIABILITY INSURANCE
We are currently insured for products liability claims up to an
aggregate of $5,000,000.
We are also an additional named insured on GSN's products liability
policy, which has an aggregate coverage of up to $2,000,000.
Through March 2004, our product liability insurance was written on an
occurrence basis; i.e., our coverage related to when an incident giving rise to
a claim occurred, irrespective of whether that particular policy was in force
when the claim was made. As of March 2004, our product liability insurance is on
a "claims made" basis. That means our coverage only becomes effective if the
policy itself is in effect when an action, or notice of an action, is lodged
with the carrier.
ITEM 2. DESCRIPTION OF PROPERTY
Our corporate offices and finished product warehouse is located in a
6,000 square foot facility at 3750 Investment Lane, Building 5, West Palm Beach,
Florida, 33404. This lease expires on October 31, 2005 and provides for lease
payments of approximately $2,375 per month. We also have leased a 4,000 square
foot storage facility, also located at 3750 Investment Lane with lease payments
of $2,136 per month. The lease expiries on October 31, 2006. All packaging and
shipping is performed at this location.
11
During the first quarter of 2002, we entered into a sublease of 4,000
square feet of excess warehouse space for approximately $1,800 per month, at
December 31, 2003 the monthly lease was increased to $2,100 per month. Suite 1A
is currently being rented on a month-to-month basis.
ITEM 3. LEGAL PROCEEDINGS
J.C. HERBERT BRYANT, III AND KMS-THIN TAB 100, INC.
The Company was involved in the litigation with J.C. Herbert Bryant,
III, a former officer, director and one of our shareholders, and KMS-Thin Tab
100, Inc., which was settled in September 2002. The settlement agreement
generally provided for Bryant and KMS to transfer the registration and ownership
of the domain names Thintab.com, Thintab.CC, and Carbcutter.cc to HNS, and to
take other action to eliminate confusion over the ownership of the Thin Tab(R)
name. Additionally, each of the adverse parties generally released the others.
As part of the settlement, HNS entered into a distribution agreement with
Bryant, beginning on September 26, 2002 and ending on September 25, 2007,
permitting Bryant to purchase certain of its products from HNS and to
exclusively distribute those products in Florida from Orlando south. HNS also
transferred its rights to the Carbolizer(TM) product to KMS. Carbolizer(TM)
contained ephedra and in our judgment would have required a considerable
investment of corporate attention and money to remanufacture, repackage, and
promote, to significantly increase its revenue share. The value of
Carbolizer(TM) in facilitating settlement of the law suit, and recovering
control over more valued HNS trademarks, was deemed of greater benefit to the
Company.
In October 2003, HNS terminated the distribution agreement with KMS
based on KMS breach of material terms of the Agreement. HNS filed suit against
KMS-Thin Tab 100, Inc. on December 1, 2003 for breach of contract, trademark
infringement and for a declaration of rights that the Distribution Agreement is
terminated and of no further force and effect. KMS has answered the complaint
and filed its own counterclaim for fraud in the inducement, trademark
infringement, dilution and fraudulent misrepresentation. Currently pending are
HNS's motion to dismiss counterclaim, motion to compel and for discovery
sanctions and motion for sanctions against KMS.
Twenty-two (22) cases have been filed alleging that our Acutrim(R)
products contain Phenylpropanolamine ("PPA") and that those products have caused
damage to the plaintiffs. Many of these cases have been consolidated in class
action suits pending in the U.S. District Court for the Western District of
Washington in Seattle, the Philadelphia County Court of Common Pleas or the
Louisiana State Court. None of the Company's Acutrim(R) products have ever
contained, or currently contains, PPA. Based on that defense, to date, all but
two cases have been voluntarily dismissed after delivery to plaintiff's counsel
information substantiating the fact that HNS's products do not presently
contain, and have not contained, PPA, or involuntarily dismissed by court order.
Of the remaining two cases, one is subject of a stipulation for dismissal and is
awaiting the Judge's final order of dismissal. The other case, being litigated
pro se, remains pending, subject to HNS's filed motion for summary judgment.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 2003, we did not submit any matters to the
vote of our security holders.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES
The common stock of the Company trades on the OTC Bulletin Board under
the trading symbol "HNNS." The prices set forth below reflect the quarterly high
and low bid information for shares of our common stock during the last two
fiscal years as reported by CSI, Inc. These quotations reflect inter-dealer
prices, without retail markup, markdown or commission, and may not represent
actual transactions. There were no trades of our securities on the OTCBB prior
to October 4, 2000.
2003 Quarter Ended High Low
------------------ ---- ---
December 31, 2003 $0.53 $0.11
September 30, 2003 0.60 0.07
June 30, 2003 0.10 0.04
March 31, 2003 0.05 0.04
2002 Quarter Ended High Low
------------------ ---- ---
December 31, 2002 $0.08 $0.04
September 30, 2002 0.15 0.08
June 30, 2002 0.17 0.05
March 31, 2002 0.55 0.05
On December 31, 2003, there were 82 holders of record of our common
stock.
Our common stock is covered by an SEC rule that imposes additional
sales practice requirements on broker-dealers who sell such securities to
persons other than established customers and accredited investors, which are
generally institutions with assets in excess of $5,000,000, or individuals with
net worth in excess of $1,000,000 or annual income exceeding $200,000 or
$300,000 jointly with their spouse. For transactions covered by the rule, the
broker-dealer must make a special suitable determination for the purchaser and
transaction prior to the sale. Consequently, the rule may affect the ability of
broker-dealers to sell our securities, and also may affect the ability of
purchasers of our stock to sell their shares in the secondary market. It may
also cause fewer broker-dealers to be willing to make a market in our common
stock, and it may affect the level of news coverage we receive.
Prior to June 29, 2000, we were not a reporting company and were not
required to file quarterly, annual, and other reports with the SEC.
We have not declared or paid any cash dividends on our common stock
since our inception, and our Board of Directors currently intends to retain all
earnings for use in the business for the foreseeable future. Any future payment
of dividends will depend upon our results of operations, financial condition,
cash requirements, and other factors deemed relevant by our Board of Directors.
13
The following table provides information as of December 31, 2003 about
our common stock that may be issued upon the exercise of options under our 1998
Stock Option Plan for employees, officers, directors, and independent
contractors.
EQUITY COMPENSATION PLAN INFORMATION
(c)
Number of securities
(a) (b) remaining available for
Number of securities to be Weighted-average exercise future issuance under
issued upon exercise of price of outstanding equity compensation plans
outstanding options, options, warrants and (excluding securities
Plan category warrants and rights rights reflected in column (a))
- --------------------------------------------------------------------------------------------------------------------
Equity compensation plans
approved by security holders 556,500 $.43 693,500
- --------------------------------------------------------------------------------------------------------------------
Equity compensation plans not
approved by security holders(1) -- -- --
- --------------------------------------------------------------------------------------------------------------------
Total 556,500 $.43 693,500
====================================================================================================================
(1) We do not maintain equity compensation plans that have not been approved by
our stockholders.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
FORWARD LOOKING STATEMENTS
The following discussion of our results of operations and financial
condition should be read along with our Consolidated Financial Statements listed
in Item 8 and the Notes to them appearing elsewhere in this Form 10-KSB.
CRITICAL ACCOUNTING POLICIES
Financial Reporting Release No. 60, which was recently released by the
U.S. Securities and Exchange Commission, encourages all companies to include a
discussion of critical accounting policies or methods used in the preparation of
financial statements. Our financial statements include a summary of the
significant accounting policies and methods used in the preparation of our
financial statements.
Management believes the following critical accounting policies affect
the significant judgments and estimates used in the preparation of the financial
statements.
REVENUE RECOGNITION
We recognize revenue when
o Persuasive evidence of an arrangement exists
o Shipment has occurred
o Price is fixed or determinable, and
o Collectability is reasonably assured
Subject to these criteria, except with respect to customers that buy our
products on "pay on scan terms," we recognize revenue at the time of shipment of
the relevant merchandise. "Pay on scan" sales are
14
treated as consignment sales by us. In the case of these consignment sales, we
record revenues, and remove the items from inventory when the customer reports
the sales to us. Normally we are notified of the customer's sales through
periodic sales reports, payments or when the customer reorders the relevant
product.
On December 31, 2003, we had approximately $286,000 of inventory on
consignment relating to its "pay on scan" sales. At December 31, 2002, we had no
inventory on consignment.
Included in the net sales in the accompanying financial statements for
the twelve months ended December 31, 2003 and 2002 are reductions for returns
and allowances, sales discounts, new store opening discounts and co-op
advertising and promotions in the amounts of $1,882,460 and $1,514,299 ,
respectively. The increase in sales reductions in year 2003 was primarily due to
the sales returns and allowances, co-op advertising and promotions.
USE OF ESTIMATES
Management's discussion and analysis of financial condition and results
of operations is based upon our financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United States
of America. The preparation of these financial statements requires management to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues, and expenses, and related disclosure of contingent assets
and liabilities. On an ongoing basis, management evaluates these estimates,
including those related to valuation allowance for the deferred tax asset,
estimated useful life of fixed assets and the carrying value of long-lived
assets, intangible assets and allowances for sales returns, doubtful accounts,
and obsolete and slow moving inventory and reserve for customer liabilities.
Management bases these estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying value of
assets and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or
conditions.
CUSTOMER LIABILITY ESTIMATES
The Company estimates and accrues expenses and liabilities for co-op
advertising and promotions and returns and allowances for outdated products as a
reduction of sales. The liability is maintained until the customer takes the
deduction against payments due. This liability is netted against the accounts
receivable account on the balance sheet. The amount at December 31, 2003 was
$863,301 and December 31, 2002 was $792,079.
We may incur a liability to a customer in three ways:
o We and the customer may agree that if the customer includes an
advertisement for our products in the customer's advertising
circulars, we will discount our products to the customer during
the period of time surrounding the use of the circulars;
o Some of our customers have a policy that requires us to fund
cooperative advertising and promotions in an amount equal to 10%
to 15% of the gross revenue generated within the year; and
o In some cases, if the dating of our product in inventory at the
customer's location expires, the customer may seek a credit from
us.
We record the liability when we determine that the customer is taking
an action that will result in an expense to the Company in the future. For
example, when we agree to fund an advertising promotion
15
in a given month, we create a liability for that promotion. We also establish
reserves for returns we believe likely. Typically, these liabilities remain
outstanding for three to six months.
OVERVIEW
We believe that industry trends as well as factors specific to us will
impact our future results. Following are some key points that we believe are
important in understanding our position today, and our outlook for the future.
TRENDS IN OUR INDUSTRY
According to the Nutrition Business Journal, revenues from the sale of
dietary supplements in year 2003 were up approximately 2 percent from those
reported in year 2002. Particularly, because of their popularity, increased
consumer use of low carbohydrate diets will benefit products like ours. Our
product formulae are not proprietary. Similar formulations to our flagship
product, Carb Cutter(R), have been developed and have achieved full distribution
at all of our customers. Substantially all of our competitors have greater
resources and name recognition than we do. Many of our competitors sell, in
addition to diet products, a broad range of health and nutrition products. Many
of our competitors sell to the same customers as we do. In addition to our
existing competitors, we believe some of these potential competitors will begin
to market carbohydrate diet assisting products. In this respect, the very
popularity of the low carbohydrate diets may encourage additional stronger
competitors to compete with us. In addition, GSN, our sole manufacturer, sells
similar products to our competitors, often with similar formulations.
We try to differentiate our products through the mixture of ingredients
in our products and the amounts of such ingredients contained in our products.
We also trademark our proprietary brand names. We believe that this helps us to
maintain consumer loyalty to our brand rather than to a specific ingredient or
combination of ingredients. We also strive to differentiate our products by
providing distinctive packaging. None of our efforts in differentiating
ourselves, however, will insure that existing or potential competitors will not
erode our market share.
The most significant barrier to entry within our industry is the
difficulty of establishing a new product. This involves significant commitment
to advertise the product, participate in trade shows, build inventory, and pay
the cost of entry with slotting fees and or free merchandise. Test marketing
also requires a significant commitment of time and capital. Those factors effect
us as well as our competition. Many of our competitors are significantly better
capitalized and have significantly more human resources than us.
REVENUE AND INCOME
Net revenues for the twelve months-ended December 31, 2003 increased by
$2,984,358 to $6,552,206 compared to net revenues of $3,567,848 in 2002. Net
Revenue from two of our major customers increased by $2,556,363. Increases in
both the co-op-advertising and promotions and the in-house advertising in the
respective amounts of $282,090 and $1,003,489 significantly contributed to the
increase in net revenue. During the twelve months ended December 31, 2003, six
companies accounted for 83.5% of our net revenues compared to 64.8% in 2002. Two
of our largest customers accounted for 61% of the net revenue in 2003 compared
to 41.5% for our two largest customers in 2002. Although we are encouraged by
the increase in net revenues generally, the increased concentration of our
business in fewer customers makes us more vulnerable to changes in their
purchasing practices or, in some cases, the customers' reluctance to do business
with suppliers if those suppliers represent too large a part of the suppliers
total sales.
16
Net income for the twelve months ended December 31, 2003 compared to
the same period in 2002, increased by $668,753, from $27,606 to $696,359.
However, of that amount, approximately $275,000 was a gain from the sale of our
Acutrim(R) product line. That means our operating income for the same twelve
month period increased by $393,753.
In 2003, our operating income was $472,932, after expensing $244,421 of
incentive compensation for our CEO. This bonus is based on a formula contained
in his employment agreement dated January 1, 2002, as follows:
o 5% of the increase in net revenues for the period as measured
against the corresponding period the year before, plus
o 10% of net income for the period.
In 2003, we have been able to increase our net revenues and maintain
control over our administrative costs. The general and administrative expenses
for year ended December 31, 2003 were $2,113,918 or 32% of net revenues versus
$1,524,678 or 42% of net revenues for the same period in 2002. While
administrative costs rose, their rate of increase was less than the rate of our
rise in revenue. As discussed in more detail below, we expect our administrative
costs to increase in 2004.
INSURANCE
Insurance for the products we sell has become significantly more
expensive. The policy becoming effective in March 2004 carries a premium over
twenty times higher than for our prior policy, and because it is written on a
"claims made" rather than an "occurrence" basis, does not provide as much
continuity of coverage as we historically have enjoyed. We purchased $5,000,000
worth of coverage for 2004, as opposed to the $6,000,000 we had in 2003. While
we believe the level of coverage to be adequate to meet the needs of our
customers and provide us with appropriate risk protection, there is no assurance
that we will be able to obtain coverage in the future. We do not believe that we
will be able to secure "claims made" coverage in the foreseeable future.
INCREASED COSTS
The increasing oversight mandated by the Sarbanes-Oxley Act coupled
with changes we have made in response to the occurrences giving rise to the
earnings restatement for the third quarter of 2003 have led to the following.
o Our auditor, Daszkal Bolton, will be required to spend more time
in assessing our internal controls and assisting us in
implementing other provisions of the Sarbanes-Oxley Act.
o The audit committee has expanded their review and interaction
with management.
o Our costs for legal and other professional services, including
the retention of professionals to consult on areas related to
Sarbanes-Oxley, will rise significantly.
17
ADEQUATE WORKING CAPITAL
Our working capital situation improved in 2003, but cash constraints
continue to limit our ability to grow. In addition, a change in our sole
manufacturer's informal overtime financing arrangements with us could make it
difficult or impossible to support our current level of sales. In addition, the
loss or reduction in sales to any of our key customers would negatively impact
our working capital. Management and the Board of Directors continue to explore
alternative sources of capital to fund operations and support potential growth,
but we have not identified any financing sources superior to or as good as that
provided to us by our sole manufacturer.
DIVERSIFICATION
In 2003, we continued to implement our Company's strategic plan of
diversifying our product line by developing and promoting new products. For
example, in 2003, we received initial orders for our new Carb Cutter(R) Phase 2
product, and, by year's end, introduced Zoom(R). It is too early to determine
whether customers will accept Carb Cutter(R) Phase 2 on a long term basis, or
whether Zoom(R) product will be successful. This strategy is intended to
minimize the impact of a shift in consumer preferences with regard to any one of
our products, a change in retailer attitude with respect to any of our products,
or any other cause of reduced sales either for a particular product or in a
particular geographical area. Despite the introduction of new products, we
remain significantly dependent on a single brand, the original Carb Cutter(R).
RECENT DEVELOPMENTS
In July of 2003, the Board of Directions determined to consider
strategic alternatives to either enhance or replace our neutraceutical business.
The Board intends to continue to assess what steps can be taken to realize
greater value for our shareholders. These include the possibility of acquiring
additional businesses for stock and/or the sale of the Company or substantially
all of its assets, including the ongoing possibility of such a sale to Mr. Tisi
or an entity controlled by him.
On November 26, 2003, we entered into an agreement with TeeZee, Inc., a
Company wholly owned by Mr. Tisi, to sell substantially all of our assets,
subject to approval by our shareholders, for $411,000 in cash and notes and the
assumption of substantially all of our liabilities. Prior to entering into the
definitive agreement, the Board of Directors considered strategic alternatives
with particular attention to the risks associated with our diet-related
nutraceuticals business and the increasingly challenging regulatory, legal and
insurance environment for the nutraceuticals industry, and weighed them against
the offer from TeeZee, Inc. and determined that, at that time, the proposed sale
was in the best interests of our shareholders. The Board also hired an
investment advisory firm, Capitalink, to render an opinion as to the fairness of
the transaction, from a financial point of view. Mr. Tisi subsequently informed
us that based upon the expiration of his employment agreement on December 31,
2003, if the sale was not approved by our shareholders, he would terminate his
employment with us. In February, we restated our earnings for the third quarter
of 2003, which lowered our reported earnings for the period. At that time, Mr.
Tisi also told the Board he was willing to continue to serve as our chief
executive officer - subject to the execution of a definitive agreement - even if
the Board decided not to accept his offer. Capitalink thereafter rescinded its
fairness opinion which was based in part on the third quarter results. As a
result, on February 23, 2003, we terminated the agreement with Tee Zee, Inc. Tee
Zee, Inc. has left open its offer to purchase substantially all of our assets.
The Board of Directors is continuing to review Mr. Tisi's offer, in light of
developments subsequent to the termination of the agreement, principally with
reference to our future prospects and Mr. Tisi's new agreement to remain as our
CEO through December 31, 2005.
On April 9, 2004, and effective as of December 31, 2003, Mr. Tisi, our
CEO, entered into a new two-year employment agreement with us. The terms of Mr.
Tisi's contract increased his base salary from
18
$147,000 to $164,000, and continues to allow him to earn a bonus based on
increases in revenue, and net income. Provisions dealing with Mr. Tisi's ability
to compete with the Company have been modified in our favor. Mr. Tisi's
agreement to continue with us through December 31, 2005 significantly increases
our flexibility in considering ways to enhance shareholder value, including the
possible sale of the Company or substantially all of its assets.
Mr. Tisi has developed relationships with our customers, vendors and
other industry participants that have enabled us to maintain our operations,
and, in the last year, grow our business. The loss of his services would
severely impair our ability to function as we currently do. In addition to being
our CEO, Mr. Tisi is responsible for our product development, marketing,
operations and finance. We have reviewed, and continue to review, supplementing
Mr. Tisi's activities with additional executive capacity, but working capital
limitations limit our ability to identify and recruit appropriate candidates.
The Board has recently expanded the role of our Chairman, James Brown.
Mr. Brown, who has to date focused primarily on opportunities that might
strategically enhance shareholder value, will have more day-to-day interaction
on areas such as financial management and strategic direction. For these
services we increased Mr. Brown's compensation in February 2004 from $3,000 per
month to $8,000 per month through July 31, 2004.
RESULTS OF OPERATIONS
Beginning with the year ended December 31, 2002, we stopped reporting
our financial results based on gross revenues and began reporting based on net
revenues. We report our net revenue after subtracting:
o co-op advertising and promotions given to the customers to
promote the product and improve sales;
o cash discounts;
o slotting fees and new store discounts; and
o returns and allowances;
These amounts were formerly included in gross revenues and for
comparison purposes net revenue numbers are not presented prior to 2002 because
they are unavailable.
In 2003, the amount of the subtraction was $1,837.460 compared to
$1,514,299 in 2002, an increase of 21% compared to an increase in net revenue of
84%. The increase in the amount of the subtraction was less than the amount of
increase in net revenues because some of our new major customers do not ask us
to participate in co-op-advertising and other promotions and, we believe,
because of the greater efficiency of advertising associated with greater volume.
NET REVENUES
Year ended December 31, 2003 compared with Year ended December 31, 2002
Net revenues for the twelve months-ended December 31, 2003 increased by
$2,984,358 to $6,552,206 versus the comparable period in 2002 of $3,567,848. Net
revenue from two of our major customers increased by $2,556,363 and accounted
for 61% of our net revenue in 2003 compared to 44.5% of our net revenue account
for by our two largest customers in 2002. Increases in the co-op-advertising and
promotions, and in-house advertising, in the amounts of $282,090 and $1,003,489
respectively, significantly contributed to the increase in net revenue. During
the twelve months ended December 31, 2003, six customers accounted for 83.6% of
our net revenues, compared to 64.8%.
19
Year ended December 31, 2002 compared with Year ended December 31, 2001
Net revenues for the twelve months-ended December 31, 2002 decreased by
$272,541 to $3,567,848 versus the comparable period in 2001 of $3,840,389, also
because of a soft market and reduced advertising.
During the twelve months ended December 31, 2002, six companies
accounted for 64.8% of our gross revenues. GNC, our largest account, accounted
for 20.5% of gross revenues versus the comparable period in 2001 of 20.8%.
COST OF SALES
Year ended December 31, 2003 compared with Year ended December 31, 2002
Cost of sales for the twelve months ended revenues for December 31,
2003 was $2,514,758, or 38.4% of net revenues, compared to $1,511,826, or 42.4%
of net revenues for the twelve months ended December 31, 2002. The decrease in
cost of sales as a percentage of net revenues is primarily attributed to higher
sales of Carb Cutter(R), which has lower cost of goods that the company average.
The purchase of larger quantities also enabled the company to obtain better
prices on major components.
Year ended December 31, 2002 compared with Year ended December 31, 2001
Cost of sales for the twelve months ended December 31, 2002 was
$1,511,826, or 42.4% of net sales, compared to $1,903,755, or 49.6% of net sales
for the twelve months ended December 31, 2001. The decrease in cost of sales as
a percentage of net sales is primarily attributed to higher sales of Carb
Cutter(R), which had a formula change in 2002 decreasing the cost of goods sold.
Additionally, the cost of sales was reduced by $73,747, which represents imputed
interest on our Note with GSN. The cost of sales as a percentage of net sales
without this discount is 44.4%.
GROSS PROFIT:
Year ended December 31, 2003 compared with Year ended December 31, 2002
Gross profit for the twelve months ended December 31, 2003 was
$4,037,448 an increase of $1,981,426, or 96.4% compared to gross profit of
$2,056,022 for the twelve months ended December 31, 2002. As a percent of net
sales, gross profit was 61.7% for the twelve months ending December 31, 2003, as
compared to 57.6% for the twelve months ended December 31, 2002. The increase in
gross profit dollars is primarily attributable to the increase in net revenue
and the decrease in cost of goods as explained above.
Year ended December 31, 2002 compared with Year ended December 31, 2001
Gross profit for the twelve months ended December 31, 2002 was
$2,056,022 an increase of $119,388, or 6.2%, compared to gross profit of
$1,936,634 for the twelve months ended December 31, 2001. As a percent of net
sales, gross profit was 57.6% for the twelve months ending December 31, 2002, as
compared to 50.4% for the twelve months ended December 31, 2001. The increase in
gross profit dollars is primarily attributed to the decrease in cost of goods as
explained above.
20
OPERATING EXPENSES:
Year ended December 31, 2003 compared with Year ended December 31, 2002
Operating expenses were $3,564,516 for the twelve months ended December
31, 2003, compared to $1,980,493 for the twelve months ended December 31, 2002,
representing an increase of $1,584,023. As a percent of net sales, operating
expenses were 54.5% for the twelve months ended December 31, 2003, compared to
55.5% for the twelve months ended December 31, 2002. Advertising and promotion
expenses were $1,428,838 for the twelve months ended December 31, 2003, compared
to $425,349 for the twelve months ended December 31, 2002, representing an
increase of $1,003,489. As a percent of net sales, advertising and promotion
expenses were 21.8% for the twelve months ended December 31, 2003, compared to
11.9% for the twelve months ended December 31, 2002. General and administration
expenses were $2,113,918 for the twelve months ended December 31, 2003, compared
to $1,524,678 for twelve months ended December 31, 2002, representing an
increase of $589,243. This increase was primarily due to the increases in:
o broker commissions of $85,644, due to the increase in our volume
of business;
o officer's bonus of $243,468, based on the increase in revenue
and the net income;
o consulting fees of $61,821, of which $37,000 was on account of
investment banking advisory services in connection with our
consideration of strategic alternatives, and the remainder of
which was on account of information technology enhancements;
o legal & professional fees of $69,642 due to the costs of the
proposed transaction with TeeZee, Inc. and the restatement of
earnings for the third quarter; and
o research and development expenses of $104,340, for three product
studies.
Year ended December 31, 2002 compared with Year ended December 31, 2001
Operating expenses were $1,980,493 for the twelve months ended December
31, 2002, compared to $3,313,837 for the twelve months ended December 31, 2001,
representing a decrease of $1,333,344. As a percent of net sales, operating
expenses were 55.5% for the twelve months ended December 31, 2002, compared to
86.3% for the twelve months ended December 31, 2001. Advertising and promotion
expenses were $425,349 for the twelve months ended December 31, 2002, compared
to $881,541 for the twelve months ended December 31, 2001, representing a
decrease of $456,192. Expenditures of $901,600 and $1,523,943 for the years 2002
and 2001, respectively, which were previously classified as advertising and
promotion expenses were classified to revenues. These expenses in 2001 were
primarily due to expenses associated with the new product launches of Fat Cutter
and Carbolizer(TM) as well as expenses associated with expanding the
distribution of our other products. General and administration expenses were
$1,524,678 for the twelve months ended December 31, 2002, compared to $2,400,680
for twelve months ended December 31, 2001, representing a decrease of $876,002.
This decrease was primarily a result of reductions in personnel expenditures,
factoring expenditures offset in part by professional fees associated with
litigation during 2002.
NET INCOME FROM OPERATIONS
Year ended December 31, 2003 compared with Year ended December 31, 2002
Net income for the twelve months ended December 31, 2003 was $696,359
or $0.19 per share, compared to $27,606 or $0.01 per share for the twelve months
ended December 31, 2002. The increase in net income of $668,753 was a result of
our commitment to control the operating expenses and the
21
increase in advertising expenditures, which attributed to the increase in gross
revenues. The sale of Acutrim contributed $274,945 or 39.5% of the net income
for the year.
Year ended December 31, 2002 compared with Year ended December 31, 2001
Net income for the twelve months ended December 31, 2002 was $27,606 or
..01 per share, compared to a net loss of $(1,399,533) or $(.39) per share for
the twelve months ended December 31, 2001. The increase in income was a direct
result of our commitment to reduce the operating expenses, resulting in a
decrease of $1,333,344 over the prior year.
CARRY FORWARD LOSS
We have a net operating loss carryforward, as of December 31, 2003 of
$366,052 for tax purposes to offset future taxable income. The net operating
loss carryforward expires in 2022.
LIQUIDITY & CAPITAL RESOURCES
During the twelve months ended December 31, 2003, the Company has
continued to control costs, and maintained profitability, with net income from
operations of $472,982. Although we anticipate high administrative costs in
2004, based on these results, and assuming we can maintain our current financing
arrangements with GSN, providing us with the informal availability or up to
$1,000,000 in credit, and continued expense control, we believe that our
operations will provide sufficient cash to support our activities for the next
12 months. However, if GSN determines to alter the informal arrangements
extending our limit of credit or our operations fail to generate positive cash
flow, it is likely we would not be able to continue our operations, or their
current level or as all.
At December 31, 2003, the Company had a positive working capital of
$167,140, compared to the prior year end, at December 31, 2002, of a working
capital deficit of $702,970, an improvement of $810,110 and is primarily the
result of increased net income, including the sale of our Acutrim(R) product
line.
At December 31, 2003, the Company had inventory of $1,159,470, compared
to $438,375 at December 31, 2001. The increased inventory, of $721,095, was
primarily the result of increased stocking and delivery requirements due to the
increased sales on all items and the stocking requirements of Phase 2 which
accounted for 34% of the total inventory.
Net cash provided by operating activities for the twelve months ended
December 31, 2003 was $441,777 compared to $190,329 provided by operating
activities for the twelve months ended December 31, 2002. The resulting increase
in cash provided was primarily due to the increases in the net income and the
satisfaction of accounts payable upon the issuance of the amended promissory
note to GSN.
Net cash from investing activities was $269,986. The funds were
provided from the sale of the Acutrim(R) trademark.
Net cash used in financing activities for the twelve months ended
December 31, 2003 was $718,421 compared to net cash used by financing activities
of $257,493 for the twelve months ended December 31, 2002. This is primarily
attributable to payments made to Garden State Nutritionals on account of the
outstanding note payable.
In early April 2002, we entered into an agreement with GSN, our sole
manufacturer, pursuant to which we agreed to repay to GSN amounts owed to them
as of the date of the agreement. The amount
22
was represented by a promissory note of approximately $700,000. Our repayment
schedule required equal monthly payments over the next twenty four months,
without interest. In connection with this agreement, we granted a blanket lien
on our assets to GSN. The occurrence of any of the following events constitute a
default under this promissory note:
o the failure of the Company to pay when due any payment of
principal and such failure continues for fifteen (15) days after
Lender notifies the Company in writing;
o the Company files for or is granted certain relief pursuant to
or within the meaning of the United States Bankruptcy Code, or
any other federal or state law relating to insolvency or relief
of debtors, and
o Christopher Tisi ceases to be the President and Chief Executive
Officer of the Company (unless a replacement reasonably
acceptable to Lender is obtained within thirty days).
In July 2003 the Company issued an amended promissory note to Garden
State Nutrition in the principal amount of $1,300,000.
The new note provided for $300,000 to be paid before December 31, 2003,
with the balance due in quarterly installments of $131,410 commencing November
1, 2003 at 4.5% per annum. At December 31, 2003, the balance owed to GSN for the
note is $778,579. We met the obligation with respect to the $300,000 by using
the proceeds from the sale of Acutrim(R) that we received in August 2003.
In early April 2002, we entered into an exclusive manufacturing
agreement with GSN that provided us with a $450,000 line of credit on current
invoices, with 60 day terms. GSN has allowed us to have as much as $1,000,000
outstanding at certain times under the line of credit. At December 31, 2002, the
balance owed to GSN under this line of credit was $892,878. Under our line of
credit, the balance owed on December 31, 2003 was $502,424.
Our working capital constraints make it difficult to grow our business,
and any reduction in informal arrangements allowing us to exceed our credit
limits with Garden State Nutritional would have a materially adverse impact on
us. Management and the Board are seeking additional sources to finance our
business. While our cash flow from operations has improved, we believe that
greater capital availability is required to facilitate future growth and to
cover additional expenses.
GOVERNMENT REGULATIONS
The processing, formulation, packaging, labeling and advertising of our
products are subject to regulation by one or more federal agencies, including
the FDA, the FTC, the Consumer Product Safety Commission, the United States
Department of Agriculture and the United States Environmental Protection Agency.
These activities are also regulated by various agencies of the states,
localities, and countries in which its products are sold.
Although we cannot predict what new legislation or regulations
governing our activities will be enacted by legislative bodies or promulgated by
agencies regulating our activities. We do know that our industry has come under
increased scrutiny, principally due to the FDA's investigation of the use of
ephedra. We believe we will become subject to additional laws or regulations
administered by the FDA
23
or other federal, state or foreign regulatory authorities. We also believe the
laws or regulations which we consider favorable may be repealed or more
stringent interpretations of current laws or regulations will be implemented in
the future. Any or all of such requirements could be a burden and costly, to us.
Future regulations could:
o require us to change the way we conduct business;
o require us to change the contents of our products;
o make us keep additional records;
o make us increase the available documentation of the properties
of our products; or
o make us increase or use different labeling and scientific proof
of product ingredients, safety or usefulness.
COMMITMENTS AND CONTINGENCIES
The Company discontinued all sales of products containing ephedra in
March 2003. Our discontinued products, Fat Cutter Plus, Thin Tab(R), and
formally owned Carbolizer(TM) product, contain ephedra, also known as "Ma
Huang," an herb which contains naturally-occurring ephedrine. These products
represented approximately 19% of our gross revenue for the twelve months ended
December 31, 2002. In 2003, we sold $61,843 of ephedra-containing products.
Ephedra containing products have been the subject of adverse publicity
in the United States and other countries relating to alleged harmful effects and
were subsequently removed from the market due to an FDA pronouncement effective
April 2004.
We market ephedrine-free products. However, these formulations may not
be popular with customers accustomed to products containing ephedra. On the
other hand, to the extent that sales of ephedra-containing products by our
competitors cease as a result of the new FDA ban, sales of our current
non-ephedra products may be positively affected.
Although we cannot predict what new legislation or regulations
governing our activities will be enacted by legislative bodies or promulgated by
agencies regulating our activities, we do know that our industry has come under
increased scrutiny principally due to the FDA's investigation of the use of
ephedra. We believe we will become subject to additional laws or regulations
administered by the FDA or other federal, state, or foreign regulatory
authorities. We also believe the laws or regulations which we consider favorable
may be repealed or more stringent interpretations of current laws or regulations
will be implemented in the future. Any or all of such requirements could be a
burden and costly, to us. Future regulations could:
o require us to change the way we conduct business;
o require us to change the contents of our products;
o make us keep additional records;
o make us increase the available documentation of the properties
of our products; or
o make us increase or use different labeling and scientific proof
of product ingredients, safety or usefulness.
24
PRODUCT LIABILITY
The availability of product liability coverage has decreased and its
cost increased materially. The Company, like other marketers of products that
are intended to be ingested, face the inherent risk of exposure to product
liability claims in the event that the use of our products results in injury. We
currently maintain product liability insurance coverage of $5,000,000.
The Company's cost to procure this $5,000,000 beginning in March 2004
of coverage was over twenty times greater than the cost to procure the
$6,000,000 worth of coverage in the prior year. In addition, the current
coverage is on a "claims made" rather than an "occurrence" basis. Our ability to
maintain appropriate products liability coverage in the future can not be
guaranteed. The number of carriers offering product liability coverage to us is
very limited. The loss of coverage would significantly impair our ability to
continue business.
We believe that our insurance coverage will be adequate to cover any
claims relating to our products. We further believe that by ceasing to sell
products containing ephedra and agreeing to accepting returns of our customers
existing inventory, we reduced potential liability relating to ephedra. We are
not aware of any claims similar to those relating to ephedra having been made
with respect to any of the other ingredients contained in our products.
CERTAIN FACTORS WHICH MAY AFFECT FUTURE RESULTS
THE COMPANY'S ACCOUNTANTS HAVE ISSUED A GOING CONCERN OPINION DUE TO THE LACK OF
CAPITAL. BECAUSE OF THE UNCERTAINTIES IN OUR ABILITY TO SATISFY ITS FUTURE
CAPITAL NEEDS, OUR INDEPENDENT AUDITORS' REPORT ON ITS FINANCIAL STATEMENTS FOR
THE YEAR ENDED DECEMBER 31, 2003 CONTAINS AN EXPLANATORY PARAGRAPH ABOUT OUR
ABILITY TO CONTINUE AS A GOING CONCERN.
IF GARDEN STATE NUTRITIONALS, OUR SOLE MANUFACTURER, FAILS TO SUPPLY
OUR PRODUCTS IN SUFFICIENT QUANTITIES AND IN A TIMELY FASHION, OUR BUSINESS MAY
SUFFER. We currently obtain 100% of our manufactured product from a single
source of supply, Garden State Nutritionals. In 2002, we entered into a two year
contract with GSN to manufacture all of our products. In the event that GSN is
unable or unwilling to provide us with the products in accordance with the terms
of our contract, delays in securing alternative sources of supply would result
in a material adverse effect upon our operations.
THE DIETARY SUPPLEMENT INDUSTRY IS HIGHLY COMPETITIVE. Many of our
competitors, particularly manufacturers of nationally advertised brand name
products, are larger and have resources substantially greater than we do. In the
future, if not currently, one or more of these companies could seek to compete
more directly with us by manufacturing and distributing their own or others'
products, or by significantly lowering the prices of their existing national
brand products. If one or more of our competitors significantly reduce their
prices on existing products in an effort to gain market share or aggressively
promote new products in an effort to enter a market, our results of operations
or market position could be adversely affected. In addition, because the
formulations of our products are not proprietary, similar formulations are
currently being developed and marketed by these competitors.
Our products may also face competition in the future from diet-related
drugs introduced by pharmaceutical companies.
WE CURRENTLY HAVE A LIMITED NUMBER OF PRODUCTS. WE CURRENTLY MARKET
SEVEN PRODUCTS, AND ARE HIGHLY RELIANT ON A SINGLE PRODUCT, THE ORIGINAL CARB
CUTTER(R). The loss of, or deterioration in the popularity of any one or more of
our other brands will have a material adverse effect on our Company.
25
OUR FAILURE TO DEVELOP AND INTRODUCE NEW PRODUCTS COULD HAVE AN ADVERSE
EFFECT ON OUR COMPANY. We believe our ability to grow in our existing market is
partially dependent upon our ability to introduce new and innovative products
into these markets. Although we seek to introduce additional products in our
existing markets, the success of new products is subject to a number of
variables, including developing products that will appeal to customers and
competing with product launches by our competitors. We cannot assure you that
our efforts to develop and introduce new products will be successful or that
customers will accept new products.
WE COULD BE ADVERSELY AFFECTED IF ANY OF OUR PRODUCTS OR ANY SIMILAR
PRODUCTS DISTRIBUTED BY OTHER COMPANIES SHOULD PROVE OR BE ASSERTED TO BE
HARMFUL TO CONSUMERS OR SHOULD SCIENTIFIC STUDIES PROVIDE UNFAVORABLE FINDINGS
REGARDING THE EFFECTIVENESS OF OUR PRODUCTS. All of our products have
certificates of analysis supplied by our manufacturer. We are highly dependent
upon our customers' and the retail consumers' perception of the overall
integrity of our business, as well as the safety and quality of our products and
similar products distributed by other companies, which may not adhere to our
quality standards. Our ability to attract and retain customers who, in turn,
attract retail consumers, could be adversely affected by negative publicity
regarding our products or one or more ingredients in our products or by the
announcement by any governmental agency of a regulatory initiative relating to
ingredients in our products.
OUR CUSTOMERS MAY DISCONTINUE USE OF OUR PRODUCTS AT ANY TIME. Our
customers order products on a purchase order basis and may discontinue the sale
of our products at any time. If product sales are discontinued, we may not
receive payment for units that are not paid for as of the time of
discontinuation. Additionally, certain of our customers have the right to take a
credit in an amount equal to the unpaid balance of the discontinued product
against other products of ours that they may purchase.
OUR SUCCESS LARGELY DEPENDS UPON NATIONAL MEDIA ATTENTION. We believe
that the historical growth experienced by the nutritional supplement market is
based in part on the national media attention regarding recent scientific
research suggesting potential health benefits from regular consumption of
certain vitamins and other nutritional products. Such research has been
described in major medical journals, magazines, newspapers and television
programs. The scientific research to date is preliminary, and there can be no
assurance of future favorable scientific results and media attention or of the
absence of unfavorable or inconsistent findings. While public awareness of the
positive effects of vitamins and nutritional supplements on health was
heightened by widely publicized reports of scientific findings supporting such
claims during 1997-1998, we believe that negative media attention focusing on
questions of efficacy, safety and label claim content have had a significant
adverse impact on the supplement industry over the past two years. In
particular, negative publicity with respect to ephedrine products has impacted
our business. The lack of growth in the nutritional supplement industry has also
been caused by the lack of new "blockbuster" products and increasing
competition, including intense private label expansion. There can be no
assurance that these factors will not be present in the future.
WE, LIKE OTHER SELLERS OF PRODUCTS THAT ARE INGESTED, FACE AN INHERENT
RISK OF EXPOSURE TO PRODUCT LIABILITY CLAIMS IF, AMONG OTHER THINGS, THE USE OF
OUR\PRODUCTS RESULTS IN INJURY. We currently have product liability insurance
for our operations in amounts we believe are adequate for our operations. There
can be no assurance, however, that such insurance will continue to be available
at a reasonable cost, if at all, or, if available, will be adequate to cover
such liabilities.
RESTRICTIVE GOVERNMENTAL REGULATIONS GOVERN THE MANUFACTURING AND
DISTRIBUTION OF OUR PRODUCTS. We are subject to numerous governmental
regulations, including, but not limited to, regulations promulgated by FDA, FTC,
and the Consumer Product Safety Commission, regarding the distribution,
labeling, and promotion of our products. All of the ingredients that we use in
our products have been reviewed by the FDA upon submission of information by
others. If we intend to use any ingredient in our products that has not already
been reviewed by the FDA, we would be required to
26
submit the new dietary ingredient to the FDA and to demonstrate a history of
safe use. If the FDA does not accept the evidence of safety we present for the
new dietary ingredient, the FDA could determine that such result ingredient
should be regulated as a food additive and require time consuming and costly FDA
approval. Additionally, under the FD&CA (including NLEA and DSHEA), the FDA has
issued regulations regarding labeling and marketing of our products, and the
NLEA regulates nutrient and ingredient labeling. The FTC regulates marketing
practices and advertising of our products. Our business and financial results
could be materially harmed by our failure to comply with these labeling and
marketing regulations.
The laws and regulations relating to our products are subject to
frequent and substantial changes resulting from legislation, adoption of rules
and regulations and administrative and judicial interpretation of existing laws.
These changes may have a dramatic effect on our business. Such changes may be
applied retroactively. The ultimate timing or effect of such changes cannot be
predicted. Our failure to comply with such laws, requirements, and regulations
could adversely affect our business and finances.
WE DEPEND ON SIGNIFICANT CUSTOMERS FOR A LARGE PERCENTAGE OF OUR NET
SALES. Our largest customers are GNC, Wal-Mart, Walgreens, Rite Aid, Eckerd's
and CVS. We do not have written agreements with any of these customers. We
cannot assure you that these customers will continue as major customers of the
Company. The loss of any of these customers, or a significant reduction in
purchase volume by any of these customers, could have a material adverse effect
on our results of operations or financial condition.
WE BELIEVE THAT TRADEMARKS AND OTHER PROPRIETARY RIGHTS ARE AMONG OUR
MOST IMPORTANT ASSETS. In fiscal 2003, substantially all of our net sales were
from products bearing proprietary brand names, such as Carb Cutter(R).
Accordingly, our future success depends upon the goodwill associated with these
brand names. Although our principal brand names are registered in the United
States, we cannot assure you that the steps we have taken to protect our
proprietary rights in our brand names will be adequate to prevent the
misappropriation of these registered brand names in the United States or abroad.
In addition, the laws of some foreign countries do not protect proprietary
rights in brand names to the same extent as do the laws of the United States. In
addition, to the extent that we rely on common law trademark rights to protect
our unregistered trademarks, such common law trademark rights do not provide us
with the same level of protection as afforded by a United States federal
registration of a trademark. In addition, common law trademark rights are
limited to the geographic area in which the trademark is actually used.
Additionally, the sales of certain of our products rely on our ability to
maintain and extend our licensing agreements with third parties, and we cannot
assure you that these third parties can successfully maintain their intellectual
property rights or that we will be successful in maintaining these licensing
agreements. If we lose the right to use these licenses, our business could be
materially adversely affected.
Although we are committed to enforce our various trademarks and other
intellectual property rights against infringement, we cannot assure you that we
will be able to successfully do so. The loss of, or deterioration in, our
intellectual property rights could adversely affect our business.
WE DEPEND SUBSTANTIALLY ON THE CONTINUED SERVICES AND PERFORMANCE OF
CHRISTOPHER TISI. Our business may be hurt if Christopher Tisi, our President
and Chief Executive Officer, leaves us. Although we have an employment agreement
with Mr. Tisi, this does not guarantee that he will remain with us. If we lose
his services, we may not be able to attract and retain additional qualified
personnel to fill his position in the future.
OUR STOCK PRICE IS LIKELY TO REMAIN VOLATILE. The stock market has,
from time to time, experienced significant price and volume fluctuations that
may be unrelated to the operating performance of particular companies. In
addition, the market price of our common stock, like the stock price of many
27
publicly traded dietary and nutritional product companies, has been, and will
likely continue to be, volatile. Prices of our common stock may be influenced by
many factors, including:
o investor perception of us;
o analyst recommendations;
o market conditions relating to dietary and nutritional product
companies;
o announcements of new products by us or our competitors;
o publicity regarding actual or potential developments relating to
products under development by us or our competitors;
o developments or disputes concerning proprietary rights;
o regulatory developments;
o period to period fluctuations in financial results of us and our
competitors;
o future sales of substantial amounts of common stock by
shareholders; and
o economic and other external factors.
WE ARE NOT LIKELY TO PAY DIVIDENDS. We have not paid any cash dividends
on our common stock and we do not plan to pay any cash dividends in the
foreseeable future. We plan to retain any earnings for the operation of our
business.
28
ITEM 7. FINANCIAL STATEMENTS
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
TABLE OF CONTENTS
PAGE
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INDEPENDENT AUDITOR'S REPORT F-1
FINANCIAL STATEMENTS
Balance Sheets as of December 31, 2003 and 2002 F-2
Statements of Income for the years ended December 31, 2003
and 2002 F-3
Statements of Changes in Stockholders' Deficit for the years
ended F-4
December 31, 2003 and 2002
Statements of Cash Flows for the years ended December 31, 2003
and 2002 F-5
Notes to Financial Statements F-6 - F19
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Stockholders
Health & Nutrition Systems International, Inc.
We have audited the accompanying balance sheets of Health & Nutrition Systems
International, Inc. as of December 31, 2003 and 2002, and the related statements
of income, changes in stockholders' deficit and cash flows for the years then
ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these 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 audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Health & Nutrition Systems
International, Inc. as of December 31, 2003 and 2002, and the results of its
operations and its cash flows for the years then ended in conformity ended in
conformity with accounting principles generally accepted in the United States of
America.
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. As discussed in Note 3 to the financial
statements, during 2003, the Company has successfully controlled costs and has
attained profitability, however there is still a substantial doubt about the
Company's ability to continue as a going concern. Management's plans regarding
those matters are also described in Note 3. The financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
/s/ DaskalBolton LLP
Boca Raton, Florida
March 19, 2004
See accompanying notes to financial statements
F-1
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
BALANCE SHEETS
DECEMBER 31, 2003 AND 2002
ASSETS
2003 2002
----------- -----------
Current assets:
Cash $ 7,406 $ 14,778
Accounts receivable, net 520,402 344,700
Inventory, net 1,159,470 438,375
Prepaids and other current assets 10,228 2,373
----------- -----------
Total current assets 1,697,506 800,226
----------- -----------
Property and equipment, net 49,683 39,302
----------- -----------
Other assets:
Trademarks, net 1,274 24,092
Security deposits 6,424 6,424
----------- -----------
Total other assets 7,698 30,516
----------- -----------
Total assets $ 1,754,887 $ 870,044
=========== ===========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 682,297 $ 1,117,407
Accrued expenses 348,069 64,680
Capital leases -- 714
Notes payable, current portion 500,000 320,395
----------- -----------
Total current liabilities 1,530,366 1,503,196
----------- -----------
Notes payable, less current portion 278,580 141,266
----------- -----------
Total liabilities 1,808,946 1,644,462
----------- -----------
Commitments and contingencies
Stockholders' deficit:
Common stock, $ 0.001 par value, authorized 30,000,000
shares; 3,829,813 and 3,629,813 shares issued and
outstanding at December 31, 2003 and 2002, respectively 3,830 3,630
Additional paid-in capital 858,612 834,812
Accumulated deficit (916,501) (1,612,860)
----------- -----------
Total stockholders' deficit (54,059) (774,418)
----------- -----------
Total liabilities and stockholders' deficit $ 1,754,887 $ 870,044
=========== ===========
See accompanying notes to financial statements
F-2
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2003 AND 2002
2003 2002
----------- -----------
Net revenue $ 6,552,206 $ 3,567,848
Cost of sales 2,514,758 1,511,826
----------- -----------
Gross profit 4,037,448 2,056,022
----------- -----------
Operating expense:
General and administrative expense 2,113,918 1,524,678
Advertising and promotion 1,428,838 425,349
Depreciation and amortization 21,760 30,466
----------- -----------
Total operating expense 3,564,516 1,980,493
----------- -----------
Income from operations 472,932 75,529
----------- -----------
Other income (expense):
Gain on sale of trademark 274,945 --
Interest expense (46,518) (47,923)
Other income (expense) (5,000) --
----------- -----------
Total other income (expense) 223,427 (47,923)
----------- -----------
Income before income taxes 696,359 27,606
----------- -----------
Benefit (provision) for income taxes -- --
----------- -----------
Net income $ 696,359 $ 27,606
=========== ===========
Net income per share - basic $ 0.19 $ 0.01
=========== ===========
Net income per share - diluted $ 0.19 $ 0.01
=========== ===========
Weighted average number of shares - basic 3,714,745 3,629,813
=========== ===========
Weighted average number of shares - diluted 3,722,745 3,629,813
=========== ===========
See accompanying notes to financial statements
F-3
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT
YEARS ENDED DECEMBER 31, 2003 AND 2002
COMMON STOCK ADDITIONAL
--------------------------- PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
----------- ----------- ----------- ----------- -----------
Balance, December 31, 2001 3,629,813 $ 3,630 $ 834,812 $(1,640,466) $ (802,024)
Net income -- -- -- 27,606 27,606
----------- ----------- ----------- ----------- -----------
Balance, December 31, 2002 3,629,813 3,630 834,812 (1,612,860) (774,418)
----------- ----------- ----------- ----------- -----------
Common stock issued for services 200,000 200 23,800 -- 24,000
Net income -- -- -- 696,359 696,359
----------- ----------- ----------- ----------- -----------
Balance, December 31, 2003 3,829,813 $ 3,830 $ 858,612 $ (916,501) $ (54,059)
=========== =========== =========== =========== ===========
See accompanying notes to financial statements
F-4
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2003 AND 2003
2003 2002
----------- ------------
Cash flows from operating activities:
Net income $ 696,359 $ 27,606
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Allowance for doubtful accounts (1,054) (14,431)
Allowance for obsolete and slow moving inventory (74,770) (70,362)
Depreciation and amortization 21,760 30,466
Gain on sale of intangible asset (274,945) --
Imputed interest expense on note payable 30,979 42,272
Common stock issued for services 24,000 --
(Increase) decrease in:
Accounts receivable (174,651) (135,477)
Inventory (646,325) (202,845)
Prepaids and other current assets (7,855) (2,373)
Increase (decrease) in:
Accounts payable 864,890 634,680
Accrued expenses 283,389 (119,207)
----------- -----------
Net cash provided by operating activities 441,777 190,329
----------- -----------
Cash flows from investing activities:
Proceeds from sale of trademark 300,000 --
Purchases of property and equipment (30,014) --
----------- -----------
Net cash provided by investing activities 269,986 --
----------- -----------
Cash flows from financing activities:
Repayments on notes payable (718,421) (237,400)
Repayments on capital leases (714) (20,083)
----------- -----------
Net cash used in financing activities (719,135) (257,483)
----------- -----------
Net decrease in cash (7,372) (67,154)
Cash, beginning of year 14,778 81,932
----------- -----------
Cash, end of year $ 7,406 $ 14,778
=========== ===========
See accompanying notes to financial statements
F-5
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 AND 2002
NOTE 1 - DESCRIPTION OF BUSINESS
Health & Nutrition Systems International, Inc. ("HNS" or "the Company") markets
and distributes weight management, energy and sports nutrition products to
numerous national and regional health, food, drug and mass-market accounts as
well as independent health and pharmacy accounts. The Company was incorporated
in Florida on October 25, 1993. HNS product sales consist of seven primary
dietary supplements: Carb Cutter(R), Carb Cutter(R) Phase 2, Thin Tab Mahuang
Free(TM), Zoom(R), Eat Less(R), Diet-a-Day(TM) Phase 2 and Fat Cutter(R) Ephedra
Free. The Company's markets are concentrated in North America and Puerto Rico.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments with original
maturities of three months or less to be cash equivalents. There are no cash
equivalents at December 31, 2003 and 2002.
Use of Estimates
The preparation of financial statements in conformity with general accepted
accounting principles requires management to make estimates and assumptions that
affect certain reported amounts and disclosures. Accordingly, actual results
could differ from those estimates.
Inventories
Inventories are stated at the lower of cost or market with cost being determined
on a standard cost basis, net of allowances for slow-moving or obsolete
inventory. Inventory allowances at December 31, 2003 and 2002 was $13,606 and
$88,376 respectively. The 2002 increase in the inventory allowances was due to
the Company establishing an allowance for Ephedra containing products. The
returns were taken in 2003 and the obsolete inventory was destroyed.
Depreciation and Amortization
Property and equipment are carried at cost. Depreciation is provided using the
straight-line or accelerated methods, over the estimated economic lives of the
assets, which range from three to seven years. Leasehold improvements are
amortized over the expected lease term. The Company reviews the valuation of
fixed and other assets and their remaining economic lives annually and adjusts
depreciation and amortization accordingly.
Revenue Recognition
The Company recognizes revenue when
o Persuasive evidence of an arrangement exists
o Shipment has occurred
o Price is fixed or determinable, and
o Collectability is reasonably assured
Subject to these criteria, except with respect to customers that buy our
products on "pay on scan terms," we recognize revenue at the time of shipment of
the relevant merchandise. "Pay on Scan" sales are treated as consignment sales
by the Company. In the case of these consignment sales, the Company
F-6
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 AND 2002
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
records revenues, and removes the items from inventory when the customer reports
the sales to the Company. Normally the Company is notified of the customer's
sales through periodic sales reports, payments, or when the customer reorders
the relevant product.
On December 31, 2003, the Company had approximately $286,000 of inventory on
consignment relating to its "pay on scan" sales. On December 31, 2002 the
Company had no outstanding consignment sales.
Included in the net sales in the accompanying financial statements are
reductions for returns and allowances, sales discounts, new store opening
discounts and co-op advertising and promotions.
Advertising Costs
The Company expenses advertising production costs as they are incurred and
advertising communication costs the first time the advertising event takes
place. Advertising and promotion expenses for the years ending December 31, 2003
and 2002 were $1,428,838 and $425,349, respectively.
Basic Earnings Per Share
Basic income per common share is computed by dividing the net income by the
weighted average number of shares of common stock outstanding during the year.
Diluted Earnings Per Share
Diluted earnings per share reflect the potential dilution that could occur if
dilutive securities (stock options and stock warrants) to issue common stock
were exercised or converted into common stock that then shared in the earnings
of the Company.
Stock Compensation
The Company has adopted Statement of Financial Accounting Standards No. 123
("SFAS 123"), "Accounting for Stock-Based Compensation." SFAS 123 encourages the
use of a fair-value-based method of accounting for stock-based awards, under
which the fair value of stock options is determined on the date of grant and
expensed over the vesting period. Under SFAS 123, companies may, however,
measure compensation costs for those plans using the method prescribed by
Accounting Principles Board Opinion No. 25 ("APB No. 25"), "Accounting for Stock
Issued to Employees." Companies that apply APB No. 25 are required to include
pro forma disclosures of net earnings and earnings per share as if the
fair-value-based method of accounting had been applied. The Company elected to
account for such plans under the provisions of APB No. 25. The Company accounts
for stock options granted to consultants under SFAS 123.
Had the compensation expense for the stock option plan been determined based on
the fair value of the options at the grant date consistent with the methodology
prescribed under Statement of Financial Standards No. 123, "Accounting for Stock
Based Compensation," at December 31, the Company's net income and earnings per
share would have been reduced to the proforma amounts indicated below:
F-7
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 AND 2002
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
2003 2002
------------ ----------
Net income
As reported $ 696,359 $ 27,606
============ ==========
Pro forma $ 685,284 $ 20,636
============ ==========
Earnings per share
As reported $ 0.19 $ 0.01
============ ==========
Pro forma $ 0.18 $ 0.01
============ ==========
Intangible Assets
Intangible assets are stated at cost less amortization. Intangible assets are
the trademarks that the Company acquired in 2000 and 2001 and are being
amortized on a straight line based over their estimated useful lives.
Accounting for Long-Lived Assets
The Company is required to periodically assess the impairment of long-lived
assets. An impairment review is performed whenever events or changes in
circumstances indicate that the carrying value may not be recoverable.
Factors considered important which could trigger an impairment review include,
but are not limited to, significant underperformance relative to expected
historical or projected future operating results, significant changes in the
manner of the acquired assets or the strategy for the overall business,
significant negative industry or economic trends, a significant decline in the
stock price for a sustained period and the Company's market capitalization
relative to net book value.
When management determines that the carrying value may not be recoverable based
upon the existence of one or more of the above indicators of impairment, any
impairment measured is based on a projected discounted cash flow method using a
discount rate commensurate with the risk inherent in the Company's current
business model.
New Accounting Pronouncements
In April 2003, the Financial Accounting Standards Board (the "FASB") issued SFAS
No. 149, "Amendment of Statement 13 on Derivative Instruments and Hedging
Activities." SFAS No. 149 amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives) and for
hedging activities under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities." SFAS No. 149 is effective for contracts entered into or
modified after June 30, 2003, except as specified and for hedging relationships
designated after June 30, 2003. The Company does not anticipate that the
adoption of this statement will have any material impact on the balance sheet or
statement of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS 150
requires that certain financial instruments, which under previous guidance were
accounted for as equity, must now be accounted for as liabilities. The financial
instruments affected include mandatorily redeemable stock, certain financial
instruments that require or may require the issuer to buy back some of its
shares in exchange for cash or other assets and certain obligations that can be
settled with shares of stock. SFAS 150 is effective for all financial
instruments entered into or modified after May 31, 2003. Otherwise it will
become effective at the beginning of the first interim period beginning after
June 15, 2003.
F-8
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 AND 2002
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
The Company does not anticipate that the adoption of this statement will have
any material impact on the balance sheet or statement of operations.
In November 2002, the FASB issued the FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"), which clarifies the
requirements for a guarantor's accounting and disclosures of certain guarantees
issued and outstanding. This interpretation elaborates on the disclosures to be
made by a guarantor in its interim and annual financial statements about its
obligations under certain guarantees that it has issued. It also clarifies that
a guarantor is required to recognize, at its inception of guarantee, a liability
for the fair value of the obligation undertaken in issuing the guarantee. The
initial recognition and initial measurement provisions of this interpretation
are applicable on a prospective basis to guarantees issued or modified after
December 31, 2002, irrespective of the guarantor's fiscal year-end. The
disclosure requirements in this interpretation are effective for financial
statements of interim or annual periods ending after December 15, 2002. The
adoption of FIN 45 did not have a material impact on the Company's consolidated
results of operations or financial position.
In November 2002, the EITF issued EITF Issue No. 00-21, "Accounting for Revenue
Arrangements with Multiple Deliverables" ("EITF 00-21"). EITF 00-21 addressed
how to account for arrangements that may involve delivery or performance of
multiple products, services, and/or rights to use assets, and when and, if so,
how an arrangement involving multiple deliverables should be divided into
separate units of accounting. It does not change otherwise applicable revenue
recognition criteria. It applies to arrangements entered into in fiscal periods
beginning after June 15, 2003, with early adoption permitted. The adoption of
EITF 00-21 did not have a material impact on the Company's consolidated results
of operations or financial position.
Shipping and Handling Fees
The Company follows the provisions of Emerging Issues Task Force Issue No. 00
- -10, "Accounting for Shipping and Handling Fees and Costs." Any amounts billed
to third-party customers for shipping and handling are included in the statement
of operations as a component of revenue. Shipping and handling costs incurred
are included as a component of cost of sales.
NOTE 3 - MANAGEMENT'S PLANS AND ISSUES AFFECTING LIQUIDITY
The Company's financial statements have been prepared assuming that the Company
will continue as a going concern. During 2003, the Company has successfully
controlled costs and attained profitability, including net income of $696,359
and cash flow from operations of $741,777. At December 31, 2003, the Company has
positive working capital of $167,140.
Management intends to continue control costs and monitor financing capabilities.
Management believes these factors will contribute toward achieving sustained
profitability.
There remains substantial doubt about the Company's ability to continue as a
going concern. The financial statements do not include any adjustments to
reflect the possible effects on the recoverability and classification of assets
or the amounts and classification of liabilities that may result form the
outcome of this uncertainty.
F-9
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 AND 2002
NOTE 4 - TRADEMARKS
In June 2001, the Financial Accounting Standards Board approved the issuance of
SFAS 142, "Goodwill and Other Intangible Assets," which establishes new
accounting and reporting requirements for goodwill and other intangible assets.
The new standards required that all intangible assets acquired that are obtained
through contractual or legal right, or are capable of being separately sold,
transferred, licensed, rented or exchanged, must be recognized as an asset apart
from goodwill. Goodwill and intangibles with indefinite lives are no longer
amortized, but are subject to an annual assessment for impairment by applying a
fair value based test. The Company applied the provisions of SFAS 142 beginning
on January 1, 2002 and performed a transitional fair value based impairment
test. In connection with adopting SFAS 142, the Company also reassessed the
useful lives and the classifications of its identifiable intangible assets and
determined that they continue to be appropriate.
The components of the Company's intangible assets subject to amortization are as
follows:
DECEMBER 31, 2003 DECEMBER 31, 2002
----------------------------------------- -----------------
GROSS GROSS
CARRYING ACCUMULATED CARRYING ACCUMULATED
AMOUNT AMORTIZATION AMOUNT AMORTIZATION
-------- ------------ -------- ------------
Amortized intangible assets:
Trademarks $ 7,228 $ 5,954 $32,228 $ 8,137
======= ======= ======= =======
Amortization expense for the years ended December 31, 2003 and 2002 was
approximately $2,125 and $2,820, respectively.
Estimated amortization of intangible assets is as follows:
2003 $ 1,098
2004 176
-------
$ 1,274
=======
The following table adjusts earnings for the adoption of SFAS 142 for the years
ended December 31, 2003 and 2002:
2003 2002
-------- --------
Net earnings:
Reported net earnings $696,359 $ 27,606
Goodwill amortization -- --
-------- --------
Adjusted net earnings $696,359 $ 27,606
======== ========
F-10
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 AND 2002
NOTE 5 - FACTORING ARRANGEMENTS
In March 2003, the Company terminated their factoring agreement with LSQ Funding
Group, L.C. (LSQ). The agreement provided that LSQ would purchase certain
receivables and advance 85% of the face amount of such receivables. The maximum
amount of receivables the Company could factor under the agreement was $750,000.
In connection with the factoring agreement, the Company granted LSQ a blanket
lien on Company assets and the President/Chief Executive Officer was required to
deliver a personal guarantee.
2003 2002
--------- ---------
Receivables assigned to factor $ -- $ 10,118
Advances to (from) factor -- (9,612)
Amounts due from factor -- 33,389
Unfactored accounts receivable, net 520,402 310,805
--------- ---------
$ 520,402 $ 344,700
========= =========
NOTE 6 - ACCOUNTS RECEIVABLE
Accounts receivable consisted of the following at December 31, 2003 and 2002:
2003 2002
--------- ---------
Accounts receivable $ 587,126 $ 685,078
Less: allowance for doubtful accounts (21,724) (22,778)
Less: allowance for sales returns (45,000) (317,600)
--------- ---------
Accounts receivable, net $ 520,402 $ 344,700
========= =========
At December 31, 2003 the Company recorded an allowance for sales returns for
$45,000. At December 31, 2002, the Company recorded an allowance for sales
returns of $317,600, including $200,000 for returns of products containing
Ephedra.
NOTE 7 - SUPPLEMENTAL CASH FLOW INFORMATION
2003 2002
---------- --------
Cash paid for interest $ 15,538 $ 9,514
========== ========
Cash paid for income taxes $ -- $ --
========== ========
Non-cash investing and financing activities:
Common stock issued for services $ 24,000 $ --
========== ========
Conversion of accounts payable to notes payable $1,000,000 $700,000
========== ========
F-11
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 AND 2002
NOTE 8 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash, accounts receivables, loans receivable, accounts
payable and other payables approximates fair value because of their short
maturities.
NOTE 9 - PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at December 31, 2003 and 2002:
2003 2002
--------- ---------
Furniture and equipment $ 38,713 $ 38,713
Office equipment 31,536 31,536
Warehouse equipment 24,349 24,349
Computer equipment 65,880 51,815
Software 56,076 40,126
Website development 2,155 2,155
Leasehold improvements 1,860 1,860
--------- ---------
220,569 190,554
Less: accumulated depreciation (170,886) (151,252)
--------- ---------
Property and equipment, net $ 49,683 $ 39,302
========= =========
Depreciation expense for the years ended December 31, 2003 and 2002 was $19,635
and $27,647, respectively.
NOTE 10 - NOTES PAYABLE
In July 2003, the Company issued an amended promissory note to Garden State
Nutritionals ("GSN") that increased the principal from the then outstanding
balance to $1,300,000. The note provided for $300,000 to be paid before December
31, 2003, with the balance due in quarterly installments of $131,410 commencing
November 1, 2003 at 4.5% per annum. The note is secured by all intangible and
tangible assets of the Company. The $300,000 portion of the note was paid in
August 2003. At December 31, 2003, the balance owed to GSN is $778,580.
On April 11, 2002, the Company entered into the agreement with GSN to repay
$700,000 owed to GSN as of the date of the agreement. The repayment schedule
required eight equal quarterly payments, without interest, starting June 1,
2002. The note was secured by a blanket second priority lien on the Company's
assets.
F-12
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 AND 2002
NOTE 10 - NOTES PAYABLE, CONTINUED
Also, on April 11, 2002 (as amended July 21, 2003), the Company entered into an
exclusive manufacturing agreement with GSN pursuant to which GSN has provided a
$450,000 line of credit with 60-day terms to the Company. GSN has informally
allowed the Company to purchase up to $1,000,000 on the line of credit. At
December 31, 2003 and 2002, the balance owed to GSN under this line of credit
was $502,424 and $892,878, respectively.
NOTE 11 - LEASE COMMITMENTS
The Company leases office and warehouse space in Riviera Beach, Florida. Rent
expense for the years ended December 31, 2003 and 2002 was $53,035 and $54,044,
respectively. The Company also leases various equipment. Lease expense for the
years ended December 31, 2003 and 2002 was $32,394 and $34,340, respectively.
In April 2002, the Company began sub-leasing part of its warehouse space for
$1,800 per month and on December 1, 2003 the lease was increased to $2,100 per
month.
Certain non-cancelable leases are classified as capital leases, and the leased
assets are included as part of property and equipment. Other leases are
classified as operating leases and are not capitalized.
Property under capital leases at December 31, 2003 and 2002 consisted of the
following:
2003 2002
-------- --------
Machinery and equipment $ 59,902 $ 59,902
Less: accumulated amortization (54,578) (40,977)
-------- --------
Total $ 5,324 $ 18,925
======== ========
Future minimum rentals for property under operating leases at December 31 are as
follows:
OPERATING
Year Ending December 31, LEASES
- ------------------------------ -------
2004 $30,278
2005 8,621
-------
Total minimum lease obligation $38,899
=======
Capital leases obligations were repaid during 2003.
F-13
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 AND 2002
NOTE 12 - STOCKHOLDERS' EQUITY
On July 30, 2003, 200,000 shares of Health & Nutrition Systems were issued to
two board members of the Company, for services performed. The fair value of the
common stock at the time of issue was $0.12 per share, and the Company recorded
compensation expense of $24,000.
During the year ended December 31, 2002, the Company did not issue any common
stock.
NOTE 13 - LEGAL MATTERS
Twenty-two (22) cases have been filed against the Company alleging that the
Company's Acutrim(R) products contain Phenylpropanolamine ("PPA") and that those
products have caused damage to the plaintiffs. Many of these cases have been
consolidated in class action suits pending in the U.S. District Court for the
Western District of Washington in Seattle, the Philadelphia County Court of
Common Pleas or the Louisiana State Court. None of the Company's Acutrim(R)
products has ever contained, or currently contains, PPA. Based on that defense,
to date, all but two cases have been voluntarily dismissed after delivery to
plaintiff's counsel information substantiating the fact that HNS's products do
not presently contain, and have not contained, PPA, or involuntarily dismissed
by court order. Of the remaining two cases, one is subject of a stipulation for
dismissal and is awaiting the Judge's final order of dismissal. The other case,
being litigated pro se, remains pending, subject to HNS's filed motion for
summary judgment.
While the Company does not believe that it has material liability based upon the
substantive allegations set forth in these cases, the legal costs that the
Company has incurred, and may incur in the future, in obtaining dismissals from
these cases could have a material adverse effect on the Company.
In 2000, the Company sued a former officer and director of the Company and KMS
Thin-Tab 100, Inc.; a corporation controlled by the former director, for
trademark infringement, unfair competition and cyber piracy. The former director
and KMS Thin-Tab 100, Inc. counterclaimed alleging a breach of distribution
agreement with the Company. On September 19, 2002, the Company announced the
settlement of all litigation between the Company, the former director and KMS
Thin-Tab 100, Inc.
The settlement agreement generally requires the former director and KMS to
transfer the registration and ownership of the domain names Thintab.com,
Thintab.cc and Carbcutter.cc to HNS and to take other actions to eliminate
confusion over the ownership of the Thin Tab(R) name. Additionally, it provides
for each of the adverse parties to generally release the others.
As part of the settlement, HNS entered into a distribution agreement with the
former officer and director, beginning on September 26, 2002 and ending
September 25, 2007, permitting him to purchase certain products from HNS and to
exclusively distribute those products in Florida from Orlando south. HNS has
agreed not to sell its products directly to certain KMS customers. The Company
recorded a legal settlement expense of $58,836 associated with this settlement.
In October 2003, HNS terminated the distribution agreement with KMS based on KMS
breach of material terms of the Agreement. HNS filed suit against KMS-Thin Tab
100, Inc. on December 1, 2003 for breach of contract, trademark infringement and
for a declaration of rights that the Distribution Agreement is terminated and of
no further force and effect. KMS has answered the Complaint and filed its own
Counterclaim for fraud in the inducement, trademark infringement, dilution and
fraudulent misrepresentation. Currently pending are HNS's motion to dismiss
counterclaim, motion to compel and for discovery sanctions and motion for
sanctions against KMS.
The Company from time to time is a party of various legal proceedings. In the
opinion of management, none of the proceedings are expected to have a material
impact on its financial position or results of operations.
F-14
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 AND 2002
NOTE 14 - CONCENTRATIONS
Credit Risk
Financial instruments, which potentially expose the Company to concentrations of
credit risk, as defined by Statement of Financial Accounting Standards No. 105,
consist primarily of trade receivables. The Company's officers have attempted to
minimize this risk by monitoring the companies for which it provided credit.
The Company maintains bank accounts at various financial institutions. At times
during the year, balances in these accounts exceeded the amount insured by the
FDIC. At December 31, 2003 and 2002, no amounts exceeded the insured limit.
Product Liability
As of December 31, 2003, the Company was insured to the extent of $6 million for
product liability claims. The Company uses vendors who are also insured. There
is a risk that certain vendors may not have sufficient product liability
insurance or may lose their insurance, or the Company may not be able to insure
at reasonable cost. In any of these events, there could be a material adverse
effect on the financial condition, results of operations or cash flows of the
Company. Subsequently, in March 2004, the Company reduced their products
liability coverage to $5 million, and their premiums were raised significantly.
Significant Customers
The Company currently has approximately 17 drug, health food, and mass retailer
customers which collectively comprised 92% of our revenues in 2003. The Company
depends on several significant customers for a large percentage of its sales.
The Company's largest customers are GNC, Wal-Mart, Walgreens, Rite Aid, and CVS.
Drugs. The Company does not have written agreements with any of these customers
or any of our other customers. The loss of one or more of these customers could
have a material adverse effect on the Company.
The Company's net revenue attributable to customers accounting for more than 10%
of the Company's net revenue for the years ended December 31, 2003 and 2002 are
as follows:
2003 2002
----------------------- -----------------------------
A $2,084,000 $602,000
B 1,829,000 879,000
Significant Supplier
During the years ended December 31, 2003 and 2002, the Company received all of
its products from one manufacturer of herbal and dietary supplements, located in
Caldwell, New Jersey. The Company is dependent on the ability of its supplier to
provide products on a timely basis and on favorable pricing terms. The loss of
the supplier or a significant reduction in product availability from the
supplier could have a material adverse effect on the Company. The Company
believes that its relationship with its supplier is satisfactory.
F-15
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 AND 2002
NOTE 15 - INCOME TAXES
The Company's evaluation of the tax benefit of its net operating loss carry
forward is presented in the following table. At December 31, 2003 and 2002, the
tax amounts have been calculated using the 34% federal and 5.5% state income tax
rates.
2003 2002
----- -----
Income tax (benefit) consists of:
Current $-- $--
Deferred -- --
--- ---
Provision (benefit) for income taxes $-- $--
=== ===
Reconciliation of the Federal statutory income tax rate to the Company's
effective tax rate is as follows:
2003 2002
--------- ---------
Taxes computed at the federal tax rate $ 236,762 $ 9,386
Non-deductible expenses 3,555 2,719
State income taxes, net of federal income tax benefit 25,657 1,292
Other -- 28,845
Decrease in deferred tax asset valuation allowance (265,974) (42,242)
--------- ---------
Provision (benefit) for income taxes $ -- $ --
========= =========
The components of the deferred tax asset were as follows at December 31:
2003 2002
--------- ---------
Deferred tax assets:
Net operating loss carryforward $ 133,530 $ 336,919
Allowance for receivables 25,109 128,084
Allowance for inventory 5,120 33,256
Accrued compensation 68,526 --
--------- ---------
Total deferred tax assets 232,285 498,259
--------- ---------
Deferred tax liabilities -- --
--------- ---------
Net deferred tax asset 232,285 498,259
--------- ---------
Valuation allowance:
Beginning of year (498,259) (540,501)
Decrease during year (265,974) 42,242
--------- ---------
Ending balance (232,285) (498,259)
--------- ---------
Net deferred taxes $ -- $ --
========= =========
As of December 31, 2003, the Company has an unused net operating loss carry
forward of $366,052 available for use on its future corporate income tax
returns. This net operating loss carry forward expires in 2021.
F-16
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 AND 2002
NOTE 16 - STOCK OPTIONS
In May 1998 the Company adopted a stock option plan. The purpose of the stock
option plan was to increase the employees and non-employee director's
proprietary interest in HNS and to align more closely their interests with the
interests of the shareholders of HNS, as well as to enable HNS to attract and
retain the services of experienced and highly qualified employees and
non-employees directors.
Options granted under this plan may either be options qualifying as incentive
stock options under Section 422 of the Internal revenue Code of 1986, as
amended, or options that do not so qualify. Any incentive option must provide
for an exercise price of not less than 100% of the fair market value of the
underlying shares on the date of such grant, but the exercise price of any
incentive option granted to an eligible employee owning more than 10% of the our
common stock must be at least 110% of such fair market value as determined on
the date of the grant.
The term of each option and the manner in which it may be exercised is
determined by the board of directors, provided that no option may be exercisable
more that 10 years after the date of its grant and, in the case of an incentive
option granted to an eligible employee owning more that 10% of the our common
stock, no more than five years after the date of the grant. The board of
directors shall determine the exercise price of non-qualified options.
We reserved an aggregate of 1,250,000 shares of common stock for issuance of
options under the stock option plan. As of December 31, 2003, the Company has
granted 556,500 options under the plan. Therefore, options to purchase 693,500
remain available to be issued. The board of directors or a committee of the
board of directors will administer the plan including, without limitation, the
selection of the persons who will be granted plan options under the plan, the
type of plan options to be granted, the number of shares subject to each plan
options and the plan option price.
The per share exercise price of shares granted under the plan may be adjusted in
the event of certain changes in the total purchase price payable upon the
exercise in full of options granted under the plan. Officers, directors and key
employees of and consultants to HNS will be eligible to receive non-qualified
options under the plan. Only officers, directors and employees of HNS who are
employed by HNS or by any subsidiary thereof are eligible to receive incentive
options.
The Company has elected to account for the stock options under the Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and
related interpretations. Accordingly, no compensation expense has been
recognized on the employee stock options. The Company accounts for stock options
granted to consultants under Financial Accounting Standards Board Statement No.
123, "Accounting for Stock-Based Compensation." The Company recognized $-0- and
$443 in compensation expense at December 31, 2003 and 2002, respectively.
During the years ended December 31, 2003 and 2002, 50,000 options were granted
to officers, directors and employees of the Company.
F-17
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 AND 2002
NOTE 16 - STOCK OPTIONS, CONTINUED
A summary of options during the years ended December 31, 2003 and 2002 is shown
below:
DECEMBER 31, 2003 DECEMBER 31, 2002
------------------------------ ------------------------------
NUMBER WEIGHTED-AVERAGE NUMBER WEIGHTED-AVERAGE
OF SHARES EXERCISE PRICE OF SHARES EXERCISE PRICE
--------- -------------- --------- --------------
Outstanding at beginning of year 506,500 $ 0.43 540,500 $ 0.50
Granted 50,000 0.04 50,000 0.12
Exercised -- -- -- --
Forfeited -- -- (84,000) (0.50)
-------- ----------- -------- -----------
Outstanding at December 31 556,500 $ 0.43 506,500 $ 0.43
======== =========== ======== ===========
Exercisable at December 31 449,900 292,050
======== ========
Available for issuance at December 31 693,500 743,500
======== ========
The fair value of each option is estimated on the date of grant using the fair
market value option-pricing model with the assumptions:
Risk-free interest rate 4.5% - 6.5%
Expected life (years) Various
Expected volatility 1.23
Expected dividends None
NOTE 17 - RECLASSIFICATIONS
Certain reclassifications have been made to the 2002 financial statements to
conform to the 2003 financial statement presentation. These reclassifications
have no effect on reported net income.
NOTE 18 - EMPLOYMENT AGREEMENT
Effective January 1, 2002, the Company entered into an two-year employment
agreement with Christopher Tisi, the Company's Chief Executive Officer,
President, and then Interim Chairman of the Board. The agreement provides for a
base salary of $147,000, as well as bonuses that are contingent upon increases
in revenue and net profits over prior years. The agreement provides that bonuses
will be determined quarterly with 33% of such bonuses to be paid quarterly. The
agreement also provides for an annual grant of 50,000 stock options under its
1998 Stock Option Plan. The options have a four-year term and will be vested
100% on the date of grant. The agreement also provides for the payment of an
amount equal to the lesser of (i) $275,000 or (ii) the maximum "golden
parachute" payment permitted to be deducted by us under the federal tax law in
the event Mr. Tisi is terminated after a change of control.
On April 9, 2004, the Company's Chief Executive Officer and President,
entered into a new two-year employment contract effective as of January 1, 2004.
The contract
o increases his base salary from $147,000 to
$164,000;
F-18
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003 AND 2002
o provides for a quarterly bonus of the sum of 5%
of the increase in net revenues compared to the
comparable quarter for the prior year and 10% of
the increase in net income over the prior year's
comparable quarter. One third of the bonus is
payable at the conclusion of the applicable
quarter; one third is payable on the conclusion
of the following quarter based on cumulative
results for the year through the end of such
quarter compared to the prior year's year to
date results, and one third is payable at year
end based on a comparison to the prior years
results;
o provides for the payment of the unpaid portion
of his 2003 bonus ($162,271) and the incremental
increase in his annual salary in 12 equal
monthly installments beginning April 1, 2004;
o provides for an annual grant of options to
purchase 50,000 shares of the Company's common
stock under the 1998 Stock Option Plan;
o provides for the payment of $275,000 in
severance upon a change in control of the
Company if the Company terminates the agreement
other than for cause, unless the Company enters
into an agreement regarding his continued
employment;
o provides he will not compete with the Company
for a one year period after the termination of
the contract (other than termination without
cause) in the wholesale distribution of sale in
the United States to retailers or intermediaries
of products which directly or otherwise
significantly compete with products sold or
distributed by the Company.
F-19
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 8A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Our principal executive officer and controller and principal accounting
officers have participated in and supervised the evaluation of our disclosure
controls and procedures that are designed to ensure that information required to
be disclosed by us in the reports that we file is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's rules and forms. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that the
information required to be disclosed by us in the reports that we file or submit
under the Act is accumulated and communicated to our management, including our
principal executive officer or officers and principal financial officer, to
allow timely decisions regarding required disclosure. Based on their evaluation
of those controls and procedures as of a date within 90 days of the date of this
filing, our CEO and Controller and accounting officer determined that the
controls and procedures are adequate and effective.
CHANGES IN INTERNAL CONTROLS
There were no significant changes, including any corrective actions
with regard to significant deficiencies and material weaknesses, in our internal
controls or in other factors that could significantly affect internal controls
since the date of the most recent evaluation of these controls by our chief
executive officer and chief financial officer.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
We have adopted a written code of ethics that applies to our senior
financial officers and persons performing similar functions. We intend to
disclose any amendments to, or waivers from, the Code on our website,
www.hnsglobal.com. Upon written request to our corporate secretary by U.S. mail,
we will provide, at no charge, a copy of such Code to any person requesting a
copy.
The other information required by this item is incorporated by
reference to our proxy statement to be filed within 120 days of December 31,
2003 in connection with solicitation of proxies for our 2004 annual meeting of
shareholders.
ITEM 10. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to
our definitive proxy statement to be filed within 120 days of December 31, 2003
in connection with solicitation of proxies for our 2004 annual meeting of
shareholders.
29
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Except for the Equity Compensation Plan Information set forth below,
the information required by this item is incorporated by reference to our
definitive proxy statement to be filed within 120 days of December 31, 2003 in
connection with solicitation of proxies for our 2004 annual meeting of
shareholders.
The following table provides information as of December 31, 2003 about
our common stock that may be issued upon the exercise of options, warrants and
rights under all of our existing equity compensation plans, including the 1998
Stock Option Plan.
--------------------------- ----------------------------- ---------------------------- ----------------------------
(c)
Number of securities
(a) (b) remaining available for
Number of securities to be Weighted-average exercise future issuance under
issued upon exercise of price of outstanding equity compensation plans
outstanding options, options, warrants and (excluding securities
Plan category warrants and rights rights reflected in column (a))
--------------------------- ----------------------------- ---------------------------- ----------------------------
Equity compensation plans
approved by security
holders 556,500 $.43 322,000
--------------------------- ----------------------------- ---------------------------- ----------------------------
Equity compensation plans
not approved by security
holders (1) -- -- --
--------------------------- ----------------------------- ---------------------------- ----------------------------
Total 556,500 $.43 322,000
=========================== ============================= ============================ ============================
(1) We do not maintain equity compensation plans that have not been approved by
our stockholders.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to
our definitive proxy statement to be filed within 120 days of December 31, 2003
in connection with solicitation of proxies for our 2004 annual meeting of
shareholders.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following documents are either filed with this report or
incorporated by reference:
3.1(a) Articles of Incorporation of the Registrant (incorporated by
reference to Exhibit 3.1(A) of Registrant's registration
statement on Form 10-SB, filed on January 31, 2000;
Commission File Number 000-29245).
3.1(b) Articles of Amendment to the Articles of Incorporation
(incorporated by reference to Exhibit 3.1(B) of Registrant's
registration statement on Form 10-SB, filed on January 31,
2000; Commission File Number 0000-29245).
3.1(c) Articles of Amendment to Articles of Incorporation
(incorporated by reference to Exhibit 3.1(C) of Registrant's
registration statement on Form 10-SB, filed on January 31,
2000; Commission File Number 000-29245).
30
3.1(d) Articles of Amendment to Articles of Incorporation
(incorporated by reference to Exhibit 3.1(D) of Registrant's
Annual Report on Form 10-KSB, filed on April 16, 2001;
Commission File Number 000-29245).
3.2 By-Laws of the Registrant (incorporated by reference to
Exhibit 3.2 of Registrant's registration statement on Form
10-SB, filed on January 31, 2000; Commission File Number
000-29245).
3.3 Amendment to the Restated Bylaws of the Company dated
September 25, 2000 (incorporated by reference to Exhibit 3.3
of Registrant's Annual Report on Form 10-KSB, filed on April
16, 2000; Commission File Number 000-29245).
3.4 Amendment to the Restated Bylaws of the Company dated
November 10, 2000 (incorporated by reference to Exhibit 3.4
of Registrant's Annual Report on form 10-KSB, filed on April
16, 2000; Commission File Number 000-29245).
10.1 Employment Agreement between the Company and Christopher Tisi
effective as of January 1, 2002 (incorporated by reference to
Exhibit 10.1 of Registrant's Current Report on Form 8-K filed
on February 13, 2002; Commission File Number 000-29245).
10.2 Severance Agreement between the Company and Steven Pomerantz
effective as of January 1, 2002 (incorporated by reference to
Exhibit 10.3 of Registrant's Current Report on Form 8-K filed
on February 13, 2002; Commission File Number 000-29245).
10.3 Factoring and Security Agreement between LSQ Funding Group
L.C. and Health and Nutrition Systems International, Inc.
effective as of March 15, 2002 (incorporated by reference to
Exhibit 10.3 of Registrant's Annual Report on Form 10-KSB,
filed on April 12, 2002; Commission File Number 000-29245).
10.4 Indemnification Agreement dated March 15, 2002 between LSQ
Funding Group L.C. and Christopher Tisi (incorporated by
reference to Exhibit 10.4 of Registrant's Annual Report on
Form 10-KSB, filed on April 12, 2002; Commission File Number
000-29245).
10.5 Indemnification Agreement between the Company and Christopher
Tisi dated January 1, 2002 (incorporated by reference to
Exhibit 10.2 of Registrant's Current Report on Form 8-K filed
on February 13, 2002; Commission File Number 000-29245).
10.6 Indemnification Agreement between the Company and Steven
Pomerantz dated January 1, 2002 (incorporated by reference to
Exhibit 10.4 of Registrant's Current Report on Form 8-K filed
on February 13, 2002; Commission File Number 000-29245).
10.7 Lease Agreement between the Company and Fred Keller, Trustee
dated November 1, 2000 (incorporated by reference to Exhibit
10.5 of Registrant's Annual Report on Form 10-KSB, filed on
April 16, 2001; Commission File Number 000-29245).
10.8 Lease Agreement between the Company and Fred Keller, Trustee
dated January 1, 2001 (incorporated by reference to Exhibit
10.6 of Registrant's Annual Report on Form 10-KSB, filed on
April 16, 2001; Commission File Number 000-29245).
10.9 Secured Party's Bill of Sale between Fleet National Bank and
the Company dated January 12, 2001 (incorporated by reference
to Exhibit 10.1 of Registrant's Current Report on Form 8-K
filed on January 26, 2001; Commission File Number 000-29245).
31
10.10 Trademark Assignment from Heritage Consumer Products, LLC to
the Company dated January 12, 2001 (incorporated by reference
to Exhibit 10.2 of Registrant's Current Report on Form 8-K
filed on January 26, 2001; Commission File Number 000-29245).
10.11 Agreement between the Company and Steven Pomerantz dated
January 12, 2001 (incorporated by reference to Exhibit 10.3
of Registrant's Current Report on Form 8-K filed on January
26, 2001; Commission File Number 000-29245).
10.12 Shareholders' Agreement among Tony D'Amato, Christopher Tisi,
and the Company dated July 13, 2000 (incorporated by
reference to Exhibit 1 of Christopher Tisi, Steven Pomerantz,
Tony Musso, and Tony D'Amato's Schedule 13D, filed on January
February 14, 2001; Commission File Number 0-29245).
10.13 Irrevocable Proxy dated July 13, 2000 (incorporated by
reference to Exhibit 2 of Christopher Tisi, Steven Pomerantz,
Tony Musso, and Tony D'Amato's Schedule 13D, filed on January
February 14, 2001; Commission File Number 0-29245).
10.14 Waiver dated January 31, 2001 (incorporated by reference to
Exhibit 3 of Christopher Tisi, Steven Pomerantz, Tony Musso,
and Tony D'Amato's Schedule 13D, filed on January February
14, 2001; Commission File Number 0-29245).
10.15 Joint Filing Agreement dated February 13, 2001 (incorporated
by reference to Exhibit 4 of Christopher Tisi, Steven
Pomerantz, Tony Musso, and Tony D'Amato's Schedule 13D, filed
on January February 14, 2001; Commission File Number
0-29245).
10.16 Exclusive Manufacturing Agreement dated April 11, 2002
between the Company and Garden State Nutritionals, a division
of VitaQuest International, Inc. (incorporated by reference
to Exhibit 10.16 of Registrant's Annual Report on Form
10-KSB, filed on April 12, 2002; Commission File Number
000-29245).
10.17 Security Agreement dated April 11, 2002 between the Company
and Garden State Nutritionals, a division of VitaQuest
International, Inc. (incorporated by reference to Exhibit
10.16 of Registrant's Annual Report on Form 10-KSB, filed on
April 12, 2002; Commission File Number 000-29245).
10.18 Health & Nutrition Systems International, Inc. 1998 Stock
Option Plan (incorporated by reference to Exhibit 10.18 of
Registrant's Annual Report on Form 10-KSB, filed on April 12,
2002; Commission File Number 000-29245).
10.19 Promissory Note dated April 11, 2002 between the Company as
borrower and Garden State Nutritionals as lender
(incorporated by reference to Exhibit 10.19 of Registrant's
Annual Report on Form 10-KSB, filed on April 12, 2002;
Commission File Number 000-29245).
10.20 Subordination Agreement dated April 11, 2002 among the
Company, LSQ Funding Group, L.C. and Garden State
Nutritionals (incorporated by reference to Exhibit 10.20 of
Registrant's Annual Report on Form 10-KSB, filed on April 12,
2002; Commission File Number 000-29245).
10.21 Amendment No. 1 dated April 29, 2002 to the Employment
Agreement between the Company and Christopher Tisi effective
as of January 1, 2002 (incorporated by reference to Exhibit
10.21 of Registrant's Annual Report on Form 10-KSB/A-1, filed
on April 30, 2002; Commission File Number 000-29245).
32
10.22 Amendment No. 1 dated April 29, 2002 to the Severance
Agreement between the Company and Steven Pomerantz effective
as of January 1, 2002 (incorporated by reference to Exhibit
10.2 of Registrant's Annual Report on Form 10-KSB/A-1, filed
on April 30, 2002; Commission File Number 000-29245).
10.23 First Amendment to Shareholders' Agreement among Tony
D'Amato, Christopher Tisi and the Company dated April 24,
2002 (incorporated by reference to Exhibit 4 of Christopher
Tisi, Steven Pomerantz and Tony D'Amato's Schedule 13D, filed
on April 29, 2002; Commission File Number 0-29245).
10.24 Irrevocable Proxy dated April 24, 2002 (incorporated by
reference to Exhibit 5 of Christopher Tisi, Steven Pomerantz
and Tony D'Amato's Schedule 13D, filed on April 29, 2002;
Commission File Number 0-29245).
10.25 Option Agreement effective as of February 12, 2002 between
the Company and Christopher Tisi (incorporated by reference
to Exhibit 10.25 of Registrant's Annual Report on Form
10-KSB/A-1, filed on April 30, 2002; Commission File Number
000-29245).
10.26 Indemnification Agreement between Ted Alflen and the Company
dated as of January 1, 2002 (incorporated by reference to
Exhibit 10.1 of Registrant's Quarterly Report on Form 10-QSB,
filed on November 14, 2002; Commission File Number
000-29245).
10.27 Indemnification Agreement between Darryl Green and the
Company dated as of January 1, 2002 (incorporated by
reference to Exhibit 10.2 of Registrant's Quarterly Report on
Form 10-QSB, filed on November 14, 2002; Commission File
Number 000-29245).
10.28 Employment Agreement between the Company and Christopher Tisi
dated as of January 1, 2004 (incorporated by reference to
Exhibit 10.1 of Registrant's Report on Form 8-K, filed April
14, 2004; Commission File Number 000-29245).
14.1 Code of Ethics *
16.1 Letter from Butner & Kahle, CPA dated September 6, 2000
(incorporated by reference to Exhibit 16.4 of Registrant's
Current Report on Form 8-K filed on September 7, 2000;
Commission File Number 000-29245).
23.1 Consent of Independent Auditors*
24 Power of attorney (included on signature page).
31.1 Certification Pursuant to Item 601(b)(31) of Regulation S-K,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.*
31.2 Certification Pursuant to Item 601(b)(31) of Regulation S-K,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.*
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
* Included with this filing
33
(b) Reports on Form 8-K
Form 8-K filed on December 4, 2003 reporting an Item 5 event.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated by reference to
our definitive proxy statement to be filed within 120 days of December 31, 2003
in connection with solicitation of proxies for our 2004 annual meeting of
shareholders.
[INTENTIONALLY LEFT BLANK]
34
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Date: April 14, 2004 Health & Nutrition Systems International, Inc.
By: /s/ Christopher Tisi
------------------------------------------
Christopher Tisi
Chief Executive Officer, President, and
Secretary (Principal Executive Officer)
Each person whose signature appears below hereby constitutes and
appoints Christopher Tisi his true and lawful attorney-in-fact and agent, with
full power of substitution, for him and in his name, place and stead, in any and
all capacities, to sign any and all amendments to this report on Form 10-KSB,
and to file the same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorney-in-fact and his agents, and each of them full power and authority to do
and perform each and every act and all intents and purposes as he might or could
do in person, hereby ratifying and confirming all that such attorney-in-fact and
agents or any of them or his or their substitute or substitutes, may lawfully do
or cause to be done by virtue hereof.
In accordance with the requirements of the Exchange Act, this report
has been signed by the following persons in the capacities and on the dates
indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ James A. Brown Chairman of the Board April 14, 2004
- ------------------------
James A. Brown
/s/ Christopher Tisi Chief Executive Officer, President, and April 14, 2004
- ------------------------ Secretary (Principal Executive Officer)
Christopher Tisi
/s/ Al Dugan Controller (Principal Accounting Officer) April 14, 2004
- ------------------------
Al Dugan
/s/ Steven A. Pomerantz Director April 14, 2004
- ------------------------
Steven A. Pomerantz
/s/ Ted Alflen Director April 14, 2004
- ------------------------
Ted Alflen
35
Index to Exhibits
Exhibit
Number Description of Exhibits
- ------- -----------------------------------------------------------------------
14.1 Code of Ethics
23.1 Consent of Independent Auditors
24 Power of attorney (included on signature page).
31.1 Certification Pursuant to Item 601(b)(31) of Regulation S-K, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification Pursuant to Item 601(b)(31) of Regulation S-K, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 14.1
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC. (THE "COMPANY")
CODE OF BUSINESS CONDUCT AND ETHICS
INTRODUCTION
This Code of Business Conduct and Ethics covers a wide range of
business practices and procedures. It does not cover every issue that may arise,
but it sets out basic principles to guide all employees of the Company. All
Company employees must conduct themselves accordingly and seek to avoid even the
appearance of improper behavior. In appropriate circumstances, the Code should
also be provided to and followed by the Company's agents and representatives,
including consultants.
If a law conflicts with a policy in this Code, the employee must comply
with the law; however, if a local custom or policy conflicts with this Code, the
employee must comply with the Code. If an employee has any questions about these
conflicts, the employee should ask his or her supervisor how to handle the
situation.
Any employee who violates the standards in this Code will be subject to
disciplinary action. If an employee is in a situation that the employee believes
may violate or lead to a violation of this Code, the employee should follow the
guidelines described in Section 14 of this Code.
1. COMPLIANCE WITH LAWS, RULES, AND REGULATIONS
Obeying the law, both in letter and in spirit, is the foundation on
which this Company's ethical standards are built. All employees must respect and
obey the laws of the cities, states, and countries in which the Company
operates. Although not all employees are expected to know the details of these
laws, it is important to know enough to determine when to seek advice from
supervisors, managers, or other appropriate personnel.
The Company holds information and training sessions to promote
compliance with laws, rules, and regulations, including insider-trading laws.
2. CONFLICTS OF INTEREST
A "conflict of interest" exists when an individual's private interest
interferes in any way - or even appears to conflict - with the interests of the
Company as a whole. A conflict situation can arise when an employee, officer, or
director takes actions or has interests that may make it difficult to perform
his or her work on behalf of the Company in an objective and effective manner.
Conflicts of interest may also arise when an employee, officer, or director, or
a member of his or her family, receives improper personal benefits as a result
of his or her position in the Company. Loans to, or guarantees of obligations
of, employees and their family members may create conflicts of interest.
It is almost always a conflict of interest for a Company employee to
work simultaneously for a competitor, customer, or supplier. An employee is not
allowed to work for a competitor as a consultant or board member. The best
policy is to avoid any direct or indirect business connection with the Company's
customers, suppliers, or competitors, except on the Company's behalf.
Conflicts of interest are prohibited as a matter of Company policy,
except under guidelines approved by the Board of Directors. Conflicts of
interest may not always be clear-cut, so if a question arises, the employee you
should consult with higher levels of management or the Company's internal
auditor. Any employee, officer, or director who becomes aware of a conflict or
potential conflict should bring it to the attention of a supervisor, manager, or
other appropriate personnel, or consult the procedures described in Section 14
of this Code.
3. INSIDER TRADING
Employees who have access to confidential information are not permitted
to use or share that information for stock trading purposes or for any other
purpose except the conduct of the Company's business. All non-public information
about the Company should be considered confidential information. To use
non-public information for personal financial benefit or to "tip" others who
might make an investment decision on the basis of this information is not only
unethical but also illegal. If a question arises, the employee should consult
the Company's Chief Financial Officer.
4. CORPORATE OPPORTUNITIES
Employees, officers, and directors are prohibited from taking for
themselves personally opportunities that are discovered through the use of
corporate property, information, or position without the consent of the Board of
Directors. No employee may use corporate property, information, or position for
improper personal gain, and no employee may compete with the Company directly or
indirectly. Employees, officers, and directors owe a duty to the Company to
advance its legitimate interests when the opportunity to do so arises.
5. COMPETITION AND FAIR DEALING
The Company seeks to outperform competitors fairly and honestly. The
Company seeks competitive advantages through superior performance, never through
unethical or illegal business practices. Stealing proprietary information,
possessing trade secret information that was obtained without the owner's
consent, or inducing such disclosures by past or present employees of other
companies is prohibited. Each employee, officer, and director should endeavor to
respect the rights of and deal fairly with the Company's customers, suppliers,
competitors, and employees. No employee, officer, or director should take unfair
advantage of anyone through manipulation, concealment, or abuse of privileged
information, misrepresentation of material facts, or any other intentional
unfair-dealing practice.
To maintain the Company's valuable reputation, compliance with the
Company's quality processes and safety requirements is essential. In the context
of ethics, quality requires that the Company's products and services meet
reasonable customer expectations. All inspection and testing documents must be
handled in accordance with all applicable regulations.
The purpose of business entertainment and gifts in a commercial setting
is to create good will and sound working relationships, not to gain unfair
advantage with customers. No gift or entertainment should ever be offered,
given, provided, or accepted by any Company employee, family member of an
employee, or agent unless it (1) is not a cash gift, (2) is consistent with
customary business practices, (3) is not excessive in value, (4) cannot be
construed as a bribe or payoff, and (5) does not violate any laws or
regulations. An employee should discuss with his or her supervisor any gifts or
proposed gifts that the employee is not certain are appropriate.
6. DISCRIMINATION AND HARASSMENT
The diversity of the Company's employees is a tremendous asset. The
Company is firmly committed to providing equal opportunity in all aspects of
employment and will not tolerate any illegal discrimination or harassment or any
kind. Examples include derogatory comments based on racial or ethnic
characteristics and unwelcome sexual advances.
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7. HEALTH AND SAFETY
The Company strives to provide each employee with a safe and healthful
work environment. Each employee has responsibility for maintaining a safe and
healthy workplace for all employees by following safety and health rules and
practices and reporting accidents, injuries, and unsafe equipment, practices, or
conditions.
Violence and threatening behavior are not permitted. Employees should
report to work in condition to perform their duties, free from the influence of
illegal drugs or alcohol. The use of illegal drugs in the workplace will not be
tolerated.
8. RECORD-KEEPING
The Company requires honest and accurate recording and reporting of
information in order to make responsible business decisions. For example, only
the true and actual number of hours worked should be reported.
Many employees regularly use business expense accounts, which must be
documented and recorded accurately. If an employee is not sure whether a certain
expense is legitimate, the employee should ask his or her supervisor or the
Company's controller. No employee, officer or director of the Company shall make
or approve payments on behalf of the Company if they will not be used or might
be used for something other than the stated purpose. Rules and guidelines are
available from the Accounting Department.
All of the Company's books, records, accounts, and financial statements
must be maintained in reasonable detail, must properly document all assets and
liabilities, must appropriately reflect the Company's transactions, and must
conform both to applicable legal requirements and to the Company's system of
internal controls. Unrecorded or "off the books" funds or assets should not be
maintained unless permitted by applicable law or regulation. No employee,
officer or director of the Company shall falsify entries for any reason, nor
will such employee, officer or director alter documents or sign documents on
behalf of the Company when he/she lacks the proper authority to do so. No
employee, agent, representative, supplier, or customer shall falsify a record to
conceal facts or for any other reason. The Company shall follow generally
accepted accounting principles and complies with Financial Accounting Standards
Board regulations to provide a uniform basis for measuring, managing, and
reporting the Company's operations.
Business records and communications often become public, and the
Company and its employees should avoid exaggeration, derogatory remarks,
guesswork, or inappropriate characterizations of people and companies that can
be misunderstood. This applies equally to e-mail, internal memos, and formal
reports. Records should always be retained or destroyed according to the
Company's record retention policies. In accordance with those policies, in the
event of litigation or governmental investigation, employees must consult with
the Company's Chief Financial Officer before taking any action because it is
critical that any impropriety or possible appearance of impropriety be avoided.
9. CONFIDENTIALITY
Employees, officers, and directors must maintain the confidentiality of
confidential information entrusted to them by the Company or its customers,
except when disclosure is authorized by an executive officer or required or
mandated by laws or regulations. Confidential information includes all
non-public information that might be of use to competitors or harmful to the
Company or its customers, if disclosed. It also includes information that
suppliers and customers have entrusted to us. The obligation to preserve
confidential information continues even after employment ends.
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10. PROTECTION AND PROPER USE OF COMPANY ASSETS
All employees, officers, and directors should endeavor to protect the
Company's assets and ensure their efficient use. Theft, carelessness, and waste
have a direct impact on the Company's profitability. Any suspected incident of
fraud or theft should be immediately reported for investigation. Company assets
should be used for legitimate business purposes and should not be used for
non-Company business, though incidental personal use may be permitted.
The obligation of employees to protect the Company's assets includes
its proprietary information. Proprietary information includes intellectual
property, such as trade secrets, patents, trademarks, and copyrights, as well as
business, marketing and service plans, engineering and manufacturing ideas,
designs, databases, records, salary information, and any unpublished financial
data and reports. Unauthorized use or distribution of this information would
violate Company policy. It could also be illegal and result in civil or even
criminal penalties.
11. PAYMENTS TO GOVERNMENT PERSONNEL
The U.S. Foreign Corrupt Practices Act prohibits giving anything of
value, directly or indirectly, to officials of foreign governments or foreign
political candidates in order to obtain or retain business. It is strictly
prohibited to make illegal payments to government officials of any country.
In addition, the U.S. government has a number of laws and regulations
regarding business gratuities that may be accepted by U.S. government personnel.
The promise, offer, or delivery to an official or employee of the U.S.
government of a gift, favor, or other gratuity in violation of these rules would
not only violate Company policy but could also be a criminal offense. State and
local governments, as well as foreign governments, may have similar rules.
12. WAIVERS OF THE CODE OF BUSINESS CONDUCT AND ETHICS
Any waiver of this Code for executive officers or directors may be made
only by the Board or a Board committee and will be promptly disclosed to
stockholders as required by law or stock exchange regulation.
13. REPORTING ANY ILLEGAL OR UNETHICAL BEHAVIOR
Employees are encouraged to talk to supervisors, managers, or other
appropriate personnel when in doubt about the best course of action in a
particular situation. Employees should report any observed illegal or unethical
behavior and any perceived violations of laws, rules, regulations, or this Code
of Business Conduct to appropriate personnel. It is the policy of the Company
not to allow retaliation for reports of misconduct by others made in good faith
by employees. Employees are expected to cooperate in internal investigations of
misconduct.
14. COMPLIANCE PROCEDURES
We must all work to ensure prompt and consistent action against
violations of this Code. However, in some situations it is difficult to know
right from wrong. Since we cannot anticipate every situation that will arise, it
is important that we have a way to approach a new question or problem. These are
the steps to keep in mind:
o Make sure you have all the facts. In order to reach the right solutions, we
must be as fully informed as possible.
4
o Ask yourself: What specifically am I being asked to do? Does it seem
unethical or improper? This will enable you to focus on the specific
question you are faced with and the alternatives you have. Use your judgment
and common sense; if something seems unethical or improper, it probably is.
o Clarify your responsibility and role. In most situations, there is shared
responsibility. Are your colleagues informed? It may help to get others
involved and discuss the problem.
o Discuss the problem with your supervisor. This is the basic guidance for all
situations. In many cases, your supervisor will be more knowledgeable about
the question and will appreciate being brought into the decision-making
process. Remember that it is your supervisor's responsibility to help solve
problems.
o Seek help from Company resources. In the rare case where it may not be
appropriate to discuss an issue with your supervisor, or where you do not
feel comfortable approaching your supervisor with your question, discuss it
locally with your office manager or your Human Resources manager. If that
also is not appropriate, call the Company's toll-free Ethics Line, which
will put you in direct contact with the appropriate people at Company
headquarters. If you prefer to write, address your concerns to the Company's
Chief Executive Officer or Chief Financial Officer.
o You may report ethical violations in confidence and without fear of
retaliation. If your situation requires that your identity be kept secret,
your anonymity will be protected. The Company does not permit retaliation of
any kind against employees for good faith reports of ethical violations.
o Always ask first, act later: If you are unsure of what to do in any
situation, seek guidance before you act.
15. SENIOR FINANCIAL OFFICERS
In addition to being subject to all of the foregoing principles, particularly
the principles set forth in Section 8 concerning record keeping, each of the
Company's senior financial officers, including the Company's principal financial
officer and controller or principal accounting officer and persons performing
similar functions, must agree with and certify to the Company's Chief Financial
Officer or, in the case of the Chief Financial Officer, to the Company's Audit
Committee, that such executive will adhere to and advocate the above principles
as well as the principles set forth below in fulfilling their responsibilities
and duties to the Company:
o Provide constituents with information that is accurate, complete,
objective, relevant, timely and understandable.
o Act in good faith, responsibly, with due care, competence and diligence,
without misrepresenting material facts or allowing such executive's
independent judgment to be subordinated.
o Share knowledge and maintain skills important and relevant to the needs
of such executive's constituents.
o Proactively promote ethical behavior as a responsible partner among
peers in such executive's work environment.
o Achieve responsible use of and control over all assets and resources
employed or entrusted to such executive.
o Conduct such executive's duties according to standards reasonably
necessary to promote:
5
o honest and ethical conduct, including the ethical handling of actual
or apparent conflicts of interest between personal and professional
relationships;
o full, fair, accurate, timely and understandable disclosure in
periodic reports required to be filed by the Company; and
o compliance with applicable governmental rules and regulations.
6
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC. (THE "COMPANY")
FINANCIAL CODE OF ETHICS
The reliability and integrity of the Company's financial statements and
other financial information as may be included in reports filed with or
furnished to the SEC, stock exchanges, governmental agencies, financial
institutions, as well as shareholders, suppliers, customers and others are
critical to the well being and reputation of the Company. In this regard, the
Company has adopted this Financial Code of Ethics.
This Financial Code of Ethics, which is also a part of the Company's
Code of Business Conduct and Ethics, covers various practices, procedures, and
actions applicable for the Company's senior financial officers. Each such
financial officer should conduct himself or herself in a manner to promote
honest and ethical conduct; full, accurate, and timely disclosure; and
compliance with law.
Each senior financial officer must conduct his or her duties according
to standards reasonably necessary to promote -
1. honest and ethical conduct, including the ethical handling of actual or
apparent conflicts of interest between personal and professional
relationships;
2. full, fair, accurate, timely, and understandable disclosure in periodic
reports required to be filed by the Company; and
3. compliance with applicable governmental rules and regulations.
No change in or waiver of this Financial Code of Ethics will be
permitted except as approved by the audit committee of the Company.
In the event of any change in or waiver of this Financial Code of
Ethics, the Company will promptly notify its shareholders by filing a Form 8-K,
by dissemination on the Internet, or by other electronic means.
7
Exhibit 23
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the Registration Statement on
Form S-8 No. 333110989 of Health & Nutrition Systems International, Inc. of our
report dated March 19, 2004, with respect to the financial statements included
in the Annual Report on Form 10-KSB of Health & Nutrition Systems International,
Inc. for the year ended December 31, 2003.
/s/ DaszkalBolton LLP
Boca Raton, Florida
April 12, 2004
Exhibit 31.1
CERTIFICATIONS
I, Christopher Tisi, President and Chief Executive Officer of Health &
Nutrition Systems International, Inc. certify that:
1. I have reviewed this report on Form 10-KSB of Health & Nutrition
Systems International, Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
small business owner as of, and for, the periods presented in this report;
4. The small business owner's other certifying officer and I are
responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) for the small business
issuer and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the small business issuer,
including its consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this report is being
prepared;
b) Evaluated the effectiveness of the small business issuer's
disclosure controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure and controls procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the small business
issuer's internal control over financial reporting that occurred during the
small business issuer's most recent fiscal quarter (the small business issuer's
fourth fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the small business
issuer's internal control over financial reporting; and
5. The small business issuer's other certifying officer and I have
disclosed, based on our most recent evaluation of internal control over
financial reporting, to the small business issuer's auditors and the audit
committee of the small business issuer's board of directors (or persons
performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting which are
reasonably likely to adversely affect the small business issuer's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the small business issuer's
internal control over financial reporting.
Date April 14, 2004
/s/ Christopher Tisi
- -----------------------
Christopher Tisi
Chief Executive Officer
Exhibit 31.2
CERTIFICATIONS
I, Al Dugan, Controller and Chief Accounting Officer of Health &
Nutrition Systems International, Inc. certify that:
1. I have reviewed this report on Form 10-KSB of Health & Nutrition
Systems International, Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
small business owner as of, and for, the periods presented in this report;
4. The small business owner's other certifying officer and I are
responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) for the small business
issuer and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the small business issuer,
including its consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this report is being
prepared;
b) Evaluated the effectiveness of the small business issuer's
disclosure controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure and controls procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the small business
issuer's internal control over financial reporting that occurred during the
small business issuer's most recent fiscal quarter (the small business issuer's
fourth fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the small business
issuer's internal control over financial reporting; and
5. The small business issuer's other certifying officer and I have
disclosed, based on our most recent evaluation of internal control over
financial reporting, to the small business issuer's auditors and the audit
committee of the small business issuer's board of directors (or persons
performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting which are
reasonably likely to adversely affect the small business issuer's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the small business issuer's
internal control over financial reporting.
Date April 14, 2004
/s/ Al Dugan
- -------------------------------------------------
Al Dugan, Controller and Chief Accounting Officer
Exhibit 32.1
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350, AS ADOPTED
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Health & Nutrition Systems
International, Inc. (the "Company") on Form 10-KSB for the fiscal year ended
December 31, 2003 as filed with the Securities and Exchange Commission on the
date hereof (the "Report"), I, Christopher Tisi, President and Chief Executive
Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
/s/ Christopher Tisi
- -----------------------
Christopher Tisi
Chief Executive Officer
April 14, 2004
Exhibit 32.2
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350, AS ADOPTED
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Health & Nutrition Systems
International, Inc. (the "Company") on Form 10-KSB for the fiscal year ended
December 31, 2003 as filed with the Securities and Exchange Commission on the
date hereof (the "Report"), I, Al Dugan, Controller (Principal Accounting
Officer) of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
/s/ Al Dugan
- -----------------------------------------
Al Dugan
Controller (Principal Accounting Officer)
April 14, 2004