UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB/A-1
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF
THE EXCHANGE ACT
FOR THE TRANSITION PERIOD FROM _____________ TO _____________
COMMISSION FILE NO. 000-29245
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
----------------------------------------------
(Exact name of small business issuer as specified in its charter)
FLORIDA
-------
(State or other jurisdiction of incorporation or organization)
65-0452156
----------
(I.R.S. Employer Identification Number)
3750 INVESTMENT LANE, SUITE 5, WEST PALM BEACH, FLORIDA 33407
-------------------------------------------------------------
(Address of principal executive offices)
(561) 863-8446
--------------
(Issuer's telephone number)
Therewere 3,832,813 shares of common stock, $0.001 par value, of the
registrant outstanding at September 30, 2003.
Transitional Small Business Disclosure Format: Yes [ ] No [X]
HEALTH AND NUTRITION SYSTEMS INTERNATIONAL, INC.
INDEX
Page
----------
Facing Sheet...................................................................... Cover Page
Index............................................................................. ii
Part I - Financial Information
Item 1. Financial Statements 1
Condensed Balance Sheet as of September 30, 2003 (Unaudited)............. 1
Condensed Statements of Operations for the three and
nine months ended September 30, 2003 and 2002 (Unaudited)................ 2
Condensed Statements of Cash Flows for the nine months ended
September 30, 2003 and 2002 (Unaudited).................................. 3
Notes to Condensed Financial Statements.................................. 4-7
Item 2. Management's Discussion and Analysis or Plan of Operations...... 8
Item 3. Controls and Procedures......................................... 16
Part II - Other Information
Item 1. Legal Proceedings.................................................. 17
Item 2. Changes in Securities.............................................. 17
Item 3. Defaults Upon Senior Securities.................................... 17
Item 4. Submission of Matters to a Vote of Security Holders................ 17
Item 5. Other Information.................................................. 17
Item 6. Exhibits and Reports on Form 8-K................................... 18
Signature......................................................................... 19
ii
PART I
ITEM 1. FINANCIAL STATEMENTS
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
CONDENSED BALANCE SHEET
(UNAUDITED)
ASSETS
SEPTEMBER 30, 2003
------------------
Current assets:
Cash $ 91,907
Accounts receivable, net 248,467
Inventory 1,372,254
-----------
Total current assets 1,712,628
-----------
Property and equipment, net 24,319
-----------
Other assets:
Trademarks 1,562
Security deposit 6,424
Prepaids 21,003
-----------
Total assets $ 1,765,936
===========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 1,054,495
Accrued expenses 197,487
Notes payable, current portion 500,000
-----------
Total current liabilities 1,751,982
-----------
Notes payable, less current portion 419,893
-----------
Total liabilities 2,171,875
Stockholders' deficit:
Common stock, $0.001 par value, authorized 30,000,000
shares; 3,832,813 shares issued and outstanding 3,830
Additional paid-in capital 858,612
Accumulated deficit (1,268,381)
-----------
Total stockholders' deficit (405,939)
-----------
Total liabilities and stockholders' deficit $ 1,765,936
===========
See accompanying notes to condensed financial statements.
-1-
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
-------------------------- --------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net Revenue $ 1,867,887 $ 859,348 $ 4,369,984 $ 2,725,828
Cost of sales 767,375 399,898 1,772,077 1,038,972
----------- ----------- ----------- -----------
Gross profit 1,100,512 459,450 2,597,907 1,686,856
----------- ----------- ----------- -----------
Operating expense:
General and administrative expense 622,590 374,874 1,431,135 1,144,383
Advertising and promotion 553,949 154,288 1,050,261 404,341
Depreciation and amortization 4,495 7,617 16,821 22,850
----------- ----------- ----------- -----------
Total operating expense 1,181,034 536,779 2,498,217 1,571,574
----------- ----------- ----------- -----------
Income (loss) from operations (80,522) (77,329) 99,690 115,282
----------- ----------- ----------- -----------
Other income (expense):
Gain on sale of Trademark 279,308 -- 279,308 --
Interest expense (14,951) (17,505) (34,519) (30,884)
----------- ----------- ----------- -----------
Income before income taxes 183,835 (94,834) 344,479 84,398
=========== =========== =========== ===========
Benefit (provision) for income taxes -- -- -- --
Net income (loss) $ 183,835 $ (94,834) $ 344,479 $ 84,398
=========== =========== =========== ===========
Net income (loss) per share - basic $ 0.05 $ (0.03) $ 0.09 $ 0.02
=========== =========== =========== ===========
Net income (loss) per share - diluted $ 0.05 $ (0.03) $ 0.09 $ 0.02
=========== =========== =========== ===========
Weighted average number of shares - basic 3,772,813 3,632,813 3,679,480 3,632,813
=========== =========== =========== ===========
Weighted average number of shares - diluted 3,786,813 3,632,813 3,693,480 3,632,813
=========== =========== =========== ===========
See accompanying notes to condensed financial statements.
-2-
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
2003 2002
----------- -----------
Net cash provided by operating activities $ 349,216 $ 161,843
----------- -----------
Cash flows from investing activities:
Proceeds from sale of trademark 300,000 --
----------- -----------
Net cash provided by investing activities 300,000 --
----------- -----------
Cash flows from financing activities:
Repayments on notes payable (571,373) (170,900)
Repayments on capital leases (714) (14,888)
-----------
Net cash used in financing activities (572,087) (185,788)
----------- -----------
Net increase (decrease) in cash 77,129 (23,945)
Cash, beginning of period 14,778 81,932
----------- -----------
Cash, end of period $ 91,907 $ 57,987
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION
Conversion of accounts payable to notes payable $ 1,000,000 $ 700,000
=========== ===========
Interest paid $ 7,500 $ --
=========== ===========
See accompanying notes to condensed financial statements.
-3-
HEALTH & NUTRITION SYSTEMS INTERNATIONAL, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
------------------------------
The accompanying unaudited condensed financial statements of Health & Nutrition
Systems International, Inc. (the "Company") have been prepared in accordance
with generally accepted accounting principles for interim financial information
and Regulation S-B. Accordingly, they do not include all of the information and
footnotes required for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation of the results for the
interim periods presented have been included.
These results have been determined on the basis of generally accepted accounting
principles and practices applied consistently with those used in the preparation
of the Company's Annual Financial Statements for the year ended December 31,
2002. Operating results for the nine months ended September 30, 2003 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2003.
It is recommended that the accompanying condensed financial statements be read
in conjunction with the financial statements and notes for the year ended
December 31, 2002, found in the Company's Form 10-KSB, as amended.
NOTE 2 - REVENUE RECOGNITION
----------------------------
The Company recognizes revenue when
o Persuasive evidence of an arrangement exists
o Shipment has occurred
o Price is fixed or determinable, and
o Collectability is reasonably assured
Subject to these criteria, except with respect to customers that buy our
products on "pay on scan terms," we recognize revenue at the time of shipment of
the relevant merchendise. "Pay on Scan" sales are treated as consignment sales
by the Company. In the case of these consignment sales, the Company records
revenues, and removes the items from inventory when the customer reports the
sales to the Company. Normally the Company is notified of the customer's sales
through periodic sales reports and payments.
On September 30, 2003, the Company had approximately $259,000 of inventory on
consignment relating to its "pay on scan" sales. On September 30, 2002, the
Company had no outstanding consignment sales.
Included in the net sales in the accompanying financial statements are
reductions for returns and allowances, sales discounts, new store opening
discounts, and co-op advertising and promotions.
NOTE 3 - LEGAL MATTERS
----------------------
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.
-4-
NOTE 4 - MANAGEMENT'S PLANS AND ISSUES AFFECTING LIQUIDITY
----------------------------------------------------------
The Company's condensed financial statements have been prepared assuming that
the Company will continue as a going concern. At September 30, 2003, the Company
had a working capital deficit of ($39,354) and adverse liquidity ratios.
During the nine months ended September 30, 2003, the Company has continued to
control costs, and maintained profitability, with net income from operation of
$99,690 and cash flow from operations of $349,216.
Management intends to continue controlling costs and monitoring operational
commitments in light of financial 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 5 - 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 $231 in
compensation expense for the nine months ended September 20, 2003.
During the nine months ended September 30, 2003, 50,000 new options were granted
to an officer of the Company, as per his employment agreement.
Had the compensation expense for the stock option plan been determined based on
the fair value of the options at the grant date consistent with the methodology
prescribed under Statement of Financial Standards No. 123, "Accounting for
Stock-Based Compensation," at September 30, the Company's net income and
earnings per share would have been reduced to the proforma amounts indicated
below:
SEPTEMBER 30, 2003
------------------
Net income
As reported $ 344,470
Additional compensation expense (4,973)
---------
Pro forma $ 339,506
=========
Earnings per share
As reported $ 0.09
=========
Pro forma $ 0.09
=========
-5-
The fair value of each option is estimated on the date of grant using the fair
market value option-pricing model with the following assumptions:
Risk-free interest rate 4.5% - 6.5%
Expected life (years) 8
Expected volatility 1.23
Expected dividends None
NOTE 6 - RECLASSIFICATION
-------------------------
Certain reclassifications have been made to the 2002 financial statements to
conform to the 2003 financial statement presentation. These reclassifications
have the effect of reducing revenue and reducing expense. Slotting fees expense
and new store discounts, charged back by customers for the nine months totaling
approximately $574,851, were previously recorded as marketing expense.
The Company has reclassified these costs as a reduction of gross sales. These
reclassifications have no effect on reported net income.
Slotting fees are one-time charges that retailers impose on vendors to initially
position the vendor's products on store shelves. New store discounts occur when
a retail chain opens new locations, and we may supply them with free or
discounted merchandise to heighten the visibility for our products in these new
marketing locations.
NOTE 7 - STOCK ISSUED
---------------------
On July 30, 2003, 200,000 shares of Health & Nutrition Systems were issued to
two board members of the Company, for services performed. The fair value of the
common stock at the time of issue was $0.12 per share, and the Company recorded
compensation expense of $24,000.
NOTE 8 - NOTE PAYABLE
---------------------
In July 2003, the Company issued an amended promissory note to Garden State
Nutrition in the principal amount of $1,300,000. The note provides for $300,000
to be paid before December 31, 2003, with the balance due in quarterly
installments of $131,410 commencing November 1, 2003 at 4.5% per annum.
NOTE 9 - RESTATEMENT
--------------------
Subsequent to the filing of the original September 30, 2003 Form 10-QSB,
management determined that an executive bonus of approximately $129,000 due its
Chief Executive Officer under the terms of his employment agreement should have
been accrued as of September 30, 2003. The effect of this correction was to
increase current liabilities and reduce net income by $129,000.
In addition, subsequent to filing its Proxy Statement on January 5, 2004, the
Securities and Exchange Commission requested additional disclosures to be
included in these condensed financial statements. These disclosures had no
effect on the total assets or net income.
-6-
The following is a summary of the effect of the correction:
STATEMENT OF OPERATIONS
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2003 SEPTEMBER 30, 2003
------------------ ------------------
Net income as previously reported $ 312,835 $ 473,479
Adjustment to accrue officer's bonus (129,000) (129,000)
----------- -----------
Net income as restated $ 183,835 $ 344,479
=========== ===========
Income per share as previously reported
Basic $ 0.08 $ 0.13
Diluted $ 0.08 $ 0.13
=========== ===========
Income per share as restated
Basic $ 0.05 $ 0.09
Diluted $ 0.05 $ 0.09
=========== ===========
BALANCE SHEET
SEPTEMBER 30, 2003
------------------
Accrued expenses as previously reported $ 68,487
Adjusted to accrue additional officer's bonus 129,000
--------
Accrued expense as restated $197,487
========
-7-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
This Quarterly Report on Form 10-QSB/A-1 contains forward-looking statements.
Any statements that are not statements of historical fact should be regarded as
forward-looking statements. For example, the words "intends," "believes,"
"anticipates," "plans," and "expects" are intended to identify forward-looking
statements. There are a number of important factors that could cause our actual
results to differ materially from those indicated by such forward-looking
statements. These factors include without limitation those factors contained in
our Form 10-KSB filed with the Securities and Exchange Commission. We do not
undertake any obligation to update any such factors or to publicly announce the
result of any revision to any of the forward looking statements contained herein
to reflect future events or developments.
The following discussion of our results of operations and financial condition
should be read together with our unaudited Financial Statements contained in
Part I, Item 1 and the related Notes in this Form 10-QSB/A-1, and our audited
Financial Statements and the related Notes contained in our Form 10-KSB filed
with the Securities and Exchange Commission.
CRITICAL ACCOUNTING POLICIES
Financial Reporting Release No. 60, which was released by the U.S. Securities
and Exchange Commission, encourages all companies to include a discussion of
critical accounting policies or methods used in the preparation of financial
statements. Our financial statements include a summary of the significant
accounting policies and methods used in the preparation of our financial
statements.
Management believes the following critical accounting policies affect the
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,
except with respect to customers that buy our products on "pay on scan" terms.
These "pay on scan" sales are treated as consignment sales by us. In the case of
these consignment sales, we record revenues, and remove the items from
inventory, when the customer reports the sales to us. Normally we are notified
of the customer's sales through periodic sales reports and payments.
On September 30, 2003, we had approximately $259,000 of inventory on consignment
relating to its "pay on scan" sales. At September 30, 2002, we had no inventory
on consignment.
Included in the net sales in the accompanying financial statements for the nine
months and the three months ended September 30, 2003 and 2002 are reductions for
returns and allowances, sales discounts, new store opening discounts and co-op
advertising and promotions in the amounts of $1,510,491 and $967,732 and
$525,499 and $300,385, respectively. The increase in sales reductions in year
2003 was primarily due to the sales returns and allowances associated with the
return of discontinued ephedra products. Freight expenses are included in cost
of sales.
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,
-8-
revenues, and expenses, and related disclosure of contingent assets and
liabilities. On an ongoing basis, management evaluates these estimates,
including those related to valuation allowance for the deferred tax asset,
estimated useful life of fixed assets and the carrying value of long-lived
assets, intangible assets and allowances for sales returns, doubtful accounts,
and obsolete and slow moving inventory and reserve for customer liabilities.
Management bases these estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying value of
assets and liabilities that are not readily apparent from other sources. Actual
results may differ from these estimates under different assumptions or
conditions.
CUSTOMER LIABILITY ESTIMATES
The Company estimates and accrues expenses and liabilities for co-op advertising
and promotions and expenses for discontinued products as a reduction of sales.
The liability is maintained until the customer takes the deduction against
payments due. This liability is netted against the accounts receivable account
on the balance sheet. The amount at September 30, 2003 was $1,154,927 and
September 30, 2002 was $414,395.
We may incur a liability to a customer in three ways:
o We and the customer may agree that if the customer includes an
advertisement for our products in the customer's advertising circulars,
we will discount our products to the customer during the period of time
surrounding the use of the circulars;
o Some of our customers have a policy that require us to fund cooperative
advertising and promotions in an amount equal to 10% to 15% of the gross
revenue generated within the year; and
o In some cases, if the dating of our product in inventory at the
customer's location expires, the customer may seek a credit from us.
We record the liability when we determine that the customer is taking an action
that will result in an expense to the Company in the future. For example, when
we agree to fund an advertising promotion in a given month, we create a
liability for that promotion. We also establish reserves for returns we believe
likely. The actual payments to the customer are made when the customer makes a
deduction on its remittances for outstanding invoices. Typically, these
liabilities remain outstanding for three to six months.
OVERVIEW
We continued to endeavor to implement the Company's strategic plan of
diversifying our product line by developing and promoting new products. This
strategy is intended to minimize the impact of a shift in consumer preferences
with regard to any one of our products, a change in retailer attitude with
respect to any of our products, or any other cause of reduced sales either for a
particular product or in a particular geographical area. Despite the
introduction of new products, we remain significantly dependent on a single
brand, Carb Cutter(R).
Net Income for the nine months ended September 30, 2003 compared to the same
period in 2002, increased by $260,081. However, of that amount, approximately
$279,000 was a gain from the sale of
-9-
our Acutrim(R) product line. That means our operating income for the same nine
month period decreased by $15,592.
In the third quarter of 2003 our operating income was $99,690, after accruing
$129,000 of incentive compensation for our Chief Executive Officer, Christopher
Tisi. This bonus is based on a formula contained in his employment agreement
dated January 1, 2002, as follows:
o 5% of the increase in Net Revenues for the period as measured against
the corresponding period the year before, plus
o 10% of Net Income for the period.
In the first nine months of 2003, we have been able to increase Gross and Net
Revenues and maintain control over our administrative costs. The general and
administrative expenses for the nine months ended September 30, 2003 were
$1,431,135 versus $1,144,383 for the same period in 2002, an increase of
$286,752, or 25%. While administrative costs rose, their rate of increase was
significantly less than the rate of our rise in revenue.
The cost of sales, as a percentage of net sales, increased by 3% for the nine
months ended September 30, 2003 compared to September 30, 2002. Our gross margin
was adversely impacted in the period by increased sales of our Carb Cutter(R)
Phase 2(TM), which carries a higher raw materials cost than the other products
we offer.
The increase in Net Revenues for the nine months ended September 30, 2003 versus
the nine months ended September 30, 2002 was $1,644,156, or 60%. The increase in
Net Revenues is largely attributable to one major customer to whom we shipped
products for the full nine month period ending September 30, 2003 versus only
three months in September 2002. The increase in Net Revenues to that single
customer for the nine months of 2003 versus 2002 was $1,217,046.
We also introduced our Phase 2 product line during the nine months ended
September 30, 2003 and sales of that product were $681,353.
The Company believes that its ability to increase advertising expenditures
during the nine months ended September 30, 2003 by $645,900 was a significant
factor in the increase in sales during such period. Much of the funding that we
used for advertising and sales promotion was supplied by a temporary increase in
payment terms granted to us by our product supplier, Garden State Nutritional.
From December 31, 2002 to September 30, 2003, our inventory increased by
$933,879. This increase was attributable to:
o the increase of sales to a major new account;
o pay on scan sales of our Carb Cutter(R)Phase 2(TM), which is sold
predominately on a pay-on-scan basis, and are treated as consignment
sales;
o other inventory carried for pay-on-scan customers; and
o an increase in inventory in anticipation of increased sales in the
fourth quarter compared to the same quarter in 2002.
-10-
During the three months ended September 30, 2003, we sold our Acutrim(R) brand
for $300,000 in cash, which resulted in a gain of $279,308. Sales of this brand
had been decreasing, and the company was facing a return of product from
retailers due to poor sales. The Acutrim(R) brand was acquired in January 2001,
and comprised 22% of the Company's Net Revenues in the year 2001, or $1,028,000.
For 2002, Acutrim(R) Net Revenues were 18% of the Company's Net Recovery Sales,
or $646,763. For the nine months ended September 30, 2003, Acutrim(R) sales were
4.8% of the Company's Net Revenues, or $210,782.
The reduction in depreciation amortization expense from $7,617 in the three
months ended September 30, 2002 to $4,495 in the three months ended September
30, 2003 is primarily attributable to the sale of the Acutrim(R) brand.
NET REVENUES
Gross revenue is the total dollars generated from the total amount of goods sold
to a customer before any deductions. Net Revenue is gross revenue reduced by
o returns and allowances;
o cash discounts;
o slotting fees and new store discounts; and
o co-op advertising and promotions given to the customers to promote the
product and improve sales.
Gross revenues for the nine months ended September 30, 2003 and three months
ended September 30, 2003 were $5,880,465 an increase of $2,186,905 or 59% and
$2,393,387 an increase of $1,233,653, or 106%, respectively, as compared to
gross revenue for the nine months ended September 30, 2002 of $3,693,560 and for
the three months ended September 30, 2002 of $1,159,733.
Net Revenue, for the three months ended September 30, 2003 were $1,867,887 an
increase of $1,008,539, or 117%, as compared to net sales of $859,348 for the
three months ended September 30, 2002. For the three months ended September 30,
2003, Net Revenues with respect to our largest customers were as follows: (i)
Eckerd accounted for $201,048 or 8%: (ii) GNC accounted for $630,630 or 26%;
(iii) Rite Aid accounted for $125,128, or 5%; (iv) Walgreen accounted for
$139,836, or 6%; (v) CVS accounted for $215,568, or 9%, and Wal-Mart accounted
for $641,340, or 27%. No other account represented more than 5% of Net Revenues
during the quarter.
Net Revenues for the nine months ended September 30, 2003 were $4,369,984, an
increase of $1,644,156 or 60%, as compared to net sales of $2,725,828 for the
nine months ended September 30, 2002. For the nine months ended September 30,
2003, Net Revenues with respect to our largest customers were as follows: (i)
Eckerd accounted for $334,793, or 6%: (ii) GNC accounted for $1,353,420, or 23%;
(iii) Rite Aid accounted for $307,665, or 5%; (iv) Walgreen accounted for
$376,788, or 6%; (v) CVS accounted for $580,273, or 10%, and Wal-Mart accounted
for $1,605,342, or 27%. No other account represented more than 5% of Net
Revenues during the nine month period.
The increase in Gross Revenues and Net Revenues for the nine months and three
months periods ended September 30, 2003 were attributable to an increase in
advertising expenditures, the introduction of new products, Eat Less(R) and
Phase 2 and sales to a major new customer.
-11-
COST OF SALES
Cost of sales for the three months ended September 30, 2003 was $767,375, or 41%
of Net Revenues, as compared to $399,898, or 47% of Net Revenues for the
corresponding period in 2002. However, cost of sales for the nine months ended
September 30, 2003 was $1,772,077, or 41% of net sales, as compared to
$1,038,972, or 38% of net sales, for the corresponding period in 2002. The cost
of sales as a percentage of gross revenues was 32% and 30% for the three months
ended September 30, 2003 and nine months ended September 30, 2003, respectively.
The dollar amount is higher due to the increased sales during the period. The
deterioration in our margins was predominately due to the higher cost of goods
sold of our new product, Carb Cutter(R) Phase 2(TM). During the nine months
ended September 30, 2003, our cost of goods sold for all products, excluding
Carb Cutter(R) Phase 2(TM), was approximately 27%; the cost of goods sold for
our Phase 2 product is approximately 49%.
GROSS PROFIT
Gross profit for the three months ended September 30, 2003 was $1,100,512 an
increase of $641,062 or 140% compared to gross profit of $459,450 for the three
months ended September 30, 2002. As a percent of net sales, gross profit was 59%
for the three months ended September 30, 2003, compared to 54% for the three
months ended September 30, 2002. The increase in gross profit of $641,062 was
primarily due to sales increases in the Carb Cutter(R) product and the
introduction of our (new) Eat Less(R) and Phase 2(TM) products. Gross profit for
the nine months ended September 30, 2003 was $2,597,907 an increase of $911,051,
or 54% compared to gross profit of $1,686,856, or the nine months ended
September 30, 2002. As a percent of net sales, gross profit was 59% for the nine
months ended September 30, 2003, compared to 62% for the nine months ended
September 30, 2002. The increase in gross profit was primarily due to the sales
increases in the Carb Cutter(R), Eat Less(R), and Phase 2 in the aggregate
amount of $2,911,930. The decrease in gross profit percentage is due to the
increase in our cost of goods sold.
OPERATING EXPENSES
Operating expenses are made up of three expense classifications:
o Advertising;
o General and Administration; and
o Depreciation and Amortization.
Operating expenses were $1,181,034 for the three months ended September 30,
2003, representing an increase of $644,255 compared to $536,779 for the three
months ended September 30, 2002. As a percent of net sales, operating expenses
were 63% for the three months ended September 30, 2003, compared to 63% for the
three months ended September 30, 2002. Advertising and promotion expenses for
the three months ended September 30, 2003, were $553,949, representing an
increase of $399,661, compared to $154,288 for the three months ended September
30, 2002. The increase in advertising expenditures has, in our opinion, been a
significant factor in increasing sales. The general and administrative expenses
were $622,590 for the three months ended September 30, 2003 compared to $374,874
for the three months ended September 30, 2002, or an increase of $247,716. The
$247,716 increase was made up of increases in several areas:
o Higher broker expenses of $27,481 due to the increase in revenues and
increases in computer expenses of $37,422.
-12-
o an increase in other routine administrative expenses of $52,467; and
o an accrual of $129,000 for management incentive compensation earned by
Mr. Tisi, as provided for in his employment contract.
Operating expenses were $2,498,217 for the nine months ended September 30, 2003,
representing an increase of $926,643, compared to $1,571,574 for the nine months
ended September 30, 2002. As a percent of net sales, operating expenses were 57%
for the nine months ended September 30, 2003, compared to 58% for the nine
months ended September 30, 2002. Advertising and promotion expenses for the nine
months ended September 30, 2003, were $1,050,261, representing an increase of
$645,920, compared to $404,341 for the nine months ended September 30, 2002. The
increase in advertising expenditures has in our opinion been a major factor in
the increase in sales volume. The general and administrative expenses were
$1,431,135 for the nine months ended September 30, 2003 compared to $1,144,383
for the nine months ended September 30, 2002, or an increase of $286,752. The
$286,752 increase was made up of:
o higher broker expenses of $62,918 due to increase in sales volume;
o increases in computer expenses of $4,086;
o increase in other routine administrative expenses of $78,476; and
o the accrual for incentive compensation earned by Mr. Tisi, as provided
for in his employment contract of $129,000.
INCOME FROM OPERATIONS
Operating Loss for the three months ended September 30, 2003 was ($80,522),
compared to a loss $(77,329) for the three months ended September 30, 2002.
Income from operations was $99,690 for the nine months ended September 30, 2003,
compared to income from operations of $115,282 for the nine months ended
September 30, 2003. This represents a decrease of $15,592, primarily due to the
increase in the operating expenses. Net income was $183,835, or $0.05 per share
for the three months ended September 30, 2003, as compared to a net loss of
$(94,834) or $(0.03) per share for the three months ended September 30, 2002.
Net income was $344,479, or $0.09 per share for the nine months ended
September 30, 2003, as compared to a net income of $84,398, or $0.02 per share
for the nine months ended September 30, 2002. The increase in net income for the
three months ended September 30, 2003 was primarily due to the gain on sale of
Acutrim(R) of $279,308.
LIQUIDITY & CAPITAL RESOURCES
At September 30, 2003, the Company had a working capital deficit of $39,354,
compared to a $592,944 working capital deficit at September 30, 2002.
Net cash provided by operating activities for the nine months ended September
30, 2003 was $349,216 compared to $161,843 provided by operating activities for
the nine months ended September 30, 2002. The resulting increase in cash is
primarily due to a net profit realized during the nine months ended September
30, 2003, due to the sale of Acutrim(R).
During the nine months ended September 30, 2003, the Company has continued to
control costs, and maintained profitability, with net income from operations of
$99,690, and cash flow from operations of
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$349,216. Based on these results, and financing arrangements with GSN and
continued expense control, we believe that our operations will provide
sufficient cash to support our activities for the next 12 months. However, if
GSN determines to alter the informal arrangements extending our limit of credit
to $1,000,000 or our operations fail to generate positive cash flow, it is
likely we would not be able to continue our operations.
Cash from investing activities was $300,000 from the sale of Acutrim(R) for the
nine months ended September 30, 2003 and there was no activity for the nine
months ended September 30, 2002.
The Acutrim(R) brand was acquired in January 2001, and comprised 22% of the
Company's sales for the year 2001 at $1,028,000. For the year 2002, Acutrim(R)
sales were 18% of the Company's sales at $646,763. For the nine months ended
September 30, 2003, the sales were 4.8% of the Company's sales at $210,782.
Net cash used in financing activities for the nine months ended September 30,
2003 was $572,087 compared to net cash used by financing activities of $185,788
for the nine months ended September 30, 2002. This is primarily attributable to
the repayment of a portion of the note to Garden State Nutritionals.
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 equal quarterly payments,
without interest, over the next eight quarters, starting June 1, 2002. In
connection with this agreement, the Company granted to GSN a blanket second
priority in 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 occurrence of any of the following events constitute a default under
this promissory note: (i) the failure of the Company to pay when due any payment
of principal and such failure continues for fifteen (15) days after Lender
notifies the Company in writing; (ii) the Company files for or is granted
certain relief pursuant to or within the meaning of the United States Bankruptcy
Code, or any other federal or state law relating to insolvency or relief of
debtors (a "Bankruptcy Law"), and (iii) Christopher Tisi ceases to be the
President and Chief Executive Officer of the Company (unless a replacement
reasonably acceptable to Lender is obtained within thirty days).
Also, on April 11, 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 has informally allowed the Company to
purchase up to $1,000,000 on the line of credit. At September 30, 2003, the
balance owed to GSN under this line of credit is $803,260.
In July 2003, the Company amended its manufacturing agreement with Garden State
Nutritionals to provide for a line of credit of $450,000 on both finished goods
and work in process. The terms of the amended agreement expire July 17, 2005. In
June of 2002, the Company acquired a significant new customer as part of an
ongoing effort to increase sales. The Company informed GSN in 2003 that
additional inventory would be needed to support this initiative, and GSN
informally increased its line of credit under its manufacturing agreement. GSN
has periodically granted flexible terms to allow us to meet new opportunities.
The loss of GSN, or a change in their policy with respect to the flexibility
that they occasionally provide, would severely limit our ability to enhance our
business.
In July 2003, the Company issued an amended promissory note to Garden State
Nutritionals in the principal amount of $1,300,000. The note provides for
$300,000 to be paid before December 31, 2003, with the balance due in quarterly
installments of $131,410 commencing November 1, 2003, at 4.5% per annum. The
$300,000 was paid in August, 2003.
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COMMITMENTS AND CONTINGENCIES
REGULATORY MATTERS
In early 2003, the Company discontinued all sales of products containing
ephedra. Those discontinued products are Fat Cutter Plus(TM), Thin Tab(R) and
Carbolizer(TM). All of these products contain ephedra, also known as Ma Huang,
an herb that contains naturally occurring ephedrine. We also conveyed ownership
of the Carbolizer(TM) brand to KMS, a Company owned by a former officer of HNS,
as part of a settlement of a judicial proceeding in September 2002.
For the twelve months ended December 31, 2002, ephedra containing products
represented approximately 19% of our gross revenue:
o Fat Cutter Plus(TM)- $605,000;
o Carbolizer(TM) - $244,000; and
o Thin Tab(R)- $116,000.
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 will, most likely, attempt to issue new rules with respect to dietary
supplements that contain ephedrine alkaloids or ban them entirely. However, it
is uncertain what restrictions the new proposed rule might contain or when a new
proposed rule will be issued. 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. We have already developed
ephedrine-free formulae for products. However, these formulations may not be
popular with customers accustomed to products containing ephedra. On the other
hand, to the extent that sales of ephedra-containing products of our competitors
decline as a result of any new rules, sales of our current non-ephedra products
may be positively affected.
GOVERNMENT REGULATIONS
The processing, formulation, packaging, labeling and advertising of our products
are subject to regulation by one or more federal agencies, including the FDA,
the FTC, the Consumer Product Safety Commission, the United States Department of
Agriculture and the United States Environmental Protection Agency. These
activities are also regulated by various agencies of the states, localities, and
countries in which its products are sold.
Although we cannot predict what new legislation or regulations governing our
activities will be enacted by legislative bodies or promulgated by agencies
regulating our activities. We do know that our industry has come under increased
scrutiny principally due to the FDA's investigation of the use of ephedra. We
believe we will become subject to additional laws or regulations administered by
the FDA or other federal, state, or foreign regulatory authorities. We also
believe the laws or regulations which we consider favorable may be repealed or
more stringent interpretations of current laws or regulations will be
implemented in the future. Any or all of such requirements could be a burden and
costly, to us. Future regulations could:
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o require us to change the way we conduct business;
o require us to change the contents of our products;
o make us keep additional records;
o make us increase the available documentation of the properties of our
products; or
o make us increase or use different labeling and scientific proof of
product ingredients, safety or usefulness.
PRODUCT LIABILITY
The Company, like other marketers of products that are intended to be ingested,
faces the inherent risk of exposure to product liability claims in the event
that the use of our products results in injury. The Company maintains product
liability insurance coverage of $6,000,000. Because of the increased scrutiny of
our industry arising out of the FDA's consideration of ephedra, or otherwise, it
may become increasingly difficult to obtain and maintain product liability
insurance coverage for products, regardless of whether they contain ephedra, at
current premiums, or at all. Our products liability coverage is on an occurrence
basis and, even if we are unable to continue to secure product liability
insurance on a claims made basis, would cover ephedra based claims. We believe
that our insurance coverage would be adequate to cover any claims made against
it relating to its products, whether based on ephedra or otherwise. We further
believe that by ceasing to sell products containing ephedra and agreeing to
accepting returns of our customers' existing inventory, it has further reduced
any potential liability relating to ephedra. We are not aware of any claims
similar to those relating to ephedra having been made with respect to any of the
other ingredients contained in its products.
GOING CONCERN QUALIFICATION
The Company's condensed financial statements have been prepared assuming that
the Company will continue as a going concern. During the nine months ended
September 30, 2003, the Company has successfully controlled costs and attained
profitability, including net income of $344,479 and cash flow from operations of
$349,216. However, at September 30, 2003, the Company has a working capital
deficit of $39,354 and adverse liquidity ratios.
The Company's continuation is dependent upon its ability to control costs and
attain a satisfactory level of profitability with sufficient financing
capabilities or equity investment.
There is substantial doubt about the Company's ability to continue as a going
concern. The financial statements do not include any adjustments to reflect the
possible effects on the recoverability and classification of assets or the
amounts and classification of liabilities that may result form the outcome of
this uncertainty.
ITEM 3. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures
------------------------------------------------
As of the end of the period, the Company carried out an evaluation of the
effectiveness of the design and operation of its disclosure controls and
procedures pursuant to Exchange Act Rule 13a-14. This evaluation was done under
the supervision and with the participation of the Company's President and its
Controller. Based upon that evaluation, they concluded that the Company's
disclosure controls and
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procedures are effective in gathering, analyzing, and disclosing information
needed to satisfy the Company's disclosure obligations under the Exchange Act.
Change in internal controls
---------------------------
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect those controls since the most recent
evaluation of such controls.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Twenty-two (22) cases have been filed alleging that our Acutrim(R) products
contain Phenylpropanolamine ("PPA") and that those products have caused damage
to the plaintiffs. Many of these cases have been consolidated in class action
suits pending in the U.S. District Court for the Western District of Washington
in Seattle, the Philadelphia County Court of Common Pleas or the Louisiana State
Court. None of the Company's Acutrim(R) products has ever contained, or
currently contains, PPA. Based on that defense, to date, all but 3 consolidated
cases have been voluntarily 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.
ITEM 2. CHANGES IN SECURITIES.
During the three months ended September 30, 2003, we issued an aggregate of
200,000 restricted common shares of the Company to two directors for their
services on our Board of Directors. This transaction was approved by the Board
of Directors on July 30, 2003 and consummated on August 13, 2003. The shares
were issued without registration in reliance of the exemption provided by
Section 4(2) of the Securities Act of 1933, as amended and Rule 506 of
Regulation D promulgated thereunder. The market value of the common stock at the
time the Board of Directors approved its issuance was $24,000, which we have
recorded as compensation expense.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibit 31.1 Certification Pursuant to Item 601(b)(31) of Regulation S-B, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.2 Certification Pursuant to Item 601(b)(31) of Regulation S-B, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.1 Certification Pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished
pursuant to Item 601(b)(32) of Regulation S-B).
Exhibit 32.2 Certification Pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished
pursuant to Item 601(b)(32) of Regulation S-B).
(b) Reports on Form 8-K during the fiscal quarter ended September 30, 2003.
None
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SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this amended report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Date: April 12, 2004 Health & Nutrition Systems International, Inc.
(The "Registrant")
By: /s/Christopher Tisi
----------------------------------------------
Christopher Tisi
Chief Executive Officer, President,
and Secretary
(Principal executive officer and duly
authorized officer)
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Exhibit Index
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
31.1 Certification Pursuant to Item 601(b)(31) of Regulation S-B, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 Certification Pursuant to Item 601(b)(31) of Regulation S-B, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(furnished pursuant to Item 601(b)(32) of Regulation S-B).
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(furnished pursuant to Item 601(b)(32) of Regulation S-B).