Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
[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 PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ____________to____________
Commission File Number: 001-13343
---------------------------------------------------------------------
ADVANTAGE MARKETING SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Oklahoma 73-1016728
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2601 Northwest Expressway, Suite 1210W
Oklahoma City, Oklahoma 73112
(Address of principal executive offices) (Zip code)
REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE: (405) 842-0131
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
Name of each exchange on
Title of each class which registered
------------------------------- ------------------------
Common Stock, $0.0001 Par Value American Stock Exchange
Redeemable Common Stock Purchase Warrants American Stock Exchange
1997-A Warrants American Stock Exchange
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
Common Stock, $0.0001 Par Value
Redeemable Common Stock Purchase Warrants
1997-A Warrants
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 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 [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes [ ] No [X]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [ ].
On June 28, 2002, 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 last sold, or the average bid and asked
prices of such common equity was $9,113,190.
As of March 24, 2003 there were 4,424,314 shares of Common Stock, par
value $0.0001 per share, outstanding.
Documents incorporated by reference: The information called for by Part
III is incorporated by reference to the definitive proxy statement for the
registrant's 2003 annual meeting of stockholders, which will be filed with the
Securities and Exchange Commission not later than 120 days after December 31,
2002.
ADVANTAGE MARKETING SYSTEMS, INC.
FORM 10-K
For the Fiscal Year Ended December 31, 2002
TABLE OF CONTENTS
Part I.
Item 1. Business.................................................................................. 3
Item 2. Properties................................................................................ 17
Item 3. Legal Proceedings......................................................................... 17
Item 4. Submission of Matters to a Vote of Security Holders....................................... 17
Part II.
Item 5. Market for Common Equity and Related Stockholder Matters.................................. 18
Item 6. Selected Financial Data................................................................... 19
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation...... 20
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................................ 29
Item 8. Financial Statements and Supplementary Data............................................... 30
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure...... 30
Part III. **
Item 14. Controls and Procedures................................................................... 30
Part IV.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K........................... 30
** Information required by Items 10, 11, 12 and 13 of Part III is incorporated
by reference from the Company's definitive proxy statements for its 2003 annual
meeting of shareholders.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Certain statements under the captions "Item 1. Business," "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operation," and elsewhere in this report constitute "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Certain, but not
necessarily all, of such forward-looking statements can be identified by the use
of forward-looking terminology such as "anticipates," "believes," "expects,"
"may," "will," or "should" or other variations thereon, or by discussions of
strategies that involve risks and uncertainties. Our actual results or industry
results may be materially different from any future results expressed or implied
by such forward-looking statements. Factors that could cause actual results to
differ materially include general economic and business conditions; our ability
to implement our business and acquisition strategies; changes in the network
marketing industry and changes in consumer preferences; competition;
availability of key personnel; increasing operating costs; unsuccessful
advertising and promotional efforts; changes in brand awareness; acceptance of
new product offerings; changes in, or the failure to comply with, government
regulations (especially food and drug laws and regulations); our ability to
obtain financing for future acquisitions and other factors.
2
PART I
ITEM 1. BUSINESS
Advantage Marketing Systems, Inc., or AMS, began operations in 1987,
and through a corporate reorganization in 1995, became an Oklahoma corporation.
We market a product line consisting of approximately one hundred products in
three categories; weight management, dietary supplement and personal care
products. These products are marketed through a network marketing organization
in which independent associates purchase products for resale to retail customers
as well as for their own personal use.
The associates in our network are encouraged to recruit interested
people to become new associates for our products. New associates are placed
beneath the recruiting associate in the "network" and are referred to as being
in that associate's "downline" organization. Our marketing plan is designed to
provide incentives to build, maintain and motivate an organization of recruited
associates in their downline organization to maximize their earning potential.
Associates generate income by purchasing our products at wholesale prices and
reselling them at retail prices. They also earn bonuses on product purchases
generated by the associates in their downline organization. See "--Network
Marketing."
On an ongoing basis, we review our product line for duplication and
sales movement and make adjustments accordingly. As of December 31, 2002, our
primary product line consisted of:
- 11 weight management products;
- 33 dietary supplement products; and
- 42 personal care products consisting primarily of skin care products.
Our products are manufactured by various manufacturers pursuant to formulations
developed for us and are sold to our independent associates located in all 50
states, the District of Columbia and Canada.
We believe that our network marketing system is ideally suited to
market weight management, dietary supplement and personal care products because
sales of such products are strengthened by ongoing personal contact between
associates and their customers. Our network marketing system appeals to a broad
cross-section of people, particularly those looking to supplement family income
or seeking part-time work. Associates are given the opportunity through
sponsored events and training sessions to network with other associates, develop
selling skills and establish personal goals. We supplement monetary incentives
with other forms of recognition in order to further motivate and foster an
atmosphere of excitement throughout our associate network.
ACQUISITION OF LIFESCIENCE TECHNOLOGIES, INC. ("LST")
Effective January 4, 2001, we purchased the LST group of companies for
$1.2 million and a five-year payment of $41,667 per month or 5% of the gross
sales of LST products, whichever is greater. The seller has the option to take
up to 860,000 shares of common stock in lieu of cash at an option price of $3.00
per share. As a result of the acquisition, we added 14 products and over 5,000
associates.
KEY OPERATING STRENGTHS
We believe the source of our success is our support of and compensation
program for our associates. We provide high-quality products and a highly
attractive bonus program, along with extensive training and motivational events
and services. We believe that we have established a strong operating platform to
support associates and facilitate future growth. The key components of this
platform include the following:
- Quality products, many of which emphasize herbs and other natural
ingredients to appeal to consumer demand for products that contribute
to a healthy lifestyle;
3
- A compensation program that permits associates to earn income from
profits on the resale of products and residual income from reorder
bonuses on product purchases within an associate's downline
organization, as well as to participate in various non-cash awards,
such as vacations, offered through promotional programs;
- A superior communications and training program that effectively and
efficiently communicates with associates by utilizing new technologies
and marketing techniques, as well as motivational events and training
seminars; and
- The employment of information technology to provide timely and accurate
product order processing, weekly bonus payment processing, detailed
associate earnings statements, and inventory management.
GROWTH STRATEGY
Our growth strategy is redirecting our product and business focus to
capitalize on our performance-based nutrition, anti-aging and weight loss
products, where AMS owns or controls proprietary formulations and exclusive
worldwide distribution rights. This redirection, along with the addition of
state of the art internet marketing technology, should increase our network of
independent associates. An increase in the number of associates generally
results in increased sales volume, and new products create enthusiasm among
associates, serve as a promotional tool in selling other products, and attract
new associates. Since 1995, we have introduced many new products to our product
line in the weight management, dietary supplement and personal care categories,
primarily through the acquisition of:
- Miracle Mountain International, Inc. in May 1996;
- Chambre International, Inc. in January 1997;
- The assets of Stay 'N Shape International, Inc., Solution Products
International, Inc., Nation of Winners, Inc., and Now International,
Inc. in April 1997;
- All rights, including formulations and trademarks for the ToppFast,
ToppStamina and ToppFitt products from ToppMed, Inc. in July 1998; and
- Proprietary formulations and trademarks for LifeScience Technologies
including the adaptogen products, Prime One and Breckman's Gold in
January 2001.
We also seek to increase sales through initiatives designed to enhance
sales in our existing markets. These initiatives include increasing the number
of training and motivational events and teleconferences, hiring additional
associate support personnel and establishing more convenient regional support
centers in targeted geographic markets.
As noted above, we seek to grow through acquisitions. The network
marketing industry is fragmented, has relatively low barriers to entry, and
includes a number of small marketing companies, many of which are being acquired
by larger companies. Our strategy is to capitalize on these market
characteristics to achieve additional growth, both in terms of associates and
product line enhancement, through the acquisition of additional network
marketing companies or the assets of such companies.
The principal objective of our acquisition strategy is to acquire other
network marketing organizations that can be combined with our network marketing
organization, resulting in increased sales volume with minimal additional
administrative cost. We will not consummate an acquisition unless, at the time,
we anticipate that such acquisition will contribute to profitability and provide
positive cash flows from operations. There is no assurance, however, that we
will in the future be able to acquire other network marketing organizations, or
that such acquisitions will result in increased profitability and cash flows.
Our growth strategy requires expanded associate services and support,
increased personnel, expanded operational and financial systems and
implementation of additional control procedures. There is no assurance
4
that we will be able to manage expanded operations effectively. Furthermore,
failure to implement financial, information management, and other systems and to
add control procedures could have a material adverse effect on our results of
operations and financial condition. Our acquisitions could involve a number of
risks including:
- The diversion of management's attention to the assimilation of the
acquired companies or assets; and
- The possibility that the acquired company or assets will not contribute
to our cash flows and profitability as expected.
Although we intend to focus principally on the expansion of sales
within the United States, we are preparing for expansion into markets in other
countries. We have products approved for sale in Japan and are reviewing other
countries, such as the United Kingdom, Australia, the Philippines and Taiwan. We
believe there are numerous additional international markets in which our network
marketing organization and products could prove successful.
INDUSTRY OVERVIEW
Network Marketing. We believe that network marketing is one of the
fastest growing channels of distribution for certain types of goods and
services.
Weight Management and Dietary Supplement Products. We believe that the
weight management and dietary supplement category is expanding because of
heightened public awareness of reports about the positive effects of weight
management and dietary supplements on health. Many individuals also use dietary
supplements as a means of preventative health care. We believe several factors
account for the steady growth of the dietary supplement category, including
increased public awareness of the reported health benefits of dietary
supplements and favorable demographic trends toward older Americans who are more
likely to consume dietary supplements.
Over the past several years, widely publicized reports and medical
research findings have suggested a correlation between the consumption of
dietary supplements and the reduced incidence of certain diseases. The United
States government and universities generally have increased sponsorship of
research relating to dietary supplements. In addition, Congress has established
the Office of Alternative Medicine within the National Institute of Health to
foster research into alternative medical treatments, which may include natural
remedies. Congress also recently established the Office of Dietary Supplements
in the National Institute of Health to conduct and coordinate research into the
role of dietary supplements in maintaining health and preventing disease.
In addition, we believe that the aging of the United States population,
together with an increased focus on preventative health care measures, will
continue to result in increased demand for dietary supplement products. We
believe these trends have helped fuel the growth of the dietary supplement
category. To meet the increased demand for dietary supplements, we and others
have introduced a number of successful dietary supplement products the past
several years, including function specific products for weight loss, sports
nutrition, menopause, energy and mental alertness. In addition, the use of a
number of ingredients, such as chromium picolinate, shark cartilage,
proanthocyanidins, citrin and colloidal minerals, have created opportunities for
us and others to offer new products.
Personal Care Products. We believe that the personal care products
market is a mature category that has been historically immune to swings in the
economy. Manufacturers and associates of personal care products must continually
improve existing products, introduce new products and communicate product
advantages to consumers. With the aging population, there appears to be a
growing demand for a wide spectrum of new products in the area of skin care.
5
PRODUCTS
Our product line consists of products in the categories of weight
management, dietary supplements and personal care. We currently market
approximately one hundred products, exclusive of variations in product size,
colors or similar variations of our basic product line.
Weight Management Category. During the years ended December
31, 2002, 2001 and 2000, 51.8%, 54.7% and 67.6% of our net sales were derived
from the 11 products in the weight management category that we market under the
Advantage Marketing Systems label. The following products represent the majority
of our product sales in the weight management category:
- AM-300--A specialized blend of herbs, including an ephedra herb
concentrate and chromium picolinate; and
- AS-200--A specialized blend of herbs and nutrients in addition to
citrin and chromium picolinate.
Dietary Supplement Category. During the years ended December 31, 2002,
2001 and 2000, 40.2%, 38.9% and 25.3% of our net sales were derived from the 33
products in the dietary supplement category, which contain herbs, vitamins,
minerals and other natural ingredients. They are sold under the Advantage
Marketing Systems label. The following products represent the majority of our
product sales in the dietary supplement category:
- Prime One and Breckman's Gold--A liquid nutritional containing natural
adaptogens, considered to be the number one performance enhancing,
health restorative and stress reliever in the world;
- Shark Cartilage Complex--Manufactured from shark fin cartilage and a
blend of curcumin, boswellia and vanadium;
- Colloidal Silver--Contains essential elements required by plants,
animals and man that we once naturally obtained from organic soils via
fruits, vegetables, nuts, grains and legumes;
- Spark of Life--A liquid nutritional drink containing a blend of herbs,
vitamins, minerals, amino acids and essential fatty acids; and
- Chlorella--Fresh water green algae containing amino acids of protein,
nucleic acids, fibers, vitamins and minerals.
Personal Care Category. In January 1997, we expanded and improved our
product line by acquiring Chambre International and its line of skin care, hair
care, family care and cosmetic products. Chambre International had been
marketing its products for over 24 years. During the years ended December 31,
2002,2001and 2000, 2.9%, 1.5% and 1.3% of our net sales were derived from the 42
personal care products marketed primarily under the Chambre label in the
personal care category. The following products represent the majority of our
product sales in the personal care category:
- NH2 Lift System--A three-part skin-care system combining enzymatic
exfoliation and isometric action to firm the skin, build muscle tone
and lift the face;
- Skin Care Collections--Include cleansing lotion, skin freshener,
oatmeal scrub, night treatment, moisturizer and protein or moisture
masque; and
- Hair Care Systems--Include keratin shampoo, conditioning rinse,
reconstructor, hair hold and style and set.
Promotional Materials. We also derive revenues from the sale of various
educational and promotional materials designed to aid our associates in
maintaining and building their businesses. Such materials include various sales
aids, informational videotapes and cassette recordings, and product and
marketing brochures.
6
Other Products and Services. Prior to focusing on weight management,
dietary supplement and personal care products in October 1993, we marketed
various packages of consumer benefit services provided by third-party providers.
The only remaining benefit service we offer is a pre-paid legal service. The
pre-paid legal services are provided by Pre-Paid Legal Services, Inc. This
program membership represented less than 1% of our net sales during 2002, 2001
and 2000.
New Product Identification. We expand our product line through the
development and acquisition of new products. New product ideas are derived from
a number of sources, including trade publications, scientific and health
journals, our management, consultants, associates and other outside parties.
Potential product acquisitions are identified in a similar manner. Prior to
introducing new products, we investigate product formulation as it relates to
regulatory compliance and other issues.
We do not maintain a product development staff, but rely upon Chemins
Company, Inc. and other manufacturers, independent researchers, vendor research
departments and others for such services. When a new product concept is
identified or when an existing product must be reformulated, the new product
concept or reformulation project is generally submitted to Chemins for technical
development and implementation. We continually review our existing products for
potential enhancements to improve their effectiveness and marketability. While
we consider our product formulations to be proprietary trade secrets, such
formulations are not patented. Accordingly, there is no assurance that another
company will not replicate one or more of our products.
Product Procurement and Distribution; Insurance. Essentially all of our
product line in the weight management and dietary supplement categories is
manufactured by Chemins Company, Inc. utilizing our product formulations.
Essentially all of our product line in the personal care category is
manufactured by GDMI, Inc. and Columbia Cosmetics, Inc. Naturtech manufactures
our adaptogen product line from our LifeScience Technologies acquisition.
We have not generally entered into long-term supply agreements with the
manufacturers of our product line or the third-party providers of our consumer
benefit services. However, we customarily enter into contracts with our
manufacturers and suppliers to establish the terms and conditions of purchases.
Our arrangements with Chemins Company, Inc. may be terminated by either party
upon the completion of any outstanding purchase orders. Therefore, there can be
no assurance that Chemins will continue to manufacture our products or provide
research, development and formulation services. In the event the relationship
with any of our manufacturers becomes impaired, we will be required to obtain
alternative manufacturing sources for our products. In such event, there is no
assurance that the manufacturing processes of our current manufacturers can be
replicated by another manufacturer. Although we have not previously experienced
product unavailability or supply interruptions, we believe that we would be able
to obtain alternative sources for our weight management, dietary supplement and
personal care products. A significant delay or reduction in availability of
products, however, could have a material adverse effect on our business,
operating results and financial condition.
We, like other marketers of products that are intended to be ingested,
face an inherent risk of exposure to product liability claims in the event that
the use of our products results in injury. We maintain a claims made policy,
with limited product liability insurance with coverage limits of $1,000,000 per
occurrence and $2,000,000 in the aggregate. Products containing ephedra, which
represented 49% of our 2002 net revenue, are not covered by our product
liability insurance. Although we do not obtain contractual indemnification, our
product manufacturers carry product liability insurance that covers our
products. Product liability claims in excess of insurance coverage may result in
significant losses, which would adversely affect product sales, results of our
operations, financial condition and the value of our common stock.
All of the items in our product line include a customer satisfaction
guarantee. Within 30 days of purchase, any retail customer or associate who is
not satisfied with our product for any reason may return it or any unused
portion to the associate from whom it was purchased or to us for a full refund
or credit toward the purchase of another product. Associates may obtain
replacements from us for products returned to them by retail customers if they
return such products on a timely basis. Furthermore, in most jurisdictions, we
maintain a buy-back program. Under this program, we will repurchase products
sold to an associate, subject to a 10% restocking charge, provided the associate
resigns and returns the product in marketable condition within 12
7
months of original purchase, or longer where required by applicable state law or
regulations. We believe this buy-back program addresses a number of the
regulatory compliance issues pertaining to network marketing systems. For the
years ended December 31, 2002, 2001 and 2000, the cost of products returned to
us was 0.6%, 1% and 2% of gross sales.
Our product line is distributed principally from our facilities in
Oklahoma City or from our regional support centers. Products are warehoused in
Oklahoma City and at selected regional support centers.
NETWORK MARKETING
We market our product line through independent associates in a network
marketing organization. At December 31, 2002, we had approximately 39,223
"active" associates. To be considered "active" an associate must have purchased
$50 in products or $22 on autoship of our products within the preceding 12
months. Our associates are independent contractors who purchase products
directly from us for resale to retail consumers. Associates may elect to work on
a full-time or part-time basis. We believe our network marketing system appeals
to a broad cross-section of people, particularly those seeking to:
- Supplement family income;
- Start a home business; or
- Pursue employment opportunities other than conventional, full-time
employment.
A majority of our associates therefore sell our products on a part-time basis.
We believe that our network marketing system is ideally suited to
market our product line because sales of such products are strengthened by
ongoing personal contact between retail consumers and associates, many of whom
use our products themselves. Sales are made through direct personal sales
presentations as well as presentations made to groups in a format known as
"opportunity meetings." These sales methods are designed to encourage
individuals to purchase our products by informing potential customers and
associates of our product line and results of personal use, and the potential
financial benefits of becoming an associate. The objective of the marketing
program is to develop a broad based network marketing organization within a
relatively short period. Our marketing efforts are typically focused on
middle-income families and individuals.
Our network marketing program encourages individuals to develop their
own downline network marketing organizations. Each new associate is either
linked to:
- The existing associate that personally enrolled the new associate into
our network marketing organization; or
- The existing associate in the enrolling associate's downline as
specified at the time of enrollment.
Growth of an associate's downline organization is dependent on the recruiting
and enrollment of additional associates within such associate's downline
organization.
Associates are encouraged to assume responsibility for training and
motivation of others within their downline organization and to conduct
opportunity meetings as soon as they are appropriately trained. We strive to
maintain a high level of motivation, morale, enthusiasm and integrity among the
members of our network marketing organization. We believe this result is
achieved through a combination of products, sales incentives, personal
recognition of outstanding achievement and quality promotional materials. Under
our network marketing program, associates purchase sales aids and brochures from
us and assume the costs of advertising and marketing our product line to their
customers as well as the direct cost of recruiting new associates. We believe
that this form of sales organization is cost efficient because our direct sales
expenses are primarily limited to the payment of bonuses, which are only
incurred when products are sold.
8
We continually strive to improve our marketing strategies, including
the compensation structure within our network marketing organization and the
variety and mix of products in our line, to attract and motivate associates.
These efforts are designed to increase monthly product sales and the recruiting
of new associates.
To aid associates in easily meeting the monthly personal product
purchase requirement to qualify for bonuses, we developed the "autoship" in
1994. Under the autoship purchasing arrangement, associates establish a standing
product order for an amount in excess of $22 that is automatically charged to
their credit cards or deducted from their bank accounts for goods shipped that
month. At December 31, 2002, 2001, and 2000, we had approximately 23,051,
27,912, and 29,761 associates participating in the autoship.
Growth of our network marketing organization is in part attributable to
our bonus structure which provides for payment of bonuses on product purchases
made by other associates in an associate's downline organization. Associates
derive income from several sources:
- First, associates earn profits by purchasing from our product line at
wholesale prices (which are discounted up to 40% from suggested retail
prices) and selling to customers at retail.
- Second, associates who establish their own downline organization may
earn bonuses of up to 40% on product purchases by associates within the
first four levels of their downline organization.
- Third, associates who have personally enrolled three active associates
and have (i) $300 per month of autoship product purchases by personally
enrolled associates on their first level and (ii) $300 per month of
autoship product purchases on their second level, become directors and
have the opportunity to build an additional director downline
organization and receive additional bonuses of 4% on product purchases
by such downline organization.
- Fourth, associates who have personally enrolled six active associates
and have (i) $600 per month of autoship product purchases by personally
enrolled associates on their first level and (ii) $600 per month of
autoship product purchases on their second level and have a total of
$2,500 wholesale volume monthly in their downline, become silver
directors and have the opportunity to build an additional silver
director downline organization and receive additional bonuses of 5% on
product purchases by such downline organization.
- Fifth, silver directors who have personally enrolled 12 active
associates and have (i) $1,200 per month of autoship product purchases
by personally enrolled associates on their first level and (ii) $1,200
per month of autoship product purchases on their second level and have
a total of $5,000 wholesale volume monthly in their downline, become
gold directors and have the opportunity to receive an additional bonus
of 3% on product purchases by their silver director downline
organization. In addition, gold directors have the opportunity to
receive generation bonuses of up to 3% on the product purchases by
associates of silver director downline organizations that originate
from their silver director downline organization through four
generations.
- Sixth, gold directors who maintain the gold director requirements and
develop four gold directors, each one from a separate leg of their
downline organization plus $40,000 wholesale volume in downline
organization, become platinum directors and have the opportunity to
build an additional platinum director downline organization and receive
additional bonuses of 5% on product purchases by such downline
organization.
Combining these levels of bonuses, our total "pay-out" on products
subject to bonuses is approximately 67% of the bonus value of product sales.
Each associate in our network marketing organization has a director, a
silver director, a gold director and a platinum director. Each director has a
silver director, a gold director and a platinum director. Each silver director
has a gold director and a platinum director. Each gold director has a platinum
director. As of December 31, 2002, we had 186 silver directors, 116 gold
directors and 45 platinum directors.
9
Under our regional support center program, we designate associates to
serve as regional support center directors and provide them special training and
support. Each regional support center director functions as a product
distribution center for our products. As of December 31, 2002, we had 58
regional support center directors.
We maintain a computerized system for processing associate orders and
calculating bonus payments which enable us to remit such payments promptly. We
believe that prompt and accurate remittance of bonuses is vital to recruiting
and maintaining associates, as well as increasing their motivation and loyalty
to us. We make weekly bonus payments based upon the previous week's product
purchases, while most network marketing companies only make monthly bonus
payments. During 2002, 2001 and 2000, we paid bonuses to 8,909, 11,814 and
11,902 associates, in the aggregate amounts of $9,414,421, $11,403,519 and
$11,271,109.
We are committed to providing the best possible support to our
associates. Associates in our network marketing organization are provided
training guides and are given the opportunity to participate in our training
programs. We sponsor regularly scheduled conference calls for our platinum
directors which include testimonials from successful associates and satisfied
customers as well as current product and promotional information. We produce a
monthly newsletter which provides information on our products and network
marketing system. The newsletter is designed to help recruit new associates by
answering commonly asked questions and includes product information and business
building information. The newsletter also provides a forum for additional
recognition of associates for outstanding performance. In addition, we regularly
sponsor training sessions for our associates across the United States. At these
training sessions associates are provided the opportunity to learn more about
our product line and selling techniques so they can build their businesses more
rapidly. We produce comprehensive and attractive four color catalogues and
brochures that display and describe our product line. We maintain a web page at
www.amsonline.com, which provides general company information along with product
line and network marketing system information.
Furthermore, in order to facilitate our continued growth and support
associate activities, we continually upgrade our management information and
telecommunications systems. These systems are designed to provide, among other
things, financial and operating data for management, timely and accurate product
ordering, bonus payment processing, inventory management and detailed associate
records. Since 1994, we have invested more than $2,590,293 to enhance our
computer and telecommunications systems.
REGULATION
In the United States, as well as in any foreign markets in which we may
sell our products, we are subject to laws, regulations, administrative
determinations, court decisions and similar constraints at the federal, state
and local levels, collectively known as regulations. These regulations include
and pertain to, among other things:
- The formulation, manufacturing, packaging, labeling, advertising,
distribution, importation, sale and storage of our products;
- Our product claims and advertising, including direct claims and
advertising as well as claims and advertising by associates, for which
we may be held responsible; and
- Our network marketing organization.
Products. The formulation, manufacturing, packaging, labeling,
advertising, distribution and sale and storage of our products are subject to
regulation by a number of governmental agencies. The federal agencies include
the Food and Drug Administration, or FDA, the Federal Trade Commission, the
Consumer Product Safety Commission, the United States Department of Agriculture
and the Environmental Protection Agency. Our activities are also regulated by
various agencies of the states, localities and foreign countries in which our
products are or may be manufactured, distributed or sold. The FDA, in
particular, regulates the formulation, manufacturing and labeling of dietary
supplements, cosmetics and skin care products, including some of our products.
10
The Dietary Supplement Health and Education Act of 1994, or DSHEA,
revised the provisions of the Federal Food, Drug and Cosmetic Act, or FFDCA,
concerning the composition and labeling of dietary supplements, which we believe
is generally favorable to the dietary supplement industry. DSHEA created a new
statutory class of "dietary supplements." This new class includes vitamins,
minerals, herbs, amino acids and other dietary substances for human use to
supplement the diet. However, DSHEA grandfathered, with certain limitations,
dietary ingredients that were on the market before October 15, 1994. A dietary
supplement containing a new dietary ingredient and placed on the market on or
after October 15, 1994 must have a history of use or other evidence establishing
a basis for expected safety. Manufacturers of dietary supplements having a
"structure-function" statement must have substantiation that the statement is
truthful and not misleading.
The majority of our sales come from products that are classified as
dietary supplements under the FFDCA. The labeling requirements for dietary
supplements have been set forth in final regulations with respect to labels
affixed to containers beginning after March 23, 1999. These regulations include
how to declare nutrient content information, and the proper detail and format
required for the "supplement facts" box. During 1999, we revised our product
labels in compliance with these regulations. Many states have also recently
become active in the regulations of dietary supplement products. These states
may require modification of labeling or formulation of certain of our products
sold in these states.
In addition, on January 6, 2000, the FDA published a Final Rule on
permissible structure/function statements to be placed on labels and in
brochures. Structure/function statements are claims of the benefit or effect of
a product or an ingredient on the body's structure or function. This regulation
does not significantly change the way that the FDA interprets structure/function
statements. Thus, we did not make any substantial label revisions based on this
regulation regarding any of our structure/function product statements.
As a marketer of products that are ingested by consumers, we are
subject to the risk that one or more of the ingredients in our products may
become the subject of adverse regulatory action. For example, one of the
ingredients in our AM-300 product is ephedra, an herb that contains
naturally-occurring ephedrine alkaloids. Our manufacturer uses a powdered
extract of that herb when manufacturing AM-300. We market AM-300 principally as
an aid in weight management. The extract is an 8% extract, which means that
every 100 milligrams of the powdered extract contains approximately eight
milligrams of naturally occurring ephedrine alkaloids. In addition, our Sine-Eze
product, used as a food supplement to relieve symptoms associated with
allergies, contains ephedrine alkaloids. Ephedrine-containing dietary
supplements have been the subject of adverse publicity in the United States and
other countries relating to alleged harmful effects.
On April 10, 1996, the FDA issued a statement warning consumers not to
purchase or ingest dietary supplements containing ephedrine that are claimed to
produce certain effects. These effects include euphoria, heightened awareness,
increased sexual sensations or increased energy. The FDA cautions that these
products pose significant adverse health risks, including dizziness, headache,
gastrointestinal distress, irregular heartbeat, heart palpitations, heart
attack, strokes, seizures, psychosis and death.
The FDA published a proposed rule in the Federal Register on June 4,
1997 that proposed significant limitations on the sale of ephedrine-containing
dietary supplements. The proposed rule would have significantly limited our
ability to sell products containing ephedra if it had been made effective. On
April 3, 2000, the FDA withdrew most of the provisions of its proposed rule.
This action was prompted largely by a report issued by the United States General
Accounting Office, or GAO, in which the GAO criticized 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 has made available for public inspection
most of these adverse event reports.
On March 7, 2003, the FDA published a notice in the Federal Register,
which indicates that it will be taking final action on the 1997 proposed rule in
the near future. The FDA re-opened the public comment period, until April 7,
2003, to allow for additional public input on the two proposed limitations on
the sale of ephedrine-containing dietary supplements that remained after the
FDA's action of April 3, 2000. One
11
proposed limitation is a warning that would be required to appear on the label
of all ephedrine-containing supplements. The other proposed limitation is that
ephedrine-containing supplements may not contain other substances that are known
to have stimulant effects (e.g., caffeine). The proposed warning addresses
potential health risks allegedly associated with ephedrine-containing dietary
supplements. It is similar, but not identical, to mandatory warnings that have
been required by Texas law since 1999 and California law since January 1, 2003.
AM-300 and our other ephedrine-containing supplements comply with these state
law requirements. However, some of our ephedrine-containing products, like
AM-300, contain caffeine or other stimulants. Therefore, if the proposed rule is
made final in its current form, it will prohibit the sale of some of our
products.
On March 13, 2003, the FDA published a proposed rule in the Federal
Register which proposes comprehensive requirements for the manufacturing,
packing and holding dietary supplements, also known as good manufacturing
practices, or GMPs. The FDA is accepting public comments on the proposed GMPs
until June 11, 2003; final GMPs will be promulgated after the FDA has reviewed
the public comments. Once final GMP regulations become effective, our
manufacturer will be required to adhere to them. The FDA will most likely
institute an effective date for the GMPs which will allow our manufacturer a
reasonable amount of time to conduct this review and, if necessary, revise its
manufacturing operations to comply with the final GMP regulations.
The Texas Department of Health promulgated a new regulation, which
became effective on January 1, 2001. The regulation requires a warning to appear
on the product label indicating that the sale of ephedra-containing products to
minors is illegal. Our AM-300 labels comply with this regulation.
In foreign markets, prior to commencing operations and prior to making
or permitting sales of our products, we may be required to obtain an approval,
license or certification from the country's ministry of health or comparable
agency. Prior to entering a new market in which a formal approval, license or
certificate is required, we are required to work extensively with local
authorities to obtain the requisite approvals. The approval process generally
requires us to present each product and product ingredient to appropriate
regulators and, in some instances, arrange for testing of products by local
technicians for ingredient analysis. Such approvals may be conditioned on
reformulation of our products or may be unavailable with respect to certain
products or ingredients.
Product Claims and Advertising. The Federal Trade Commission and
certain states regulate advertising, product claims and other consumer matters,
including advertising of our products. All advertising, promotional and
solicitation materials used by associates require our approval prior to use. The
Federal Trade Commission has instituted enforcement actions against several
dietary supplement companies for false or deceptive advertising, including the
use of testimonials.
We provide no assurance that:
- The Federal Trade Commission will not question our past or future
advertising or other operations; or
- A state will not interpret product claims presumptively valid under
federal law as illegal under that state's regulations.
Also, our associates and their customers may file actions on their own
behalf, as a class or otherwise, and may file complaints with the Federal Trade
Commission or state or local consumer affairs offices. These agencies may take
action on their own initiative or on a referral from associates, consumers or
others. If taken, these actions may result in:
- Entries of consent decrees;
- Refunds of amounts paid by the complaining associate or consumer;
- Refunds to an entire class of associates or customers;
12
- Other damages; and
- Changes in our method of doing business.
A complaint based on the practice of one associate, whether or not such
activities were authorized by us, could result in an order affecting some or all
associates in a particular state, and an order in one state could influence
courts or government agencies in other states. Enforcement proceedings resulting
from these complaints may result in significant defense costs, settlement
payments or judgments and could have a material adverse effect on our results of
operations or financial condition.
Compliance Efforts. We attempt to remain in full compliance with all
applicable laws and regulations governing the manufacture, labeling, sale,
distribution, and advertising of our dietary supplements. We retain special
legal counsel for advice on both Food and Drug Administration and Federal Trade
Commission legal issues. In particular, we work closely with special legal
counsel who specializes in Dietary Supplement Health and Education Act
regulations for label revisions, content of structure/function statements,
advertising copy, and also the position of the Food and Drug Administration on
ephedra-containing products.
Network Marketing System. Our network marketing system is subject to
federal and state laws and regulations administered by the Federal Trade
Commission and various state agencies. These laws and regulations include
securities, franchise investment, business opportunity and criminal laws
prohibiting the use of "pyramid" or "endless chain" types of selling
organizations. These regulations are generally directed at ensuring that product
sales are ultimately made to consumers (as opposed to other associates) and that
advancement within the network marketing system is based on sales of products,
rather than investment in the company or other non-retail sales related
criteria.
The compensation structure of a network marketing system is very
complex. Compliance with all of the applicable regulations and laws is uncertain
because of the evolving interpretations of existing laws and regulations and the
enactment of new laws and regulations pertaining in general to network marketing
systems and product distribution. We have an ongoing compliance program with
assistance from legal counsel experienced in the laws and regulations pertaining
to network sales organizations. We are not aware of any legal actions pending or
threatened by any governmental authority against us regarding the legality of
our network marketing operations.
We currently have independent associates in all 50 states, the District
of Columbia and Canada. We review the requirements of various states as well as
seek legal advice regarding the structure and operation of our selling
organization to ensure that it complies with all of the applicable laws and
regulations pertaining to network sales organizations. On the basis of these
efforts and the experience of our management, we believe that we are in
compliance with all applicable federal and state regulatory requirements. We
have not obtained any no-action letters or advance rulings from any federal or
state security regulator or other governmental agency concerning the legality of
our operations, nor are we relying on a formal opinion of counsel to this
effect. Accordingly, there is the risk that our network marketing system could
be found to be in noncompliance with applicable laws and regulations, which
could then:
- Result in enforcement action and imposition of penalties;
- Require modification of our network marketing system;
- Result in negative publicity; or
- Have a negative effect on associate morale and loyalty.
Any of these consequences could have a material adverse effect on our sales as
well as our financial condition.
We are subject to the risk of challenges to the legality of our network
marketing system by our associates, both individually and as a class. Generally
such challenges would be based on claims that our network marketing system was
operated as an illegal "pyramid scheme" in violation of federal securities laws,
state unfair practice and fraud laws and the Racketeer Influenced and Corrupt
Organizations Act.
13
Two important Federal Trade Commission cases have established legal
precedent for determining whether a network marketing system constitutes an
illegal pyramid scheme. The first, IN RE KOSCOT INTERPLANETARY, INC., 86 F.T.C.
1106 (1975), set forth a standard for determining whether a marketing system
constituted a pyramid scheme. Under the KOSCOT standard, a pyramid scheme is
characterized by the participants' payment of money to a company in return for:
- The right to sell a product; and
- The right to receive, in return for recruiting other participants into
the program, rewards that are unrelated to sales of the product to
ultimate users.
Applying the KOSCOT standard in IN RE AMWAY CORP., 93 F.T.C. 618 (1979), the
Federal Trade Commission determined that a company will not be classified as
operating a pyramid scheme if the company adopts and enforces policies that in
fact encourage retail sales to consumers and prevent "inventory loading".
Inventory loading occurs when associates purchase large quantities of
non-returnable inventory to obtain the full amount of compensation available
under the system. In AMWAY, the Federal Trade Commission found that the
marketing system of Amway Corporation did not constitute a pyramid scheme,
noting the following Amway policies:
- Participants were required to buy back, from any person they recruited,
any saleable, unsold inventory upon the recruit leaving Amway;
- Every participant was required to sell at wholesale or retail at least
70% of the products bought in a given month in order to receive a bonus
for that month; and
- In order to receive a bonus in a month, each participant was required
to submit proof of retail sales made to 10 different consumers.
We believe that our network marketing system is not classified as a
pyramid scheme under the standards set forth in KOSCOT, AMWAY, and other
applicable law. In particular, in most jurisdictions, we maintain an inventory
buy-back program to address the problem of inventory loading. Pursuant to this
program, we repurchase products sold to an associate (subject to a 10%
restocking charge) provided that the associate:
- Resigns; and
- Returns the product in marketable condition within 12 months of
original purchase, or longer where required by applicable state law or
regulations.
Our literature provided to associates describes our buy-back program. In
addition, pursuant to agreements with our associates, each associate represents
that at least 70% of the products he or she buys will be sold to non-associates.
However, as is the case with other network marketing companies, the bonuses paid
by us to our associates are based on product purchases including purchases of
products that are personally consumed by the downline associates. Basing bonuses
on sales of personally consumed products may be considered an inventory loading
purchase. Furthermore, associates' bonuses are based on the wholesale prices
received by us on product purchases or, in some cases based upon the particular
product purchased, on prices less than the wholesale prices.
In the event of challenges to the legality of our network marketing
system by associates, we would be required to:
- Demonstrate that our network marketing policies are enforced; and
- That the network marketing system and associates' compensation
thereunder serve as safeguards to deter inventory loading and encourage
retail sales to the ultimate consumers.
14
In WEBSTER V. OMNITRITION INTERNATIONAL, INC., 79 F.3d 776 (9th Cir.
1996), the United States Court of Appeals held that a class action brought
against Omnitrition International, Inc., a multilevel marketing seller of
nutritional supplements and skin care products, should be allowed to proceed to
trial. The plaintiffs, former associates of Omnitrition's products, alleged that
Omnitrition's selling program was an illegal pyramid scheme and claimed
violations of Racketeer Influenced and Corrupt Organizations Act and several
federal and state fraud and securities laws. Despite evidence that Omnitrition
complied with the AMWAY standards, the court ruled that a jury would have to
decide whether Omnitrition's policies, many of which apparently were similar to
compliance policies adopted by us, were adequate to ensure that Omnitrition's
marketing efforts resulted in a legitimate product marketing and distribution
structure and not an illegal pyramid scheme. We believe that our marketing and
sales programs differ in significant respects from those of Omnitrition, and
that our marketing program complies with applicable law. The two most
significant differences are:
- The Omnitrition marketing plan required associates to purchase $2,000
in merchandise in order to qualify for bonuses as compared to $22 on
autoship under our marketing program; and
- The Omnitrition inventory repurchase policy was limited to products
that were less than three months old as compared to one year under our
inventory repurchase policy.
Lessons from the OMNITRITION case are that:
- A selling program which operates to generate only the minimum purchases
necessary to qualify for bonuses is suspect; and
- A selling program must operate to generate purchases independently of
the payment of bonuses in order to have a legitimate product marketing
and distribution structure.
We believe that our selling program operates to generate significant purchases
"for intrinsic value" as demonstrated by our sales figures. During the month of
December 2002, 19,639 of our associates placed a total of 24,201 orders
averaging $58 in size while only a single $22 on autoship per month is necessary
to qualify for bonuses. In view of the holding of the court of appeals in the
OMNITRITION case, however, there is no assurance that, if challenged, we would
prevail against private plaintiffs alleging violations of anti-pyramid and
securities laws. A final ruling against us in such a suit could result in the
imposition of a material liability against us. Moreover, even if we were
successful in defending against such suit, the costs of such defense, both in
dollars spent and in management time, could be material and adversely affect our
operating results. In addition, the negative publicity of such a suit could
adversely affect our sales and ability to attract and retain associates.
Nutrition for Life International, Inc., one of our competitors and a
multilevel seller of personal care and nutritional supplements, announced in
January 1997, that it had settled class action litigation brought by associates
alleging fraud in connection with the operation of a pyramid scheme. Nutrition
for Life paid in excess of $3 million to settle claims brought on behalf of its
associates, and related securities fraud claims brought on behalf of certain
purchasers of its stock.
We believe that our marketing program is significantly different from
the program allegedly promoted by Nutrition for Life and that our marketing
program is not in violation of anti-pyramid laws or regulations. Two issues in
the Nutrition for Life matter were a $1,000 buy-in urged on new recruits, and
the paying of commissions on product vouchers prior to the actual delivery of
product. By design, our marketing program offers no incentive to anyone to make
a large personal purchase nor do we use product vouchers. Actual average order
size in December 2002 was $58. However, there is no assurance that claims
similar to the claims brought against Nutrition for Life and other multilevel
marketing organizations will not be brought against us, or that we will prevail
in the event any such claims were made. Furthermore, even if we were successful
in defending against any such claims, the cost of conducting such a defense,
both in dollars spent and in management time, could be material and adversely
affect our operating results and financial condition. In addition, the negative
publicity of such a suit could adversely affect our sales and ability to attract
and retain associates.
15
INTELLECTUAL PROPERTY
We use several trademarks and trade names in connection with our
products and operations. As of December 31, 2002, we had 52 federal trademark
registrations with the United States Patent and Trademark Office. We 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. Also, common law
trademark rights are limited to the geographic area in which the trademark is
actually used. In addition, our product formulations are not protected by
patents and are not patentable. Therefore, there can be no assurance that
another company will not replicate one or more of our products.
COMPETITION
We are subject to significant competition in recruiting associates from
other network marketing organizations, including those that market products in
the weight management, dietary supplement and personal care categories, as well
as other types of products. There are over 300 companies worldwide that utilize
network marketing techniques, many of which are substantially larger, offer a
greater variety of products, and have available considerably greater financial
resources than us. Our ability to remain competitive depends, in significant
part, on our success in recruiting and retaining associates through an
attractive bonus plan and other incentives. We believe that our bonus plan and
incentive programs provide our associates with significant income potential.
However, there can be no assurance that our programs for recruitment and
retention of associates will continue to be successful.
In addition, the business of marketing products in the weight
management, dietary supplement and personal care categories is highly
competitive. This market segment includes numerous manufacturers, other network
marketing companies, catalog companies, associates, marketers, retailers and
physicians that actively compete in the sale of such products. We also compete
with other providers of such products, especially retail outlets, based upon
convenience of purchase and immediate availability of the purchased product. The
market is highly sensitive to the introduction of new products or weight
management plans, including various prescription drugs, which may rapidly
capture a significant share of the market. As a result, our ability to remain
competitive depends in part upon the successful introduction and addition of new
products to our line.
Our network marketing competitors include small, privately held
companies, as well as larger, publicly held companies with greater financial
resources and greater product and market diversification and distribution. Our
competitors include Shaklee Corporation, Market America, Inc., The A.L. Williams
Corporation, Mary Kay Cosmetics, Inc., Amway Corporation, and Nutrition for Life
International, Inc.
EMPLOYEES
As of December 31, 2002, we had 67 full-time and 11 part-time
employees, consisting of 5 executive officers, 23 involved in administrative
activities, 9 involved in marketing activities, 15 involved in customer service
activities, 11 involved in business development activities and 15 involved in
shipping activities. Our employees are not represented by a labor organization.
We consider our employee relations to be good.
AVAILABILITY OF INFORMATION
We file periodic reports and proxy statements with the Securities and
Exchange Commission, or SEC. The public may read and copy any materials we file
with the SEC at the SEC's Public Reference Room at 450 Fifth Street, N.W.,
Washington, D.C. 20549. The public may obtain information about the operation of
the Public Reference Room by calling the SEC at 1-800-SEC-0330. We file our
reports with the SEC electronically. The SEC maintains an Internet site that
contains reports, proxy and information statements, and other information
regarding issuers that file electronically with the SEC. The address of this
site is http://www.sec.gov.
Our internet address is www.amsonline.com. We make available on our
website, free of charge, copies of our annual report of Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K and
16
amendments to those reports filed or furnished pursuant to Section 13(a) of the
Exchange Act as soon as reasonably possible after we electronically file such
material with, or furnish to, the SEC.
ITEM 2. PROPERTIES
We maintain our executive office in 10,003 square feet at 2601
Northwest Expressway, Suites 1210W and 1120W, Oklahoma City, Oklahoma
73112-7293. These premises are occupied pursuant to long-term leases which
expire on May 31, 2003 and January 31, 2005, and which require monthly rental
payments of $7,986 and $2,530. Both leases have been extended for terms to
expire on May 31, 2008. In addition we have our prior warehouse facility, at
4000 N. Lindsay in Oklahoma City, under a lease expiring May 31, 2003, with
monthly lease payments of $5,601. In June 2001, we completed our new warehouse
and distribution facility. The 23,346 square foot, $1.3 million facility is
subject to a mortgage. All our properties are in good condition.
ITEM 3. LEGAL PROCEEDINGS
The case of Ronald Potter et al v. Advantage Marketing Systems, Inc. et
al, a products liability claim, was filed in the Oklahoma County District Court
in March 2003. The Plaintiffs claim that the ingestion of ephedra included in
AM-300 resulted in the death of Pamela Sue Potter. An answer to the petition is
due by April 30, 2003. As such, we have not had sufficient time to either
investigate the facts of this case or analyze appropriate defenses to the
allegations. We will deny any wrongdoing and intend to vigorously defend the
claim. The amount of damages sought is unknown, but include compensatory and
punitive damages.
The case of In re Jose Garcia v. Advantage Marketing Systems, Inc., a
products liability claim, was filed in the Superior Court of California, San
Bernardino County, in February 2003. The Plaintiff claims personal injury and
lost wages resulting from the ingestion of ephedra included in AM-300. An answer
to the petition is due by April 23, 2003. As such, we have not had sufficient
time to either investigate the facts of this case or analyze appropriate
defenses to the allegations. We will deny any wrongdoing and intend to
vigorously defend the claim. The amount of damages sought is unknown.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of our fiscal year ended December 31, 2002.
17
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
From November 6, 1997 to June 14, 1999, our common stock was traded on
the Nasdaq SmallCap Market under the symbol "AMSO." On June 15, 1999, our common
stock began trading on the American Stock Exchange under the symbol "AMM."
On March 24, 2003, the closing sale price of our common stock on the
American Stock Exchange was $1.51. We believe there are approximately 1,606
holders of our common stock. The following table sets forth the high and low
closing sale price of our common stock on the American Stock Exchange.
COMMON STOCK
CLOSING BID PRICES
------------------
HIGH LOW
---- ---
2002--CALENDAR QUARTER ENDED:
March 31...................................................... $2.60 $1.95
June 30....................................................... $3.05 $1.96
September 30.................................................. $2.35 $1.90
December 31................................................... $2.00 $1.20
2001--CALENDAR QUARTER ENDED:
March 31...................................................... $3.30 $2.00
June 30....................................................... $3.24 $2.50
September 30.................................................. $3.06 $2.70
December 31................................................... $2.99 $2.40
No cash dividends were declared as of December 31, 2002 or are anticipated.
Equity Compensation Plan Information
(a) (b) (c)
Number of securities
remaining available
for future issuance
under equity
Number of securities to Weighted-average compensation plans
be issued upon exercise exercise price of (excluding securities
of outstanding options, outstanding options, reflected in
Plan Category warrants and rights warrants and rights column (a))
- ------------- ----------------------- -------------------- --------------------
Equity plans approved by security
holders............................. 1,083,403 $2.66 41,597
Equity compensation plan not
approved by security holders........ 673,250 $1.95 -
------------ -------
Total............................... 1,756,653 $2.36 41,597
============ =======
Prior to approval of the 1995 Stock Option Plan, the Company issued 673,250
incentive stock options to employees and associates. These options have a term
of 10 years, are exercisable, in whole or in part, at any time prior to the
termination date, and have an exercise price of $1.75 to $2.00 per share. The
options may be assigned or transferred, in whole or in part, so long as such
assignment or transfer is in accordance with and subject to the provisions of
the Securities Act of 1933, as amended, and the rules promulgated thereunder.
18
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial and statistical data,
computed as a percentage of net sales, for the years ended December 31, 2002,
2001, 2000, 1999 and 1998. The selected financial data are derived from our
audited consolidated financial statements and should be read in conjunction with
them and the Notes thereto. The results of operations for the periods presented
are not necessarily indicative of our future operations.
YEAR ENDED DECEMBER 31,
-----------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
INCOME STATEMENT DATA:
Net sales ............................ $ 22,303,581 $ 28,440,920 $ 26,707,936 $ 22,427,551 $ 13,287,824
Cost of sales ........................ 15,126,983 19,231,150 17,929,701 15,610,941 8,999,229
------------ ------------ ------------ ------------ ------------
Gross profit ...................... 7,176,598 9,209,770 8,778,235 6,816,610 4,288,595
Marketing, distribution and
administrative expenses:
Marketing ......................... 2,487,006 2,304,922 2,981,372 1,691,978 904,198
Distribution and administrative ... 5,768,245 6,875,871 5,076,436 3,544,960 2,644,574
------------ ------------ ------------ ------------ ------------
Total marketing, distribution and
administrative expenses ........... 8,255,251 9,180,793 8,057,808 5,236,938 3,548,772
Goodwill impairment .................. 3,788,374 -- -- -- --
------------ ------------ ------------ ------------ ------------
Income (loss) from operations ..... (4,867,027) 28,977 720,427 1,579,672 739,823
Other income (expense):
Interest and dividends, net ....... (53,984) (31,800) 310,599 364,270 309,908
Other income (expense) ............ (39,170) 16,841 (81,560) 7,866 39,280
Settlement of additional tax
liability........................ -- -- -- -- (421,623)
------------ ------------ ------------ ------------ ------------
Total other income (expense) ......... (93,065) (14,959) 229,039 372,136 (72,435)
------------ ------------ ------------ ------------ ------------
Income (loss) before income taxes .... (4,960,092) 14,018 949,466 1,951,808 667,388
Income tax (benefit) ................. (1,755,057) 5,467 456,532 676,025 253,340
------------ ------------ ------------ ------------ ------------
Net income (loss) .................... $ (3,205,035) $ 8,551 $ 492,934 $ 1,275,783 $ 414,048
============ ============ ============ ============ ============
Net income (loss) per common
share - basic .................... $ (0.73) $ -- $ 0.12 $ 0.31 $ 0.10
============ ============ ============ ============ ============
Net income (loss) per common
share - assuming dilution ........ $ (0.73) $ -- $ 0.09 $ 0.27 $ 0.09
============ ============ ============ ============ ============
Weighted average common shares
outstanding - basic ............... 4,419,196 4,379,486 4,283,461 4,139,706 4,191,760
============ ============ ============ ============ ============
Weighted average common shares
outstanding - assuming dilution ... 4,419,196 4,692,298 5,476,277 4,778,576 4,503,411
============ ============ ============ ============ ============
STATISTICAL DATA:
Total cost of sales ............... 67.8 % 67.6% 67.1% 69.6% 67.7%
Gross profit ...................... 32.2 % 32.4% 32.9% 30.4% 32.3%
Total marketing, distribution and
administrative expense .......... 37.0 % 32.3% 30.2% 23.4% 26.7%
Net income (loss) ................. (14.4)% 0.0% 1.8% 5.7% 3.1%
CASH FLOW DATA:
Net cash provided by (used in)
operating activities .............. $ 694,712 $ 1,508,177 $ (62,480) $ 2,370,939 $ 1,242,254
19
Net cash provided by (used in)
investing activities .............. 68,193 (1,383,960) (885,350) (5,473,205) (996,283)
Net cash provided by (used in)
financing activities .............. (537,795) 781,284 (638,377) (524,057) (732,030)
BALANCE SHEET DATA:
Total assets ...................... $ 10,686,269 $ 14,672,404 $ 11,690,250 $ 12,160,383 $ 10,717,483
Total liabilities ................. 3,355,840 4,127,226 1,266,345 1,928,400 1,494,871
Stockholders' equity .............. 7,330,429 10,545,178 10,423,905 10,231,983 9,222,612
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
The following discussion should be read in conjunction with our consolidated
financial statements and notes thereto under Item 8 below.
GENERAL
Our business and operations during the last five years have been
significantly affected by the acquisitions of Miracle Mountain International,
Inc. in May 1996, Chambre International, Inc. in January 1997, the assets of
Stay 'N Shape International, Inc., Solution Products International, Inc., Nation
of Winners, Inc., and Now International, Inc. in April 1997, ToppMed Inc. in
July 1998 and LifeScience Technologies Inc. in January 2001. As a result of
these acquisitions and asset purchases, we acquired 11,790 associates and added
129 products to our product line.
Miracle Mountain Acquisition. Effective May 31, 1996, Miracle Mountain
International, Inc. became one of our wholly owned subsidiaries. Miracle
Mountain was a network marketer of various third-party manufactured nutritional
supplement products. In connection with the Miracle Mountain acquisition, we
issued 20,000 shares of our common stock. As a result of the Miracle Mountain
acquisition, we added one product to our line and 1,690 additional associates.
Chambre Acquisition. Effective January 31, 1997, Chambre International,
Inc. became one of our wholly owned subsidiaries. Chambre International was a
network marketer of various third-party manufactured cosmetic, skin care and
hair care products. In connection with the Chambre acquisition, we issued 14,000
shares of our common stock. As a result of the Chambre acquisition, we added 74
products to our line, 68 in the personal care category and six in the dietary
supplement category, and 2,100 additional associates.
Stay 'N Shape International Asset Purchase. We purchased all of the
assets, including the network marketing organizations, of Stay 'N Shape
International, Inc., Solution Products International, Inc., Nation of Winners,
Inc., and Now International, Inc. on April 16, 1997. In connection with this
asset purchase, we paid cash of $1,174,441 and issued 125,984 shares of our
common stock. As a result of this asset purchase, we added 39 products to our
line, 38 in the weight management and dietary supplement categories and one in
the personal care category, and 3,000 additional associates.
ToppMed Asset Purchase. On July 31, 1998, we acquired all rights,
including formulations and trademarks, for the ToppFast, ToppStamina and
ToppFitt products from ToppMed, Inc. for $192,000.
LifeScience Technologies Acquisition. On January 4, 2001, we purchased
the LifeScience Technologies, or LST, group of companies for $1.2 million and a
five year payment of $41,667 per month or 5% of the gross sales of LifeScience
Technologies products, whichever is greater. The seller has the option to take
up to 860,000 shares of our common stock in lieu of cash at an option price of
$3.00 per share. As a result of this acquisition, we added 14 products and over
5,000 associates.
Critical Accounting Policies. We prepare our consolidated financial
statements in conformity with accounting principles generally accepted in the
United States, which require us to make estimates and
20
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the year.
Actual results could differ from those estimates. We consider the following
policies to be most critical in understanding the judgments that are involved in
preparing our financial statements and the uncertainties that could impact our
results of operations, financial condition and cash flows.
Throughout this report, "net sales" represents the gross sales amounts
reflected on our invoices to our associates less associate discounts, sales
returns, and freight income. Beginning June 1, 2001, we adopted a new billing
policy, which requires billing customers a portion of freight costs, which is
included in net sales. All of our products include a customer satisfaction
guarantee. Our products may be returned within 30 days of purchase for a full
refund or credit toward the purchase of another product. We also have a buy-back
program whereby we repurchase products sold to an independent associate (subject
to a restocking fee), provided the associate terminates his/her associateship
agreement with us and returns the product within 12 months of original purchase
in marketable condition. We receive our net sales price in cash or through
credit card payments upon receipt of orders from associates.
Our "gross profit" consists of net sales less:
- Commissions and bonuses, consisting of commission payments to
associates based on their current associate level within their
organization, and other one-time incentive cash bonuses to
qualifying associates;
- Cost of products, consisting of the prices we pay to our
manufacturers for products and royalty overrides earned by
qualifying associates on sales within their associate organizations;
and
- Cost of shipping, consisting of costs related to shipments, duties
and tariffs, freight expenses relating to shipment of products to
associates, and similar expenses.
We recognize revenue upon shipment of products, training aids and promotional
material to the independent associates. All of our customers pay for sales in
advance of shipment. As such, we have no trade receivables. Loans to associates
are repayable in five years or less; are secured by commissions controlled by
us; and are no longer allowed. Interest rates on loans are typically two percent
or more above the Prime rate and are fixed. All loans and receivables are
secured by guaranteed payment sources that are within our control. As such,
management believes there is no need for an allowance for doubtful accounts.
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 142, "Goodwill and Other Intangible
Assets". This standard requires companies to stop amortizing existing goodwill
and intangible assets with indefinite lives effective January 1, 2002. Under the
new rules, companies would only adjust the carrying amount of goodwill or
indefinite life intangible assets upon an impairment of the goodwill or
indefinite life intangible assets. We implemented these standards effective
January 1, 2002. Based on an evaluation of goodwill at October 31, 2002, we
determined that goodwill of approximately $3,800,000 was 100% impaired and
should be written off in its entirety.
We write down our inventory to provide for estimated obsolete or
unsalable inventory based on assumptions about future demand for our products
and market conditions. If future demand and market conditions are less favorable
than management's assumptions, additional inventory write-downs could be
required. Likewise, favorable future demand and market conditions could
positively impact future operating results if written-off inventory is sold.
We account for contingencies in accordance with SFAS No. 5, "Accounting
for Contingencies". SFAS 5 requires that we record an estimated loss from a loss
contingency when information available prior to issuance of our financial
statements indicates that it is probable than an asset has been impaired or a
liability has been incurred at the date of the financial statements and the
amount of the loss can be reasonable estimated. Accounting for contingencies
such as legal and income tax matters requires us to use our judgment. Many legal
and tax contingencies can take years to resolve. Generally, as the time period
21
increases over which the uncertainties are resolved, the likelihood of changes
to the estimate of the ultimate outcome increases. However, an adverse outcome
in these matters could have a material impact on our results of operations,
financial condition and cash flows.
Units Offering. On November 12, 1997, we completed the offering of
1,495,000 units, each consisting of one share of common stock and one redeemable
common stock purchase warrant. As a result of this offering, we received
proceeds of $6,050,000. Each redeemable common stock purchase warrant is
exercisable for the purchase of one share of our common stock for $3.40 on or
before November 6, 2002. In connection with this offering, we sold to the
underwriters, Paulson Investment Company, Inc. and Joseph Charles & Assoc.,
Inc., warrants exercisable for the purchase of 130,000 units for $5.40 per unit
on or before November 6, 2002. On September 16, 2002, we extended the exercise
period for the redeemable stock purchase warrants and the underwriter warrants
from November 6, 2002 to November 6, 2003.
Warrant Modification Offering and Rights Offering. In January 1997, we
distributed non-transferable rights to our common stock shareholders. These
rights entitled the holders to subscribe for and purchase up to 2,148,191 units,
each unit consisting of one share of our common stock and one 1997-A warrant,
for the price of $6.80 per unit.
Concurrently, we called and redeemed our outstanding class A and class
B common stock purchase warrants for $.0008 per warrant on March 17, 1997.
However, in connection with the warrant redemption, we offered to the holders of
the class A and class B warrants the right to purchase units, each comprised of
one share of common stock and one 1997-A warrant, at an exercise price of $6.00
per unit.
Each 1997-A warrant is exercisable on or before November 6, 2002, to
purchase one share of common stock for $3.40, subject to adjustment in certain
events. We may redeem the 1997-A warrants at any time upon 30 days notice, at a
price of $.0001 per 1997-A warrant. On September 16, 2002, we extended the
exercise period for the 1997-A warrants from November 6, 2002 to November 6,
2003.
We received proceeds from these two offerings of $2,154,357.
Accumulated offering costs of $323,076 were charged against the net proceeds
from these offerings. Pursuant to these offerings we issued 337,211 shares of
common stock and the same number of 1997-A warrants.
Associate Stock Purchase Plan. We registered 5,000,000 stock purchase
plan participation interests in the Advantage Marketing Systems, Inc. 1998
Associate Stock Purchase Plan. The participation interests are offered to the
associates of our products and services in lots of five participation interests.
A participant in this plan is entitled through purchase of the participation
interests to purchase in the open market through the plan, shares of our common
stock. The participation interests are non-transferable. Other than an annual
service fee of $5.00 per participant and a transaction fee of $1.25 per month,
we do not receive any proceeds from the purchase of the common stock by the
plan. The offering price of each participation interest is $1.00, and each
participant is initially required to purchase a minimum of 25 participation
interests.
RESULTS OF OPERATIONS
Comparison of 2002 and 2001
Our net sales during the year ended December 31, 2002, decreased by
$6,137,339, or 21.6%, to $22,303,581 from $28,440,920 during the year ended
December 31, 2001. During 2002, we made sales to approximately 40,000
associates, compared to sales during 2001 to approximately 71,597 associates.
Associates at December 31, 2002 were down from 2001 due to decreased recruiting
activity. At December 31, 2002, we had approximately 39,000 "active" associates
compared to approximately 69,700 at December 31, 2001. An associate is
considered to be "active" if he or she has made a product purchase of $50 or
more from us or is enrolled in our autoship program within the previous 12
months. Sales per associate per month increased to $58 for 2002, compared to $28
for 2001.
Our cost of sales during 2002 decreased by $4,104,167, or 21.3%, to
$15,126,983 from $19,231,150 during 2001. This decrease was attributable to:
22
- A decrease of $2,432,420 in associate commissions and bonuses;
- A decrease of $1,279,169 in the cost of products sold; and
- A decrease of $391,582 in shipping costs.
Total cost of sales as a percentage of net sales increased to 67.8% during the
year ended December 31, 2002, from 67.6% during the same period in 2001. This
was primarily due to an increase in cost of shipping to 7.5% of net sales from
7.3%, which was due to increased rates and an increase in commissions and
bonuses to 41.5% of net sales from 41.1%. This increase was partially offset by
a decrease in cost of products sold to 18.8% of net sales from 19.2% due to
efficiency in inventory purchasing and carrying cost.
Our gross profit decreased $2,033,172, or 22.1%, to $7,176,598 during
2002 from $9,209,770 during 2001. The gross profit decreased as a percentage of
net sales to 32.2% in 2002 from 32.4% in 2001, as reflected in our cost of goods
sold decrease.
Marketing, distribution and administrative expenses decreased $925,542,
or 10.1%, to $8,255,251 during the year ended December 31, 2002, from $9,180,793
during the same period in 2001. This decrease was primarily attributable to:
- Non-recurring expenses in 2001 of approximately $255,000 related to
the operation of the LifeScience Technologies California warehouse
in January and February of 2001, plus the transition costs related
to the LifeScience Technologies acquisition in January 2001;
- A decrease in depreciation and amortization expense of approximately
$167,000, due to the cessation of goodwill amortization in 2002 per
FASB 142 (See Note 1 to our financial statements);
- A decrease in professional services expense of approximately
$300,000 due to the buyout of options in 2001, and a change in
auditing firm in 2002, saving us approximately $76,000; and
- A decrease in contract services from 2001 of $193,600 incurred to
supplement our technical staff during the LifeScience Technologies
acquisition transition.
The marketing, distribution and administrative expenses as a percentage
of net sales increased to 37.0% in 2002, from 32.3% in 2001.
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 142, "Goodwill and Other Intangible
Assets". This standard required companies to stop amortizing existing goodwill
and other intangible assets with indefinite lives effective January 1, 2002.
Under the new rules, companies would only adjust the carrying amount of goodwill
or indefinite life intangible assets upon an impairment of the goodwill or
indefinite life intangible assets. We implemented this standard effective
January 1, 2002. Upon an evaluation at October 31, 2002, we determined that
goodwill was impaired and should be written off in its entirety. This resulted
in a one-time impairment charge of $3,788,374, or 17.0% of net sales for 2002.
Our net other expense increased by $78,106 to net other expense of
$93,065 during 2002, from a net other expense of $14,959 during the same period
in 2001. This increase was primarily due to:
- A decrease in investment income of $28,000 related to marketable
securities offset by an increase in interest income of $22,000;
- A decrease in collection of written off accounts receivable of
$11,000 related to collection of old, outstanding debt;
- A loss on sale of marketable securities of $30,000; and
- A loss on sale of assets of $17,500.
23
Our income (loss) before taxes decreased $4,974,110, to a loss of
$4,960,092 during 2002, from income of $14,018 during 2001. Income (loss) before
taxes as a percentage of net sales was (22.2%) and 0.0% during 2002 and 2001.
Income tax expense (benefit) during 2002 and 2001 was $(1,755,057) and $5,467.
Our net income (loss) decreased $3,213,586, to a net loss of $3,205,035 during
2002, from a net income of $8,551 during 2001. This decrease in net income
(loss) was attributable to:
- The increase in interest expense net of interest income of $78,106
to net other expense of $93,065 during 2002 from net other expense
of $14,959 during 2001;
- The decrease in gross profit of $2,033,172 to $7,176,598 during 2002
from $9,209,770 during 2001;
- The impairment of goodwill of $3,788,374; and
- The decrease in marketing, distribution and administrative expense
of $925,542 to $8,255,251 during 2002 from $9,180,793 during 2001.
Net income as a percentage of net sales decreased to (14.4%) during 2002, from
0.0% during 2001.
Comparison of 2001 and 2000
Our net sales during the year ended December 31, 2001, increased by
$1,732,984, or 6.5%, to $28,440,920 from $26,707,936 during the year ended
December 31, 2000. During 2001, we made sales to 71,597 associates, compared to
sales during 2000 to 79,500 associates. At December 31, 2001, we had
approximately 69,700 "active" associates compared to approximately 76,600 at
December 31, 2000. Sales per associate per month increased from $28 to $33 for
2001, compared to 2000.
Our cost of sales during 2001 increased by $1,301,449, or 7.3%, to
$19,231,150 from $17,929,701 during 2000. This increase was attributable to:
- An increase of $725,608 in associate commissions and bonuses due to
increased sales;
- A decrease of $220,503 in the cost of products sold due to the
consolidation of product lines; and
- An increase of $796,344 in shipping costs primarily due to increased
shipping rates by U.P.S. and U.S.P.S.
Total cost of sales, as a percentage of net sales increased to 67.6% during the
year ended December 31, 2001, from 67.1% during the same period in 2000. This
was due to an increase in cost of shipping to 7.3% of net sales from 4.8%, due
to increased rates. The increase was partially offset by a decrease in cost of
products sold to 19.2% of net sales from 21.3% due to efficiency in inventory
purchasing and carrying cost.
Our gross profit increased $431,535, or 4.9%, to $9,209,770 during 2001
from $8,778,235 during 2000. The gross profit decreased as a percentage of net
sales to 32.4% of net sales from 32.9%, reflected in our cost of goods sold
decrease.
Marketing, distribution and administrative expenses increased
$1,122,985, or 13.9%, to $9,180,793 during the year ended December 31, 2001,
from $8,057,810 during the same period in 2000. This increase was primarily
attributable to:
- A decrease in promotion costs of approximately $460,000;
- An increase in staffing and related payroll cost of approximately
$375,000 necessary to support our expected increase in sales
activity and improve internal programs;
24
- Non-recurring expenses of approximately $255,000 related to the
operation of the LifeScience Technologies California warehouse in
January and February of 2001, which facilities have now been closed,
plus the transition costs related to the LifeScience Technologies
acquisition in January 2001;
- An increase in depreciation and amortization expense of
approximately $335,000, including amortization of goodwill resulting
from the LifeScience Technologies acquisition in the amount of
$125,440;
- An increase in professional services cost of $120,000 due to the
buyout of options;
- An increase in contract services of $245,000 incurred to supplement
our technical staff during the LifeScience Technologies acquisition
transition; and
- An increase in insurance expense of $245,000 due to policy premium
increases on general liability and director and officer insurance,
as well as higher levels of activity and corresponding increases in
other variable costs, such as postage, telephone, newsletter, bank
card service charges and supplies.
The marketing, distribution and administrative expenses as a percentage
of net sales increased to 32.3% in 2001, from 30.2% in 2000.
Our net other income decreased by $243,998 to net other expense of
$14,959 during 2001, from a net other income of $229,039 during the same period
in 2000. This decrease was primarily attributable to a decrease in investment
income of approximately $131,000 related to marketable securities, along with an
increase in interest expense of $144,000 related to the LST note payable.
Our income before taxes decreased $935,447, or 98.5%, to $38,019 during
2001, from $949,466 during 2000. Income before taxes as a percentage of net
sales was 0.0% and 3.6% during 2001 and 2000. Income taxes during 2001 and 2000
were $5,467 and $456,532. Our net income decreased $484,383, or 98.3%, to $8,551
during 2001, from $492,934 during 2000. This decrease in net income was
attributable to:
- The decrease in interest income net of interest expense of $243,998,
or 14.7%, to net other expense of $14,959 during 2001 from net other
income of $229,039 during 2000;
- The increase in the marketing, distribution and administrative
expenses; and
- The increase in gross profit of $431,535 to $9,209,770 during 2001
from $8,778,235 during 2000.
Net income as a percentage of net sales decreased to 0.0% during 2001, from 1.8%
during 2000.
Seasonality
No pattern of seasonal fluctuations exists due to the growth patterns
that we are currently experiencing. However, there is no assurance that we will
not become subject to seasonal fluctuations in operations.
ACCOUNTING STANDARDS TO BE ADOPTED
In April 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (SFAS) No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical
Corrections", that, among other things, rescinded SFAS No. 4, "Reporting Gains
and Losses from Extinguishment of Debt". With the rescission of SFAS No. 4, the
early extinguishments of debt generally will no longer be classified as an
extraordinary item for financial statement presentation purposes. The provision
is effective for fiscal years beginning after May 15, 2002. We do not anticipate
that the adoption of SFAS No. 145 will have a material effect on our financial
position or results of operations.
25
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities", which replaces Emerging Issues
Task Force Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity" (including Certain
Costs Incurred in a Restructuring). The new standard required 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.
The statement is to be applied prospectively to exit or disposal activities
initiated after December 31, 2002. We do not anticipate that the adoption of
SFAS No. 146 will have a material effect on our financial position or results of
operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure", which amended SFAS No. 123,
"Accounting for Stock-Based Compensation". The new standard provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. Additionally, the statement
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in the annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used in reported results. This statement is effective for financial statements
for fiscal years ending after December 15, 2002. In compliance with SFAS No.
148, we have elected to continue to follow the intrinsic value method in
accounting for our stock-based employee compensation arrangement as defined by
APB No. 25.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirement for Guarantees, Including Indirect
Guarantees of Indebtedness of Others", or FIN 45. For a guarantee subject to
FASB Interpretation No. 45, a guarantor is required to measure and recognize the
fair value of the guarantee liability at inception. For many guarantees, fair
value will likely be determined using the expected present value method
described FASB Concepts Statement 7, "Using Cash Flow Information and Present
Value in Accounting Measurements". In addition, FIN 45 provides new disclosure
requirements. We adopted the disclosure requirements of FIN 45 as of December
31, 2002. The measurement and liability recognition provisions are applied
prospectively to guarantees or modifications after December 31, 2002. We
anticipate that FIN 45 will not have a material impact on our financial
statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities", or FIN 46. Subject to certain criteria defined
in the Interpretation, FIN 46 will require consolidation by business enterprises
of variable interest entities if the enterprise has a variable interest that
will absorb the majority of the entity's expected losses, receive the majority
of it's expected returns, or both. The provisions of FIN 46 are effective
immediately for interests acquired in variable interest entities after January
31, 2003, and at the beginning of the first interim or annual period beginning
after June 15, 2003, for interests acquired in variable interest entities before
February 1, 2003. We will adopt FIN 46 in the third quarter of 2003. Certain
disclosures concerning variable interest entities are required in financial
statements initially issued after January 31, 2003. We are evaluating the effect
of FIN 46 but do not believe FIN 46 will have a material impact on our financial
statements.
COMMITMENTS AND CONTINGENCIES
Recent Regulatory Developments - A significant portion of our net sales
continues to be dependent upon our AM-300 product. Our net sales of AM-300
represented 48.8% and 52.0% of net sales for the years ended December 31, 2002
and 2001. One of the ingredients in our AM-300 products is ephedra, an herb that
contains naturally occurring ephedrine. Our manufacturer uses a powdered extract
of that herb when manufacturing AM-300. We market AM-300 principally as an aid
in weight management. The extract is an 8% extract, which means that every 100
milligrams of the powdered extract contains approximately eight milligrams of
naturally occurring ephedrine alkaloids. In addition, our Sine-Eze product, used
as a food supplement to relieve symptoms associated with allergies, contains
ephedrine alkaloids. Ephedrine containing products have been the subject of
adverse publicity in the United States and other countries relating to alleged
harmful effects.
The FDA published a proposed rule in the Federal Register on June 4,
1997, which proposed significant limitations on the sale of ephedrine-containing
dietary supplements. The proposed rule would have significantly limited our
ability to sell products containing ephedra if it had been made effective. On
26
April 3, 2000, the FDA withdrew most of the provisions of its proposed rule.
This action was prompted largely by a report issued by the United States General
Accounting Office, or GAO, in which the GAO criticized 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 has made available for public inspection
most of these adverse event reports.
On March 7, 2003, the FDA published a notice in the Federal Register,
which indicates that it will be taking final action on the 1997 proposed rule in
the near future. The FDA re-opened the public comment period, until April 7,
2003, to allow for additional public input on the two proposed limitations on
the sale of ephedrine-containing dietary supplements that remained after the
FDA's action of April 3, 2000. One proposed limitation is a warning that would
be required to appear on the label of all ephedrine-containing supplements. The
other proposed limitation is that ephedrine-containing supplements may not
contain other substances that are known to have stimulant effects (e.g.,
caffeine). The proposed warning addresses potential health risks allegedly
associated with ephedrine-containing dietary supplements. It is similar, but not
identical, to mandatory warnings that have been required by Texas law since 1999
and California law since January 1, 2003. AM-300 and our other
ephedrine-containing supplements comply with these state law requirements.
However, some of our ephedrine-containing products, like AM-300, contain
caffeine or other stimulants. Therefore, if the proposed rule is made final in
its current form, it will prohibit the sale of some of our products in their
present formulations.
On March 13, 2003, the FDA published a proposed rule in the Federal
Register which proposes comprehensive requirements for the manufacturing,
packing and holding dietary supplements, also known as good manufacturing
practices. The FDA is accepting public comments on the proposed GMPs until June
11, 2003; final GMPs will be promulgated after the FDA has reviewed the public
comments. Once final GMP regulations become effective, our manufacturer will be
required to adhere to them. The FDA will most likely institute an effective date
for the GMPs which will allow our manufacturer a reasonable amount of time to
conduct this review and, if necessary, revise its manufacturing operations to
comply with the final GMP regulations.
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 maintain
limited product liability insurance coverage with limits of $1,000,000 per
occurrence and $2,000,000 in the aggregate. Products containing ephedra, which
represented approximately 49% of our 2002 net revenue, are not covered by our
product liability insurance. We generally do not obtain contractual
indemnification from our product manufacturers. However, all of our product
manufacturers carry product liability insurance, which covers our products. A
product liability claim could result in material losses.
Legal Proceedings - We are currently involved in two products liability
suits related to the ingestion of our ephedra-based products. Answers to these
petitions are due April 23 and 30, 2003. As such, we have not had sufficient
time to either investigate the facts of these cases or analyze appropriate
defenses to the allegations. We will deny any wrongdoing and intend to
vigorously defend the claims. The amounts of damages sought are unknown, but
include compensatory and punitive damages.
LIQUIDITY AND CAPITAL RESOURCES
Our primary source of liquidity has been cash provided by sales of our
common stock, marketable securities and operating activities. At December 31,
2002, we had working capital of $3,186,584 compared to $3,110,607 at December
31, 2001. We believe our cash and cash equivalents and cash flows from
operations will be sufficient to fund our working capital needs over the next 12
months. During the year ended December 31, 2002, net cash provided by operating
activities was $694,712, net cash provided by investing activities was $68,193,
and net cash used in financing activities was $537,795. We had a net increase in
cash during this period of $225,111, primarily as a result of operations. Our
working capital needs over the next 12 months consist primarily of marketing,
distribution and administrative expenses.
In 2001, we completed construction of a 23,346 square foot distribution
and call center facility in Oklahoma City. This project was funded, in part,
with bank loans of $980,000 for the land and building and
27
$166,216 for the warehouse equipment. Both loans are with Bank One Oklahoma,
N.A. and accrue interest at an annual rate of .25% under the prime rate.
The loans contain covenants restricting us from various activities
without written consent of Bank One, the most significant of which restrict us
from:
- Transferring, selling or otherwise disposing of any assets;
- Making any loans to any persons or entity in excess of $500,000 in the
aggregate;
- Engaging in any merger or acquisition in which we are not the surviving
corporation;
- Changing executive management personnel; and
- Purchasing or acquiring any interest in any other entity.
The loans also contain financial covenants requiring us to maintain:
- Tangible Net Worth, consisting of total assets excluding intangible
assets less total liabilities excluding subordinated debt, of at least
$5,500,000;
- Debt coverage ratio, consisting of net income plus amortization,
depreciation and interest expense, divided by current maturities of
long term debt and capital leases plus interest expense, of at least
125%; and
- Debt to EBITDA ratio, consisting of current and long term maturities of
debt and capital leases, divided by net income plus amortization,
depreciation, income tax and interest expense, of less than 250%
through December 31, 2002, less than 225% for 2003 and less than 200%
thereafter.
At December 31, 2002, we were not in compliance with our debt coverage
ratio or the debt to EBITDA ratio. Per letter dated February 18, 2003, Bank One
Oklahoma, N.A. granted a waiver for the covenant violations for the period ended
December 31, 2002. We have negotiated a new agreement with Bank One, whereby the
debt is secured by marketable securities. As such, the debt will no longer be
subject to financial covenants.
The following summarizes our contractual obligations at December 31,
2002 and the effect such obligations are expected to have on our liquidity and
cash flow in future periods.
LESS THAN 3-5
TOTAL 1 YEAR 1-3 YEARS YEARS
----- ------ --------- -----
Bank loans and notes (1) ... $2,444,628 $ 455,296 $1,140,439 $ 848,893
Capital lease obligations .. 257,500 109,898 147,602 --
Operating leases ........... 137,332 102,000 35,332 --
---------- ---------- ---------- ----------
Total ...................... $2,839,460 $ 667,194 $1,323,373 $ 848,893
========== ========== ========== ==========
(1) See Note 4 to our financial statements.
At December 31, 2002, we had marketable debt and equity securities of
$1,621,143 compared to $1,663,650 at December 31, 2001. All of our securities
are unrestricted investments.
During the first quarter of 1998, we agreed to loan John W. Hail, our
Chief Executive Officer and a major shareholder, up to $250,000. Subsequently we
also agreed to loan up to an additional $75,000. In 2000, an additional $200,000
was approved. On January 1, 2001 the outstanding balance on all the notes plus
interest were combined into one note payable in monthly installments. Our board
of directors unanimously approved the loans and extension. These loans are
collateralized by stock and property, and bear interest at 8% per annum. As of
December 31, 2002, the balance due on these loans plus interest was $63,561.
These loans will be paid in full in 2003. No new loans will be made to our
officers or directors.
28
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our balance sheet includes marketable securities, which we believe are
a conservative blend of income and growth investments resulting in moderate
market risk. We invest in equity marketable securities to generate capital
growth, and fixed-income marketable securities to provide current income.
Because of the nature of these investments, both current interest rates and
equity market movements will affect total return and risk. Our fixed income
investments of approximately $820,000 are subject to interest risk and market
value risk. We have approximately $800,000 of equity investments that are
exposed to market risk.
Interest Rate Risk. We currently maintain an investment portfolio of
high-quality fixed-income marketable securities. All securities are available
for sale and recorded in the balance sheet at fair value with fluctuations in
fair value reported as a component of accumulated other comprehensive income in
stockholders equity. We do not hedge our investment portfolio or our outstanding
credit facility or other long-term indebtedness. Fixed-income investments with a
maturity date of three months or less at the date of purchase are deemed to be
cash equivalents. Any remaining fixed-income securities are considered
short-term and mainly consist of investments in U.S. Treasury notes and bonds.
The following table lists our cash equivalents and our short-term
fixed-income marketable securities at December 31, 2002 and December 31, 2001:
DECEMBER 31, 2002 DECEMBER 31, 2001
----------------- -----------------
AVERAGE AVERAGE
INTEREST FAIR INTEREST RATE FAIR
RATE(1) COST VALUE (1) COST VALUE
-------- ---- -----