UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF
THE EXCHANGE ACT
FOR THE TRANSITION PERIOD FROM _____________ TO _____________
COMMISSION FILE NO. 000-29245
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
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(Exact name of small business issuer as specified in its charter)
FLORIDA
-------
(State or other jurisdiction of incorporation or organization)
65-0452156
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(I.R.S. Employer Identification Number)
3750 INVESTMENT LANE, SUITE 5, WEST PALM BEACH, FLORIDA 33407
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(Address of principal executive offices)
(561) 863-8446
--------------
(Issuer's telephone number)
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 [ ]
There were 3,832,813 shares of common stock, $0.001 par value, of the
registrant outstanding at June 30, 2004.
Transitional Small Business Disclosure Format: Yes [ ] No [X]
HEALTH AND NUTRITION SYSTEMS INTERNATIONAL, INC.
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INDEX
Page
PART I - FINANCIAL INFORMATION...........................................................................1
Item 1. Financial Statements..........................................................................1
Item 2. Management's Discussion and Analysis or Plan of Operation.....................................7
Item 3. Controls and Procedures......................................................................18
PART II - OTHER INFORMATION..............................................................................18
Item 1. Legal Proceedings............................................................................18
Item 2. Changes in Securities and Small Business Issuer Purchases of Equity Securities...............19
Item 3. Defaults Upon Senior Securities..............................................................19
Item 4. Submission of Matters to a Vote of Security Holders..........................................19
Item 5. Other Information............................................................................19
Item 6. Exhibits and Reports on Form 8-K.............................................................20
SIGNATURES...............................................................................................21
i
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
CONDENSED BALANCE SHEET
JUNE 30, 2004
(UNAUDITED)
- --------------------------------------------------------------------------------
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ASSETS
------
Current assets:
Cash $ 40,335
Accounts receivable, net (175,504)
Inventory 1,164,676
Prepaid expenses 55,344
-----------
Total current assets 1,084,851
-----------
Property and equipment, net 88,815
-----------
Other assets:
Trademarks, net 697
Security deposits 8,019
-----------
Total other assets 8,716
-----------
Total assets $ 1,182,382
===========
LIABILITIES AND STOCKHOLDERS' DEFICIT
-------------------------------------
Current liabilities:
Accounts payable $ 1,391,811
Accrued expenses 271,676
Notes payable, current portion 504,671
-----------
Total current liabilities 2,168,158
-----------
Notes payable, less current portion 27,971
-----------
Total liabilities 2,196,129
-----------
Stockholders' deficit:
Common stock $0.001 par value, authorized 30,000,000 shares;
3,832,813 shares issued and outstanding 3,830
Additional paid-in capital 858,612
Accumulated deficit (1,876,189)
-----------
Total stockholders' deficit (1,013,747)
-----------
Total liabilities and stockholders' deficit $ 1,182,382
===========
See accompanying notes to condensed financial statements
1
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
CONDENSED STATEMENTS OF OPERATIONS
JUNE 30, 2004
(UNAUDITED)
- --------------------------------------------------------------------------------
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2004 2003 2004 2003
----------- ----------- ----------- -----------
Revenue $ 1,390,171 $ 1,436,549 $ 2,879,547 $ 2,502,096
Cost of sales 700,177 553,284 1,340,113 1,004,702
----------- ----------- ----------- -----------
Gross profit 689,994 883,265 1,539,434 1,497,394
----------- ----------- ----------- -----------
Operating expense:
General and administrative expense 855,739 467,351 1,306,210 808,544
Advertising and promotion 687,941 333,901 1,161,755 496,312
Depreciation and amortization 7,155 4,883 13,052 12,326
----------- ----------- ----------- -----------
Total operating expense 1,550,835 806,135 2,481,017 1,317,182
----------- ----------- ----------- -----------
Income from operations (860,841) (77,130) (941,583) 180,212
----------- ----------- ----------- -----------
Other income (expense):
Interest expense (8,106) (8,740) (18,104) (19,568)
----------- ----------- ----------- -----------
Income before income taxes (868,947) (68,390) (959,687) 160,644
----------- ----------- ----------- -----------
Benefit (provision) for income taxes -- -- -- --
----------- ----------- ----------- -----------
Net income $ (868,947) $ (68,390) $ (959,687) $ 160,644
=========== =========== =========== ===========
Net income per share - basic $ (0.23) $ (0.02) $ (0.25) $ 0.04
=========== =========== =========== ===========
Net income per share - diluted $ (0.23) $ (0.02) $ (0.25) $ 0.04
=========== =========== =========== ===========
Weighted average number of shares - basic 3,832,813 3,632,813 3,832,813 3,632,813
=========== =========== =========== ===========
Weighted average number of shares - diluted 3,832,813 3,632,813 3,832,813 3,632,813
=========== =========== =========== ===========
See accompanying notes to condensed financial statements
2
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
CONDENSED STATEMENTS OF CASH FLOWS
JUNE 30, 2004
(UNAUDITED)
- --------------------------------------------------------------------------------
SIX MONTHS ENDED
JUNE 30,
2004 2003
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Net cash provided by operating activities $ 330,801 $ 194,319
--------- ---------
Cash flows from investing activities:
Purchase of property and equipment (28,251) --
--------- ---------
Net cash used in investing activities (28,251) --
Cash flows from financing activities:
Repayments on notes payable (269,621) (197,000)
Repayments on capital leases -- (714)
--------- ---------
Net cash used in financing activities (269,621) (197,714)
--------- ---------
Net increase (decrease) in cash 32,929 (3,395)
Cash, beginning of period 7,406 14,778
--------- ---------
Cash, end of period $ 40,335 $ 11,383
========= =========
Supplemental disclosure of cash flow information:
Note payable for purchase of automobile $ 23,357 $ --
========= =========
See accompanying notes to condensed financial statements
3
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
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NOTE 1 - BASIS OF PRESENTATION
- ------------------------------
The accompanying unaudited condensed financial statements of Health & Nutrition
Systems International, Inc. (the "Company") have been prepared in accordance
with generally accepted accounting principles for interim financial information
and Regulation S-B. Accordingly, they do not include all of the information and
footnotes required for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation of the results for the
interim periods presented have been included.
These results have been determined on the basis of generally accepted accounting
principles and practices applied consistently with those used in the preparation
of the Company's Annual Financial Statements for the year ended December 31,
2003. Operating results for the six months ended June 30, 2004 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2004.
It is recommended that the accompanying condensed financial statements be read
in conjunction with the financial statements and notes for the year ended
December 31, 2003, found in the Company's Form 10-KSB.
NOTE 2 - 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 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 June 30, 2004, the Company had approximately $247,300 of inventory on
consignment relating to its "pay on scan" sales. On June 30, 2003, the Company
had no outstanding consignment sales.
Included in net sales in the accompanying financial statements are reductions
for anticipated returns and allowances, sales discounts, new store opening
discounts, and co-op advertising and promotions.
4
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 3 - LEGAL MATTERS
- ----------------------
The Company from time to time is a party to various legal proceedings. The
Company has been sued in the U.S. District Court for the Southern District of
New York by Window Rock Enterprises, Inc. for statutory and common law trademark
infringement, trade dress infringement, unfair competition and dilution under
both federal and New York state laws. This suit arises out of the Company's
distribution of its CortiLess(R) product. The Company has answered the suit,
denying the allegations, and the Court has scheduled a status conference on the
matter during September 2004. At that time, the Court may fix deadlines for
discovery, dispositive motions and a tentative trial period. The Company does
not believe this suit has merit and has undertaken all reasonable steps to
minimize its potential liability for monetary damages and/or injunctive relief
in this instance. If a court were to issue a ruling adverse to the Company's
interests, however, it could have a materially adverse impact on the Company.
The Company is a party in two other legal actions. In the opinion of the
Company's management, neither of those proceedings are expected to have a
material impact on its financial position or results of operations.
NOTE 4- ACCOUNTS RECEIVABLE
- ---------------------------
As of June 30, 2004, the Company had a negative accounts receivable balance of
$175,504. The negative accounts receivable balance is the result of establishing
o a reserve of $554,100 for the anticipated return of the
Company's products based on notice from customers indicating
that they intended to discontinue selling it
o a reserve of $77,000 for the anticipated return of products
following the merger of two major customers based on notice
from the acquirer that it would be returning all SKUs from the
acquired chain that were not SKUs of the acquirer.
After the application of these two reserves, our accounts receivable balance was
further reduced by $718,827 of other customer liabilities. The total amount of
the reduction was $1,349,927 as of June 30, 2004. The result of the allowances
and the reductions for customer liabilities is the negative accounts receivable
balance of $175,504.
NOTE 5- MANAGEMENT'S PLANS AND ISSUES AFFECTING LIQUIDITY
- ---------------------------------------------------------
The Company's condensed financial statements have been prepared assuming that
the Company will continue as a going concern. However, in the first six months
of 2004, the Company's administrative costs, cost of goods as a percentage of
net revenues, and advertising expenses all rose. In addition, the Company
established reserves for anticipated product returns of $631,100. As a result,
for the first six months of 2004, the Company had a net loss of $959,687. Cash
flow provided from operations was $330,800. The increase in advertising
expenditures and general and administrative expenses were financed in part by a
temporary increase in payment terms by our supplier, Garden State Nutritionals.
At June 30, 2004, the Company has a working capital deficit of $1,083,307 and
adverse liquidity ratios.
The Company's management intends to enhance efforts to control costs, and is
closely monitoring its financial capabilities. The Company's management believes
that controlling costs and financial discipline are critical to its ability to
operate profitably.
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 from the
outcome of this uncertainty.
NOTE 6- STOCK OPTIONS
- ---------------------
The non-qualified stock option plan adopted by the Company in May 1998
authorized the Company to grant options to purchase 1,250,000 of its common
shares.
5
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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.
During the six months ended June 30, 2004, in conjunction with the execution of
a new employment contract, Mr. Christopher Tisi, our Chief Executive Officer,
was granted options to purchase 50,000 shares of HNS stock at $.30. Those
options have a four-year term.
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 June 30, 2004, the Company's net income and
earnings per share would have been reduced to the proforma amounts indicated
below:
JUNE 30, 2004
-------------
Net income
As reported $ (969,257)
=============
Pro forma $ (959,687)
=============
Earnings per share
As reported $ (0.25)
==============
Pro forma $ (0.25)
==============
The fair value of each option is estimated on the date of grant using the fair
market value option-pricing model with the following assumptions:
Risk-free interest rate 4.5% - 6.5%
Expected life (years) Various
Expected volatility 1.23
Expected dividends None
NOTE 7- NOTES PAYABLE
- ---------------------
In July 2003, the Company issued an amended promissory note to Garden State
Nutritionals in the principal amount of $1,300,000 bearing interest at 4.5% per
annum. The balance of the note at June 30, 2004 was $511,185. The note is
payable in quarterly installments of $131,410.
In January 2004, the Company purchased a vehicle for use by a salesperson. To
facilitate the purchase, the Company issued a promissory note for $23,356
payable to a financial institution. A personal guarantee was required by the
lender to consummate the purchase. Our Chief Executive Officer, Christopher
Tisi, provided the guarantee. The balance of the note as of June 30, 2004 was
$21,457.
6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
This quarterly report on Form 10-QSB contains forward-looking statements. 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 contained in
our Form 10-KSB filed with the Securities and Exchange Commission. We do not
undertake any obligation to update any such factors or to publicly announce the
result of any revision to any of the forward looking statements contained herein
to reflect future events or developments.
The following discussion of our results of operations and financial condition
should be read together with our unaudited Financial Statements contained in
Part I, Item 1 and the related Notes in this Form 10-QSB and our audited
Financial Statements and the related Notes contained in our Form 10-KSB filed
with the Securities and Exchange Commission.
CRITICAL ACCOUNTING ESTIMATES
Financial Reporting Release No. 60, which was 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
probable returns, 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 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 June 30, 2004, we had approximately $247,300 of inventory on consignment
relating to "pay on scan" sales. At June 30, 2003, we had no inventory on
consignment.
Included in the net revenue in the accompanying financial statements for the six
months ended June 30, 2004 and 2003 are reductions for sales discounts, new
store opening discounts, co-op advertising and promotions, and anticipated
returns and allowances in the aggregate amounts of $1,376,741 and $984,982,
respectively. The larger reduction in the six months ending June 20, 2004 was
primarily due to increases in reserves for anticipated returns and allowances.
For the six months ended June 30, 2004, we established
o a reserve of $554,100 for the anticipated return of one of our
products based on notices from customers indicating that they
intended to discontinue selling it
7
o a reserve of $77,000 for the return of products following the
merger of two major customers based on notice from the
acquirer that it would be returning all SKUs from the acquired
chain that were not SKUs of the acquirer.
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, dated products, and anticipated returns and allowances as a
reduction of sales. The liability is maintained until the customer actually
takes the deduction, typically by deducting the amount of the claim from
remittances due to the Company. This liability is netted against the accounts
receivable account on the balance sheet. Typically, these liabilities remain
outstanding for three to six months as previously described. At June 30, 2004,
the amount of customer related liabilities was $1,349,927 compared to $1,000,529
at June 30, 2003.
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 require 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 in a given month, we create a
liability for that promotion.
We established reserves of $631,100 for the period ended June 30, 2004 on
account of anticipated returns, as compared to $175,000 for the six months ended
June 30, 2003.
RECENT DEVELOPMENTS
In July of 2003, the Board of Directions determined to consider strategic
alternatives to either enhance or replace our nutraceutical 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 our Chief Executive
Officer and President, Christopher Tisi, or an entity controlled by him.
8
Furthermore, based primarily on
o our loss of $959,687 for the six months ended June 30, 2004,
o our continued dependence on Garden State Nutritionals'
informal extension of favorable payment terms to us to finance
our operations,
o the increased cost of maintaining our status as a public
company,
o the costs of defending the action brought against us in
connection with our new CortiLess(R)product, and
o objections to the Company's advertising by the National
Advertising Division,
we may consider filing for reorganization under the protection of federal
bankruptcy laws. One of the possibilities involved in a reorganization also
would be a sale of our assets - possibly to Mr. Tisi.
On November 26, 2003, we entered into an agreement with TeeZee, Inc., a company
wholly owned by Mr. Tisi, our chief executive officer and president, to sell
TeeZee, Inc. 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, L.C., 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 2004, 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 employment 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 continued to review TeeZee's offer in light of developments subsequent
to the termination of the agreement. On April 22, 2004, the Board rejected the
offer. The Board primarily based its decision as not in the current best
interest of the shareholders, the current market value of the Company's shares,
current operations, and Mr. Tisi's recent agreement to stay with the company
through December 31, 2005. In addition, the Board chose to afford itself more
time to consider strategic alternatives. The Board intends to continue to
consider strategic alternatives to increase shareholder value, which
alternatives may include
o the sale of our current business, a merger or other
combination with another enterprise,
o our filing for reorganization under federal bankruptcy laws,
or both.
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;
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 net income. 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. Amounts paid in any
quarter are not subject to refund;
9
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
employment 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
sales in the United States to retailers or intermediaries of
products which directly or otherwise significantly compete
with products sold or distributed by the Company.
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.
To partially mitigate our sole reliance on Mr. Tisi, the Board 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.
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 two percent (2%) from those
reported in year 2002. Particularly, because of their popularity, increased
consumer use of low carbohydrate diets may 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 that other potential competitors may 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.
The National Advertising Division, a quasi-governmental enterprise which often
works closely with the FTC, has undertaken a significant review of
advertisements for diet industry products. As part of that review, we received
notice that the NAD objected to parts of one of our print advertisements. We
agreed to modify the language. However, if our competitors are not similarly
challenged, or choose to expand significant resources in an attempt to maintain
portions of their advertisements that the NAD deems objectionable, our ability
to present our product comprehensively would be seriously impaired.
COMPANY TRENDS
- --------------
Insurance
- ---------
Insurance for the products we sell has become significantly more expensive. Our
new policy, which became effective in March 2004 and carried a premium of
$157,000, is over twenty times higher than our prior policy. Because it is
written on a "claims made" rather than an "occurrence" basis, it does not
provide as much continuity of coverage as we historically have enjoyed. We
10
purchased $5,000,000 worth of coverage for 2004, as opposed to the $6,000,000
that we had in place in 2003. While we believe the level of coverage is 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 coverage that is
written on an "occurrence basis" 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, is spending more time in
assessing our internal controls and assisting us in
implementing other provisions of the Sarbanes-Oxley Act, and
our costs have increased accordingly.
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, has risen, and we believe will continue to
rise significantly in the future.
Adequate Working Capital
- ------------------------
Our working capital position improved in 2003, but has deteriorated in 2004. For
the six months ended June 30, 2004, our working capital declined by
approximately $1,250,448. At June 30, 2004, we had a working capital deficit of
($1,083,307). Our ability to grow has always been limited by cash constraints.
Our loss in the first six months and the resulting increase in cash constraints
will limit it even more. Cash constraints limit our ability to grow. In
addition, a change in our sole manufacturer's informal financing arrangements
with us, which occasionally enable us to exceed our payment terms, could make it
difficult or impossible to support our current level of sales. The loss or
reduction in sales to any of our key customers would also 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 have not identified any financing sources superior to or as good as that
provided to us by our sole manufacturer.
Diversification
- ---------------
We differentiate our products through the mixture of ingredients and the
relative amounts of those ingredients 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.
Until and unless we develop additional products that are accepted by the market,
we remain largely dependent on the sales of one product, Carb Cutter(R). Subject
to our ability to finance it, we intend to continue to implement our 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, we introduced Zoom(R). We introduced two
new products, Carb Cutter A-B and CortiLess(R), in the second quarter of 2004.
There is no assurance that these products will experience widespread consumer
acceptance. It is too early to determine whether customers will accept Carb
Cutter(R) Phase 2 on a long term basis, or whether Zoom(R) or our other new
products will be successful. Consumer tastes change quickly and product
formulations, as well as their attendant marketing support, may fail to yield
projected results. For example, after a very promising initial reception, one of
the products we introduced in 2003 experienced a sharp drop in demand; the brand
has failed to achieve the level of acceptance needed to sustain long term
viability despite our best efforts to support it. Our 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).
11
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. For the first six months of
2004, we increased our advertising expenditures to support the introduction of
new products during the first half of the year, but liquidity constraints
prohibit us from maintaining advertising at that increased level.
These factors also affect our competition. However, many of our competitors are
significantly better capitalized and have significantly greater human resources
than us.
RESULTS OF OPERATIONS
SUMMARY
- -------
Net revenues for the three months ended June 30, 2004 were $1,390,171 compared
to $1,436,549 for the same period in 2003, a decrease of $46,378, or 3%. General
and administrative expenses for the three months ended June 30, 2004 were
$855,738 compared to $467,351 for the same period in 2003, an increase of
$388,388, or 83%. The cost of sales, as a percentage of net sales, increased 11
% for the three months ended June 30, 2004, compared to June 30, 2003. The gross
profit for the three months ended June 30, 2004 was $689,993, or 50% of net
revenue compared to the same period in 2003 of $883,265, or 61%, a decrease of
$193,272.
Net revenues for the six months ended June 30, 2004 were $2,879,547, compared to
$2,502,096 for the same period in 2003, an increase of $377,451, or 15%. General
and administrative expenses for the six months ended June 30, 2004 were
$1,306,206 compared to $808,544 for the same period in 2003, an increase of
$497,666, or 61%. The cost of sales, as a percentage of net sales, increased by
only 7 % for the six months ended June 30, 2004, compared to June 30, 2003. The
gross profit for the six months ended June 30, 2004 was $1,539,434, or 53% of
net revenue compared to the same period in 2003 of $1,497,294, or 60%, an
increase of $42,040.
We believe that increasing advertising expenditures by $354,040 during the three
months and $665,443 for the six months ended June 30, 2004 was a significant
factor in generating increased net revenues for the periods. For the six months
ended June 30, 2004, we dedicated a substantial portion of our cash flow from
operations to fund our advertising expenditures. However, our current liquidity
issues will make it impossible to continue to fund advertising at the same level
and, we believe, adversely affects sales.
We had a loss of ($959,687) for the six months ended June 30, 2004, compared to
net income of $160,644 in the same period of 2003, a decrease of $1,120,331.
This decrease was primarily because we
o established reserves of $631,000 for anticipated product
returns, compared to reserves of $175,000 for the six months
ended June 30, 2003,
o increased advertising expenses from $496,312 to $1,161,755;
and
o general and administrative costs and expenses from $808,544 to
$1,306,210.
Most of our business continues to be with a few large customers. During the
three months and six months ended June 30, 2004, our five largest customers
comprised approximately 93% and 97% of our net revenues, respectively. This
compares with approximately 87% and 83% for the same periods in 2003. The
increased concentration of our business with a few customers makes us more
vulnerable to changes in their purchasing practices.
12
NET REVENUES
- ------------
We report our net revenue after deducting:
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.
Some of our new customers do not ask us to participate in co-op advertising and
other promotions. The increases were primarily the result of establishing
reserves for anticipated product returns. The aggregate amounts of the
deductions for the three months and six months ended June 30, 2004 were $780,972
and $1,376,741 compared to $433,745 and 984,982 for the same periods in 2003 -
increases for the comparable three month and six month periods ended June 30,
2004 of 80% and 39%, respectively. The increases were primarily the result of
establishing reserves for anticipated returns.
Net revenues for the three months ended June 30, 2004 were $1,390,171 compared
to $1,436,549 for the corresponding period in 2003, a decrease of $46,378, or 3%
despite increased advertising. The decrease was primarily a result of
establishing reserves for anticipated product returns of $463,100 for one of our
products. Three new products accounted for approximately 34% of the net revenue
in the period.
Net revenues for the six months ended June 30, 2004 were $2,879,547 compared to
$2,502,096 for the corresponding period in 2003, an increase of $377,451, or
15%. Net Revenues for the period were reduced by 631,100 on account of the
establishing reserves for anticipated product returns. Three new products
accounted for approximately 17% of the net revenue in the period.
We believe that increasing advertising expenditures by $354,040 during the three
months and $665,443 for the six months ended June 30, 2004 and the introduction
of new products were the significant factors in the increase in our net revenues
during the six month period.
NET INCOME (LOSS)
- -----------------
Our net loss for the three months ended June 30, 2004, was $868,947, compared to
a profit of $68,390 for the three months ended June 30, 2003, a decrease of
$937,337. Net loss per share was ($0.23) for the three months ended June 30,
2004, as compared to a net profit of $0.02 per share for the three months ended
June 30, 2003. This decrease was primarily because we
o established a reserve of $386,100 for one of our products, as
several of our customers notified us that they intend to
discontinue selling it, and $77,000 for the return of products
due to a merger of two large chains, both of which were our
customers,
o increased advertising expenses by $354,040; and
o increased general and administrative expenses by 388,388.
Our net loss for the six months ended June 30, 2004, was $959,687, compared to a
profit of $160,644 for the six months ended June 30, 2003, a decrease of
$1,120,331. Net loss per share was ($0.25) for the six months ended June 30,
2004, as compared to a net profit of $0.04 per share for the six months ended
June 30, 2003. This decrease was primarily because we
o established a reserve of $554,100 for one of our products, as
several of our customers notified us that they intended to
discontinue selling it, and $77,000 for return of products due
to a merger of two large chains, both of which were our
customers,
o increased advertising expenses by $665,443; and
o increased general and administrative expenses by $497,666.
13
COST OF SALES
- -------------
Cost of sales for the three months ended June 30, 2004 was $700,177, or 50% of
net revenues, as compared to $553,284, or 39% of net revenues for the
corresponding period in 2003. The dollar amount is higher because of increased
sales during the period. The percentage is as a function of Net Revenues higher
because the establishment of reserves against potential product returns resulted
in the large reduction from sales of $780,972 compared to $433,745 for the
corresponding period in 2003.
Cost of sales for the six months ended June 30, 2004 was $1,340,113, or 47% of
net revenues, as compared to $1,004,702, or 40% of net revenues for the
corresponding period in 2003. The dollar amount is higher because of increased
sales before giving effect to reserves for anticipated product returns during
the period. The percentage as a function of Net Revenues is higher due to the
large reduction of $1,376,741 from sales compared to $984,982 for the
corresponding period in 2003 and the increase in Phase 2 sales during the six
months, which has a larger cost of sales percentage.
While our cost of sales will always grow as an absolute number as sales volume
increases, we believe that our cost of sales will return to a number nearer to
the prior periods in future.
GROSS PROFIT
- ------------
Gross profit for the three months ended June 30, 2004 was $689,994, a decrease
of $193,271, or 21%, compared to gross profit of $883,265 for the three months
ended June 30, 2003. As a percent of net sales, gross profit was 50% for the
three months ended June 30, 2004, compared to 61% for the three months ended
June 30, 2003. The decrease in gross profit of $193,271 was primarily due to a
decrease in net revenue compared to the corresponding period in 2003.
Gross profit for the six months ended June 30, 2004 was $1,539,434 an increase
of $42,040, or 2%, compared to gross profit of $1,497,394 for the six months
ended June 30, 2003. As a percent of net sales, gross profit was 53% for the six
months ended June 30, 2004, compared to 60% for the six months ended June 30,
2003. The increase in gross profit of $42,040 was primarily due to an increase
in net revenue.
OPERATING EXPENSES
- ------------------
Operating expenses are made up of:
o Advertising;
o General and Administration expenses; and
o Depreciation and Amortization.
Operating expenses were $1,550,835 for the three months ended June 30, 2004,
compared to $806,135 for the three months ended June 30, 2003, representing an
increase of $774,700. As a percentage of net revenues, operating expenses were
112% for the three months ended June 30, 2004, compared to 56% for the three
months ended June 30, 2003. All three categories of operating expenses
increased.
Advertising and promotion expenses for the three months ended June 30, 2004 were
$687,941, compared to $333,901 for the three months ended June 30, 2003, an
increase of $354,040, of which $302,000 related to new products. Advertising and
promotion as a percentage of net revenue for the three months ended June 30,
2004 was 48%, compared to 23% for the three months ended June 30, 2003.
General and administrative expenses were $855,739 for the three months ended
June 30, 2004, compared to $467,351 for the three months ended June 30, 2003 -
an increase of $388,388. As a percentage of net revenue, general and
administrative expenses were 62% for the three months ended June 30, 2004,
compared to 33% for the
14
three months ended June 30, 2003. The increased expenses were primarily
attributable to increases in spending from
o technology - $10,000;
o directors expenses - $20,000;
o insurance - $40,000;
o personnel - $42,000;
o research and development - $58,000; and
o legal fees - $103,000.
Legal expenses increased primarily as a result of increased compliance work
associated with our status as a publicly traded company and continuing
litigation with Mr. Bryant and his affiliates. We incurred research and
development costs primarily in connection with new products introduced in the
six month period. We also determined to add personnel, increased the
compensation of some existing employees, and increased our fees to Mr. Brown as
Chairman of the Board.
Depreciation amortization expenses were $7,155 for the three months ended June
30, 2004, representing an increase of $2,272 compared to $4,883 for the three
months ended June 30, 2003. The increase is attributed to the purchase of an
automobile.
Operating expenses were $2,481,017 for the six months ended June 30, 2004, an
increase of $1,163,835 over the $1,317,182 that we experienced for the six
months ended June 30, 2003. Operating expenses were 86% of net revenues for the
six months ended June 30, 2004, compared to 53% for the six months ended June
30, 2003. All categories of operating expenses increased.
Advertising and promotion expenses for the six months ended June 30, 2004 were
$1,161,755, compared to $496,312 for the six months ended June 30, 2003, an
increase of $665,443, of which $305,000 was for new products and the remainder
to support sales of existing products. The increase in advertising expenditures
has, in our opinion, been a significant factor in increasing sales. Advertising
and promotion as a percentage of net revenue for the six months ended June 30,
2004 was 40%, compared to 20% for the six months ended June 30, 2003.
General and administrative expenses were $1,306,210 for the six months ended
June 30, 2004, compared to $808,544 for the six months ended June 30, 2003 - an
increase of $497,666. As a percentage of net revenue, general and administrative
expenses were 45% for the six months ended June 30, 2004, compared to 32% for
the six months ended June 30, 2003. The increased expenses were primarily
attributable to increases in spending for
o technology - $23,000;
o directors expenses - $48,000;
o insurance - $50,000;
o research and development - $57,000;
o personnel - $77,000; and
o legal fees - $93,000
The same factors that contributed to the increase in general and administrative
expenses for the three months ended June 30, 2004 contributed to the increase
for the six month period.
Depreciation amortization expenses were $13,052 for the six months ended June
30, 2004, an increase of $726 compared to $12,326 for the six months ended June
30, 2003. The increase is attributed to the purchase of an automobile.
INVENTORY
- ---------
Inventory was $1,164,676 at June 30, 2004, compared to $581,778 at June 30, 2003
- - an increase of $582,898. The increase reflects the need to hold sufficient
inventory to support new customers acquired after June 30, 2003, and to support
the introduction of our new products, and is consistent with the inventory at
the end of December 31, 2003 of $1,159,470.
15
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
At June 30, 2004, the Company had a working capital deficit of $1,083,307,
compared to a $684,710 working capital deficit at June 30, 2003. At the end of
2003, the Company had a positive working capital of $167,140. The decrease was
mainly due to the decrease in the accounts receivable reflecting our increased
reserves for potential product returns and the increase in the accounts payable
reflecting a disproportionate increase in expenses compared to net revenue.
Net cash provided by operating activities for the six months ended June 30, 2004
was $330,800 compared to $194,319 for the six months ended June 30, 2003. The
primary activities providing the cash was the decrease in the accounts
receivables and increase in the accounts payable, including the informal
extension of credit terms by Garden State Nutritionals.
Net cash used in investing activities for the six months ended June 30, 2004 was
$28,251. No cash was used by financing activities in the six months ended June
30, 2003. This increase is attributable to the purchase of an automobile.
Net cash used in financing activities for the six months ended June 30, 2004 was
$269,621 compared to net cash used by financing activities of $197,714 for the
six months ended June 30, 2003. This increase is attributable to higher cash
repayments of the note to Garden State Nutritionals.
In early April 2002, we entered into an agreement with Garden State
Nutritionals, 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 constitutes 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 GSN 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 June 30, 2004, the balance owed to GSN under the note is
$511,185.
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 June 30, 2003, the balance owed to
GSN under this line of credit was $1,088,276. Under our line of credit, the
balance owed on June 30, 2004 was $874,589. GSN allows us to periodically exceed
our payment terms. There is no assurance that GSN will continue to allow us to
exceed our stated payment terms in the future.
Our working capital constraints make it difficult to grow our business, and any
reduction in informal arrangements allowing us to exceed our credit limits or to
increase our payment terms with GSN would have a materially adverse impact on
us. Management and the Board have sought, and are continuing to seek additional
sources to finance our business. Our cash flow from operations continues to be
positive; however, for the period ended June 30, 2004 our positive cash flow was
based on GSN's willingness to allow us to exceed our stated payment terms. We
believe that greater capital availability is required to facilitate future
growth and to cover additional expenses.
16
COMMITMENTS AND CONTINGENCIES
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 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.
PRODUCT LIABILITY
- -----------------
The Company, like other marketers of products that are intended to be ingested,
faces the inherent risk of exposure to product liability claims in the event
that the use of our products results in injury. The Company maintains product
liability insurance coverage of $5,000,000. Because of the increased scrutiny of
our industry, it has become increasingly difficult to obtain and maintain
product liability insurance coverage for products. We applied for coverage with
over 40 different companies, and very few provided us a quote. The cost for
coverage rose in excess of 2,500%, and we procured 16% less coverage than one
year ago.
GOING CONCERN QUALIFICATION
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 our financial statements for
the year ended December 31, 2003 contains an explanatory paragraph about our
ability to continue as a going concern.
If GSN, 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, GSN. 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 Company's continuation is dependent upon its ability to control costs and
attain a satisfactory level of profitability with sufficient financing
capabilities or equity investment.
17
There is 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 from the outcome of
this uncertainty.
ITEM 3. CONTROLS AND PROCEDURES.
Evaluation of disclosure controls and procedures
- ------------------------------------------------
As of the end of the period, the Company carried out an evaluation of the
effectiveness of the design and operation of its disclosure controls and
procedures pursuant to Exchange Act Rule 13a-14. This evaluation was done under
the supervision and with the participation of the Company's President and its
Controller. Based upon that evaluation, they concluded that the Company's
disclosure controls and procedures are effective in gathering, analyzing, and
disclosing information needed to satisfy the Company's disclosure obligations
under the Exchange Act.
Change in internal controls
- ---------------------------
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect those controls since the most recent
evaluation of such controls.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
The Company has been sued in the U.S. District Court for the Southern District
of New York by Window Rock Enterprises, Inc. for statutory and common law
trademark infringement, trade dress infringement, unfair competition and
dilution under both federal and New York state laws. This suit arises out of its
distribution of its CortiLess(R) product. The Company has answered the suit,
denying the allegations, and the Court has scheduled a status conference on the
matter during September 2004. At that time, the Court may fix deadlines for
discovery, dispositive motions and a tentative trial period. The Company does
not believe this suit has merit and has undertaken all reasonable steps to
minimize its potential liability for monetary damages and/or injunctive relief
in this instance. If a court were to issue a ruling adverse to the Company's
interests, however, it could have a materially adverse impact on the Company.
The Company is a party in two other legal actions. In the opinion of the
Company's management, neither of those proceedings are expected to have a
material impact on its financial position or results of operations.
Twenty-two (22) cases were 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, all of the cases have been
either voluntarily or involuntarily dismissed by court order. No further PPA
cases remain pending against HNS.
The Company was involved in 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's breach of material terms of the Agreement. HNS
18
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.
The Court has since granted HNS' Motion for Partial Summary Judgment, dismissing
KMS' counterclaims for fraud in the inducement and for fraudulent
misrepresentation. The Court has also found KMS liable for attorney's fees as a
sanction for discovery violations. HNS has scheduled a second Motion for Partial
Summary Judgment, to address HNS' claims for breach of contract and for failure
to pay an account balance according to the stated terms. The second Motion for
Partial Summary Judgment is scheduled for hearing in September 2004. The Court
will call this matter for a conference to schedule a trial date on October 29,
2004 on all remaining issues.
ITEM 2. CHANGES IN SECURITIES AND SMALL BUSINESS ISSUER PURCHASES OF
EQUITY SECURITIES.
As provided for in his new employment contract, we granted our Chief Executive
Officer, Christopher Tisi, options to purchase 50,000 shares of our common stock
at an exercise price of $.30 per share, the closing price of our stock on April
8, 2004, when we entered into the contract. Mr. Tisi is entitled to the same
grant on each anniversary date of the employment agreement. The options vest
immediately, have a four-year term from the date of grant, and are exercisable
at the fair marked value on the date of grant.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Company's 2004 annual meeting of shareholders was held on May 21, 2004 at
The Waterford Hotel & Conference Center, 11360 US Highway One, North Palm Beach,
Florida to vote on the election of three (3) directors to hold office until the
annual meeting of shareholders in 2005 and until their respective successors are
duly elected and qualified.
Proxies for the annual meeting were solicited pursuant to Regulation 14A under
the Securities Exchange Act of 1934, as amended, and there was no solicitation
in opposition to the Company's solicitation.
The holders of record of an aggregate of 3,133,649 shares of the Company's
common stock, out of 3,832,813 shares outstanding on the record date for the
annual meeting, were present either in person or by proxy, and constituted a
quorum for the transaction of business at the annual meeting.
All nominees for director were elected with voting as detailed below:
FOR WITHHELD
--- --------
James A. Brown 82% 0.69%
Steven A. Pomerantz 82% 0.69%
Theodore Alflen 82% 0.69%
ITEM 5. OTHER INFORMATION.
None
19
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibit 31.1 Certification Pursuant to Item 601(b)(31) of Regulation
S-B, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
Exhibit 31.2 Certification Pursuant to Item 601(b)(31) of Regulation
S-B, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
Exhibit 32.1 Certification Pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(furnished pursuant to Item 601(b)(32) of Regulation S-B).
Exhibit 32.2 Certification Pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(furnished pursuant to Item 601(b)(32) of Regulation S-B).
(b) Reports on Form 8-K during the fiscal quarter ended June 30, 2004.
The registrant filed a report dated April 9, 2004 on Form 8-K on April
14, 2004, reporting an Item 5 Event.
The registrant filed a report dated April 22, 2004 on Form 8-K on April
26, 2004, reporting an Item 5 Event.
The registrant filed a report dated May 18, 2004 on Form 8-K on May 20,
2004, reporting an Item 5 Event.
20
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: August 13, 2004 Health & Nutrition Systems International, Inc.
(The "Registrant")
By: /s/Christopher Tisi
-------------------
Christopher Tisi
Chief Executive Officer, President,
and Secretary
(Principal executive officer and duly
authorized officer)
21
Exhibit Index
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
31.1 Certification Pursuant to Item 601(b)(31) of Regulation S-B, 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-B, 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
(furnished pursuant to Item 601(b)(32) of Regulation S-B).
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(furnished pursuant to Item 601(b)(32) of Regulation S-B).
Exhibit 31.1
CERTIFICATIONS
I, Christopher Tisi, Chief Executive Officer of Health & Nutrition
Systems International, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-QSB 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 report, fairly present in all material respects the
financial condition, results of operations and cash flows of the small business
issuer as of, and for, the periods presented in this report;
4. The small business issuer'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 controls and procedures, as of the end of the
period covered by this report based on such evaluations; 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.
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 or financial
reporting.
Date: August 13, 2004
/s/Christopher Tisi
-------------------
Christopher Tisi
Chief Executive Officer
Exhibit 31.2
CERTIFICATIONS
I, Al Dugan, Controller and Principal Accounting Officer of Health &
Nutrition Systems International, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-QSB 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 report, fairly present in all material respects the
financial condition, results of operations and cash flows of the small business
issuer as of, and for, the periods presented in this report;
4. The small business issuer'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 controls and procedures, as of the end of the
period covered by this report based on such evaluations; 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.
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 or financial
reporting.
Date: August 13, 2004
/s/Al Dugan
--------------------------------------------
Al Dugan
Controller (Principal 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 Quarterly Report of Health & Nutrition Systems
International, Inc. (the "Company") on Form 10-QSB for the quarterly period
ended June 30, 2004 as filed with the Securities and Exchange Commission on the
date hereof (the "Report"), I, Christopher Tisi, 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.
Health & Nutrition Systems International, Inc.
/s/Christopher Tisi
-----------------------
Christopher Tisi
Chief Executive Officer
August 13, 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-QSB for the quarterly period
ending June 30, 2004 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.
Health & Nutrition Systems International, Inc.
/s/Al Dugan
-------------------------------------------
Al Dugan
Controller (Principal Accounting Officer)
August 13, 2004