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 SEPTEMBER 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
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(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
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(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 September 30, 2004.
Transitional Small Business Disclosure Format: Yes [ ] No [X]
HEALTH AND NUTRITION SYSTEMS INTERNATIONAL, INC.
INDEX
Page
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PART I - FINANCIAL INFORMATION...........................................1
Item 1. Financial Statements...........................................1
Item 2. Management's Discussion and Analysis or Plan of Operation......8
Item 3. Controls and Procedures.......................................20
PART II - OTHER INFORMATION..............................................21
Item 1. Legal Proceedings.............................................21
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds...21
Item 3. Defaults Upon Senior Securities...............................22
Item 4. Submission of Matters to a Vote of Security Holders...........22
Item 5. Other Information.............................................22
Item 6. Exhibits......................................................22
SIGNATURES...............................................................23
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
CONDENSED BALANCE SHEET
SEPTEMBER 30, 2004
(UNAUDITED)
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ASSETS
September 30,
2004
-----------
Current Assets:
Cash $ 16,961
Accounts receivable, net 46,550
Inventory 1,030,484
Prepaid Expenses 97,095
-----------
Total current assets 1,191,090
-----------
Property and equipment, net 84,487
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Other assets:
Trademarks, net 409
Security deposits 8,019
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Total other assets 8,428
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Total assets $ 1,284,005
===========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current Liabilities:
Accounts payable $ 1,433,601
Accrued expenses 283,272
Notes payable, current portion 394,980
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Total current liabilities 2,111,853
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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 (1,690,290)
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Total stockholders' deficit (827,848)
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Total liabilities and stockholders' deficit $ 1,284,005
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See accompanying notes to financial statements
-1-
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
CONDENSED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Revenue $ 2,370,380 $ 1,867,887 $ 5,249,928 $ 4,369,984
Cost of sales 941,164 767,375 2,281,277 1,772,077
----------- ----------- ----------- -----------
Gross profit 1,429,216 1,100,512 2,968,651 2,597,907
----------- ----------- ----------- -----------
Operating expense:
General and administrative expense 641,933 622,590 1,948,143 1,431,135
Advertising and promotion 585,975 553,949 1,747,731 1,050,261
Depreciation and amortization 8,941 4,495 21,993 16,821
----------- ----------- ----------- -----------
Total operating expense 1,236,849 1,181,034 3,717,867 2,498,217
----------- ----------- ----------- -----------
Income from operations 192,367 (80,522) (749,216) 99,690
----------- ----------- ----------- -----------
Other income (expense):
Gain on sale -- 279,308 -- 279,308
Interest expense (6,468) (14,951) (24,572) (34,519)
----------- ----------- ----------- -----------
Income before income taxes 185,899 183,835 (773,788) 344,479
----------- ----------- ----------- -----------
Benefit (provision) for income taxes -- -- -- --
----------- ----------- ----------- -----------
Net income $ 185,899 $ 183,835 $ (773,788) $ 344,479
=========== =========== =========== ===========
Net income per share - basic $ 0.05 $ 0.05 $ (0.20) $ 0.09
=========== =========== =========== ===========
Net income per share - diluted $ 0.05 $ 0.05 $ (0.20) $ 0.09
=========== =========== =========== ===========
Weighted average number of shares - basic 3,832,813 3,772,813 3,832,813 3,679,480
=========== =========== =========== ===========
Weighted average number of shares - diluted 3,833,813 3,786,813 3,832,813 3,693,480
=========== =========== =========== ===========
See accompanying notes to financial statements
-2-
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
CONDENSED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004
AND 2003 (UNAUDITED)
NINE MONTHS ENDED
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SEPTEMBER 30, SEPTEMBER 30,
2004 2003
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Net cash provided by operating activities $ 449,088 $ 349,216
----------- -----------
Cash flows from investing activities:
Proceeds from sale of trademark -- 300,000
Purchase of property and equipment (32,576) --
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Net cash used in investing activities (32,576) 300,000
Cash flows from financing activities:
Repayments on notes payable (406,957) (571,373)
Repayments on capital leases -- (714)
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Net cash used in financing activities (406,957) (572,087)
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Net increase in cash 9,555 77,129
Cash, beginning of period 7,406 14,778
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Cash, end of period $ 16,961 $ 91,907
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SUPPLEMENTAL CASH FLOW INFORMATION:
Note payable for purchase of automobile $ 23,357 --
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Conversion of accounts payable to notes payable -- $ 1,000,000
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Interest paid -- $ 7,500
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See accompanying notes to financial statements
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HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
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 nine months ended September 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 September 30, 2004, the Company had $187,511 of inventory on consignment
relating to its "pay on scan" sales. On September 30, 2003, the Company had
$259,062 of inventory on consignment relating to its "pay on scan" sales.
Included in the revenue in the accompanying financial statements are reductions
for returns and allowances, sales discounts, new store opening discounts, and
co-op advertising and promotions.
NOTE 3 - LEGAL MATTERS
The Company from time to time is a party of various legal proceedings. In the
opinion of the Company's management, none of the proceedings are expected to
have a material impact on its financial position or results of operations.
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NOTE 4 - ACCOUNTS RECEIVABLE
The Company has a positive accounts receivable balance at the end of September
30, 2004 of $46,550. Accounts receivable before reductions for customer
liabilities were $1,078,014. The amount of customer liabilities offset against
accounts receivable was $1,031,464. The Company created reserves of $631,000 in
the quarter ended June 30, 2004 for anticipated product returns or credits. Of
that amount, $166,000 was applied to customer returns in the third quarter and
the reserve was accordingly reduced.
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 nine months
of 2004 the Company's administrative costs, cost of goods sold as a percentage
of revenues, and advertising expenses all rose. As a result, in the nine months
ended September 30, 2004, the Company had a net loss of $773,788. Cash flow
provided from operations was $449,088. 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
September 30, 2004, the Company has a working capital deficit of $920,763 and
adverse liquidity ratios.
The Company's management intends to continue to closely control costs and
monitor financial capabilities.
On October 15, 2004 the Company filed for protection under Chapter 11 of the
United States Bankruptcy Code. The Company is operating using funds available to
it under a cash collateral agreement with Garden State.
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.
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.
-5-
During the nine months ended September 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 September 30, 2004, the Company's net income and
earnings per share would have been reduced to the proforma amounts indicated
below:
SEPTEMBER 30, 2004
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Net loss
As reported $ (773,788)
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Pro forma $ (783,348)
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Loss per share
As reported $ (0.20)
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Pro forma $ (0.20)
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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
Nutrition in the principal amount of $1,300,000 bearing interest at 4.5% per
annum. The balance of the note at September 30, 2004 was $374,575. The note is
payable in quarterly installments of $131,410.
In January 2004, the Company purchased a vehicle for use by its salesperson, and
issued a note to a financial institution for $23,356. 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 at September
30, 2004 was $20,405.
NOTE 8 - SUBSEQUENT EVENTS
On October 15, 2004, the Company filed for reorganization under Chapter 11 of
the federal bankruptcy laws. We are currently developing a plan of
reorganization that will be submitted to the court for approval.
In connection with the Chapter 11 filing, the Company entered into an asset
purchase agreement with TeeZee, Inc., which has agreed to serve as the stand-by
bidder to purchase our existing business. TeeZee is a Florida-based company that
was formed by Christopher Tisi, who currently is an employee of HNS and was
formerly Chief Executive Officer and one of the directors.
Under the terms of the asset purchase agreement, TeeZee, Inc. has offered to
acquire substantially all of the assets in exchange for a total consideration of
$2,285,000, consisting of a cash payment of $350,000 and the assumption of
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approximately $1,935,000 of the debt. If the plan is confirmed, and the sale
takes place, the proceeds will be used by the Company to identify and facilitate
entry into a more profitable line of business, either through a merger or
otherwise, with the goal of providing our shareholders with greater opportunity
for long-term share appreciation.
The consummation of the contemplated transaction is subject to approval of the
bankruptcy court, satisfaction of various closing conditions and other terms and
conditions, all as more specifically set forth in the asset purchase agreement.
Other bidders may submit higher and better bids for consideration.
-7-
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
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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 September 30, 2004, we had approximately $187,511 of inventory on consignment
relating to "pay on scan" sales. At September 30, 2003, we had approximately
$259,062 of inventory on consignment. This reduction was attributable to one
customer that discontinued selling one of our products, and another customer
which reduced the amount of our other products they carry in inventory.
Included in the revenue in the accompanying financial statements for the nine
months ended September 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 $1,586,545 and $1,510,481,
respectively. The larger reduction in the nine months ending September 30, 2004
-8-
was primarily due to increases in reserves for anticipated returns and
allowances. For the nine months ended September 30, 2004, we established
o a reserve of $388,100 for the anticipated return of one of our products
based on notices received from customers indicating that they intended
to discontinue selling it
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
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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. At September 30, 2004, the amount of
customer related liabilities was $1,031,464 compared to $1,154,927 at September
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.
-9-
We established reserves of $465,100 for the period ended September 30, 2004 on
account of anticipated returns, as compared to $175,000 for the nine months
ended September 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
has continued to assess what steps can be taken to realize greater value for our
shareholders as the financial performance of our operating business declined in
a very competitive market. The Board has considered 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
former Chief Executive Officer and President, Christopher Tisi, or an entity
controlled by him.
Reorganization filing
- ---------------------
On October 15, 2004, we filed for reorganization under Chapter 11 of the federal
bankruptcy laws. The Board based this decision primarily on the following
factors:
o our loss of $773,788 for the nine months ended September 30, 2004,
o concern with respect to 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 are currently developing a plan of reorganization that will be submitted to
the court for approval.
In connection with the Chapter 11 filing, we entered into an asset purchase
agreement with TeeZee, Inc., which has agreed to serve as the stand-by bidder to
purchase our existing business. TeeZee, Inc. is a Florida-based company that was
formed by Christopher Tisi, who currently is an employee of HNS and was formerly
our Chief Executive Officer and one of our directors.
Under the terms of the asset purchase agreement, TeeZee, Inc. has offered to
acquire substantially all of our assets in exchange for a total consideration of
$2,285,000, consisting of a cash payment of $350,000 and the assumption of
approximately $1,935,000 of our debt. If the plan is confirmed, and the sale
takes place, the proceeds will be used by us to identify and facilitate our
entry into a more profitable line of business, either through a merger or
otherwise, with the goal of providing our shareholders with greater opportunity
for long-term share appreciation.
The consummation of the contemplated transaction is subject to approval of the
bankruptcy court, satisfaction of various closing conditions and other terms and
conditions, all as more specifically set forth in the asset purchase agreement.
Other bidders may submit higher and better bids for consideration.
In September, and prior to submitting his proposal, Mr. Tisi entered into an
amendment to his employment contract with us which provides he step down as
Chief Executive Officer in order to consider making and facilitating the
submission of his stand-by bid. Although Mr. Tisi will not serve in any
executive capacity with us under the terms of the agreement, he will continue as
an employee of HNS, and will continue to assist us in conducting our operations.
-10-
At the same time Mr. Tisi entered into the amendment to his contract, Mr. James
A. Brown, Chairman of the Board, was elected to serve as our Chief Executive
Officer. In connection with becoming chief executive officer, Mr. Brown's
compensation was increased from $8,000 per month to $9,200 per month.
The amendment to the contract provides for a hiatus period through our emergence
from reorganization. During that time certain, provisions of the contract are
suspended. After the hiatus period, or upon the emergence from reorganization,
the employment agreement will be reinstated under the terms of the amendment.
Background
- ----------
On November 26, 2003, we entered into an agreement with TeeZee, Inc. for the
latter to buy 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.
As a result of our earnings restatement, Capitalink 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 TeeZee, Inc., which had 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 as not in the
best interest of the shareholders. The Board primarily based its determination
on the then current market value of the Company's shares, then current
operations, and Mr. Tisi's recent agreement to stay with the company through
December 31, 2005. The Board chose to afford itself more time to consider
strategic alternatives. As described above, the Board has continued to consider
strategic alternatives to increase shareholder value.
On April 9, 2004, Mr. Tisi had entered into a new two-year employment contract,
effective as of January 1, 2004. The contract
o increased his base salary from $147,000 to $164,000;
o provided for a quarterly bonus of the sum of 5% of the increase in
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;
o provided 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 provided for an annual grant of options to purchase 50,000 shares of
our common stock under the 1998 Stock Option Plan;
-11-
o provided 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 provided 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.
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. The area in which the Company focuses, diet and energy,
has been negatively impacted in 2004 by declining interest by the public in
low-carbohydrate diets. The rush of competitors to market products similar to
our flagship product, CarbCutter(R), has slowed down. Several companies have
withdrawn their products because of weak demand. Nevertheless, several other
competitors have introduced competing products and achieved full distribution
with all of our customers. Our product formulae are not proprietary.
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, 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
current 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
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.
-12-
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 nine months ended September 30, 2004, our working capital declined by
approximately $1,087,903. At September 30, 2004, we had a working capital
deficit of ($920,763). Our ability to grow has always been limited by cash
constraints. Our loss in the first nine 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.
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, CarbCutter(R).
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 nine 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.
-13-
RESULTS OF OPERATIONS
Summary
- -------
Revenues for the three months ended September 30, 2004 were $2,370,380 compared
to $1,867,887 for the same period in 2003, an increase of $502,493, or 27%.
General and administrative expenses for the three months ended September 20,
2004 were $641,933, compared to $622,590 for the same period in 2003, an
increase of $19,343, or 3%. The cost of sales, as a percentage of net sales,
decreased 1 % for the three months ended September 30, 2004, compared to
September 30, 2003. The gross profit for the three months ended September 30,
2004 was $1,429,217, or 60% of revenue compared to the same period in 2003 of
$1,100,512, or 59% an increase of $328,705.
Revenues for the nine months ended September 30, 2004 were $5,249,928, compared
to $4,369,984 for the same period in 2003, an increase of $879,944, or 20%.
General and administrative expenses for the nine months ended September 30, 2004
were $1,948,143, compared to $1,431,135 for the same period in 2003, an increase
of $517,008, or 36%. The cost of sales, as a percentage of revenue, increased by
2% for the nine months ended September 30, 2004, compared to September 30, 2003.
The gross profit for the nine months ended September 30, 2004 was $2,968,651, or
57% of revenue compared to the same period in 2003 of $2,597,907, or 59%, an
absolute increase of $370,744.
We believe that increasing advertising expenditures by $32,026 during the three
months and $697,470 for the nine months ended September 30, 2004 was a
significant factor in generating increased revenues for the periods. For the
nine months ended September 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 ($773,788) for the nine months ended September 30, 2004,
compared to net income of $344,479 in the same period of 2003, a decrease of
$1,118,267. This decrease was primarily because we
o established reserves of $465,100 for anticipated product returns,
compared to reserves of $175,000 for the nine months ended September
30, 2003,
o increased advertising expenses from $1,050,261 to $1,747,731; and
o increased general and administrative costs and expenses from $1,431,135
to $1,948,143.
Most of our business continues to be with a few large customers. During the
three months and nine months ended September 30, 2004, our eight largest
customers comprised approximately 83% and 86% of our revenues, respectively.
This compares with approximately 79% and 82% 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.
Revenues
- --------
We report our 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.
-14-
Some of our new customers do not ask us to participate in co-op advertising and
other promotions. The aggregate amounts of the deductions for the three months
and nine months ended September 2004 were $209,805 and $1,586,545, compared to
$525,499 and $1,510,481 for the same periods in 2003 - the three months
decreased $315,694, compared to the comparable three months in 2003. The nine
months increased $76,064 compared to the comparable nine months in 2003. We
believe these fluctuations reflect normal promotional variations.
Revenues for the three months ended September 30, 2004 were $2,370,380, compared
to $1,867,887 for the corresponding period in 2003, an increase of $503,493, or
27%. Three new products accounted for approximately 34% of revenue during the
period.
Revenues for the nine months ended September 30, 2004 were $5,249,928 compared
to $4,369,984 for the corresponding period in 2003, an increase of $879,944, or
20%. Revenues for the period were reduced by $465,100 on account of the
establishing reserves for anticipated product returns. Three new products
accounted for approximately 36% of the revenue in the period.
We believe that increasing advertising expenditures by $32,026 during the three
months and $697,470 for the nine months ended September 30, 2004, and the
introduction of new products were the significant factors in the increase in our
revenues during the nine month period.
Net Income (Loss)
- -----------------
Our net profit for the three months ended September 30, 2004, was $185,899,
compared to a profit of $183,835 for the three months ended September 30, 2003,
an increase of $2,064. Net profit per share was $0.05 for the three months ended
September 30, 2004, as compared to a net profit of $0.05 per share for the three
months ended September 30, 2003. This increase was primarily because we
increased revenue by $502,493 based on increased sales and compared to an
increase in total operating expenses by only $55,815. In 2003, the net income
was primarily due to the gain on sale of $279,308.
Our net loss for the nine months ended September 30, 2004, was ($773,788),
compared to a profit of $344,479 for the nine months ended September 30, 2003, a
decrease of $1,118,267. Net loss per share was ($0.20) for the nine months ended
September 30, 2004, as compared to a net profit of $0.09 per share for the nine
months ended September 30, 2003. This decrease was primarily because we
o established a reserve of $465,100 for anticipated return of products;
o increased advertising expenses by $697,470; and
o increased general and administrative expenses by $517,008.
Cost of Sales
- -------------
Cost of sales for the three months ended September 30, 2004 was $941,164, or 40%
of revenues, as compared to $767,375, or 41% of revenues for the corresponding
period in 2003. The dollar amount is higher because of increased sales during
the period. The percentage as a function of revenue is higher because the
establishment of reserves against potential product returns resulted in the
lower reduction from sales of $209,805, compared to $525,499 for the
corresponding period in 2003.
Cost of sales for the nine months ended September 30, 2004 was $2,281,277, or
43% of revenues, as compared to $1,772,077, or 41% of 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 revenues is higher due to the large
reduction of $1,586,545 from sales compared to $1,510,481 for the corresponding
-15-
period in 2003 and the increase in Phase 2 sales during the nine months, which
has a higher cost of sales.
Gross Profit
- ------------
Gross profit for the three months ended September 30, 2004 was $1,429,217, an
increase of $328,705, or 30%, compared to gross profit of $1,100,512 for the
three months ended September 30, 2003. As a percent of net sales, gross profit
was 60% for the three months ended September 30, 2004, compared to 59% for the
three months ended September 30, 2003. The increase in gross profit of $328,705
was primarily due to an increase in revenue compared to the corresponding period
in 2003.
Gross profit for the nine months ended September 30, 2004 was $2,968,651, an
increase of $370,744, or 14%, compared to gross profit of $2,597,907 for the
nine months ended September 30, 2003. As a percent of net sales, gross profit
was 57% for the nine months ended September 30, 2004, compared to 59% for the
nine months ended September 30, 2003. The increase in gross profit of $370,744
was primarily due to an increase in revenue.
Operating Expenses
- ------------------
Operating expenses are made up of:
o Advertising;
o General and Administration expenses; and
o Depreciation and Amortization.
Operating expenses were $1,236,849 for the three months ended September 30,
2004, compared to $1,181,034 for the three months ended September 30, 2003,
representing an increase of $55,815. As a percentage of revenues, operating
expenses were 52% for the three months ended September 30, 2004, compared to 63%
for the three months ended September 30, 2003. All three categories of operating
expenses increased.
Advertising and promotion expenses for the three months ended September 30, 2004
were $585,975, compared to $553,949 for the three months ended September 30,
2003, an increase of $32,026. Advertising and promotion as a percentage of
revenue for the three months ended September 30, 2004 was 25%, compared to 30%
for the three months ended September 30, 2003. The decrease as a percentage of
revenue is attributable to increased sales.
General and administrative expenses were $641,933 for the three months ended
September 30, 2004, compared to $622,590 for the three months ended September
30, 2003, an increase of $19,343. As a percentage of revenue, general and
administrative expenses were 27% for the three months ended September 30, 2004,
compared to 33% for the three months ended September 30, 2003. The increased
expenses were primarily attributable to increases and decreases in spending from
o technology - $(18,000);
o directors expenses - $(9,000);
o insurance - $41,000;
o personnel - $(24,000);
o research and development - $(26,000); and
o legal fees - $40,000.
Legal expenses increased primarily because of increased compliance work
associated with our status as a publicly traded company and continuing
litigation with Mr. Bryant and his affiliates. We eliminated research and
-16-
development costs in the third quarter; expenditures related to new products
were incurred during the six months ended June 30, 2004.
Personnel fees declined versus the prior period predominately because bonus
compensation was lower. We incurred $28,800 in bonus paid to Mr. Tisi in the
three months ended September 30, 2004, compared to $144,900 in the same period
in 2003, all based on the compensation formula included in his employment
contract. Offsetting this were increases in costs due to the addition of new
personnel, and increases in the compensation of certain key employees.
Depreciation amortization expenses were $8,941 for the three months ended
September 30, 2004, representing an increase of $4,446, compared to $4,495 for
the three months ended September 30, 2003. The increase is attributed to the
purchase of an automobile.
Operating expenses were $3,717,867 for the nine months ended September 30, 2004,
an increase of $1,219,650 over the $2,498,217 that we experienced for the nine
months ended September 30, 2003. Operating expenses were 71% of revenues for the
nine months ended September 30, 2004, compared to 57% for the nine months ended
September 30, 2003. All categories of operating expenses increased.
Advertising and promotion expenses for the nine months ended September 30, 2004
were $1,747,731, compared to $1,050,261 for the nine months ended September 30,
2003, an increase of $697,470, 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 revenue for the nine months ended
September 30, 2004 was 33%, compared to 24% for the nine months ended September
30, 2003.
General and administrative expenses were $1,948,143 for the nine months ended
September 30, 2004, compared to $1,431,135 for the nine months ended September
30, 2003 - an increase of $517,008. As a percentage of revenue, general and
administrative expenses were 37% for the nine months ended September 30, 2004,
compared to 33% for the nine months ended September 30, 2003. The increased
expenses were primarily attributable to increases in spending for
o technology - $5,000;
o directors expenses - $38,000;
o insurance - $92,000;
o research and development - $31,000;
o personnel - $63,000; and
o legal fees - $133,000.
Legal expenses increased primarily because of increased compliance work
associated with our status as a publicly traded company and continuing
litigation with Mr. Bryant and his affiliates. Directors' expenses increased
primarily because of the increase in Mr. Brown's compensation. Research and
development expenses increased due to the research related to new products.
Insurance costs increased by approximately 100% because the cost of attaining
product liability coverage rose. The personnel expenses for the nine months rose
due to the addition of new personnel and increases in the compensation of
certain key existing employees.
Depreciation amortization expenses were $21,993 for the nine months ended
September 30, 2004, an increase of $5,172, compared to $16,821 for the nine
months ended September 30, 2003. The increase is attributed to the purchase of
an automobile and computer equipment.
-17-
Inventory
- ---------
Inventory was $1,030,484 at September 30. 2004, compared to $1,372,254 at
September 30, 2003 - a decrease of $341,770. The inventory is consistent with
the inventory at the end of December 31, 2003 of $1,159,470, and the decrease
reflects normal inventory fluctuations.
Liquidity and Capital Resources
- -------------------------------
At September 30, 2004, the Company had a working capital deficit of ($920,763),
compared to a ($89,646) working capital deficit at September 30, 2003. At the
end of 2003, the Company had a positive working capital of $167,140. The
increase in the working capital deficit was mainly due to
o the decrease in the accounts receivable reflecting our increased
reserves for potential product returns
o the increase in the accounts payable reflecting a disproportionate
increase in expenses compared to revenue, resulting in a significant
nine month loss.
Net cash provided by operating activities for the nine months ended September
30, 2004 was $449,088 compared to $349,216 for the nine months ended September
30, 2003, primarily based on an increase in accounts payable, including the
informal extension of credit terms by Garden State Nutritionals.
Net cash used in investing activities for the nine months ended September 30,
2004 was $32,576. This is attributable to the purchase of an automobile and
computer equipment in the same period in 2003, net cash from financing
activities of $300,000 was provided by the sale of a trademark.
Net cash used in financing activities for the nine months ended September 30,
2004 was $406,957 compared to net cash used by financing activities of $572,087
for the nine months ended September 30, 2003. This decrease is attributable to a
decrease in 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.
-18-
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 September 30, 2004, the balance owed to GSN under the note is
$374,575.
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 September 30, 2003, the balance owed
to GSN under this line of credit was $803,260. Under our line of credit, the
balance owed on September 30, 2004 was $1,102,857. GSN has allowed us to
periodically exceed our payment terms.
In October, GSN entered into a cash collateral agreement with us. The agreement
has been approved by the bankruptcy court. We expect it will provide us with
sufficient funding to proceed with the bankruptcy process. There are two primary
components:
o With respect to amortization payments on the promissory note
held by GSN, payments were reduced from $11,000 per week to
$5,000 for the first two weeks of the Company's stay in
Chapter 11, and $9,000 per week thereafter.
o With respect to our open account, GSN agreed to suspend
payments on the outstanding balance due on the date of filing
of $1,070,487, until we emerge from Chapter 11. We will pay
according to GSN's regular terms for product acquired while we
are operating under Chapter 11.
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.
-19-
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.
On October 15, 2004 the Company filed for protection under Chapter 11 of the
United States Bankruptcy Code.
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.
-20-
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
HNS is a defendant in the trademark infringement suit filed by Window Rock
Enterprises, Inc. in the U.S. District Court for the Southern District of New
York (Case No. 04-CV-4334). Specifically, the suit alleges statutory and common
law trademark infringement, trade dress infringement, unfair competition and
dilution under both federal and New York state laws with respect to HNS's use of
Window Rock Enterprises, Inc.'s Cortiless(R) product. HNS has filed an answer
and affirmative defenses to the complaint, denying the allegations. The parties
have submitted a joint scheduling report which discloses HNS's potential to add
third parties and a counterclaim against Window Rock. The court recently held a
scheduling conference and set various pre-trial deadlines. The trial is
(tentatively) set to take place in the latter part of 2005.
HNS 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. As part of the settlement, HNS entered into a
distribution agreement with Mr. Bryant, beginning on September 26, 2002 and
ending on September 25, 2007, permitting Mr. Bryant to purchase certain products
from HNS and to exclusively distribute those products in Florida from Orlando
south. In October 2003, HNS terminated the distribution agreement with KMS based
on KMS's breach of material terms of the agreement. On December 1, 2003, HNS
filed suit against KMS-Thin Tab 100, Inc. in the Palm Beach County Circuit Court
(Case No. 2003CA012757XXCDAN) 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 fraud-based counterclaims were dismissed with
prejudice by the Court on summary judgment. KMS subsequently amended its
counterclaim to allege a breach of contract under the distribution agreement.
Another pending Motion for Summary Judgment remains on HNS's claims for breach
of contract. The Court has granted HNS discovery sanctions in the sum of $5,400
plus expert fees. The Court has scheduled this matter as number 3 for trial on
December 13, 2004 on any remaining issues.
From time to time, HNS has been named as a defendant (among others) in various
class-action suits alleging that HNS's Acutrim(R) products contain
Phenylpropanaolmine (PPA) and that these products have damaged plaintiffs. Many
of these cases have been pending in the U.S. District Court for the Western
District of Washington, the Philadelphia County Court of Common Pleas, or in
Louisiana state court. Because none of HNS's Acutrim(R) products contain PPA,
HNS has been dismissed (voluntarily or involuntarily) as a defendant in these
proceedings. As of the filing of this report, no further cases involving HNS's
Acutrim(R) products are pending in any court.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
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.
-21-
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
In October, GSN entered into a cash collateral agreement with us. The agreement
has been approved by the bankruptcy court. We expect it will provide us wit
sufficient funding to proceed with the bankruptcy process. There are two primary
components:
o With respect to amortization payments on the promissory note
held by GSN, payments were reduced from $11,000 per week to
$5,000 for the first two weeks of the Company's stay in
Chapter 11, and $9,000 per week thereafter.
o With respect to our open account, GSN agreed to suspend
payments on the outstanding balance due on the date of filing
of $1,070,487, until we emerge from Chapter 11. We will pay
according to GSN's regular terms for product acquired while we
are operating under Chapter 11.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None
ITEM 6. 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).
-22-
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: November 15, 2004 Health & Nutrition Systems International, Inc.
(The "Registrant")
By: /s/ James A. Brown
--------------------------------------
James A. Brown
Chief Executive Officer
(Principal executive officer and duly
authorized officer)
-23-
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, James A. Brown, 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: November 15, 2004
/s/ James A. Brown
-----------------------
James A. Brown
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: November 15, 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 September 30, 2004 as filed with the Securities and Exchange Commission on
the date hereof (the "Report"), I, James A. Brown, 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/ James A. Brown
------------------------
James A. Brown
Chief Executive Officer
November 15, 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 September 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)
November 15, 2004