U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
|X| Annual report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended December 31, 2002
[ ] Transition report under section 13 or 15(d) of the Securities Exchange
Act of 1934 for the transition period from _____________________- to
_____________________
Commission file number 0-29245
Health & Nutrition Systems International, Inc.
(Name of small business issuer in its charter)
FLORIDA 65-0452156
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(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
3750 INVESTMENT LANE, SUITE 5
WEST PALM BEACH, FLORIDA 33407
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (561) 863-8446
Securities registered under Section 12(b) of the Exchange Act:
NONE
Name of each exchange on which registered:
NONE
Securities registered under Section 12(g) of the Exchange Act:
COMMON STOCK, PAR VALUE $.001 PER SHARE
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X ] No [ ]
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B is not contained in this form, and no disclosure will
be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference to Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]
State issuer's revenues for its most recent fiscal year. $3,567,848.
State the aggregate market value of the voting and non-voting common
equity held by non-affiliates computed by reference to the price at which the
common equity was sold, or the average bid and asked price of such common
equity, as of a specified date within the past 60 days. The aggregate market
value of the voting stock held by non-affiliates on March 29, 2002 was $145,193
(computed at the closing price of the common stock of the issuer outstanding on
March 17, 2002)
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: 3,629,813 shares of common
stock were outstanding as of March 20, 2003.
Documents Incorporated by Reference: certain portions of the
registrant's Definitive Proxy Statement relating to the Annual Meeting of
Shareholders to be held on July 7, 2003 are incorporated by reference into Part
III of this Form 10-KSB.
Transitional Small Business Disclosure Format: Yes [ ] No [X]
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
FORM 10-KSB
INDEX
PART I......................................................................................................................1
ITEM 1. DESCRIPTION OF BUSINESS.......................................................................................1
ITEM 2. DESCRIPTION OF PROPERTY.......................................................................................9
ITEM 3. LEGAL PROCEEDINGS.............................................................................................9
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...........................................................9
PART II....................................................................................................................10
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.....................................................10
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION....................................................12
ITEM 7. FINANCIAL STATEMENTS.........................................................................................21
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.........................21
PART III...................................................................................................................22
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH
SECTION 16(a) OF THE EXCHANGE ACT..........................................................................22
ITEM 10. EXECUTIVE COMPENSATION.......................................................................................22
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS...............22
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS...............................................................23
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.............................................................................23
ITEM 14. CONTROLS AND PROCEDURES......................................................................................26
SIGNATURES.................................................................................................................27
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FORWARD-LOOKING INFORMATION MAY PROVE INACCURATE
This annual report on Form 10-KSB contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Act of 1934, as amended, and is subject to the safe harbor created by
those sections. These forward looking statement concern the Company's
operations, economic performance and financial condition, including but not
limited to the information under the caption "Management's Discussion and
Analysis or Plan of Operation." These statements are based on management's
beliefs as well as assumptions made by and information currently available to
management, including statements regarding future economic performance and
financial condition, liquidity and capital resources and management's plans and
objectives. Any statements that are not statements of historical fact should be
regarded as forward-looking statements. For example, the words "intends,"
"believes," "anticipates," "plans," and "expects" are intended to identify
forward-looking statements. There are a number of important factors that could
cause our actual results to differ materially from those indicated by such
forward-looking statements. These factors include without limitation those
factors described under "Certain Factors Which May Affect Future Results" in
this annual report. In addition, the recent terrorist attacks on the United
States, current and future responses by the U.S. government, the war in the
Persian Gulf, the effects of these events on consumer confidence and demand, the
introduction of products that compete with the Company's products, the loss of
significant customers, and the availability to the Company and deployment by the
Company of capital, increase the uncertainty inherent in forward-looking
statements. In addition, recent government action and the surrounding negative
publicity regarding ephedra-containing products have caused us to discontinue
selling products containing ephedra. These factors, among others, could cause
our actual results to differ materially from those indicated by such
forward-looking statements.
ii
PART I
ITEM 1 DESCRIPTION OF BUSINESS
GENERAL
Health & Nutrition Systems International, Inc. (the "Company," "HNS,"
"we" or "us") was organized as a Florida corporation on October 25, 1993. Our
fiscal year end is December 31. Our corporate offices are located at 3750
Investment Lane Building, Building #5, West Palm Beach, FL 33404. Our phone
number is (561) 863-8446.
We develop, market and sell weight management, energy and sport
nutrition products to national and regional, food, drug, health, pharmacy and
mass-market accounts, as well as to independent health and pharmacy accounts.
Our product formulations are not proprietary and therefore, our strategy is to
create market awareness and sales through the name branding each of our products
as well as the "Health and Nutrition Systems" name.
PRODUCTS
We market and sell the following products:
o ACUTRIM(R) NATURAL -- This is a dietary supplement that uses a
special blend of natural ingredients to help the consumer burn
fat by supporting healthy carbohydrate and fat metabolism.
o THIN TAB(R)MAHUANG FREE -- Thin Tab(R)Mahuang Free offers the
same benefits as Thin Tab(R)in an ephedra-free formula.
o CARBCUTTER(R) -- CarbCutter(R) helps convert carbohydrates
into energy. The Carb Free Blend activates a Cellular
Transport System (CTS) that shuttles newly consumed
carbohydrates into the cells where it then can be metabolized
for energy instead of being stored as fat
As of March 15, 2003, we stopped selling two products, ThinTab(R) and
Fat Cutter Plus, which contained ephedra, because of negative publicity related
to the use of ephedra. Retailers who purchased those products from us may,
however, continue to sell them from their inventory. A third product,
Carbolizer(TM), was transferred to a third party as part of a larger general
settlement of pending litigation. Carbolizer(TM) also contained ephedra. In
2002, these three products accounted for 19% of our total revenue.
Acutrim(R) Natural was introduced into our product line in 2001. The
Acutrim(R) trademark was purchased by us in the first quarter of 2001. After we
purchased the trademark, we completely reformulated the Acutrim(R) product to
our current product, Acutrim(R) Natural.
CERTIFICATES OF ANALYSIS
Garden State Nutritional, a division of Vitaquest International Inc.,
is the only manufacturer of our products. See "Manufacturing and Shipping." GSN
provides a certificate of analysis for each of our products which gives
laboratory test results performed by GSN that verify product quality and
ingredients. We deliver these certificates to our customers, and to consumers,
upon request.
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CLINICAL TESTING
In order to enhance consumer confidence in our products, during 2001,
we initiated and completed independent clinical testing of each of our products.
These double blind placebo trials were conducted by Marshall-Blum LLC, an
independent research company with twenty years of experience in product testing.
Marshall-Blum follows strict clinical guidelines to assist with product
compliance with applicable regulations and scientific standards.
MARKETING
We currently design and develop all of our products, marketing and
advertising in house. We strive to create market awareness and sales through
name-brand recognition of our trademarked products We target print advertising
to develop brand awareness and recognition. During 2002 and 2001, we spent 8.4%
and 14.8% respectively, of our total revenues advertising our products in
consumer magazines such as Cosmopolitan, Mademoiselle, Glamour, Fitness,
Redbook, Allure, Muscle and Fitness, and others. We intend to continue promoting
our products through the print media.
In addition to print advertising, we have ongoing "co-op" programs with
all of the major retailers who sell our products. These programs obligate us to
spend a certain percentage of projected revenue to be generated by sales of our
products on targeted advertising for that retailer through marketing vehicles
such as Sunday newspaper inserts and 10-30 day price specials. We are obligated
to spend these co-op dollars irrespective of the actual revenue generated by the
sales of our products with that retailer. These co-op programs allow us to
target several million consumers and drive sales to the specific retailer. In
2002 and 2001, we spent approximately $823,481, 16.2% and $1,252,000, 21.1%,
respectively of our total gross revenues on advertising and promotion, on these
"co-op" programs.
All of our products are included in the "plan-o-gram" marketing
programs of the major retailers who sell our products. These programs give our
products identical shelf and aisle positions in all locations in a particular
chain of stores using a pre-planned, in-store display format. The plan-o-gram
program guarantees consistent distribution and location of our products in all
stores. The major retailers periodically review the products that participate in
their plan-o-gram programs, sometimes as often as quarterly. There can be no
assurance that our products will remain in any given retailer's plan-o-gram
program. If one of our products is removed from a retailer's plan-o-gram
program, it is likely that the sales volume of that product by that retailer
will decline.
MANUFACTURING AND SHIPPING
We obtain 100% of our manufacturing from Garden State Nutritional, a
division of Vitaquest International Inc. GSN is a state-of-the-art supplement,
liquid and powder manufacturer which owns a 200,000 square foot manufacturing
facility in West Caldwell, New Jersey. GSN has been known as an industry leader
for more than 25 years. GSN has the capacity to support the production of all of
HNS's product line. During 2001, we did not have a term contract with GSN, but
rather acquired our needed inventory on a purchase order basis. In early April
2002, we entered into a two year exclusive manufacturing contract with GSN under
which we purchase all of our products requirements from GSN. Although back-up
suppliers are identified and available, the loss of this supplier would have a
material adverse affect on us. GSN's research and development personnel, in
conjunction with our in-house team, develop our product formulations. Pursuant
to the terms of our exclusive manufacturing agreement with GSN, we have a
$450,000 line of credit with GSN with 60 day terms. GSN informally alowed the
Company to purchase up to $1,000,000 on the line of credit. At December 31,
2002, the balance owed to GSN under this line of credit is $892,878.
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Our production/assembly personnel package products received from GSN.
Our production/assembly personnel fill out shipping documents and oversee
quality control and inventory flow. Our large retailer orders are shipped on
pallets using the preferred freight company of the retailer's choice.
INTELLECTUAL PROPERTY
Our policy is to pursue registration of all of the trademarks
associated with our key products. We currently own trademarks registered with
the United States Patent and Trademark Office for our Acutrim(R), and
CarbCutter(R) products and for our "On the Move(R)" advertising slogan. We have
also applied for trademark protection in the United States relating to several
of our advertising phrases, such as "I cheat," "We cheat," "Do you cheat?,"
Joint Lube, Fat Drops, Come Together, Thin Tab Carb Blocker, Thin Shake and Carb
Blocker. Federally registered trademarks have a perpetual life, provided that
they are renewed on a timely basis and are used properly as trademarks, subject
to certain rights of third parties to seek cancellation of the marks.
We also rely on common law trademark rights to protect our unregistered
trademarks. Common law trademark rights do not provide us with the same level of
protection as afforded by a United States federal registration of a trademark.
In addition, common law trademark rights are limited to the geographic area in
which the trademark is actually used.
We regard our trademarks and other proprietary rights as valuable
assets and believe that such rights have significant value in the marketing of
our products. We have in the past, and intend to continue in the future to,
vigorously protect our trademarks against infringement, both in the United
States and in foreign countries.
EMPLOYEES
We currently have twelve (12) full-time employees; four (4) are
managerial, four (4) are engaged in sales and marketing, two (2) are
administrative personnel and two (2) are assembly personnel. We believe our
relationship with our employees is good.
PRODUCT DISTRIBUTION
GENERAL
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Our customers are predominantly drug, health food, and mass retailers
who then sell our products to the retail consumer. We do not have contracts with
our customers to purchase our products. All of our customers purchase our
products on a purchase order basis.
DRUG, HEALTH FOOD AND MASS RETAILERS
During 2002, we continued to diversify our customer base by
establishing one or more of our products in more than eighteen (18) different
drug, health food, and mass retailers. Each of our products has achieved "full
distribution" in each of the chains that sell it, which means that if one of our
products is sold by a retailer, it is sold in every location operated by that
retailer. We estimate that CarbCutter(R) and Acutrim(R) Natural are now
available in more than 25,000 store locations nationwide. Because our customers
purchase our products on a purchase order basis, there can be no assurance that
our products will continue to have "full distribution" (or any distribution) by
the retailers that carry them.
One or more of our products are currently sold in the following mass
retailers: Wal-Mart (2048 locations), Walgreens (3,520 locations), Rite-Aid
(3,631 locations), CVS (4,123 locations), Brooks (Maxi
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Drug) (330 locations), Vitamin World (600 locations), H. E. Butt Grocery Co.
(280 locations), Wakefern (200 locations), Sav-On (1,300 locations), Giant
Landover (180 locations), Giant Eagle (188 locations), Eckerd's (2,650
locations), GNC (4,000 locations), Target (968 locations), Albertsons (2,128
locations), Duane Reade (193 locations), Long's (430 locations) and Vitamin
Shoppe (78 locations).
In 2002, we derived approximately $4,835,691 (or 95.2%) of gross
revenues from these customers. In 2001, we derived$5,524,760 (or 92.9%) of gross
revenues from drug, health food, and mass retailer customers. The term "gross
revenues" as used in this document relates to revenues excluding sales returns,
allowances and discount, slotting fees paid, co-op advertising and promotion
expense.
INDEPENDENT RETAIL HEALTH AND PHARMACY STORES
Our in-house staff of telemarketers (HNS Direct) has opened 4,000 new
accounts with independent retail health and pharmacy stores since we began this
program in January, 1999. These stores are not owned by a chain but are
independently owned and operated. We also participate in trade shows attended by
buyers for these independent retail health and pharmacy stores. In 2002, we
derived $246,456 (or 4.8%) of revenues from independent health and pharmacy
accounts. In 2001, we derived $419,827 (or 7.1%) of revenues from independent
health and pharmacy accounts. We believe that our revenue from the independent
customers declined in 2002 in part due to many independents going out of
business, our concentration of distribution efforts on our mass retailer
distribution network, and our focus on re-orders with existing independent
customers rather than on generating new accounts through special promotions.
Although we intend to work to expand the HNS Direct program using our existing
web site, HNSDirect.com and our in-house telemarketing program, we can offer no
assurance that we will be able to maintain or expand our number of independent
retail accounts in the future.
SIGNIFICANT CUSTOMERS
We currently have approximately 15 drug, health food, and mass retailer
customers which collectively comprised 87.0% of our gross revenues in 2002. We
depend on several significant customers for a large percentage of our sales. Our
largest customers are GNC, Wal-Mart, Walgreens, Rite Aid, Target, and Eckerd
Drugs. We do not have written agreements with any of these customers or any of
our other customers.
During the fiscal year ending 2002, GNC represented approximately 20.5%
of our gross sales, Wal-Mart represented approximately 12.2 % of our gross
sales, Walgreens represented approximately 10.6% of our gross sales, Rite Aid
represented approximately 10.1% of our gross sales, Target represented
approximately 7.0% of our gross sales, Eckerd's represented approximately 5.1%
of our gross sales. The loss of any one or more of our significant customers
would have a material adverse effect on our operations.
GOVERNMENT REGULATIONS
The processing, formulation, packaging, labeling and advertising of our
products are subject to regulation by one or more federal agencies, including
the Food and Drug Administration ("FDA"), the Federal Trade Commission ("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. In addition, we manufacture and market
certain of our products in substantial compliance with the guidelines
promulgated by the United States Pharmacopoeia Convention, Inc. ("USP") and
other voluntary standard organizations.
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The Dietary Supplemental Health and Education Act ("DSHEA") recognizes
the importance of good nutrition and the availability of safe dietary
supplements in preventive health care. DSHEA amends the Federal Food, Drug and
Cosmetic Act ("FFD&CA") by defining dietary supplements, which include vitamins,
minerals, nutritional supplements and herbs, as a new category of food, separate
from conventional food. Under DSHEA, the FDA is generally prohibited from
regulating such dietary supplements as food additives or drugs. It requires the
FDA to regulate dietary supplements so as to guarantee consumer access to
beneficial dietary supplements, allowing truthful and proven claims. Generally,
dietary ingredients that were on the market before October 15, 1994 may be sold
without FDA pre-approval and without notifying the FDA. However, new dietary
ingredients (those not used in dietary supplements marketed before October 15,
1994) require pre-market submission to the FDA of evidence of a history of their
safe use, or other evidence establishing that they are reasonably expected to be
safe. There can be no assurance that the FDA will accept the evidence of safety
for any new dietary ingredient that we may decide to use, and the FDA's refusal
to accept such evidence could result in regulation of such dietary ingredients
as food additives, requiring the FDA pre-approval based on newly conducted,
costly safety testing. Also, while DSHEA authorizes the use of statements of
nutritional support in the labeling of dietary supplements, the FDA is required
to be notified of such statements, and there can be no assurance that the FDA
will not consider particular labeling statements we use to be drug claims rather
than acceptable statements of nutritional support, necessitating approval of a
costly new drug application, or re-labeling to delete such statements. It is
also possible that FDA could allege false statements were submitted to it if
structure/function claim notifications was either non-existent or so lacking in
scientific support as to be plainly false.
FFD&CA also authorizes the FDA to promulgate good manufacturing
practice regulations ("GMP") for dietary supplements, which would require
special quality controls for the manufacture, packaging, storage and
distribution of supplements. Although the final version of the GMP rules has not
yet been issued, we anticipate we will be in substantial compliance with the
proposed regulations, once they are enacted. FFD&CA further authorizes the FDA
to promulgate regulations governing the labeling of dietary supplements. Such
rules, which were issued on September 23, 1997, entail specific requirements
relative to the labeling of our dietary supplements. The rules, which took
effect in March 1999, also require additional record keeping and claim
substantiation, reformulation, or discontinuance of certain products. We believe
we are in substantial compliance with these new requirements.
All of our products are classified as dietary supplements under the
FFD&CA. In September 1997, the FDA issued regulations governing the labeling and
marketing of dietary supplement products. These regulations cover:
o the identification of dietary supplements and their nutrition
and ingredient labeling;
o the wording used for claims about nutrients, health claims and
statements of nutritional support;
o labeling requirements for dietary supplements for which "high
potency" and "anti-oxidant" claims are made;
o notification procedures for statements on dietary supplements;
and
o pre-market notification procedures for new dietary ingredients
in dietary supplements.
The notification procedures became effective in October 1997. The
labeling requirements became effective on March 23, 1999. Where required, we
revised our product labels as necessary to reflect the requirements. We believe
we substantially comply with these requirements. In addition, we are required to
continue our ongoing program of providing evidence for our product performance
claims, and notify the FDA of certain types of performance claims made for our
products. Our substantiation program
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involves ongoing compilation and review of scientific literature pertinent to
the ingredients contained in our products and the claims we make about them.
In certain markets, including the United States, claims made with
respect to dietary supplements, personal care or any of our other products may
change the regulatory status of our products. For example, in the United States,
the FDA could possibly take the position that claims made for some of our
products make those products new drugs requiring preliminary approval. The FDA
could also place those products within the scope of its a Food and Drug
Administration over-the-counter (OTC) drug regulations and require it to comply
with a published FDA OTC monograph. OTC monographs dictate permissible
ingredients, appropriate labeling language and require the marketer or supplier
of the products to register and file annual drug listing information with the
Food and Drug Administration. We do not at present sell OTC drug products. If
the FDA were to assert that our product claims cause them to be considered new
drugs or fall within the scope of over-the-counter regulations, we would be
required to either file a new drug application, comply with the applicable
monographs, or change the claims made in connection with our products.
Additionally, dietary supplements are subject to the Nutrition,
Labeling and Education Act (NLEA), which regulates health claims, ingredient
labeling and nutrient content claims characterizing the level of a nutrient in a
product. NLEA prohibits the use of any health claim for dietary supplements
unless the health claim is supported by significant scientific agreement and is
pre-approved by the FDA.
The FTC regulates the marketing practices and advertising of all our
products. In the past several years, the FTC instituted enforcement actions
against several dietary supplement companies for false and misleading marketing
practices and advertising of certain products. These enforcement actions have
resulted in consent decrees and monetary payments by the companies involved.
Under FTC standards, the dissemination of any false advertising constitutes an
unfair or deceptive act or practice actionable under Section 45 of the Fair
Trade Commission Act and a false advertisement actionable under Section 52 of
that act. A false advertisement is one that is "misleading in a material
respect." In determining whether an advertisement or labeling information is
misleading in a material respect, FTC determines not only whether overt
representations and implied representations are false but also whether the
advertisement fails to reveal material facts. Under FTC's standard, any health
benefit representation made in advertising must be backed by "competent and
reliable scientific evidence" by which FTC means:
tests, analyses, research studies, or other evidence based upon the
expertise of professionals in the relevant area, that have been
conducted and evaluated in an objective manner by persons qualified to
do so, using procedures generally accepted by the profession to yield
accurate and reliable results.
The FTC has increased its review of the use of the type of testimonials
we use in our business. The Federal Trade Commission requires competent and
reliable evidence substantiating claims and testimonials at the time that such
claims of health benefit are first made. The failure to have this evidence when
product claims are first made violates the Federal Trade Commission Act.
Although the FTC has never threatened an enforcement action against us for the
advertising of our products, there can be no assurance that the FTC will not
question our advertising or other operations in the future.
We may be required to obtain an approval, license or certification from
a foreign country's ministry of health or comparable agency prior to entering a
new foreign market. We work with local authorities in order to obtain the
requisite approvals, license or certification before entering a foreign market.
The approval process generally requires us to present each of our products and
product ingredients to appropriate regulators and, in some instances, arrange
for testing of our products by local technicians for ingredient analysis. Such
approvals may be conditioned on reformulation of our products
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or may be unavailable with respect to certain of our products or certain
ingredients contained in our products. We must also comply with product labeling
and packaging regulations that are different from country to country. In markets
where a formal approval license or certification is not required, we will rely
upon the advice of local counsel, in each country, to help us ensure we comply
with the law.
In addition, we cannot predict whether new legislation or regulations
governing our activities will be enacted by legislative bodies or promulgated by
agencies regulating our activities, or what the effect of any such legislation
or regulations on our business would be. We may be subject to additional laws or
regulations administered by the FDA or other federal, state or foreign
regulatory authorities, the repeal of laws or regulations which we consider
favorable, such as the DSHEA, or more stringent interpretations of current laws
or regulations, from time to time in the future. We cannot predict the content
of any future laws, regulations, interpretations or applications. We also cannot
predict the future impact of the different governmental regulations; however,
any or all of such requirements could be a burden and costly, to us. Future
regulations could, however:
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.
COMPETITION
The diet industry is highly competitive. We compete directly with the
following companies who sell to our customers and their diet product brands:
Atkins Nutritional, Twinlabs, Metabolife International, Inc, Rexall Sundown,
Dexatrim, Natures Bounty (NBTY) and Slim Fast. We also compete indirectly with
companies that use direct marketing to distribute diet products directly to the
retail consumer without the use of an intermediary such as a mass retailer.
These companies use television and radio advertising which can range from thirty
second commercials to full length thirty minute infomercials. Many of these
companies also attempt to bring their best selling brands to the retail market
and such products then also compete directly with our products.
Our product formulas are not proprietary. Similar formulations are
currently being developed and marketed by our competitors. Substantially all of
our competitors have greater resources and name recognition than we do. Many of
our competitors sell, in addition to diet products, a broad range of health and
nutrition products. In addition, many of our competitors sell to the same
customers as we do. In addition, GSN, our sole manufacturer, sells similar
products to our competitors, often with similar formulations. We strive to
differentiate our products through the mixture of ingredients in our products
and the amounts of such ingredients contained in our products. We also trademark
our proprietary brand names such as, the "Carb Free Blend" in CarbCutter(R) See
"Intellectual Property." We believe that this allows us to maintain consumer
loyalty to our brand rather than to a specific ingredient or combination of
ingredients. We also strive to differentiate our products by providing
distinctive packaging.
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The most significant barrier to entry within our industry is the
difficulty of establishing a new product. This involves a major capital
commitment to advertise, participate in trade shows, build inventory, and pay
the cost of entry with slotting fees and or free merchandise. Test marketing
also requires a significant commitment of time and capital.
FINANCING
FACTORING
During 2002, we factored certain of our accounts receivable with
Alliance Financial Capital, Inc. On March 15, 2002, we terminated our factoring
agreement with Alliance and entered into a factoring agreement with LSQ Funding
Group, L.C. (LSQ). We only factor certain large accounts, and we do not factor
the accounts serviced through HNS Direct. The agreement with LSQ provides that
LSQ will purchase certain of our receivables and advance to us 85% of the face
amount of such receivables. The term of this agreement is one year. The maximum
amount of receivables we may factor under our agreement with LSQ is $750,000,
and there is no minimum amount required to be factored. In connection with the
factoring agreement, we granted to LSQ a blanket lien on our assets. In
connection with the LSQ Factoring Agreement, our President and Chief Executive
Officer was required to deliver a personal indemnity agreement to LSQ. The LSQ
contract expired in March of 2003 and the Company did not renew it.
GSN FINANCING
In early April 2002, we entered into an agreement with GSN, our sole
manufacturer, pursuant to which we agreed to repay to GSN amounts owed to them
as of the date of the agreement which were approximately $700,000. Our repayment
schedule requires equal monthly payments over the next twenty four months,
without interest. In connection with this agreement, we granted a blanket second
priority lien on our assets to GSN.
Also, in early April 2002, we entered into an exclusive manufacturing
agreement with GSN pursuant to which GSN has provided us with a $450,000 line of
credit, on current invoices, with 60 day terms. GSN informally allowed the
Company to purchase up to $1,000,000 on the line of credit. At December 31, 2002
the balance owed to GSN under this line of credit is $892,878.
VENDOR FINANCING
We consider our relationships with our vendors to be good. During 2002,
we were able to increase our credit limits as well as improve our payment terms
with certain vendors.
PRODUCTS LIABILITY INSURANCE
We are currently insured for products liability claims up to an
aggregate of $6,000,000. While our products liability policy currently covers
our products which contain ephedra, there can be no assurance that this coverage
will be available in the future at premium rates that were consider acceptable,
or at all.
We are also an additional named insured on GSN's products liability
policy which have aggregate coverage of up to $5,000,000.
-8-
ITEM 2. DESCRIPTION OF PROPERTY
Our corporate offices and finished product warehouse is located in a
6,000 square foot facility at 3750 Investment Lane, Building 5, West Palm Beach,
Florida, 33404. This lease expires on October 31, 2003 and provides for lease
payments of approximately $2,172 per month. We also have leased a 4,000 square
foot storage facility with lease payments of $1,767 per month. The lease
expiries on October 31, 2003. All packaging and shipping is performed at this
location.
During the first quarter of 2002, we entered into a sublease of 4,000
square feet of excess warehouse space for approximately $1,800 per month.
ITEM 3. LEGAL PROCEEDINGS
NEW YORK CITY DEPARTMENT OF CONSUMER AFFAIRS
In January 2001, the New York City Department of Consumer Affairs
("DCA") issued a Notice of Violation ("NOV") relating to certain claims made by
the Company relating to CarbCutter(R). In January 2002, HNS reached a settlement
with the DCA which provided for the payment to DCA of $10,000 and no admission
of guilt, liability or misconduct of any kind by HNS.
J.C. HERBERT BRYANT, III AND KMS-THIN TAB 100, INC.
The Company was involved in the litigation with J.C. Herbert Bryant,
III ("Bryant") and KMS-Thin Tab 100, Inc. ("KMS,") 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@ 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 has agreed not to sell its products directly to
certain KMS customers. HNS booked a legal settlement expense of $58,836
associated with this settlement.
The Company has been sued by six unaffiliated plaintiffs alleging that
the Company's Acutrim(R) products contain Phenylpropanolamine ("PPA") and that
those products have caused damage to the plaintiffs. The Company believes it can
demonstrate that none of the Company's Acutrim(R) products has ever contained,
or currently contains, PPA. To date, one of these cases has been dismissed after
delivery to plaintiff's counsel of information substantiating the fact that
HNS's products do not presently contain, and have not contained, PPA. While the
Company does not believe that HNS has material liability based upon the
substantive allegations set forth in these cases, the legal costs that the
Company has incurred, and may incur in the future, in obtaining dismissals from
these cases could have a material adverse effect on the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
During the fourth quarter of 2002, we did not submit any matters to the
vote of our security holders.
-9-
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The common stock of the Company trades on the OTC Bulletin
Board under the trading symbol "HNNS." The prices set forth below reflect the
quarterly high and low bid information for shares of our common stock during the
last two fiscal years as reported by CSI, Inc. These quotations reflect
inter-dealer prices, without retail markup, markdown or commission, and may not
represent actual transactions.
-10-
There were no trades of our securities on the OTCBB prior to October 4,
2000.
Fiscal Year 2002 High Low
---------------- ---- ---
Fourth Quarter 0.08 0.04
Third Quarter 0.15 0.08
Second Quarter 0.17 0.05
First Quarter 0.55 0.05
Fiscal Year 2001 High Low
---------------- ---- ---
Fourth Quarter 0.28 0.10
Third Quarter 0.51 0.14
Second Quarter 1.03 0.23
First Quarter 2.06 0.63
As of March 20, 2002, there were 83 holders of record of our common
stock.
Our common stock is covered by an SEC rule that imposes additional
sales practice requirements on broker-dealers who sell such securities to
persons other than established customers and accredited investors, which are
generally institutions with assets in excess of $5,000,000, or individuals with
net worth in excess of $1,000,000 or annual income exceeding $200,000 or
$300,000 jointly with their spouse. For transactions covered by the rule, the
broker-dealer must make a special suitable determination for the purchaser and
transaction prior to the sale. Consequently, the rule may affect the ability of
broker-dealers to sell our securities, and also may affect the ability of
purchasers of our stock to sell their shares in the secondary market. It may
also cause fewer broker-dealers to be willing to make a market in our common
stock, and it may affect the level of news coverage we receive.
Prior to June 29, 2000, we were not a reporting company and were not
required to file quarterly, annual, and other reports with the SEC.
We have not declared or paid any cash dividends on our common stock
since our inception, and our Board of Directors currently intends to retain all
earnings for use in the business for the foreseeable future. Any future payment
of dividends will depend upon our results of operations, financial condition,
cash requirements and other factors deemed relevant by our Board of Directors.
The following table provides information as of December 31, 2002 about
our common stock that may be issued upon the exercise of options under our 1998
Stock Option Plan for employees, officers, directors and independent
contractors.
-11-
EQUITY COMPENSATION PLAN INFORMATION
------------------------------- ---------------------------- ---------------------------- ----------------------------
PLAN CATEGORY NUMBER OF SECURITIES TO BE WEIGHTED-AVERAGE EXERCISE NUMBER OF SECURITIES
ISSUED UPON EXERCISE OF PRICE OF OUTSTANDING REMAINING AVAILABLE FOR
OUTSTANDING OPTIONS, OPTIONS, WARRANTS AND FUTURE ISSUANCE UNDER EQUITY
WARRANTS AND RIGHTS (A) RIGHTS COMPENSATION PLANS (EXCLUDING
SECURITIES REFLECTED IN
COLUMN (A))
------------------------------- ---------------------------- ---------------------------- ----------------------------
Equity compensation plans
approved by security holders 506,500 $.14 322,000
------------------------------- ---------------------------- ---------------------------- ----------------------------
Equity compensation plans not
approved by security holders
(1)
------------------------------- ---------------------------- ---------------------------- ----------------------------
TOTAL 506,500 $.14 322,000
------------------------------- ---------------------------- ---------------------------- ----------------------------
(1) We do not maintain equity compensation plans that have not been approved by
our stockholders.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
This annual report on Form 10-KSB contains forward-looking statements
and information. Any statements that are not statements of historical fact
should be regarded as forward-looking statements. For example, the words
"intends," "believes," "anticipates," "plans," and "expects" are intended to
identify forward-looking statements. There are a number of important factors
that could cause our actual results to differ materially from those indicated by
such forward-looking statements. These factors include without limitation those
factors described under "Certain Factors That May Affect Future Operations" in
this annual report. In addition, the recent terrorist attacks on the United
States, possible responses by the U.S. government, the effects on consumer
demand, the financial markets and other conditions increase the uncertainty
inherent in forward-looking statements. Finally, recent government action and
the surrounding publicity regarding ephedra-containing products may make it
difficult for us to obtain and maintain product liability insurance for our
products containing ephedra at current premiums. This could cause our actual
results to differ materially from those indicated by such forward-looking
statements.
The following discussion of our results of operations and financial
condition should be read along with our Consolidated Financial Statements listed
in Item 7 and the Notes to them appearing elsewhere in this Form 10-KSB.
CRITICAL ACCOUNTING POLICIES
Financial Reporting Release No. 60, which was recently released by the
U.S. Securities and Exchange Commission, encourages all companies to include a
discussion of critical accounting policies or methods used in the preparation of
financial statements. Our financial statements include a summary of the
significant accounting policies and methods used in the preparation of our
financial statements.
Management believes the following critical accounting policies affect
the significant judgments and estimates used in the preparation of the financial
statements.
REVENUE RECOGNITION
Revenues are recognized at the time of shipment of the respective
merchandise. Cost of sales includes freight cost. Included in the net sales in
the accompanying financial statements for the twelve months ended December 31,
2002 and 2001 are returns and allowances and sales discounts in the amounts of
$612,700 and $579,255, respectively.
APPLICATION OF EIFT 01-9, "ACCOUNTING FOR CONSIDERATION GIVEN BY A VENDOR TO
CUSTOMER (INCLUDING A RESELLER OF THE VENDOR'S PRODUCTS)"
In accordance with EITF 01-9, we reclassified expenses relating to
slotting fees paid, co-op advertising and promotions, from operating expenses to
revenues. The term "gross revenues" as used in this document relates to the
revenues excluding the above mentioned advertising expenses and sales returns,
allowances and discounts. Gross revenues for 2002 and 2001 are $5,082,147 and
$5,944,587 respectively, and the co-op advertising expenses are $901,599 and
$1,524,943 respectively.
-12-
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.
OVERVIEW
Like most consumer businesses, our business is affected by general
economic, political and public safety conditions that impact consumer confidence
and spending. The impact of the terrorist attacks of September 11, 2001 and the
government's response to them including the commencement of the Persian Gulf
war, have had short-term and also have had, and may continue to have, long-term
adverse effects on our revenues, results of operations, financial condition and
prospects. The industy revenues reported in year 2002 were down approximately
25% percent from those reported in year 2001. We believe that this trend will
reverse itself in the year 2003 and report an up turn in the industry.
During 2002, we continued to implement our strategic plan to diversify
our product line through the development and promotion of two new products: Fat
Cutter Plus and Acutrim(R) Natural as well as the promotion and expansion of the
distribution of CarbCutter(R). This strategy is aimed at reducing the negative
impact upon us of (i) a shift in consumer preferences with regard to any one of
our products, (ii) a change in retailer preferences for our products, or (iii)
any other cause of reduced sales either for a particular product or in a
particular geographical region because of negative publicity. The Company
announced on December 19, 2002 that it had made a strategic decision to
discontinue the sales of all ephedra-based products. As a result, the Company
discontinued sales of Thin Tab(R) and Fat Cutter Plus in the first quarter of
2003. Our retail customers, however, may continue to sell those products from
their inventory. Alternatively, they may try to return the products to us. In
2002, sales of those products were $965,608 or 19% of total revenue. At December
31, 2002, the Company recorded an allowance for sales returns of $317,600,
including $200,000 for returns of products containing ephedra expected in 2003.
We cannot predict the effects of the discontinuance of these products
on our revenues, results of operations, financial condition and prospects. See
"Commitments and Contingencies."
-13-
RESULTS OF OPERATIONS
NET SALES:
Year ended December 31, 2002 compared with Year ended December 31, 2001
Gross revenues for the twelve months ended December 31, 2002 decreased
by $862,440, to $5,082,147,versus the comparable period in 2001 of $5,944,587.
The decrease was due to the decrease in sales to our major customers of $689,069
and a decrease in our in-house telemarketing revenue of $173,371. We believe
these decreases were primarily based on a generally soft market and reduced
advertising. During the twelve months ended December 31, 2002, six companies
accounted for 65.5% of the gross revenues. GNC, our largest account, accounted
for 20.5% of total sales versus the comparable period in 2001 of 20.8%. Net
revenues for the twelve months ended December 31, 2002 decreased by $272,541 to
$3,567,848 versus the comparable period in 2001 of $3,840,389.
Year ended December 31, 2001 compared with Year ended December 31, 2000
Gross revenues for the twelve months ended December 31, 2001 decreased
by $298,943 to $5,944,587 versus the comparable period in 2000 of $5,645,644.
The decrease was primarily due to the decrease in our in-house telemarketing
revenue of $603,550 in fiscal year 2001 versus the comparable period in fiscal
2000. During the twelve months ended December 31, 2001, six companies accounted
for 73.5% of the total Company's revenues. GNC, our largest account, accounted
for 20.8% of total sales versus the comparable period in 2000 of 45.0%. Net
revenues for the twelve months ended December 31, 2001 decreased by $954,465 to
$3,840,389 versus the comparable period in 2000 of $4,794,854.
COST OF SALES
Year ended December 31, 2002 compared with Year ended December 31, 2001
Cost of sales for the twelve months ended December 31, 2002 was
$1,511,826 or 42.4% of net sales, compared to $1,903,755 or 49.6% of net sales
for the twelve months ended December 31, 2001. The decrease in cost of sales as
a percentage of net sales is primarily attributed to higher sales of
CarbCutter(R), which had a formula change decreasing the cost of goods sold on
this product in fiscal year 2002. Additionally, the cost of sales was reduced by
$73,747 which represents imputed interest on the Company's Note with GSN. The
cost of sales as a percentage of net sales without this discount is 44.4%.
Year ended December 31, 2001 compared with Year ended December 31, 2000
Cost of sales for the twelve months ended December 31, 2001 was
$1,903,755 or 49.6% of net sales, compared to $1,472,528 or 30.7% of net sales
for the twelve months ended December 31, 2000. The increase in cost of sales as
a percentage of net sales is primarily attributed to higher sales of
CarbCutter(R), which had a formula change increasing the cost of goods sold on
this product in fiscal year 2001, and the reformulation of Acutrim Natural(R)
that increased the cost of sales percentage.
-14-
GROSS PROFIT:
Year ended December 31, 2002 compared with Year ended December 31, 2001
Gross profit for the twelve months ended December 31, 2002 was
$2,056,022 an increase of $119,388, or 6.2%, compared to gross profit of
$1,936,634 for the twelve months ended December 31, 2001. As a percent of net
sales, gross profit was 57.6% for the twelve months ending December 31, 2002, as
compared to 50.4% for the twelve months ended December 31, 2001. The increase in
gross profit dollars is primarily attributed to the decrease in cost of goods as
explained above.
Year ended December 31, 2001 compared with Year ended December 31, 2000
Gross profit for the twelve months ended December 31, 2001 was
$1,936,634 a decrease of $1,385,691 or 41.7%, compared to gross profit of
$3,322,325 for the twelve months ended December 31, 2000. As a percent of net
sales, gross profit was 50.4% for the twelve months ending December 31, 2001, as
compared to 69.2% for the twelve months ended December 31, 2000. The decrease in
gross profit is primarily attributed to the increase in cost of goods for the
CarbCutter(R) and also Acutrim(R) Natural, each of which were reformulated in
2001 and as a result of such reformulation, has a lower gross margin than the
prior year.
OPERATING EXPENSES:
Year ended December 31, 2002 compared with Year ended December 31, 2001
Operating expenses were $1,980,493 for the twelve months ended December
31, 2002, compared to $3,313,837 for the twelve months ended December 31, 2001,
representing a decrease of $1,333,344. As a percent of net sales, operating
expenses were 55.5% for the twelve months ended December 31, 2002, compared to
86.3% for the twelve months ended December 31, 2001. Advertising and promotion
expenses were $425,349 for the twelve months ended December 31, 2002, compared
to $881,541 for the twelve months ended December 31, 2001, representing a
decrease of $456,192. Expenditures of $901,600 and $1,523,943 for the years 2002
and 2001 respectively, which were previously classified as advertising and
promotion expenses were classified to revenues. These expenses in 2001 were
primarily due to expenses associated with the new product launches of Fat Cutter
and Carbolizer as well as expenses associated with expanding the distribution of
our other products. General and administration expenses were $1,524,678 for the
twelve months ended December 31, 2002, compared to $2,400,680 for twelve months
ended December 31, 2001, representing a decrease of $876,002. This decrease was
primarily a result of reductions in personnel expenditures, factoring
expenditures offset in part by professional fees associated with litigation
during 2002.
Year ended December 31, 2001 compared with Year ended December 31, 2000
Operating expenses were $3,313,837 for the twelve months ended December
31, 2001, compared to $3,238,121 for the twelve months ended December 31, 2000,
representing an increase of $75,716. As a percent of net sales, operating
expenses were 86.3% for the twelve months ended December 31, 2001, compared to
67.5% for the twelve months ended December 31, 2000. Advertising and promotion
expenses were $881,541 for the twelve months ended December 31, 2001, compared
to $1,007,694 for the twelve months ended December 31, 2000, representing a
decrease of $126,153. General and administration expenses were $2,400,680 for
the twelve months ended December 31, 2001, compared to $2,201,478 for the twelve
months ended December 31, 2000, an increase of 9.0%. This increase was primarily
a result of additional personnel expenditures and professional fees associated
with litigation during 2001.
-15-
NET INCOME FROM OPERATIONS
Year ended December 31, 2002 compared with Year ended December 31, 2001
Net income for the twelve months ended December 31, 2002, was $27,606
or .01 per share compared to a net loss of $(1,399,533) or $(.39) per share for
the twelve months ended December 31, 2001. The increase in income was a direct
result of our commitment to reduce the operating expenses, resulting in a
decrease of $1,333,344 over the prior year.
Year ended December 31, 2001 compared with Year ended December 31, 2000
Net loss for the twelve months ended December 31, 2001, was
$(1,399,533) or (.39) per share compared to net income of $70,562 or $.02 per
share for the twelve months ended December 31, 2000. The decrease in income was
a direct result of our commitment to the advertising and promotion of our
product lines. Advertising, Slotting Fees, Co-ops, Free Goods and Promotion
Expenditures increased $789,392 or 48.8% over the previous twelve months ended
December 31, 2000.
CARRY FORWARD LOSS
We have a net operating loss carry forward, as of December 31, 2002, of
$895,346 for tax purposes to affect future taxable income. The net operating
loss carry forwards expire in 2022.
LIQUIDITY & CAPITAL RESOURCES
At December 31, 2002, the Company had a working capital deficit of
$702,970 compared to the prior year end, at December 31, 2001, of $900,663. This
is an improvement of $197,693. In early April 2002, we entered into an agreement
with GSN, our sole manufacturer, pursuant to which we agreed to repay to GSN
amounts we owed to them as of the date of the agreement which were approximately
$700,000 over the next twenty-four months. Our current liabilities from accounts
payable and accrued expenses increased during 2002 by $593,084.
Net cash provided by operating activities for the year ended December
31, 2002 was $190,329 and resulted primarily from decreased operating expenses.
Net cash provided by investing activities was $0 for the year ended December 31,
2002 Net cash used in financing activities for the year ended December 31, 2002
was $(257,483) which includes repayment of notes payable of $237,400 and $20,083
for capital lease payments. Net cash used in operating activities for the year
ended December 31, 2001 was $(33,650) and resulted primarily from increased
operating expenses. Net cash provided by investing activities was $122,163 for
the year ended December 31, 2001, which resulted from purchases of trademarks
for $25,000 and the release of a certificate of deposit as collateral for a bank
loan of approximately $150,000.
-16-
During 2001, we factored certain of our accounts receivable with
Alliance Financial Capital, Inc. On March 15, 2002, we terminated our factoring
agreement with Alliance and entered into a factoring agreement with LSQ Funding
Group, L.C. (LSQ). The term of this agreement is one year. The maximum amount of
receivables we may factor under our agreement with LSQ is $750,000, and there is
no minimum amount required to be factored. In connection with the factoring
agreement, we granted to LSQ a blanket lien on our assets. Our factoring
arrangement provides us with cash at the time of shipment of the product. The
Company decided not to renew the LSQ agreement in March 2003.
As stated above, in early April 2002, we entered into an agreement with
GSN, our sole manufacturer, pursuant to which we agreed to repay to GSN amounts
we owed to them as of the date of the agreement which were approximately
$700,000. In connection with this agreement, we granted to GSN a blanket second
priority lien on our assets. Also, in early April 2002, we entered into an
exclusive manufacturing agreement with GSN pursuant to which GSN has provided us
with a $450,000 line of credit with 60 day terms. At December 31, 2002, we
owed GSN $892,878.
COMMITMENTS AND CONTINGENCIES
Regulatory Matters - Our discontinued products, Fat Cutter Plus, Thin
Tab(R), and formally owned Carbolizer(TM) product, contain ephedra, also known
as "Ma Huang," an herb which contains naturally-occurring ephedrine. These
products represented approximately 19% of our gross revenue for the twelve
months ended December 31, 2002. Ephedra containing products have been the
subject of adverse publicity in the United States and other countries relating
to alleged harmful effects. The company has discontinued all sales of products
containing ephedra.
In April 2000, the FDA withdrew most of the provisions of its proposed
rule regarding dietary supplements that contain ephedrine alkaloids. The
proposed rule, which was published in 1997, would have significantly limited our
ability to sell Fat Cutter Plus, ThinTab and Carbolizer if it had been made
effective. The FDA's withdrawal of the provisions removed most, but not all, of
the limitations. This action was prompted largely by a report issued by the
United States General Accounting Office (GAO) in which the GAO criticized as
faulty the scientific basis for the proposed rule and the FDA's evaluation of
approximately 900 reports of adverse events supposedly related to the
consumption of dietary supplements containing ephedrine alkaloids. The FDA made
available for public inspection most of the adverse event reports on April 3,
2000.
On October 25, 2000, several trade organizations for the dietary
supplement industry submitted a petition to the FDA which concerned the
remaining provisions of the proposed rule regarding dietary supplements that
contain ephedrine alkaloids. The petition requested the FDA to: (1) withdraw the
remaining provisions of the proposed rule, and (2) adopt new standards for
dietary supplements that contain ephedrine alkaloids, which were set forth in
the petition. The FDA has not publicly responded to this petition.
The FDA will, most likely, attempt to issue a new proposed rule with
respect to dietary supplements that contain ephedrine alkaloids. However, it is
uncertain what restrictions the new proposed rule might contain or when a new
proposed rule will be issued. In our opinion, it is unlikely that a final
regulation will be issued by the FDA during 2002. Consequently, we are unable at
the present time to predict the ultimate resolution of these issues, or their
ultimate impact on our results of operations or financial condition. In the
event that these rules limit our ability to sell our products containing
ephedra, we have already developed ephedrine-free formulae for those products.
In addition, to the extent that sales of ephedra-containing products of our
competitors decline as a result of any new rules, sales of our current
non-ephedra products may be positively affected.
Product Liability - We, like other marketers of products that are
intended to be ingested, face the inherent risk of exposure to product liability
claims in the event that the use of our products results in injury. We currently
-17-
maintain product liability insurance coverage of $6,000,000. It may become
increasingly difficult to obtain and maintain product liability insurance
coverage for products containing ephedra at current premiums, or at all.
Although we believe our current liability coverage is sufficient to cover claims
which have been or may be asserted against us, if they are in the future, our
product liability insurance coverage could prove to be inadequate and these
claims could result in material losses.
CERTAIN FACTORS WHICH MAY AFFECT FUTURE RESULTS
If Garden State Nutritionals, our sole manufacturer, fails to supply
our products in sufficient quantities and in a timely fashion, our business may
suffer. We currently obtain 100% of our manufactured product from a single
source of supply, Garden State Nutritionals. In 2002, we entered into a two year
contract with GSN to manufacture all of our products. In the event that GSN is
unable or unwilling to provide us with the products in accordance with the terms
of our contract, delays in securing alternative sources of supply would result
in a material adverse effect upon our operations.
The dietary supplement industry is highly competitive. The diet
industry is highly competitive. Many of our competitors, particularly
manufacturers of nationally advertised brand name products, are larger and have
resources substantially greater than we do. In the future, if not currently, one
or more of these companies could seek to compete more directly with us by
manufacturing and distributing their own or others' products, or by
significantly lowering the prices of their existing national brand products. If
one or more of our competitors significantly reduce their prices on existing
products in an effort to gain market share or aggressively promote new products
in an effort to enter a market, our results of operations or market position
could be adversely affected. In addition, because the formulations of our
products are not proprietary, similar formulations are currently being developed
and marketed by these competitors.
Our products may also face competition in the future from diet-related
drugs introduced by pharmaceutical companies.
We currently have a limited number of products. We currently market
seven products. The loss of, or deterioration in the popularity of any one or
more of our other brands will have a material adverse effect on our Company.
Our failure to develop and introduce new products could have an adverse
effect on our Company. We believe our ability to grow in our existing market is
partially dependent upon our ability to introduce new and innovative products
into these markets. Although we seek to introduce additional products in our
existing markets, the success of new products is subject to a number of
variables, including developing products that will appeal to customers and
competing with product launches by our competitors. We cannot assure you that
our efforts to develop and introduce new products will be successful or that
customers will accept new products.
We could be adversely affected if any of our products or any similar
products distributed by other companies should prove or be asserted to be
harmful to consumers or should scientific studies provide unfavorable findings
regarding the effectiveness of our products. All of our products have
certificates of analysis supplied by our manufacturer, and we have completed
independent clinical testing of all of our products. We are highly dependent
upon our customers' and the retail consumers' perception of the overall
integrity of our business, as well as the safety and quality of our products and
similar products distributed by other companies, which may not adhere to our
quality standards. Our ability to attract and retain customers who, in turn,
attract retail consumers, could be adversely affected by negative publicity
regarding our products or one or more ingredients in our products or by the
announcement by any governmental agency of a regulatory initiative relating to
ingredients in our products.
-18-
Our customers may discontinue use of our products at any time. Our
customers order products on a purchase order basis and may discontinue the sale
of our products at any time. If product sales are discontinued, we may not
receive payment for units that are not paid for as of the time of
discontinuation. Additionally, certain of our customers have the right to take a
credit in an amount equal to the unpaid balance of the discontinued product
against other products of ours that they may purchase.
Our success largely depends upon national media attention. We believe
that the historical growth experienced by the nutritional supplement market is
based in part on the national media attention regarding recent scientific
research suggesting potential health benefits from regular consumption of
certain vitamins and other nutritional products. Such research has been
described in major medical journals, magazines, newspapers and television
programs. The scientific research to date is preliminary, and there can be no
assurance of future favorable scientific results and media attention or of the
absence of unfavorable or inconsistent findings. While public awareness of the
positive effects of vitamins and nutritional supplements on health was
heightened by widely publicized reports of scientific findings supporting such
claims during 1997-1998, we believe that negative media attention focusing on
questions of efficacy, safety and label claim content have had a significant
adverse impact on the supplement industry over the past two years. In
particular, negative publicity with respect to ephedrine products has impacted
our business. The lack of growth in the nutritional supplement industry has also
been caused by the lack of new "blockbuster" products and increasing
competition, including intense private label expansion. There can be no
assurance that these factors will not be present in the future.
We, like other sellers of products that are ingested, face an inherent
risk of exposure to product liability claims if, among other things, the use of
our\products results in injury. We currently have product liability insurance
for our operations in amounts we believe are adequate for our operations. There
can be no assurance, however, that such insurance will continue to be available
at a reasonable costs, if at all, or, if available, will be adequate to cover
such liabilities.
Restrictive governmental regulations govern the manufacturing and
distribution of our products. We are subject to numerous governmental
regulations, including but not limited to regulations promulgated by FDA, FTC
and the Consumer Product Safety Commission, regarding the distribution, labeling
and promotion of our products. All of the ingredients that we use in our
products have been reviewed by the FDA upon submission of information by others.
If we intend to use any ingredient in our products that has not already been
reviewed by the FDA, we would be required to submit the new dietary ingredient
to the FDA and to demonstrate a history of safe use. If the FDA does not accept
the evidence of safety we present for the new dietary ingredient, the FDA could
determine that such result ingredient should be regulated as a food additive and
require time consuming and costly FDA approval. Additionally, under the FD&CA
(including NLEA and DSHEA), the FDA has issued regulations regarding labeling
and marketing of our products, and the NLEA regulates nutrient and ingredient
labeling. The FTC regulates marketing practices and advertising of our products.
Our business and financial results could be materially harmed by our failure to
comply with these labeling and marketing regulations.
The laws and regulations relating to our products are subject to
frequent and substantial changes resulting from legislation, adoption of rules
and regulations and administrative and judicial interpretation of existing laws.
These changes may have a dramatic effect on our business. Such changes may be
applied retroactively. The ultimate timing or effect of such changes cannot be
predicted. Our failure to comply with such laws, requirements and regulations
could adversely affect our business and finances.
-19-
We depend on significant customers for a large percentage of our net
sales. Our largest customers are GNC, Wal-Mart, Walgreens, Rite Aid, Target,
Eckerd's and CVS. We do not have written agreements with any of these customers.
We cannot assure you that these customers will continue as major customers of
the Company. The loss of any of these customers, or a significant reduction in
purchase volume by any of these customers, could have a material adverse effect
on our results of operations or financial condition.
We believe that trademarks and other proprietary rights are among our
most important assets. In fiscal 2002, substantially all of our net sales were
from products bearing proprietary brand names, including Acutrim(R) Natural Thin
Tab(R) and CarbCutter(R). Accordingly, our future success depends upon the
goodwill associated with these brand names. Although our principal brand names
are registered in the United States, we cannot assure you that the steps we have
taken to protect our proprietary rights in our brand names will be adequate to
prevent the misappropriation of these registered brand names in the United
States or abroad. In addition, the laws of some foreign countries do not protect
proprietary rights in brand names to the same extent as do the laws of the
United States. In addition, to the extent that we rely on common law trademark
rights to protect our unregistered trademarks, such common law trademark rights
do not provide us with the same level of protection as afforded by a United
States federal registration of a trademark. In addition, common law trademark
rights are limited to the geographic area in which the trademark is actually
used. Additionally, the sales of certain of our products rely on our ability to
maintain and extend our licensing agreements with third parties, and we cannot
assure you that these third parties can successfully maintain their intellectual
property rights or that we will be successful in maintaining these licensing
agreements. If we lose the right to use these licenses, our business could be
materially adversely affected.
Although we are committed to enforce our various trademarks and other
intellectual property rights against infringement, we cannot assure you that we
will be able to successfully do so. The loss of, or deterioration in, our
intellectual property rights could adversely affect our business.
We depend substantially on the continued services and performance of
our senior management. Our business may be hurt if Chris Tisi, our President and
Chief Executive Officer, leaves us. Although we have an employment agreement
with Mr. Tisi, this does not guarantee that he will remain with us. If we lose
his services, we may not be able to attract and retain additional qualified
personnel to fill his position in the future.
Control of our company is concentrated among a limited number of
stockholders who can exercise significant influence over all matters requiring
stockholder approval. As of December 31, 2002, our present directors, executive
officers and their respective affiliates and related entities beneficially owned
approximately 33% of our outstanding common stock and common stock equivalents.
In addition, our President and Chief Executive Officer has agreed with certain
other significant shareholders to vote together on certain matters. These
stockholders can exercise significant influence over all matters requiring
stockholder approval, including the election of directors and the approval of
significant corporate transactions. This concentration of ownership may also
potentially delay or prevent a change in control of our company.
-20-
Our stock price is likely to remain volatile. The stock market has,
from time to time, experienced significant price and volume fluctuations that
may be unrelated to the operating performance of particular companies. In
addition, the market price of our common stock, like the stock price of many
publicly traded dietary and nutritional product companies, has been and will
likely continue to be volatile. Prices of our common stock may be influenced by
many factors, including:
o investor perception of us;
o analyst recommendations;
o market conditions relating to dietary and nutritional product
companies;
o announcements of new products by us or our competitors;
o publicity regarding actual or potential developments relating
to products under development by us or our competitors;
o developments or disputes concerning proprietary rights;
o regulatory developments;
o period to period fluctuations in financial results of us and
our competitors;
o future sales of substantial amounts of common stock by
shareholders; and o economic and other external factors.
We are not likely to pay dividends. We have not paid any cash dividends
on our common stock and we do not plan to pay any cash dividends in the
foreseeable future. We plan to retain any earnings for the operation of our
business.
ITEM 7. FINANCIAL STATEMENTS
The financial statements are included beginning at F-1. See Index to
the Financial Statements.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
-21-
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
We have adopted a written code of ethics that applies to our senior
financial officers and persons performing similar functions, which Code has been
filed as Exhibit 14 hereto. We intend to disclose any amendments to, or waivers
from, the Code on our website, www.hnsglobal.com. Upon written request to our
corporate secretary by U.S. mail, we will provide, at no charge, a copy of such
Code to any person requesting a copy.
The other information required by this Item will be included in our
Proxy Statement which will be filed with the Securities and Exchange Commission
in connection with our 2003 Annual Meeting of Shareholders and is incorporated
herein by reference.
ITEM 10. EXECUTIVE COMPENSATION
The information required by this Item will be included in our Proxy
Statement which will be filed with the Securities and Exchange Commission in
connection with our 2003 Annual Meeting of Shareholders and is incorporated
herein by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
EQUITY COMPENSATION PLAN INFORMATION
------------------------------- ---------------------------- ---------------------------- ----------------------------
PLAN CATEGORY NUMBER OF SECURITIES TO BE WEIGHTED-AVERAGE EXERCISE NUMBER OF SECURITIES
ISSUED UPON EXERCISE OF PRICE OF OUTSTANDING REMAINING AVAILABLE FOR
OUTSTANDING OPTIONS, OPTIONS, WARRANTS AND FUTURE ISSUANCE UNDER
WARRANTS AND RIGHTS (A) RIGHTS EQUITY COMPENSATION PLANS
(EXCLUDING SECURITIES
REFLECTED IN COLUMN (A))
------------------------------- ---------------------------- ---------------------------- ----------------------------
Equity compensation plans
approved by security holders 506,500 $.14 322,000
------------------------------- ---------------------------- ---------------------------- ----------------------------
Equity compensation plans not
approved by security holders
(1)
------------------------------- ---------------------------- ---------------------------- ----------------------------
TOTAL 506,500 $.14 322,000
------------------------------- ---------------------------- ---------------------------- ----------------------------
(1) We do not maintain equity compensation plans that have not been approved by
our stockholders.
The other information required by this Item will be included in our
Proxy Statement which will be filed with the Securities and Exchange Commission
in connection with our 2003 Annual Meeting of Shareholders and is incorporated
herein by reference.
-22-
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item will be included in our Proxy
Statement which will be filed with the Securities and Exchange Commission in
connection with our 2003 Annual Meeting of Shareholders and is incorporated
herein by reference.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Documents filed as part of this Form 10-KSB
FINANCIAL STATEMENTS:
o Independent Auditors' Report
o Balance Sheets as of December 31, 2002 and 2001
o Statements of Operations for the years ended December
31, 2002 and 2001
o Statements of Changes in Stockholders' Equity for the
years ended December 31, 2002 and 2001
o Statements of Cash Flows for the years ended December
31, 2002 and 2001
o Notes to Financial Statements
THE FOLLOWING EXHIBITS ARE FILED AS PART OF THIS FORM 10-KSB
The exhibits to this Form 10-KSB appear following the Company's
Financial Statements included in this report.
3.1(a) Articles of Incorporation of the Registrant (incorporated by reference to Exhibit 3.1(A) of Registrant's
registration statement on Form 10-SB, filed on January 31, 2000; Commission File Number 000-29245).
3.1(b) Articles of Amendment to the Articles of Incorporation (incorporated by reference to Exhibit 3.1(B) of
Registrant's registration statement on Form 10-SB, filed on January 31, 2000;
Commission File Number 0000-29245).
3.1(c) Articles of Amendment to Articles of Incorporation (incorporated by reference to Exhibit 3.1(C) of
Registrant's registration statement on Form 10-SB, filed on January 31, 2000;
Commission File Number 000-29245).
3.1(d) Articles of Amendment to Articles of Incorporation (incorporated by reference to Exhibit 3.1(D) of
Registrant's Annual Report on Form 10-KSB, filed on April 16, 2001; Commission File Number 000-29245).
3.2 By-Laws of the Registrant (incorporated by reference to Exhibit 3.2 of Registrant's
registration statement on Form 10-SB, filed on January 31, 2000; Commission File Number
000-29245).
3.3 Amendment to the Restated Bylaws of the Company dated September 25, 2000 (incorporated by
reference to Exhibit 3.3 of Registrant's Annual Report on Form 10-KSB, filed on April 16,
2000; Commission File Number 000-29245).
3.4 Amendment to the Restated Bylaws of the Company dated November 10, 2000 (incorporated by
reference to Exhibit 3.4 of Registrant's Annual Report on form 10-KSB, filed on April 16,
2000; Commission File Number 000-29245).
10.1 Employment Agreement between the Company and Chris Tisi effective as of January 1, 2002
(incorporated by reference to Exhibit 10.1 of Registrant's Current Report on Form 8-K
filed on February 13, 2002; Commission File Number 000-29245).
-23-
10.2 Severance Agreement between the Company and Steven Pomerantz effective as of January 1, 2002
(incorporated by reference to Exhibit 10.3 of Registrant's Current Report on Form 8-K filed on
February 13, 2002; Commission File Number 000-29245).
10.3 Factoring and Security Agreement between LSQ Funding Group L.C. and Health and Nutrition Systems
International, Inc. effective as of March 15, 2002 (incorporated by reference to Exhibit 10.3 of
Registrant's Annual Report on Form 10-KSB, filed on April 12, 2002; Commission File Number
000-29245).
10.4 Indemnification Agreement dated March 15, 2002 between LSQ Funding Group L.C. and Christopher
Tisi (incorporated by reference to Exhibit 10.4 of Registrant's Annual Report on Form 10-KSB,
filed on April 12, 2002; Commission File Number 000-29245).
10.5 Indemnification Agreement between the Company and Chris Tisi dated January 1, 2002
(incorporated by reference to Exhibit 10.2 of Registrant's Current Report on Form 8-K filed on
February 13, 2002; Commission File Number 000-29245).
10.6 Indemnification Agreement between the Company and Steven Pomerantz dated January 1, 2002 (incorporated
by reference to Exhibit 10.4 of Registrant's Current Report on Form 8-K filed on February 13, 2002;
Commission File Number
000-29245).
10.7 Lease Agreement between the Company and Fred Keller, Trustee dated November 1, 2000
(incorporated by reference to Exhibit 10.5 of Registrant's Annual Report on Form 10-KSB, filed
on April 16, 2001; Commission File Number 000-29245).
10.8 Lease Agreement between the Company and Fred Keller, Trustee dated January 1, 2001
(incorporated by reference to Exhibit 10.6 of Registrant's Annual Report on Form 10-KSB, filed
on April 16, 2001; Commission File Number 000-29245).
10.9 Secured Party's Bill of Sale between Fleet National Bank and the Company dated January 12,
2001 (incorporated by reference to Exhibit 10.1 of Registrant's Current Report on Form 8-K
filed on January 26, 2001; Commission File Number 000-29245).
10.10 Trademark Assignment from Heritage Consumer Products, LLC to the Company dated January 12,
2001 (incorporated by reference to Exhibit 10.2 of Registrant's Current Report on Form 8-K
filed on January 26, 2001; Commission File Number 000-29245).
10.11 Agreement between the Company and Steven Pomerantz dated January 12, 2001 (incorporated by
reference to Exhibit 10.3 of Registrant's Current Report on Form 8-K filed on January 26,
2001; Commission File Number 000-29245).
10.12 Shareholders' Agreement among Tony D'Amato, Chris Tisi, and the Company dated July 13, 2000
(incorporated by reference to Exhibit 1 of Christopher Tisi, Steven Pomerantz, Tony Musso, and
Tony D'Amato's Schedule 13D, filed on January February 14, 2001; Commission File Number
0-29245).
10.13 Irrevocable Proxy dated July 13, 2000 (incorporated by reference to Exhibit 2 of Christopher
Tisi, Steven Pomerantz, Tony Musso, and Tony D'Amato's Schedule 13D, filed on January February
14, 2001; Commission File Number 0-29245).
10.14 Waiver dated January 31, 2001 (incorporated by reference to Exhibit 3 of Christopher Tisi,
Steven Pomerantz, Tony Musso, and Tony D'Amato's Schedule 13D, filed on January
February 14, 2001; Commission File Number 0-29245).
10.15 Joint Filing Agreement dated February 13, 2001 (incorporated by reference to Exhibit 4 of
Christopher Tisi, Steven Pomerantz, Tony Musso, and Tony D'Amato's Schedule 13D, filed on
January February 14, 2001; Commission File Number 0-29245).
-24-
10.16 Exclusive Manufacturing Agreement dated April 11, 2002 between the Company and Garden State
Nutritionals, a division of VitaQuest International, Inc. (incorporated by reference to Exhibit
10.16 of Registrant's Annual Report on Form 10-KSB, filed on April 12, 2002; Commission File
Number 000-29245).
10.17 Security Agreement dated April 11, 2002 between the Company and Garden State Nutritionals, a
division of VitaQuest International, Inc. (incorporated by reference to Exhibit 10.16 of
Registrant's Annual Report on Form 10-KSB, filed on April 12, 2002; Commission File Number
000-29245).
10.18 Health & Nutrition Systems International, Inc. 1998 Stock Option Plan (incorporated by
reference to Exhibit 10.18 of Registrant's Annual Report on Form 10-KSB, filed on April 12,
2002; Commission File Number 000-29245).
10.19 Promissory Note dated April 11, 2002 between the Company as borrower and Garden State
Nutritionals as lender (incorporated by reference to Exhibit 10.19 of Registrant's
Annual Report on Form 10-KSB, filed on April 12, 2002; Commission File Number 000-29245).
10.20 Subordination Agreement dated April 11, 2002 among the Company, LSQ Funding Group, L.C. and
Garden State Nutritionals (incorporated by reference to Exhibit 10.20 of Registrant's Annual
Report on Form 10-KSB, filed on April 12, 2002; Commission File Number 000-29245).
10.21 Amendment No. 1 dated April 29, 2002 to the Employment Agreement between the Company and Chris
Tisi effective as of January 1, 2002 (incorporated by reference to Exhibit 10.21 of
Registrant's Annual Report on Form 10-KSB/A-1, filed on April 30, 2002; Commission File Number
000-29245).
10.22 Amendment No. 1 dated April 29, 2002 to the Severance Agreement between the Company and Steven
Pomerantz effective as of January 1, 2002 (incorporated by reference to Exhibit 10.2 of
Registrant's Annual Report on Form 10-KSB/A-1, filed on April 30, 2002; Commission File Number
000-29245).
10.23 First Amendment to Shareholders' Agreement among Tony D'Amato, Chris Tisi and the Company
dated April 24, 2002 (incorporated by reference to Exhibit 4 of Christopher Tisi, Steven
Pomerantz and Tony D'Amato's Schedule 13D, filed on April 29, 2002; Commission File Number
0-29245).
10.24 Irrevocable Proxy dated April 24, 2002 (incorporated by reference to Exhibit 5 of Christopher
Tisi, Steven Pomerantz and Tony D'Amato's Schedule 13D, filed on April 29, 2002; Commission
File Number 0-29245).
10.25 Option Agreement effective as of February 12, 2002 between the Company and Christopher Tisi
(incorporated by reference to Exhibit 10.25 of Registrant's Annual Report on Form 10-KSB/A-1,
filed on April 30, 2002; Commission File Number 000-29245).
10.26 Indemnification Agreement between Ted Alflen and the Company dated as of January 1, 2002
(incorporated by reference to Exhibit 10.1 of Registrant's Quarterly Report on Form 10-QSB,
filed on November 14, 2002; Commission File Number 000-29245).
10.27 Indemnification Agreement between Darryl Green and the Company dated as of January 1, 2002
(incorporated by reference to Exhibit 10.2 of Registrant's Quarterly Report on Form 10-QSB,
filed on November 14, 2002; Commission File Number 000-29245).
14.1 Code of Ethics
16.1 Letter from Butner & Kahle, CPA dated September 6, 2000 (incorporated by reference to Exhibit
16.4 of Registrant's Current Report on Form 8-K filed on September 7, 2000; Commission File
Number 000-29245).
-25-
24 Power of attorney (included on signature page)
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 1002.
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 1002.
(b) Reports on Form 8-K
1. Form 8-K filed on December 10, 2001 reporting an Item 5 event.
2. Form 8-K filed on December 18, 2001 reporting an Item 5 event.
ITEM 14. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
Our principal executive officer and controller and principal accounting
officers have participated in and supervised the evaluation of our disclosure
controls and procedures that are designed to ensure that information required to
be disclosed by us in the reports that we file is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commission's rules and forms. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that the
information required to be disclosed by us in the reports that we file or submit
under the Act is accumulated and communicated to our management, including our
principal executive officer or officers and principal financial officer, to
allow timely decisions regarding required disclosure. Based on their evaluation
of those controls and procedures as of a date within 90 days of the date of this
filing, and of the filing of our original 10-KSB for the year ended December 31,
2002, our CEO and Controller and accounting officer determined that the controls
and procedures are adequate and effective.
(b) Changes in internal controls.
There were no significant changes, including any corrective actions
with regard to significant deficiencies and material weaknesses, in our internal
controls or in other factors that could significantly affect internal controls
since the date of the most recent evaluation of these controls by our chief
executive officer and chief financial officer.
-26-
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: March 31, 2003 Health & Nutrition Systems International, Inc.
By: /s/ Christopher Tisi
--------------------------------------
Christopher Tisi
Interim Chairman of the Board,
Chief Executive Officer and President
(Principal Executive Officer)
Each person whose signature appears below hereby constitutes and
appoints Chris Tisi his true and lawful attorney-in-fact and agent, with full
power of substitution and resubstitution, for him and in his name, place and
stead, in any and all capacities, to sign any and all amendments to this report,
and to file the same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying all
that said attorney-in-fact and agent or his substitute or substitutes, or any of
them, may lawfully do or cause to be done by virtue hereof.
In accordance with the requirements of the Exchange Act, this report
has been signed by the following persons in the capacities and on the dates
indicated.
SIGNATURE TITLE DATE
/s/ Christopher Tisi Interim Chairman of the Board, March 31, 2003
---------------------- Chief Executive Officer and President
Christopher Tisi (Principal Executive Officer)
/s/ Al Dugan Controller (Principal Accounting Officer) March 31, 2003
----------------------
Al Dugan
/s/ Steven A. Pomerantz Director March 31, 2003
-----------------------
Steven A. Pomerantz
/s/ Ted Alflen Director March 31, 2003
-----------------------
Ted Alflen
-27-
CERTIFICATIONS
--------------
I, Christopher Tisi, certify that:
1. I have reviewed this annual report on Form 10-KSB of Health &
Nutrition Systems International, Inc.;
2. Based on my knowledge, this annual 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
annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date March 31, 2003
/s/ Christopher Tisi, Chief Executive Officer
----------------------------------------------
-28-
CERTIFICATIONS
--------------
I, Al Dugan, certify that:
1. I have reviewed this annual report on Form 10-KSB of Health &
Nutrition Systems International, Inc.;
2. Based on my knowledge, this annual 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
annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date March 31, 2003
/s/ Al Dugan, Controller and Chief Accounting Officer
-----------------------------------------------------
-29-
TABLE OF CONTENTS
Independent Auditor's Report....................................................................................F-1
Financial Statements:
Balance Sheets as of December 31, 2002 and 2001..............................................................F-2
Statements of Operations for the years ended December 31, 2002 and 2001......................................F-3
Statements of Changes in Stockholders' Deficit for the years ended
December 31, 2002 and 2001................................................................................F-4
Statements of Cash Flows for the years ended December 31, 2002 and 2001......................................F-5
Notes to Financial Statements ...............................................................................F6-F17
INDEPENDENT AUDITOR'S REPORT
----------------------------
To the Board of Directors and Stockholders
Health & Nutrition Systems International, Inc.
We have audited the accompanying balance sheets of Health & Nutrition Systems
International, Inc. as of December 31, 2002 and 2001, and the related statements
of operations, changes in stockholders' deficit and cash flows for the years
then ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Health & Nutrition Systems
International, Inc. as of December 31, 2002 and 2001, and the results of its
operations and its cash flows for the years then ended in conformity with
auditing principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. As discussed in Note 3 to the financial
statements, the Company had a significant loss from operations and had negative
cash flows from operations, which raises substantial doubt about the Company's
ability to continue as a going concern. Management's plans regarding those
matters are also described in Note 3. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
/s/ Daszkal Bolton LLP
Boca Raton, Florida
February 17, 2003
F-1
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
BALANCE SHEETS
DECEMBER 31, 2002 AND 2001
ASSETS
------
2002 2001
----------- -----------
Current assets:
Cash $ 14,778 $ 81,932
Accounts receivable, net 344,700 194,792
Inventory 438,375 165,168
Prepaids and other current assets 2,373 --
----------- -----------
Total current assets 800,226 441,892
----------- -----------
Property and equipment, net 39,302 66,949
----------- -----------
Other assets:
Other assets, net 30,516 33,335
----------- -----------
Total other assets 30,516 33,335
----------- -----------
Total assets $ 870,044 $ 542,176
=========== ===========
LIABILITIES AND STOCKHOLDERS' DEFICIT
-------------------------------------
Current liabilities:
Accounts payable $ 1,117,407 $ 1,105,116
Accrued expenses 64,680 183,887
Capital leases, current portion 714 19,152
Notes payable 320,395 34,400
----------- -----------
Total current liabilities 1,503,196 1,342,555
----------- -----------
Notes payable, less current portion 141,266 1,645
----------- -----------
Total liabilities 1,644,462 1,344,200
----------- -----------
Stockholders' deficit:
Common stock, $ 0.001 par value, authorized 30,000,000
shares; 3,629,813 and 3,629,813 shares issued and
outstanding at December 31, 2002 and 2001, respectively 3,630 3,630
Additional paid-in capital 834,812 834,812
Accumulated deficit (1,612,860) (1,640,466)
----------- -----------
Total stockholders' deficit (774,418) (802,024)
----------- -----------
Total liabilities and stockholders' deficit $ 870,044 $ 542,176
=========== ===========
See accompanying notes for financial statements
F-2
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2002 AND 2001
2002 2001
----------- -----------
Revenue $ 3,567,848 $ 3,840,389
Cost of sales 1,511,826 1,903,755
----------- -----------
Gross profit 2,056,022 1,936,634
----------- -----------
Operating expense:
General and administrative expense 1,524,678 2,400,680
Advertising and promotion 425,349 881,541
Depreciation and amortization 30,466 31,616
----------- -----------
Total operating expense 1,980,493 3,313,837
----------- -----------
Income (loss) from operations 75,529 (1,377,203)
----------- -----------
Other income (expense):
Interest income -- 5,902
Interest expense (47,923) (23,347)
Other income (expense) -- 3,003
----------- -----------
Total other income (expense) (47,923) (14,442)
----------- -----------
Income (loss) before income taxes 27,606 (1,391,645)
----------- -----------
Benefit (provision) for income taxes -- (7,888)
Net income (loss) $ 27,606 $(1,399,533)
=========== ===========
Net income per share - basic $ 0.01 $ (0.39)
=========== ===========
Net income per share - diluted $ 0.01 $ (0.39)
Weighted average number of shares - basic 3,629,813 3,612,472
=========== ===========
Weighted average number of shares - diluted 3,629,813 3,612,472
=========== ===========
See accompanying notes for financial statements
F-3
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 2002 AND 2001
Common Stock Additional Stock
------------------------- Paid-In Subscription Accumulated
Shares Amount Capital Receivable Deficit Total
----------- ----------- ----------- --------- ----------- -----------
Balance, December 31, 2000 3,604,813 3,605 831,537 -- (240,933) 594,209
Common stock issued for legal settlement 20,000 20 1,980 -- -- 2,000
Common stock issued for services 5,000 5 1,295 -- -- 1,300
Net loss - December 31, 2001 -- -- -- -- (1,399,533) (1,399,533)
----------- ----------- ----------- --------- ----------- -----------
Balance, December 31, 2001 3,629,813 3,630 834,812 -- (1,640,466) (802,024)
Net income - December 31, 2002 -- -- -- -- 27,606 27,606
----------- ----------- ----------- --------- ----------- -----------
Balance, December 31, 2002 3,629,813 $ 3,630 $ 834,812 $ -- $(1,612,860) $ (774,418)
=========== =========== =========== ========= =========== ===========
See accompanying notes for financial statements
F-4
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002 AND 2001
2002 2001
----------- -----------
Cash flows from operating activities:
Net income (loss) $ 27,606 $(1,399,533)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Allowance for doubtful debts (14,431) (7,173)
Allowance for obsolete and slow moving inventory (70,362) 6,407
Depreciation and amortization 30,466 31,616
Imputed interest expense on note payable 42,272 --
Deferred tax asset -- 7,888
Common stock issued for services -- 3,300
(Increase) decrease in:
Accounts receivable (135,477) 310,216
Inventory (202,845) 127,981
Prepaids and other current assets (2,373) 168,454
Other assets -- (1,828)
Increase (decrease) in:
Accounts payable 634,680 657,512
Accrued expenses (119,207) 61,510
----------- -----------
Net cash provided by (used in) operating activities 190,329 (33,650)
----------- -----------
Cash flows from investing activities:
Investment in trademarks -- (25,000)
Proceeds from certificates of deposit -- 150,687
Purchases of property and equipment -- (3,524)
----------- -----------
Net cash provided by investing activities -- 122,163
----------- -----------
Cash flows from financing activities:
Repayments on notes payable (237,400) (115,600)
Repayments on capital leases (20,083) (21,533)
Proceeds from related parties -- 4,967
----------- -----------
Net cash used in financing activities (257,483) (132,166)
----------- -----------
Net decrease in cash (67,154) (43,653)
Cash, beginning of year 81,932 125,585
----------- -----------
Cash, end of year $ 14,778 $ 81,932
=========== ===========
See accompanying notes for financial statements
F-5
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 1 - DESCRIPTION OF BUSINESS
Health & Nutrition Systems International, Inc. ("HNS" or "the Company") markets
and distributes weight management, energy and sports nutrition products to
numerous national and regional health, food, drug and mass market accounts as
well as independent health and pharmacy accounts. The Company was incorporated
in Florida on October 25th, 1993. HNS product sales consist of six primary
dietary supplements: Acutrim Natural(R), Thin Tab(R), Carb Cutter(TM),
Carbolizer(TM), Thin Tab Mahuang Free(TM), and Fat Cutter(R). The current
markets are concentrated in North America and Puerto Rico. One manufacturer
produces all of the HNS dietary supplements.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
---------------------------------------------------
Cash and Cash Equivalents
-------------------------
The Company considers all highly liquid debt instruments with original
maturities of three months or less to be cash equivalents. There are no cash
equivalents at December 31, 2002 and 2001.
Use of Estimates
----------------
The preparation of financial statements in conformity with general accepted
accounting principles requires management to make estimates and assumptions that
affect certain reported amounts and disclosures. Accordingly, actual results
could differ from those estimates.
Inventories
-----------
Inventories are stated at the lower of cost or market with cost being determined
on a standard cost basis, net of allowances for slow-moving or obsolete
inventory. Inventory allowances at December 31, 2002 and 2001 was $88,376 and
$18,014, respectively. Freight is included in inventory and expensed as a
component of cost of sales.
Depreciation and Amortization
-----------------------------
Property and equipment are carried at cost. Depreciation is provided using the
straight-line or accelerated methods, over the estimated economic lives of the
assets, which range from three to seven years. Leasehold improvements are
amortized over the expected lease term. The Company reviews the valuation of
fixed and other assets and their remaining economic lives annually and adjusts
depreciation and amortization accordingly.
Trademarks
----------
The Company records the costs of trademarks as intangible assets and amortizes
their value over their estimated economic life.
Revenue Recognition
-------------------
Revenue is recognized at the date of shipment to customers. Provision is made
for an estimate of product returns and doubtful accounts and is based on
historical experience.
F-6
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
--------------------------------------------------------------
Advertising Costs
-----------------
The Company expenses advertising production costs as they are incurred and
advertising communication costs the first time the advertising event takes
place. Advertising and promotion expenses for the years ending December 31, 2002
and 2001 were $425,349 and $881,541, respectively.
Basic Earnings Per Share
------------------------
Basic income per common share is computed by dividing the net income by the
weighted average number of shares of common stock outstanding during the year.
Diluted Earnings Per Shares
---------------------------
Diluted earnings per share reflect the potential dilution that could occur if
dilutive securities (stock options and stock warrants) to issue common stock
were exercised or converted into common stock that then shared in the earnings
of the Company.
New Accounting Pronouncements
-----------------------------
In April 2002, the FASB issued SFAS 145, Rescission of FASB Statements No. 4,
44, and 64, Amendment of the FASB Statement No. 13, and Technical Corrections.
SFAS 145 rescinds the provisions of SFAS No. 4 that requires companies to
classify certain gains and losses from debt extinguishments as extraordinary
items, eliminates the provisions of SFAS No. 44 regarding transition to the
Motor Carrier Act of 1980 and amends the provisions of FASB No. 13 to require
that certain lease modifications be treated as sale leaseback transactions. The
provisions of FASB 145 related to classification of debt extinguishments are
effective for fiscal years beginning after May 15, 2002. The provisions of SFAS
145 related to lease modifications is effective for transactions occurring after
May 15, 2002. Earlier application is encouraged. The Company believes that the
adoption of SFAS 145 will not have a material impact on its financial
statements.
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. The standard requires companies to recognize costs
associated with exit or disposal activities when they are incurred rather than
at the date of a commitment to an exit or disposal plan. Examples of costs
covered by the standard include lease termination costs and certain employee
severance costs that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity. The Company
believes that the adoption of SFAS 146 will not have a material impact on its
financial statements.
In July 2002, the FASB issued SFAS No. 147, Acquisitions of Certain Financial
Institutions. The provisions of this Statement institute the application of the
purchase method of accounting to all acquisitions of financial institutions,
except transactions between two or more mutual enterprises. Further, the
provisions of the Statement that relate to the application of Statement 144
apply to certain long-term customer-relationship intangible assets recognized in
an acquisition of a financial institution, including those acquired in
transactions between mutual enterprises. The Company believes that the adoption
of SFAS 147 will not have a material impact on its financial statements.
F-7
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 3 - MANAGEMENT'S PLANS AND ISSUES AFFECTING LIQUIDITY
The Company's financial statements have been prepared assuming that the Company
will continue as a going concern. During 2002, the Company has successfully
controlled costs and has attained profitability, including net income of $27,606
and cashflow from operations of $190,329. However, at December 31, 2002, the
Company has a working capital deficit of $702,970 and adverse liquidity ratios.
Management intends to continue to control costs and monitor financing
capabilities. Management believes these factors will contribute toward achieving
sustained profitability.
There remains substantial doubt about the Company's ability to continue as a
going concern. The financial statements do not include any adjustments to
reflect the possible effects on the recoverability and classification of assets
or the amounts and classification of liabilities that may result from the
outcome of this uncertainty.
NOTE 4 - FACTORING ARRANGEMENTS
-------------------------------
In 2002, the Company factored certain of its accounts receivable, without
recourse, with a commercial finance company. The factor purchases the
receivables for the face amount of certain invoices, less a discount rate fee of
2.125%. The Company maintains a reserve account with the factor of 15%.
On March 15, 2002, the Company terminated their factoring agreement with
Alliance Financial Capital, Inc. and entered into a factoring agreement with LSQ
Funding Group, L.C. (LSQ). The agreement provides that LSQ will purchase certain
receivables and advance 85% of the face amount of such receivables. The term of
this agreement is one year. The maximum amount of receivables the Company may
factor under the agreement is $750,000, and there is no minimum amount required
to be factored. In connection with the factoring agreement, the Company granted
LSQ a blanket lien on Company assets and the President/Chief Executive Officer
was required to deliver a personal guarantee. The LSQ contract expired in March
2003 and the Company did not renew it.
In 2001, the Company factored certain of its accounts receivable, without
recourse, with a commercial finance company. The factor purchases the
receivables for the face amount of certain invoices, less a discount rate fee of
1.75%. The Company maintains a reserve account with the factor of 20% to 50%,
depending on the customer, of the outstanding receivables held by the factor.
The reserve account may be charged additional fees from 3.35% to 4.75% on
invoices paid beyond the agreed to terms.
F-8
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 5 - ACCOUNTS RECEIVABLE
----------------------------
2002 2001
--------- ---------
Accounts receivable $ 685,078 $ 352,002
Less: allowance for doubtful accounts (22,778) (37,210)
Less: allowance for sales returns (317,600) (120,000)
--------- ---------
Accounts receivable, net $ 344,700 $ 194,792
========= =========
Accounts receivable consisted of the following at December 31, 2002 and 2001:
At December 31, 2002, the Company recorded an allowance for sales returns of
$317,600, including $200,000 for returns of products containing ephedra expected
in 2003.
At December 31, 2001, the allowance for sales returns of $120,000 results from
expected returns of one product with expiration dates in March and May 2002.
NOTE 6 - RELATED PARTY TRANSACTIONS
-----------------------------------
For years ended December 31, 2002 and 2001, a certain related party made
aggregate purchases of approximately $2,423 and $63,881, respectively.
In 2001, a former officer of the Company and a member of the Board of Directors
guaranteed a short-term loan from a bank. See Note 10.
NOTE 7 - SUPPLEMENTAL CASH FLOW INFORMATION
-------------------------------------------
2002 2001
--------- -------
Cash paid for interest $ 9,514 $23,347
========= =======
Cash paid for income taxes $ -- $ --
========= =======
Non-cash investing and financing activities:
Common stock issued for services $ -- $ 3,300
========= =======
Conversion of accounts payable to notes
payable $ 700,000 $ --
========= =======
F-9
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 8 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash, accounts receivables, loans receivable, accounts
payable and other payables approximates fair value because of their short
maturities.
NOTE 9 - PROPERTY AND EQUIPMENT
-------------------------------
Property and equipment consisted of the following at December 31, 2002 and 2001:
2002 2001
--------- ---------
Furniture and equipment $ 38,713 $ 38,713
Office equipment 31,536 31,536
Warehouse equipment 24,349 24,349
Computer equipment 51,815 51,815
Software 40,126 40,126
Website development 2,155 2,155
Leasehold improvements 1,860 1,860
--------- ---------
190,554 190,554
Less: accumulated depreciation (151,252) (123,605)
--------- ---------
Property and equipment, net $ 39,302 $ 66,949
========= =========
Depreciation expense for the years ended December 31, 2002 and 2001 was $27,647
and $28,795, respectively.
NOTE 10 - NOTES PAYABLE
-----------------------
On April 11, 2002, the Company entered into an agreement with Garden State
Nutritionals (GSN), sole manufacturer, to repay $700,000 owed to GSN as of the
date of the agreement. The repayment schedule requires eight equal quarterly
payments, without interest, starting June 1, 2002. In connection with this
agreement, the Company granted to GSN a blanket second priority lien on the
Company's assets under a Security Agreement, which may only be, foreclosed upon
the event the Company fails to make (3) consecutive quarterly principle payments
in accordance with the terms of the promissory note. The GNS debt has been
recorded as a note payable with an imputed interest rate of 9% per annum and
with the interest calculated over the term on the loan in the amount of $73,747.
The cost of sales was reduced in the amount of $73,747, which represents imputed
interest on the note. GNS granted the Company a waiver on the first quarterly
payment due June 1, 2002 of $87,500. This amount shall be due and payable on
March 1, 2004. At December 31, 2002, the balance owed to GSN is $497,000.
Also, on April 11, 2002, the Company entered into an exclusive manufacturing
agreement with GSN pursuant to which GSN has provided a $450,000 line of credit
with 60-day terms to the Company. During 2002, GSN informally allowed the
Company to purchase up to $1,000,000 on the line of credit. At December 31,
2002, the balance owed to GSN under this line of credit is $892,878.
F-10
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 10 - NOTES PAYABLE, CONTINUED
----------------------------------
On January 15, 2002, the Company received a short-term loan from a bank in the
amount of $23,400. Interest accrues at a rate of 4.75% per annum and is
collateralized by a certificate of deposit in the amount of $23,400 owned by a
former officer of the Company and member of the Board of Directors. The loan was
paid in full on July 15, 2002.
On January 12, 2001, the Company received a short-term loan from a bank in the
amount of $100,000. Interest accrued at a rate of 7.73% per annum and was
collateralized by a certificate of deposit in the amount of $100,000 owned by a
former officer of the Company and member of the Board of Directors. The loan was
paid in full on January 12, 2002.
On December 15, 2000, the Company received a short-term loan from a bank in the
amount of $150,000. Interest accrued at a rate of 8.1% per annum and the note
was collateralized by two certificates of deposits totaling $150,687. This note
was paid in full on December 15, 2001.
NOTE 11 - LEASE COMMITMENTS
---------------------------
The Company leases office and warehouse space in Riviera Beach, Florida. Rent
expense for the years ended December 31, 2002 and 2001 was $54,044 and $64,664,
respectively. The Company also leases various equipment. Lease expense for the
years ended December 31, 2002 and 2001 was $34,340 and $29,952, respectively.
In April 2002, the Company began sub-leasing part of its warehouse space for
$1,800 per month.
Certain non-cancelable leases are classified as capital leases, and the leased
assets are included as part of property and equipment. Other leases are
classified as operating leases and are not capitalized. The obligations under
capital leases are at fixed rates ranging from 10% to 23% and are collateralized
by the corresponding equipment.
Property under capital leases at December 31, 2002 and 2001 consisted of the
following:
2002 2001
-------- --------
Machinery and equipment $ 15,104 $ 59,902
Less: accumulated amortization (13,841) (27,442)
-------- --------
Total $ 1,263 $ 32,460
======== ========
Future minimum rentals for property under operating and capital leases at
December 31 are as follows:
F-11
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
Capital Operating
Year Ending December 31, Leases Leases
--------------------------------------------------- -------- --------
2003 $ 790 $ 82,704
2004 -- 23,008
2005 -- 6,214
2006 -- --
-------- --------
Total minimum lease obligation 790 111,926
Less: interest 76 --
-------- --------
Present value of total minimum lease payments 714 $111,926
========
Less: current portion 714
--------
Non-current portion $ --
========
NOTE 12 - STOCKHOLDERS EQUITY
-----------------------------
During the year ended December 31, 2002, the Company issued no common stock for
cash or in exchange of services.
During the year ended December 31, 2001, the Company issued its common stock for
cash and in exchange of services as follows:
The Company issued 20,000 shares of common stock as settlement of a lawsuit, as
disclosed in Note 13, valued at $2,000.
The Company issued 5,000 shares of common stock to consultants for professional
services rendered, valued at $1,300.
NOTE 13 - LEGAL MATTERS
-----------------------
The Company has been sued by six unaffiliated plaintiffs alleging that the
Company's Acutrim(R) products contain PPA and that those products have caused
damage to the plaintiffs. The Company's position on these matters is that none
of the Company's Acutrim(R) products has ever contained, or currently contains,
PPA. To date, twelve out of the twenty of these cases has been dismissed after
delivery to plaintiff's counsel of information substantiating the fact that the
Company's products do not presently contain, and have not contained, PPA. While,
the Company does not believe that it has material liability based upon the
substantive allegations set forth in these cases, the legal costs that the
Company has incurred, and may incur in the future, in obtaining dismissals from
these cases could have a material adverse effect on the Company.
In 2000, the Company sued a former officer and director of the Company and KMS
Thin-Tab 100, Inc., a corporation controlled by the former director, for
trademark infringement, unfair competition and cyber piracy. The former director
and KMS Thin-Tab 100, Inc. counterclaimed alleging a breach of distribution
agreement with the Company. On September 19, 2002, the Company announced the
settlement of all litigation between the Company, the former director and KMS
Thin-Tab 100, Inc.
F-12
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
The settlement agreement generally requires the former director and KMS to
transfer the registration and ownership of the domain names Thintab.com,
Thintab.cc and Carbcutter.cc to HNS and to take other actions to eliminate
confusion over the ownership of the Thin Tab(R) name. Additionally, it provides
for each of the adverse parties to generally release the others. As part of the
settlement, HNS entered into a distribution agreement with Bryant, beginning on
September 26, 2002 and ending 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 has agreed not to sell its products directly to
certain KMS customers. The Company recorded a legal settlement expense of
$58,836 associated with this settlement.
During the year ended December 31, 2000, the Company filed a Complaint for
Declatory Relief in reference to the effectiveness of various Stock Purchase
Agreements among shareholders, the cancellation of certain shares and the
rightful ownership of these shares. On December 21, 2001, a settlement agreement
was reached in which the Company issued 20,000 shares of common stock, valued at
$2,000 and a net cash settlement of $18,750. At December 31, 2001, $11,000 of
the cash settlement amount had been paid, with the remaining amount included in
accounts payable.
The Company from time to time is a party of various legal proceedings. In the
opinion of management, none of the proceedings are expected to have a material
impact on its financial position or results of operations.
NOTE 14 - CONCENTRATIONS
------------------------
Credit Risk
-----------
Financial instruments, which potentially expose the Company to concentrations of
credit risk, as defined by Statement of Financial Accounting Standards No. 105,
consist primarily of trade receivables. The Company's officers have attempted to
minimize this risk by monitoring the companies for which it provided credit.
The Company maintains bank accounts at various financial institutions. At times
during the year, balances in these accounts exceeded the amount insured by the
FDIC. At December 31, 2002 and 2001, no amounts exceeded the insured limit.
Product Liability
-----------------
The Company is currently insured to the extent of $6 million for product
liability claims and uses vendors who are also insured. There is a risk that
certain vendors may not have sufficient product liability insurance or may lose
their insurance, or the Company may not be able to insure at reasonable cost. In
any of these events, there could be a material adverse effect on the financial
condition, results of operations or cash flows of the Company.
Significant Customers
---------------------
During the year ended December 31, 2002, sales to six customers represented
sixty-six percent (66%) of the Company's revenue.
During the year ended December 31, 2001, sales to six customers represented
seventy-four percent (74%) of the Company's revenue.
F-13
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 14 - CONCENTRATIONS, CONTINUED
-----------------------------------
Significant Supplier
--------------------
During the years ended December 31, 2002 and 2001, the Company received 100% of
its products from one manufacturer of herbal and dietary supplements, located in
Caldwell, New Jersey. The Company is dependent on the ability of its supplier to
provide products on a timely basis and on favorable pricing terms. The loss of
the supplier or a significant reduction in product availability from the
supplier could have a material adverse effect on the Company. The Company
believes that its relationship with its supplier is satisfactory.
NOTE 15 - INCOME TAXES
----------------------
The Company's evaluation of the tax benefit of its net operating loss
carryforward is presented in the following table. At December 31, the tax
amounts have been calculated using the 34% federal and 5.5% state income tax
rates.
2002 2001
--------- ---------
Income tax (benefit) consists of:
Current $ -- $ --
Deferred -- --
--------- ---------
Provision (benefit) for income taxes $ -- $ --
========= =========
Reconciliation of the Federal statutory income tax rate to the Company's
effective tax rate is as follows:
2002 2001
--------- ---------
Taxes computed at combined federal and
state tax rate $ 9,386 $(473,159)
Non-deductible expenses 2,719 3,835
State income taxes, net of federal income
tax benefit 1,292 (50,107)
Other 28,845 (20,135)
Effect of change in income tax rate -- 6,953
Increase (decrease) in deferred tax asset
valuation allowance (42,242) 540,501
--------- ---------
Provision (benefit) for income taxes $ -- $ 7,888
========= =========
F-14
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 15 - INCOME TAXES, CONTINUED
---------------------------------
The components of the deferred tax asset were as follows at December 31:
2002 2001
--------- ---------
Deferred tax assets:
Net operating loss carryforward $ 336,919 $ 464,427
Allowance for receivables 128,084 69,295
Allowance for inventory 33,256 6,779
Litigation costs related to capital -- --
--------- ---------
Total deferred tax assets 498,259 540,501
--------- ---------
Deferred tax liabilities:
Net deferred tax asset 498,259 540,501
--------- ---------
Valuation allowance:
Beginning of year (540,501) --
Decrease (increase) during year 42,242 (540,501)
--------- ---------
Ending balance (498,259) (540,501)
Net deferred taxes $ -- $ --
========= =========
As of December 31, 2002, the Company has an unused net operating loss
carryforward of $895,346 available for use on its future corporate income tax
returns. This net operating loss carryforward expires in 2022.
NOTE 16 - STOCK OPTIONS
-----------------------
The non-qualified stock option plan adopted by the Company in May 1998
authorized the Company to grant 1,250,000 of its common shares.
The Company has elected to account for the stock options under the Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and
related interpretations. Accordingly, no compensation expense has been
recognized on the employee stock options. The Company accounts for stock options
granted to consultants under Financial Accounting Standards Board Statement No.
123, "Accounting for Stock-Based Compensation." The Company recognized $443 and
$847 in compensation expense at December 31, 2002 and 2001, respectively.
During the year ended December 31, 2002, 50,000 options were granted to
officers, directors and employees of the Company.
During the year ended December 31, 2001, no options were granted to officers,
directors and employees of the Company.
F-15
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 16 - STOCK OPTIONS, CONTINUED
----------------------------------
A summary of options during the years ended December 31, 2002 and 2001 is shown
below:
December 31, 2002 December 31, 2001
----------------------- -----------------------
Number Weighted-Average Number Weighted-Average
of Shares Exercise Price of Shares Exercise Price
-------- ----------- -------- -----------
Outstanding at beginning of year 540,500 $ 0.14 710,000 $ 0.14
Granted 50,000 -- -- --
Exercised -- -- -- --
Forfeited (84,000) (0.14) (169,500) (0.14)
-------- ----------- -------- -----------
Outstanding at December 31 506,500 $ 0.14 540,500 $ 0.14
======== =========== ======== ===========
Exercisable at December 31 354,500 252,750
======== ========
Available for issuance at December 31 322,000 372,000
======== ========
Had the compensation expense for the stock option plan been determined based on
the fair value of the options at the grant date consistent with the methodology
prescribed under Statement of Financial Standards No. 123, "Accounting for Stock
Based Compensation," at December 31, the Company's net income and earnings per
share would have been reduced to the proforma amounts indicated below:
2002 2001
--------- -------------
Net income (loss)
As reported $ 27,606 $ (1,399,533)
========= =============
Pro forma $ 20,636 $ (1,417,186)
========= =============
Earnings per share
As reported $ 0.01 $ (0.39)
========= =============
Pro forma $ 0.01 $ (0.39)
========= =============
The fair value of each option is estimated on the date of grant using the fair
market value option pricing model with the assumptions:
Risk-free interest rate 4.5% - 6.5%
Expected life (years) Various
Expected volitility 1.23
Expected dividends None
F-16
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
NOTE 17 - RECLASSIFICATIONS
---------------------------
Certain reclassifications have been made to the 2001 financial statements to
conform to the 2002 financial statement presentation. These reclassifications
have no effect on reported net income. In 2002 and 2001, the Company
reclassified $901,599 and $1,524,943, respectively, of promotion and
co-operative advertising fees to revenues from the operating expense
"Advertising and promotion."
F-17
Index to Exhibits
-----------------
Exhibit
Number Description
------ -----------
3.1(a) Articles of Incorporation of the Registrant (incorporated by reference to Exhibit 3.1(A) of Registrant's
registration statement on Form 10-SB, filed on January 31, 2000; Commission File Number 000-29245).
3.1(b) Articles of Amendment to the Articles of Incorporation (incorporated by reference to Exhibit 3.1(B) of
Registrant's registration statement on Form 10-SB, filed on January 31, 2000;
Commission File Number 0000-29245).
3.1(c) Articles of Amendment to Articles of Incorporation (incorporated by reference to Exhibit 3.1(C) of
Registrant's registration statement on Form 10-SB, filed on January 31, 2000;
Commission File Number 000-29245).
3.1(d) Articles of Amendment to Articles of Incorporation (incorporated by reference to Exhibit 3.1(D) of
Registrant's Annual Report on Form 10-KSB, filed on April 16, 2001; Commission File Number 000-29245).
3.2 By-Laws of the Registrant (incorporated by reference to Exhibit 3.2 of Registrant's
registration statement on Form 10-SB, filed on January 31, 2000; Commission File Number
000-29245).
3.3 Amendment to the Restated Bylaws of the Company dated September 25, 2000 (incorporated by
reference to Exhibit 3.3 of Registrant's Annual Report on Form 10-KSB, filed on April 16,
2000; Commission File Number 000-29245).
3.4 Amendment to the Restated Bylaws of the Company dated November 10, 2000 (incorporated by
reference to Exhibit 3.4 of Registrant's Annual Report on form 10-KSB, filed on April 16,
2000; Commission File Number 000-29245).
10.1 Employment Agreement between the Company and Chris Tisi effective as of January 1, 2002
(incorporated by reference to Exhibit 10.1 of Registrant's Current Report on Form 8-K
filed on February 13, 2002; Commission File Number 000-29245).
10.2 Severance Agreement between the Company and Steven Pomerantz effective as of January 1, 2002
(incorporated by reference to Exhibit 10.3 of Registrant's Current Report on Form 8-K filed on
February 13, 2002; Commission File Number 000-29245).
10.3 Factoring and Security Agreement between LSQ Funding Group L.C. and Health and Nutrition Systems
International, Inc. effective as of March 15, 2002 (incorporated by reference to Exhibit 10.3 of
Registrant's Annual Report on Form 10-KSB, filed on April 12, 2002; Commission File Number
000-29245).
10.4 Indemnification Agreement dated March 15, 2002 between LSQ Funding Group L.C. and Christopher
Tisi (incorporated by reference to Exhibit 10.4 of Registrant's Annual Report on Form 10-KSB,
filed on April 12, 2002; Commission File Number 000-29245).
10.5 Indemnification Agreement between the Company and Chris Tisi dated January 1, 2002
(incorporated by reference to Exhibit 10.2 of Registrant's Current Report on Form 8-K filed on
February 13, 2002; Commission File Number 000-29245).
10.6 Indemnification Agreement between the Company and Steven Pomerantz dated January 1, 2002 (incorporated
by reference to Exhibit 10.4 of Registrant's Current Report on Form 8-K filed on February 13, 2002;
Commission File Number 000-29245).
10.7 Lease Agreement between the Company and Fred Keller, Trustee dated November 1, 2000
(incorporated by reference to Exhibit 10.5 of Registrant's Annual Report on Form 10-KSB, filed
on April 16, 2001; Commission File Number 000-29245).
10.8 Lease Agreement between the Company and Fred Keller, Trustee dated January 1, 2001
(incorporated by reference to Exhibit 10.6 of Registrant's Annual Report on Form 10-KSB, filed
on April 16, 2001; Commission File Number 000-29245).
10.9 Secured Party's Bill of Sale between Fleet National Bank and the Company dated January 12,
2001 (incorporated by reference to Exhibit 10.1 of Registrant's Current Report on Form 8-K
filed on January 26, 2001; Commission File Number 000-29245).
10.10 Trademark Assignment from Heritage Consumer Products, LLC to the Company dated January 12,
2001 (incorporated by reference to Exhibit 10.2 of Registrant's Current Report on Form 8-K
filed on January 26, 2001; Commission File Number 000-29245).
10.11 Agreement between the Company and Steven Pomerantz dated January 12, 2001 (incorporated by
reference to Exhibit 10.3 of Registrant's Current Report on Form 8-K filed on January 26,
2001; Commission File Number 000-29245).
10.12 Shareholders' Agreement among Tony D'Amato, Chris Tisi, and the Company dated July 13, 2000
(incorporated by reference to Exhibit 1 of Christopher Tisi, Steven Pomerantz, Tony Musso, and
Tony D'Amato's Schedule 13D, filed on January February 14, 2001; Commission File Number
0-29245).
10.13 Irrevocable Proxy dated July 13, 2000 (incorporated by reference to Exhibit 2 of Christopher
Tisi, Steven Pomerantz, Tony Musso, and Tony D'Amato's Schedule 13D, filed on January February
14, 2001; Commission File Number 0-29245).
10.14 Waiver dated January 31, 2001 (incorporated by reference to Exhibit 3 of Christopher Tisi,
Steven Pomerantz, Tony Musso, and Tony D'Amato's Schedule 13D, filed on January
February 14, 2001; Commission File Number 0-29245).
10.15 Joint Filing Agreement dated February 13, 2001 (incorporated by reference to Exhibit 4 of
Christopher Tisi, Steven Pomerantz, Tony Musso, and Tony D'Amato's Schedule 13D, filed on
January February 14, 2001; Commission File Number 0-29245).
10.16 Exclusive Manufacturing Agreement dated April 11, 2002 between the Company and Garden State
Nutritionals, a division of VitaQuest International, Inc. (incorporated by reference to Exhibit
10.16 of Registrant's Annual Report on Form 10-KSB, filed on April 12, 2002; Commission File
Number 000-29245).
10.17 Security Agreement dated April 11, 2002 between the Company and Garden State Nutritionals, a
division of VitaQuest International, Inc. (incorporated by reference to Exhibit 10.16 of
Registrant's Annual Report on Form 10-KSB, filed on April 12, 2002; Commission File Number
000-29245).
10.18 Health & Nutrition Systems International, Inc. 1998 Stock Option Plan (incorporated by
reference to Exhibit 10.18 of Registrant's Annual Report on Form 10-KSB, filed on April 12,
2002; Commission File Number 000-29245).
10.19 Promissory Note dated April 11, 2002 between the Company as borrower and Garden State
Nutritionals as lender (incorporated by reference to Exhibit 10.19 of Registrant's
Annual Report on Form 10-KSB, filed on April 12, 2002; Commission File Number 000-29245).
10.20 Subordination Agreement dated April 11, 2002 among the Company, LSQ Funding Group, L.C. and
Garden State Nutritionals (incorporated by reference to Exhibit 10.20 of Registrant's Annual
Report on Form 10-KSB, filed on April 12, 2002; Commission File Number 000-29245).
10.21 Amendment No. 1 dated April 29, 2002 to the Employment Agreement between the Company and Chris
Tisi effective as of January 1, 2002 (incorporated by reference to Exhibit 10.21 of
Registrant's Annual Report on Form 10-KSB/A-1, filed on April 30, 2002; Commission File Number
000-29245).
10.22 Amendment No. 1 dated April 29, 2002 to the Severance Agreement between the Company and Steven
Pomerantz effective as of January 1, 2002 (incorporated by reference to Exhibit 10.2 of
Registrant's Annual Report on Form 10-KSB/A-1, filed on April 30, 2002; Commission File Number
000-29245).
10.23 First Amendment to Shareholders' Agreement among Tony D'Amato, Chris Tisi and the Company
dated April 24, 2002 (incorporated by reference to Exhibit 4 of Christopher Tisi, Steven
Pomerantz and Tony D'Amato's Schedule 13D, filed on April 29, 2002; Commission File Number
0-29245).
10.24 Irrevocable Proxy dated April 24, 2002 (incorporated by reference to Exhibit 5 of Christopher
Tisi, Steven Pomerantz and Tony D'Amato's Schedule 13D, filed on April 29, 2002; Commission
File Number 0-29245).
10.25 Option Agreement effective as of February 12, 2002 between the Company and Christopher Tisi
(incorporated by reference to Exhibit 10.25 of Registrant's Annual Report on Form 10-KSB/A-1,
filed on April 30, 2002; Commission File Number 000-29245).
10.26 Indemnification Agreement between Ted Alflen and the Company dated as of January 1, 2002
(incorporated by reference to Exhibit 10.1 of Registrant's Quarterly Report on Form 10-QSB,
filed on November 14, 2002; Commission File Number 000-29245).
10.27 Indemnification Agreement between Darryl Green and the Company dated as of January 1, 2002
(incorporated by reference to Exhibit 10.2 of Registrant's Quarterly Report on Form 10-QSB,
filed on November 14, 2002; Commission File Number 000-29245).
14.1 Code of Ethics
16.1 Letter from Butner & Kahle, CPA dated September 6, 2000 (incorporated by reference to Exhibit
16.4 of Registrant's Current Report on Form 8-K filed on September 7, 2000; Commission File
Number 000-29245).
24 Power of attorney (included on signature page)
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 1002.
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 1002.