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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, 2003
( ) 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.)
711 N.E. 39th Street
Oklahoma City, Oklahoma 73105
(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
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
Common Stock, $0.0001 Par Value
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 30, 2003, 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 $5,612,436.
As of March 19, 2004 there were 6,690,469 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 2004 annual meeting of stockholders, which will be filed with the
Securities and Exchange Commission not later than 120 days after December 31,
2003.
ADVANTAGE MARKETING SYSTEMS, INC.
FORM 10-K
For the Fiscal Year Ended December 31, 2003
TABLE OF CONTENTS
Part I.
Item 1. Business..................................................................................................... 3
Item 2. Properties................................................................................................... 19
Item 3. Legal Proceedings............................................................................................ 19
Item 4. Submission of Matters to a Vote of Security Holders.......................................................... 20
Part II.
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities................................................................................................... 20
Item 6. Selected Financial Data...................................................................................... 21
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation......................... 22
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................................................... 30
Item 8. Financial Statements and Supplementary Data.................................................................. 31
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure......................... 31
Item 9A. Controls and Procedures...................................................................................... 31
Part III. **
Part IV.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.............................................. 32
** Information required by Part III is incorporated by reference from the
Company's definitive proxy statements for its 2004 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.
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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 develop and distribute performance-based nutritional, weight loss and
personal care products. We distribute our products through a network marketing
system using independent distributors that we refer to as "associates."
We distribute our products direct to the public through network
marketing. We believe that network marketing is the most effective form of
distribution for products that require additional information. Person-to-person
product education is expensive and not normally available through traditional
distribution channels.
Network marketing appeals to a wide cross-section of people,
particularly those seeking to supplement income, start a home-based business, or
pursue entrepreneurial opportunities other than conventional full-time
employment. We consider the attractive compensation plan, monthly cash bonus
pools, along with trips, prizes and incentives to be attractive components of
the AMS network marketing system.
Our marketing plan is designed to provide financial incentives to
build and manage a team of recruited associates in their downline organization.
On an ongoing basis, we review our product line for duplication and
sales movement and make adjustments accordingly. As of December 31, 2003, our
primary product lines consisted of:
- 34 nutritional products;
- 8 weight management products; and
- 18 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 nutritional, weight management and personal care products because sales
of such products are strengthened by ongoing personal contact between associates
and their customers. 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 had 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, which was never exercised. As a result of the acquisition, we added
14 products and over 5,000 associates. We paid the remaining balance of the
acquisition cost, plus accrued interest on January 29, 2004.
KEY OPERATING STRENGTHS
Our principal objective is to be a leading developer and distributor of
weight loss products and performance-based wellness systems. Our strategy to
achieve this objective and maintain our position in the industry is to
capitalize on our operating strengths, which include the development and sale of
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performance-based products, a strong product development capability, an
attractive compensation plan for associates, and an experienced management team.
Performance-based Products. We have developed a line of high-quality
health products based on industry demand. We believe that the development and
delivery of essential vitamins, minerals, and other supplements will help
individuals achieve top physical, mental and emotional performance.
Product Development. Our product development effort is based on the
identification of next generation health discoveries, anticipation of consumer
demand and the acquisition of completed and tested new product technology. Our
management team continually:
- Investigates health, performance and industry trends for new
natural extracts and formulated products;
- Searches for formulations and ingredients that may be
candidates for new products;
- Identifies and compares existing and newly identified
nutritional supplements;
- Updates and improves existing products as new discoveries in
nutrition are made; and
- Prepares products to comply with regulatory requirements of
international markets we enter.
Manufacturing. We outsource all manufacturing of our own products for
the following reasons:
- Quality control is easier to monitor at established
facilities;
- The market for quality services in the marketplace is
competitive and attractive; and
- We believe our financial resources are better allocated to
product development, marketing services and sales support.
Attractive Associate Compensation Plan and Benefits. We are committed
to providing a highly competitive compensation plan to attract and retain
associates, who constitute our sales force. We believe the AMS associate
compensation plan is one of the most financially rewarding in the network
marketing industry. We pay daily incentives for recruiting new associates and
weekly commissions for product sales. The AMS compensation plan is a consistent
plan, meaning associates can recruit and receive compensation daily and weekly
for their business in any market in which we conduct business. To drive sales,
plus provide product information and team management skills for associates, we
sponsor events throughout the year which offer information about our products
and the network marketing system. These meetings are designed to assist new
associates with business development and provide a forum for product
development, in addition to providing interaction with successful associates and
our management.
Experienced Management Team. Our management team includes individuals
with expertise in various managerial disciplines, including marketing, customer
service, information technology, finance and operations. The current executive
management team is responsible for developing an infrastructure to support rapid
growth, strengthening our financial condition, and improving operational
controls.
GROWTH STRATEGY
We seek to grow our business by pursuing the following strategies:
New Associate and Preferred Customer Recruiting, Training and
Development. We recognize the need to aggressively grow our associate sales
force, thereby building new sales. In 2003, we re-launched the Company to the
industry after restructuring the marketing, sales and internet business
strategies. We focused on the development and distribution of performance-based
nutrition and weight loss products that will allow consumers to see and feel the
difference, and others to noticeably recognize the difference in them within a
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short period of time. We recognize the value that repositioning offers, backed
by our exclusive core products: AM-300, Prime One, Prime One Concentrate and
ToppFast.
With new product packaging, new leadership and an enhanced commission
plan for recruiting, we are focused on building the associate customer base and
assisting associates in building their businesses and have declared 2004 "The
Year of Recruiting". This focus includes the introduction of a monthly cash
bonus pool targeted at new associate recruiting, the establishment of two, 24
hour-a-day, seven day-a-week Internet sites and weekly hotel opportunity
meetings intended to present the business opportunity to potential associates.
During 2003, we focused on associate recruiting by introducing two Internet
marketing systems, with training approved and supported by the Company. We
launched a cutting edge recruiting and product selling website for associates as
well as an advanced lead generation and recruiting marketing site that allows
associates to market online for new customers and associates.
As a result of this focus, we are positioned to increase associate
enrollments in fiscal year 2004. In an effort to aggressively attract and retain
associates, we intend to continue to introduce new performance-based products
that deliver noticeable results, to enhance the compensation plan, to introduce
Internet marketing, to introduce duplicatable sales tools, to expand weekly
meetings and to enhance infrastructure to promote customer service levels.
New Market Entry. We believe that, in addition to the U.S. and Canadian
markets, significant growth opportunities continue to exist in international
markets. We intend to select new markets following an assessment of several
factors including market size, anticipated demand for AMS products, receptivity
to network marketing, and ease of entry, which includes consideration of
possible regulatory restrictions on our products or network marketing system. We
will begin preparation for further international expansion as sales leadership
develops. We envision a seamlessly integrated associate compensation plan in
each market that allows associates to receive commissions for global sales. This
seamless downline (associate's sales organization, including the associate's
recruits and their recruits) structure would be designed to allow an associate
to build a global network by creating downlines across national borders.
Associates would not be required to establish new downlines or to re-qualify for
higher levels of compensation in newly opened markets. We believe that going to
a seamless compensation plan provides significant motivation and reward for
associates to expand internationally by entering these new markets.
New Product Introduction. Using our marketing demand and development
capabilities, we will continue to introduce new products and continuously
enhance existing products. Products introduced in 2003 include AM-300 Fat
Burning Solution, Spark of Life -daily liquid nutritional, Topp Fast meal
replacement shakes, Prime Plus anti-catabolic lean muscle enhancer, Vital
Chelates Plus, The Sorgente Trio Non-Surgical facelift and Coral Calcium. Our
practice is to introduce new products, primarily at Company-sponsored events,
based on demand.
Strategic Acquisitions. We believe that attractive acquisition
opportunities may arise in the future. We intend to pursue strategic acquisition
opportunities that would grow our customer base, expand product lines, enhance
manufacturing and technical expertise, allow vertical integration, or otherwise
complement our business or further our strategic goals.
INDUSTRY OVERVIEW
The nutrition industry includes many small- and medium-sized companies
that manufacture and distribute products generally intended to maintain the
body's health and general well being. The four major product categories within
the nutrition industry are as follows:
- Nutritional Supplements - products such as vitamins and
minerals, sports performance enhancers, meal replacements,
dietary supplements, herbs and botanicals, and compounds
derived from these substances;
- Natural and Organic Foods - products such as cereals, milk,
non-dairy beverages, and frozen entrees;
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- Functional Foods - products with added ingredients or
fortification specifically for health or performance
purposes; and
- Natural Personal Care - products combining nutrition with
skin care.
We believe that the nutrition industry is being fueled by the
following:
- The public's exposure to more widely accepted natural and
homeopathic alternatives;
- The desire to slow down the aging process;
- The national and worldwide trend toward preventive health
care combining Eastern and Western medicine; and
- The rapid product introductions taking place in response to
scientific research fueled by new demand.
Nutritional products are distributed through six major sales channels.
Each channel has changed in recent years, primarily due to advances in
technology and communications, resulting in improved product distribution and
faster dissemination of information. The major sales channels are as follows
(AMS associates participate in four of the six channels listed below):
- Mass market retailers, including mass merchandisers, drug
stores, supermarkets and discount stores;
- Natural health food retailers;
- Network marketing;
- Mail order;
- Healthcare professionals and practitioners; and
- The Internet.
PRODUCTS
Our primary product lines include nutritional, weight management and
personal care. We currently market approximately sixty products, exclusive of
variations in product size, colors or similar variations of our basic product
line.
Nutritional. This product line includes antioxidants, minerals,
vitamins, and other nutritional supplements. The nutritional supplement products
are designed to provide optimal absorption, bioavailability, and efficacy.
During the years ended December 31, 2003, 2002 and 2001, 44.9%, 40.2% and 38.9%
of our net sales were derived from the 34 products in the nutritional category,
which contain herbs, vitamins, minerals and other natural ingredients. The
top-selling products in this category are Prime One, Prime One Concentrate and
Spark of Life liquid nutritional which totaled approximately 16.0%, 3.8% and
4.3%, respectively, of net sales in fiscal year 2003.
Weight Management. This product line was developed to provide a
comprehensive approach to weight management including the AM-300 family of
weight loss supplements, along with weight loss systems. During the years ended
December 31, 2003, 2002 and 2001, the weight management category represented
48.0%, 51.8% and 54.7% of our net sales. Sales were derived from the eight
products in the weight management category that we market under the Advantage
Marketing Systems label.
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Personal Care. This product line includes scientifically developed
natural products designed to support healthy skin and hair. Products in this
line include those from the Chambre International line and products acquired
from Dr. Robert Nakamura and Immudyne Inc. The three-product wrinkle and
facial-line reducing system is called "Nino Sorgente Skin Care" and includes eye
serum, facial serum and daily moisturizer. During the years ended December 31,
2003, 2002 and 2001, 2.8%, 2.9% and 1.5% of our net sales were derived from the
18 products in the personal care category.
Promotional Materials. In addition to these three principal product
lines, we have developed and sell to associates materials and online tools
designed to assist them in building their business and selling products. These
sales aids are generally written and produced by AMS and include product audio
tapes, CD ROM'S, video tapes, brochures and business forms designed by us and
printed by outside publishers. We periodically contract with authors and
publishers to produce or provide books, tapes, and other items dealing with
health topics and personal motivation, which are made available to associates.
New associates are required to purchase an enrollment packet containing
training materials that assist in beginning and growing a business. Associates
do not earn commissions on the sale of sales aids or enrollment packets.
Other Products and Services. Prior to focusing on nutritional, weight
management 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 2003, 2002
and 2001.
New Product Identification. We are committed to continuous product
innovation and improvement through market demand and products backed by science.
The mission of our science and product development is to develop, for target
groups, advanced wellness products that deliver performance-based results around
our core peak performance and weight loss focus. That is, products that deliver
noticeable results, slow the aging process, reduce the risk of chronic illness,
and promote long-term health. New product ideas and research efforts are
supported using a combination of our advisory talent and research, third-party
studies and sponsored research. We intend to dedicate resources for the science
and development of new products and reformulation of existing products. Prior to
introducing new products, we investigate product formulation as it relates to
regulatory compliance and other issues.
For products on which we acquire the distribution or ownership rights,
we maintain and access any and all science and research related to those
products. For example, the acquisition of Prime One brought over 45 years of
research and thousands of trials and studies on the Prime One products and
ingredients. The distribution rights for Immudyne's Sorgente skin care system
brought the use of patents, studies and documentation for use in our marketing
effort.
We maintain an advisory relationship with Dr. Robert Nakamura, and also
rely upon the product development staff of 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 category is manufactured by Chemins
Company, Inc. utilizing our product formulations. Naturtech manufactures our
nutritional product line, and essentially all of our product line in the
personal care category is manufactured by GDMI, Inc. and Columbia Cosmetics,
Inc.
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All our vendors have assured us that they conduct quality control
processes, and laboratory analysts test for biological contamination of raw
materials and finished goods. In the analytical chemistry laboratory, analysts
test for chemical contamination and accurate active ingredient levels of raw
materials and finished products. Both laboratories conduct stability tests on
finished products to determine product shelf life.
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 nutritional, weight management 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.
Most of the raw materials used in the manufacture of our products are
available from a number of suppliers. We have not generally experienced
difficulty in obtaining necessary quantities of raw materials. When supplies of
certain raw materials have tightened, we have been able to find alternative
sources as needed, and believe we will be able to do so in the future if the
need arises.
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 35.9% of our 2003 net sales, 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 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, 2003, 2002 and 2001, the cost of products returned to
us was 0.9%, 0.6% and 1% 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 and distribute our products through a network marketing
system and sell directly to associates and preferred customers. At December 31,
2003, we had approximately 18,552 "active" associates. To be considered "active"
an associate must have purchased $50 in products or $22 on autoship of our
products within the preceding 90 days. Network marketing is a form of
person-to-person direct selling through a network of vertically organized
independent distributors who purchase products at wholesale prices from the
manufacturer for resale to retail consumers. The emergence of readily available
means of mass communication such as personal computers, facsimiles, low-cost
long distance telephone services, and the Internet have
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contributed to the rapid growth of network marketing. The concept of network
marketing is based on the strength of personal recommendations that frequently
come from friends, neighbors, relatives, and close acquaintances. We believe
that network marketing is an effective way to distribute our products because it
allows person-to-person product education, which is not as readily available
through other distribution channels. 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.
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 card or deducted from their bank account for goods shipped that
month. At December 31, 2003, 2002, and 2001, we had approximately 16,343,
23,051, and 27,912 associates participating in the autoship.
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Our bonus structure 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 earn profits from the products sold in the sign-up
of new associates from our enroller bonuses and lucrative coding
bonuses, which are tied to the downline organization;
- Third, associates who establish their own downline organization may
earn bonuses of up to 36% of bonus value on product purchases by
associates within the first four levels of their downline organization;
- Fourth, associates who have $600 per month of product purchases on
their first and second levels combined, become directors and have the
opportunity to build an additional director downline organization and
receive additional bonuses of 4% of bonus value on product purchases by
such downline organization;
- Fifth, associates who have $1,200 per month of product purchases on
their first and second levels combined, two director legs and $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% of bonus value on
product purchases by such downline organization;
- Sixth, associates who have $1,800 per month of product purchases on
their first level and second levels combined, two silver legs 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% of bonus value on product purchases by their silver director
downline organization. In addition, gold directors have the opportunity
to receive generation bonuses of up to 3% of bonus value on the product
purchases by associates of silver director downline organizations that
originate from their silver director downline organization through four
generations; and
- Seventh, associates who maintain the gold director requirements and
develop three 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% of bonus value on product purchases by such
downline organization.
Combining these levels of bonuses, our total "pay-out" on products
subject to bonuses is approximately 63% of the bonus value of product sales, and
42.1% of total 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, 2003, we had 295 silver directors, 393 gold
directors and 50 platinum directors.
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, 2003, we had 38
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 2003, 2002 and 2001, we paid bonuses to 6,824, 8,909 and
11,814 associates, in the aggregate amounts of $7,504,420, $9,414,421 and
$11,403,519, respectively.
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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.
From time to time, associates fail to adhere to the AMS policies and
procedures, including those governing the marketing of our products or
representations regarding the compensation plan. We systematically review
reports of alleged associate misbehavior. Infractions of the policies and
procedures are reported to a compliance committee that determines what
disciplinary action may be warranted in each case. If we determine that an
associate has violated any of the AMS policies and procedures, we may take a
number of disciplinary actions. For example, we may terminate the associate's
purchase and distribution rights completely, or impose sanctions such as
warnings, fines, or probation. We may also withdraw or deny awards, suspend
privileges, withhold commissions until specific conditions are satisfied, or
take other appropriate actions at our discretion. An in-house compliance
department also routinely reviews associate activities.
We believe that the ability to efficiently manage distribution,
compensation, manufacturing, inventory control, and communications functions
through the use of sophisticated and dependable information processing systems
is critical to our success. To optimally support our customer base and core
business processes, our information technology resources consist of a
customized, Web-enabled order-entry system and an integrated system to manage
inventory, production planning, fulfillment, and financial information. Our
information systems are maintained by in-house staff and outside consultants.
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 $2,700,000 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 restrictions 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, or FTC,
the Consumer Product Safety Commission, the United States Department of
Agriculture and the Environmental
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Protection Agency. Our activities are also regulated by various codes and
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.
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 category of products, or "dietary supplements." This new category
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
using a "structure-function" statement or claim 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 and DSHEA. The labeling requirements for
dietary supplements have been set forth in final regulations, with respect to
labels affixed to containers, effective 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 to be in compliance with these regulations. Many states have also
recently become active in the regulation of dietary supplement products. These
states may require modification of labeling or formulation of certain of our
products sold in these states, e.g. Texas and California.
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 positive
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. We believe that AMS has adequate substantiation for all
label claims used.
Ehpedra. 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. Ephedrine-containing
dietary supplements have been the subject of adverse publicity in the United
States and other countries relating to alleged harmful effects, or adverse
events.
On February 11, 2004, the FDA issued and published in the Federal
Register its Final Rule on Ephedrine-containing Supplements, stating that since
an "unreasonable risk" had been determined, such supplements would be considered
"adulterated" under the FFDCA, and thus may not be sold. In essence, this Final
Rule (or regulation) imposes a national ban on ephedrine supplements.
The effective date of this regulation is April 12, 2004. The Company
will comply with the new regulation and cease all sales and advertisement of
AM-300 and any other ephedra-containing supplement on April 12, 2004.
Anticipating the eventuality of a total ban, over a year ago AMS formulated an
Ephedra-free AM-300 for weight loss. After April 12, 2004, this non-ephedra
product will still be permitted, and we expect strong sales. For the future, the
FDA has indicated that it will now consider whether alternatives to Ephedra,
other weight loss and energy stimulants (such as bitter orange) similarly carry
an unreasonable risk. These proposals to limit stimulant ingredients, if
finalized, may necessitate reformulations of some of our weight loss products.
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Finally, as the press, the FDA, and members of Congress and of the
supplement industry have all predicted, the very issuance of the Final Rule on
Ephedra may cause Congress to rethink and amend DSHEA as to how safety in
supplements may be ensured. In particular, there is growing sentiment (including
from one herbal trade association) to make Adverse Event Reporting mandatory for
all manufacturers and marketers of dietary supplements, so that FDA may take
action more quickly than it did on Ephedra, when a harmful herb or other
ingredient is suspected.
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. Again, after
April 12, 2004, no sales of ephedrine-containing supplements are allowed
nationally, and thus state regulations such as this are superceded and moot.
Manufacturing. 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 accepted 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.
Advertising and Website. The FDA considers website promotional content
to constitute "labeling," and thus the AMS website must not contain disease
claims or drug claims, but only permissible structure/function claims. The FTC
governs the advertising of dietary supplements, in any medium or vehicle--print
ads, radio spots, infomercials, etc.--including on Internet ads and websites.
The fundamental FTC rule is that all material advertising claim, whether express
(direct) or implied, must be substantiated by reliable and competent scientific
evidence. Because our website must comply with both FDA and FTC regulations, we
routinely ask our regulatory compliance counsel to review certain web pages,
especially the content of new product promotions. When necessary, our regulatory
counsel also reviews the scientific substantiation for particular claims (again,
especially for new products such as Prime One, an anti-stress and weight loss
product) to determine if it is sufficient, and also that there are no disease
claims present, the main FDA issue. AMS also requires associate websites to be
in compliance with FDA and FTC regulations. As such, and to ensure Internet
compliance, associates may only copy or link to our corporate website. Any
independent websites are absolutely unauthorized, and their creators are solely
liable for defending any regulatory enforcement actions.
In markets outside the United States, prior to commencing operations or
marketing products, we may be required to obtain approvals, licenses, or
certifications from a country's ministry of health or comparable agency.
Approvals or licensing may be conditioned on reformulation of AMS products for
the market or may be unavailable with respect to certain products or product
ingredients. We must also comply with local product labeling and packaging
regulations that vary from country to country. Foreign regulatory requirements
have not placed a significant burden on our ability to operate in current
foreign countries.
Product Claims and Advertising. Advertising of products is subject to
regulation by the FTC under the FTC Act. Section 5 of the FTC Act prohibits
unfair methods of competition and unfair or deceptive acts or practices in or
affecting commerce. Section 12 of the FTC Act provides that the dissemination
of, or causing to be disseminated, any false advertisement pertaining to drugs
or foods, which would include dietary supplements, is an unfair or deceptive act
or practice. Under the FTC's Substantiation Doctrine, an advertiser is required
to have a "reasonable basis" for all objective product claims before the claims
are made. Failure to adequately substantiate claims may be considered either
deceptive or unfair practices. Pursuant to this FTC requirement, we are required
to have adequate substantiation for all material advertising claims made for our
products.
In recent years the FTC has initiated numerous investigations of and
actions against dietary supplement, weight management, and cosmetic products and
companies. The FTC has issued a guidance
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document to assist companies in understanding and complying with the
substantiation requirement. We have organized the documentation to support our
advertising and promotional practices in compliance with these guidelines.
The FTC may enforce compliance with the law in a variety of ways, both
administratively and judicially, using compulsory process, cease and desist
orders, and injunctions. FTC enforcement can result in orders requiring, among
other things, limits on advertising, corrective advertising, consumer redress,
divestiture of assets, rescission of contracts, and such other relief as the
agency deems necessary to protect the public. Violation of these orders could
result in substantial financial or other penalties. We have not been notified
that we were the subject of any action by the FTC, but any action in the future
by the FTC could materially adversely affect our ability to successfully market
our products.
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. Laws and regulations in each country in which
we operate prevent the use of deceptive or fraudulent practices that have
sometimes been inappropriately associated with legitimate direct selling and
network marketing activities. These laws include anti-pyramiding, securities,
lottery, referral selling, anti-fraud and business opportunity statutes,
regulations, and court cases. Illegal schemes, typically referred to as
"pyramid," "chain distribution," or "endless chain" schemes, compensate
participants primarily or solely for the introduction or enrollment of
additional participants into the scheme. Often these schemes are characterized
by large up-front entry or sign-up fees, over-priced products of low value,
little or no emphasis on the sale or use of products, high-pressure recruiting
tactics, and claims of huge and quick financial rewards requiring little or no
effort. Generally these laws are directed at ensuring that product sales
ultimately are made to consumers and that advancement within sales organizations
is based on sales of the enterprise's products, rather than investments in the
organizations or other non-retail sales related criteria or activity. Where
required by law, we obtain regulatory approval of our network marketing system,
or, where approval is not required or available, the favorable opinion of local
counsel as to regulatory compliance.
We currently have independent associates in all 50 states, the District
of Columbia, and Canada. In addition to federal regulation in the United States,
each state has enacted its own "Little FTC Act" to regulate sales and
advertising. Occasionally we receive requests to supply information regarding
our network marketing plan to regulatory agencies. Although we have from time to
time modified our network marketing system to comply with interpretations of
various regulatory authorities, we believe that our network marketing program is
in compliance with laws and regulations relating to network marketing activities
in our current markets. Nevertheless, we remain subject to the risk that, in one
or more of our present or future markets, the marketing system or the conduct of
certain associates could be found not to be in compliance with applicable laws
and regulations. Failure by an associate or us to comply with these laws and
regulations could have a material adverse effect on our business in a particular
market or in general. Any or all of these factors could adversely affect the way
we do business and could affect our ability to attract potential associates or
enter new markets. In the United States, the FTC has been active in its
enforcement efforts against both pyramid schemes and legitimate network
marketing organizations with certain legally problematic components, having
instituted several enforcement actions resulting in signed settlement agreements
and payment of large fines. Although to our knowledge, we have not been the
target of an FTC investigation, there can be no assurance that the FTC will not
investigate us in the future. Noncompliance with applicable laws and regulations
could:
- Result in enforcement action and imposition of penalties;
- Require modification of our network marketing system;
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- 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 cannot predict the nature of any future law, regulation,
interpretation, or application, nor can we predict what effect additional
governmental legislation or regulations, judicial decisions, or administrative
orders, when and if promulgated, would have on our business in the future. It is
possible that future developments may require that we revise our network
marketing program. Any or all of these requirements could have a material
adverse effect on our business, results of operations, and 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.
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.
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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.
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 2003, 18,552 of our associates placed a total of 22,085 orders
averaging $61 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.
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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 2003 was $61. 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.
INTELLECTUAL PROPERTY
Trademarks. We have developed and use registered trademarks in our
business, particularly relating to the corporate and product names. We use
several trademarks and trade names in connection with our products and
operations. As of December 31, 2003, we had 30 federal trademark registrations
with the United States Patent and Trademark Office. Federal registration of a
trademark enables the registered owner of the mark to bar the unauthorized use
of the registered mark in connection with a similar product in the same channels
of trade by any third party anywhere in the United States, regardless of whether
the registered owner has ever used the trademark in the area where the
unauthorized use occurs. We have filed applications and own trademark
registrations, and we intend to register additional trademarks in foreign
countries where AMS products are or may be sold in the future. Protection
afforded registered trademarks in some jurisdictions may not be as extensive as
the protection available in the United States.
We also claim ownership and protection of certain product names,
unregistered trademarks, and service marks under common law. Common law
trademark rights do not provide the same level of protection afforded by
registration of a trademark. In addition, common law trademark rights are
limited to the geographic area in which the trademark is actually used. We
believe these trademarks, whether registered or claimed under common law,
constitute valuable assets, adding to recognition of AMS and the marketing of
AMS products. We therefore believe that these proprietary rights have been and
will continue to be important in enabling us to compete.
Trade Secrets. We own certain intellectual property, including trade
secrets, which we seek to protect, in part, through confidentiality agreements
with employees and other parties, although some employees involved in research
and development activities have not entered into these agreements. Even where
these agreements exist, there can be no assurance that these agreements will not
be breached, that we would have adequate remedies for any breach, or that our
trade secrets will not otherwise become known to or independently developed by
competitors. Our proprietary product formulations are generally considered trade
secrets, but are not otherwise protected under intellectual property laws.
COMPETITION
The business of developing and distributing nutritional, personal care,
and weight management products such as those we sell and distribute is highly
competitive. Numerous manufacturers, distributors, and retailers compete for
consumers and, in the case of other network marketing companies, for associates.
We compete directly with other entities that develop, manufacture, market, and
distribute products in each of our product lines. We compete with these entities
by emphasizing the underlying science, value, and high quality of our products
as well as the convenience and financial benefits afforded by our network
marketing
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system and compensation plan. However, many of our competitors are substantially
larger and have greater financial resources and broader name recognition. Our
markets are highly sensitive to the introduction of new products that may
rapidly capture a significant share of those markets.
The nutritional supplement market is characterized by:
- Large selections of essentially similar products that are
difficult to differentiate;
- Retail consumer emphasis on value pricing;
- Constantly changing formulations based on evolving scientific
research;
- Low entry barriers resulting from low brand loyalty, rapid
change, widely available manufacturing, low regulatory
requirements, and ready access to large distribution
channels; and
- A lack of uniform standards regarding product ingredient
sources, potency, purity, absorption rate, and form.
Similar factors are also characteristic of products comprising our
other product lines. There can be no assurance that we will be able to
effectively compete in this intensely competitive environment. In addition,
nutritional, personal care, and weight management products can be purchased in a
wide variety of channels of distribution, including retail stores. Our product
offerings in each product category are relatively few compared to the wide
variety of products offered by many of our competitors and are often premium
priced. As a result, our ability to remain competitive depends in part upon the
successful introduction of new products and enhancements of existing products.
We also compete with other network marketing organizations for the
time, attention, and commitment of new and current associates. Our ability to
remain competitive depends, in significant part, on our success in recruiting
and retaining associates. We believe that we offer a rewarding associate
compensation plan and attractive associate benefits and services. To the extent
practicable, our associate compensation plan is designed to be seamless,
permitting international expansion without re-qualification or re-entry
requirements. We pay incentives weekly, reducing the time an associate must wait
between purchase and sale of products and payment of commissions. There can be
no assurance that our programs for recruiting and retaining associates will be
successful. We also compete for the time, attention, and commitment of this
independent associate force. The pool of individuals interested in the business
opportunities presented by network marketing tends to be limited in each market
and is reduced to the extent other network marketing companies successfully
recruit these individuals into their businesses. Although we believe that we
offer an attractive opportunity for our associates, there can be no assurance
that other network marketing companies will not be able to recruit our existing
associates or deplete the pool of potential associates in a given market.
We believe that the leading network marketing company in the world,
based on total sales, is Amway Corporation and its affiliates, and that Avon
Products, Inc. is the leading direct seller of beauty and related products
worldwide. Leading competitors in the nutritional network marketing and
nutritional product industry include Herbalife International, Inc., Market
America, Inc., Nature's Sunshine Products, Inc., NBTY, Nu Skin Enterprises,
Inc., Twinlab Corporation, and Weider Nutrition. We believe there are other
manufacturers of competing product lines that may launch direct selling
enterprises, which will compete with us in certain product lines and for
associates. There can be no assurance that we will be able to successfully meet
the challenges posed by this increased competition.
EMPLOYEES
As of December 31, 2003, we had 58 full-time and 11 part-time
employees, consisting of four executive officers, 23 involved in administrative
activities, eight involved in marketing activities, 22 involved in customer
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service and business development activities and 12 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 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 offices in our state of the art distribution
and call center located at 711 NE 39th Street, Oklahoma City, OK 73105. The
23,346 square foot, $1.3 million facility was completely paid for in January
2004. We are currently working to sub-lease the previous executive offices at
the Northwest Expressway location, which is still under contract through May 31,
2008, and have lease rental costs of approximately $11,000 per month. 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 allege that the ingestion of ephedra included in
AM-300 resulted in the death of Pamela Sue Potter. We have filed an Answer to
the Petition. Written discovery and responses have been exchanged. Otherwise,
there has been little action in the case. We have denied any wrongdoing and
intend to vigorously defend the claim. The amount of damages sought is unknown,
but includes 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. We have
filed an Answer to the Petition. Written discovery and responses have been
exchanged. Otherwise, there has been little action in the case. We have denied
any wrongdoing and intend to vigorously defend the claim. The amount of damages
sought is unknown.
On March 5, 2004, we were sued in Ross v. Advantage Marketing Systems,
Inc., Superior Court of the State of California for the County of Los Angeles,
Case No. BC 309118. No answer or other responsive pleading has yet been filed.
The plaintiff alleges that she took AM-300, which contains ephedra, and was
injured as a result. She seeks actual, compensatory and punitive damages, plus
an accounting and disgorgement of profits we purportedly earned as a result of
allegedly illegal conduct. We intend to vigorously defend the case.
On March 8, 2004, we were sued in Purcell v. Advantage Marketing
Systems, Inc. and The Chemins Company, Inc., District Court in and for Pontotoc
County, State of Oklahoma, Case No. C-04-127. No answer or other responsive
pleading has yet been filed. The plaintiff alleges that he took AM-300, which
contains ephedra, and was injured as a result. He seeks actual and punitive
damages in an amount in excess of $10,000. We intend to vigorously defend the
case.
19
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, 2003.
PART II
ITEM 5. MARKET FOR REGISTSRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
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 19, 2004, the closing sale price of our common stock on the
American Stock Exchange was $5.25. 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
---- ---
2003--CALENDAR QUARTER ENDED:
March 31......................................... $1.79 $1.20
June 30.......................................... $1.49 $1.15
September 30..................................... $2.99 $1.21
December 31...................................... $6.59 $2.80
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
We have never declared or paid cash dividends on our common stock. We
currently intend to retain future earnings, if any, to fund the development and
growth of our business. Future cash dividends, if any, will be determined by the
Board of Directors and will be based on earnings, available capital, financial
condition, and other factors deemed relevant by the Board of Directors.
Equity Compensation Plan Information
(c)
Number of securities
remaining available
for future issuance
(a) (b) 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............ 2,261,808 $2.06 863,192
Equity compensation plan
not approved by security
holders(1).................. 430,000 $1.92 --
--------- -------
Total....................... 2,691,808 $2.04 863,192
========= =======
(1) Prior to approval of the 1995 Stock Option Plan, the Company issued
673,250 incentive stock options to employees and associates, 430,000 of which
remain outstanding. 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.
20
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, 2003,
2002, 2001, 2000 and 1999. 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,
-----------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
INCOME STATEMENT DATA:
Net sales............................ $18,486,178 $22,303,581 $28,440,920 $26,707,936 $22,427,551
Cost of sales........................ 12,750,336 15,126,983 19,231,150 17,929,701 15,610,941
----------- ----------- ----------- ----------- -----------
Gross profit..................... 5,735,842 7,176,598 9,209,770 8,778,235 6,816,610
Marketing, distribution and
administrative expenses:
Marketing ....................... 1,538,981 2,487,006 2,304,922 2,981,372 1,691,978
Distribution and administrative.. 7,242,167 5,768,245 6,875,871 5,076,436 3,544,960
----------- ----------- ----------- ----------- -----------
Total marketing, distribution and
administrative expenses ......... 8,781,148 8,255,251 9,180,793 8,057,808 5,236,938
Goodwill impairment.................. -- 3,788,374 -- -- --
----------- ----------- ----------- ----------- -----------
Income (loss) from operations ... (3,045,306) (4,867,027) 28,977 720,427 1,579,672
Other income (expense):
Interest and dividends,net....... (74,704) (53,895) (31,800) 310,599 364,270
Other income (expense)........... (39,690) (39,170) 16,841 (81,560) 7,866
----------- ----------- ----------- ----------- -----------
Total other income (expense) ........ (114,394) (93,065) (14,959) 229,039 372,136
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes (3,159,700) (4,960,092) 14,018 949,466 1,951,808
Income tax (benefit)................. (590,839) (1,755,057) 5,467 456,532 676,025
----------- ----------- ----------- ----------- -----------
Net income (loss).................... $(2,568,861) $(3,205,035) $ 8,551 $ 492,934 $ 1,275,783
=========== =========== =========== =========== ===========
Net income (loss) per common
share-basic...................... $ (0.57) $ (0.73) $ -- $ 0.12 $ 0.31
=========== =========== =========== =========== ===========
Net income (loss) per common
share-assuming dilution.......... $ (0.57) $ (0.73) $ -- $ 0.09 $ 0.27
=========== =========== =========== =========== ===========
Weighted average common shares
outstanding-basic ............... 4,508,986 4,419,196 4,379,486 4,283,461 4,139,706
=========== =========== =========== =========== ===========
Weighted average common shares
outstanding-assuming dilution.... 4,508,986 4,419,196 4,692,298 5,476,277 4,778,576
=========== =========== =========== =========== ===========
STATISTICAL DATA:
Total cost of sales.............. 69.0% 67.8% 67.6% 67.1% 69.6%
Gross profit..................... 31.0% 32.2% 32.4% 32.9% 30.4%
Total marketing, distribution
and administrative expense....... 47.5% 37.0% 32.3% 30.2% 23.4%
Net income (loss)................ (13.9)% (14.4)% 0.0% 1.8% 5.7%
CASH FLOW DATA:
Net cash provided by (used in)
operating activities ............ $(1,042,590) $ 694,712 $ 1,508,177 $ (62,480) $2,370,939
Net cash provided by (used in)
investing activities............. (237,197) 68,193 (1,383,960) (885,350) (5,473,205)
Net cash provided by (used in)
financing activities............. 2,381,769 (537,795) 781,284 (638,377) (524,057)
BALANCE SHEET DATA:
Total assets .................... $12,204,019 $10,686,269 $14,672,404 $11,690,250 $12,160,383
Total liabilities ............... 3,910,156 3,355,840 4,127,226 1,266,345 1,928,400
Stockholders' equity............. 8,293,863 7,330,429 10,545,178 10,423,905 10,231,983
21
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
Since 1996, our business and operations have been significantly
affected by the acquisitions of, or acquisitions of the assets of, Miracle
Mountain International, Inc., Chambre International, Inc., Stay 'N Shape
International, Inc., Solution Products International, Inc., Nation of Winners,
Inc., Now International, Inc. , ToppMed Inc. and LifeScience Technologies Inc.,
or LST. Over the years, these acquisitions and asset purchases have added 11,790
associates to our ranks and 129 products to our product line.
LST was our most recent acquisition. On 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 had 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. We paid the balance of the
acquisition price, plus accrued interest, in full on January 29, 2004.
We have historically earned a material portion of our revenues from our
AM-300 product, which contains ephedra. In 2003, the FDA banned the use of
ephedra in nutritional supplements. While the FDA's decision had an adverse
effect on our 2003 revenues, we had been preparing for this contingency. Over
the last several years, through strategic acquisitions, product redevelopment
and refocus of weight loss products, we have built a multi-product peak
performance, weight loss and nutritional product line that is predominately
non-ephedra. We have seen positive results in converting our AM-300 customers to
AM-300 Ephedra Free or other weight loss products in states like New York,
Illinois and California that have previously banned ephedra. A majority of the
customers have chosen one or more of our other performance-based weight loss and
nutritional products. We anticipate the same positive results with our remaining
AM-300 customers. As a result, we do not anticipate that the FDA ban on ephedra
will materially impact our financial condition or results of operations.
The following table sets forth information used by management to assess
our results of operations over the prior three (3) years, both in aggregate
amounts and the percentage increase or decrease over the prior year:
%increase %increase
2003 (decrease) 2002 (decrease) 2001
---- ---------- ---- ---------- ----
Net sales ........................... $18,486,178 (17.1)% $22,303,581 (21.6)% $28,440,920
Gross profit ........................ 5,735,842 (20.1) 7,176,598 (22.1) 9,209,770
Net Income (Loss) ................... (2,568,861) 19.8 (3,205,035) (37,481.4) 8,551
Free Cash Flow(1) ................... (1,449,481) (6,256.5) (22,802) 92.2 (290,722)
Average Monthly Purchases per
Associate(2) ........................ $ 61 5.2 $ 58 107.1 $ 28
Total Associates .................... 44,000 0.1 40,000 (44.4) 72,000
Active Associates ................... 19,000 (51.3) 39,000 (44.3) 70,000
(1) Free cash flow is defined as cash flow from operations minus capital
expenditures.
2003 2002 2001
------------ --------- -----------
Cash flow from operations.... ($ 1,042,590) $ 694,713 $1,508,177
Capital expenditures......... 406,891 717,515 1,798,899
------------ --------- -----------
Free cash flow............... ($ 1,449,481) ($ 22,802) ($ 290,722)
============ ========= ===========
(2) Average monthly purchases per associates is calculated by dividing total
sales by total number of associate transactions.
22
Below we discuss the reasons for the reductions in the above matrices for 2003
versus 2002 and 2001. To reverse this trend, we have emphasized the recruiting
of new sales associates as our best model for growth in 2004. We believe we can
attract and retain experienced and new sales associates through our WellnessCEO
system, our new compensation plan, our refocused product offerings, and our new
customer acquisition program.
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 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, beginning June 1, 2001, a portion of freight costs. 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
- A portion of the 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 our independent associates. All of our customers pay for sales in
advance of shipment. As such, we have no trade receivables. We used to make
loans to associates, which were repayable in five years or less, and which were
secured by commissions controlled by us. Associate loans are no longer allowed.
Interest rates on loans were typically two percent or more above the Prime rate
and were fixed. All loans and receivables were secured by guaranteed payment
sources that were within our control. As such, there was no need for an
allowance for doubtful accounts. We were still collecting on prior associate
loans as of December 31, 2003 in the total amount of $241,878.
23
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
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. Each redeemable common stock purchase warrant was
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 12, 2003. On October 14, 2003, we extended the
exercise period for the redeemable stock purchase warrants and the underwriter
warrants from November 12, 2003 to November 12, 2004. On December 10, 2003 we
announced the redemption of all outstanding redeemable stock purchase warrants
and the underwriter warrants not exercised by January 16, 2004. Rather than have
their warrants redeemed, substantially all of the holders of the redeemable
stock purchase warrants and the underwriter warrants exercised their warrants on
or before the redemption date. Proceeds from the exercise of the redeemable
stock purchase warrants and the underwriter warrants totaled $5,394,615. The
redemption price for the unexercised warrants totaled $11,870.
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 was exercisable on or before November 6, 2002, to
purchase one share of common stock for $3.40, subject to adjustment in certain
events. On September 16, 2002, we extended the exercise period for the 1997-A
warrants from November 6, 2002 to November 12, 2003. On October 14, 2003, we
extended the exercise period for the 1997-A warrants from November 12, 2003 to
November 12, 2004. On December 10, 2003, we announced the redemption of all
outstanding 1997-A warrants not exercised by January 16, 2004. Rather than have
their warrants redeemed, substantially all of the holders of the 1997-A warrants
24
exercised their warrants on or before the redemption date. Proceeds from the
exercised of the 1997-A warrants totaled $714,877. The redemption price for the
unexercised warrants totaled $25.
In January 2004, we issued 1,170,064 shares of common stock upon
exercise of the redeemable stock purchase warrants, the underwriter warrants and
the 1997-A warrants.
RESULTS OF OPERATIONS
Comparison of 2003 and 2002
Our net sales during the year ended December 31, 2003, decreased by
$3,817,403, or 17.1%, to $18,486,178 from $22,303,581 during the year ended
December 31, 2002. During 2003, we made sales to approximately 44,000
associates, compared to sales during 2002 to approximately 40,000 associates.
The aggregate number of associates at December 31, 2003 was down from 2002 due
to decreased recruiting activity. At December 31, 2003, we had approximately
19,000 "active" associates compared to approximately 39,000 at December 31,
2002. 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 90 days. Sales per associate per month increased to $61 for 2003,
compared to $58 for 2002.
Our cost of sales during 2003 decreased by $2,376,647, or 15.7%, to
$12,750,336 from $15,126,983 during 2002. This decrease was attributable to
reduced sales, resulting in:
- A decrease of $1,469,426 in associate commissions and bonuses;
- A decrease of $764,519 in the cost of products sold; and
- A decrease of $142,702 in shipping costs.
Total cost of sales as a percentage of net sales increased to 69.0% during the
year ended December 31, 2003, from 67.8% during the same period in 2002. This
was primarily due to an increase in cost of shipping to 8.3% of net sales from
7.5%, which was due to increased rates, and an increase in commissions and
bonuses to 42.1% of net sales from 41.5%. This increase was partially offset by
a decrease in cost of products sold to 18.5% of net sales from 18.8% due to
efficiency in inventory purchasing and carrying cost.
Our gross profit decreased $1,440,756 or 20.1%, to $5,735,842 during
2003 from $7,176,598 during 2002. The gross profit decreased as a percentage of
net sales to 31.0% in 2003 from 32.2% in 2002, as reflected in our cost of goods
sold increase as a percentage of net sales.
Marketing, distribution and administrative expenses increased $525,897
or 6.4%, to $8,781,148 during the year ended December 31, 2003, from $8,255,251
during the same period in 2002. This increase was primarily attributable to:
- An increase in executive employee costs of approximately $670,000
related to the accrual of future payments on employment agreements;
- An increase in bonus expense of approximately $320,000 related to
exercise of employee stock options;
- An increase in information systems consulting expense of approximately
$95,000 due to changes in Internet programs;
- An increase in consulting expense of approximately $70,000 related to
executive management consulting;
- An increase of approximately $68,000 in legal expenses related to the
current litigation;
- An increase in vehicle expense of approximately $65,000 related to the
write down of vehicles;
- An increase in bad debt expense of $24,500 due to the write off of
uncollectible associate advances; and
- A loss on sale of assets of approximately $117,000.
25
The increase in marketing, distribution and administrative expenses were
partially offset by:
- A decrease in convention expenses of approximately $330,000 related to
lower costs for our annual convention and regional conferences;
- A decrease in promotion costs of approximately $200,000;
- A decrease in administrative expense of approximately $155,000, related
primarily to decreases in bank charges and executive dues;
- A decrease in travel expense of approximately $144,000; and
- A decrease of approximately $99,000 in rent and insurance costs related
to better rates for liability insurance and to the lease expiration on
our old warehouse building.
The marketing, distribution and administrative expenses as a percentage
of net sales increased to 47.5% in 2003, from 37.0% in 2002.
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 $21,329 to net other expense of
$114,394 during 2003, from a net other expense of $93,065 during the same period
in 2002. This increase was primarily due to:
- A decrease in investment income of $15,000 related to marketable
securities; and
- A loss on sale of marketable securities of $14,000.
Our loss before taxes decreased $1,800,392 to a loss of $3,159,700
during 2003, from a loss of $4,960,092 during 2002. Income (loss) before taxes
as a percentage of net sales was (17.1%) and (22.2%) during 2003 and 2002.
Income tax expense (benefit) during 2003 and 2002 was ($590,839) and
($1,755,057). Our net loss decreased $636,174, to a net loss of $2,568,861
during 2003, from a net loss of $3,205,035 during 2002. This decrease in net
loss was attributable to:
- The decrease in gross profit to $5,735,842 during 2003 from $7,176,598
during 2002;
- The impairment of goodwill of $3,788,374 in 2002;
- The increase in marketing, distribution and administrative expense to
$8,781,148 during 2003 from $8,255,251 during 2002; and
- The creation of a deferred tax valuation allowance of $441,000.
Net loss as a percentage of net sales decreased to (13.9%) during 2003, from
(14.4%) during 2002.
26
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.
The aggregate number of associates at December 31, 2002 decreased 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 due to
decreased recruiting. 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
reduced sales, resulting in:
- 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 increase as a percentage of net sales.
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.
27
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.
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 net other expense to $93,065 during 2002 from net other
expense of $14,959 during 2001;
- The decrease in gross profit 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 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.
Seasonality
No pattern of seasonal fluctuations exists. However, there is no
assurance that we will not become subject to seasonal fluctuations in the
future.
ACCOUNTING STANDARDS TO BE ADOPTED
In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest Entities"
(VIEs), which is an interpretation of Accounting Research Bulletin (ARB) No. 51,
"Consolidated Financial Statements." FIN 46, as revised by FIN 46 (R), addresses
the application of ARB No. 51 to VIEs, and generally would require that assets,
liabilities and results of the activity of a VIE be consolidated into the
financial statements of the enterprise that is considered the primary
beneficiary. This interpretation applies immediately to VIEs created after
January 31, 2003, and to VIEs in which a company obtains an interest after that
date. We have not created or obtained an interest in any VIEs. In addition, the
interpretation becomes applicable on December 31, 2003 for special purpose
entities (SPEs) created prior to February 1, 2003. As of December 31, 2003, we
had no SPEs for which we were considered the primary beneficiary. For non-SPEs
in which a company holds a variable interest that it acquired before February 1,
2003, the FASB has postponed the date on which the interpretation will become
applicable to March 31, 2004. We have determined the adoption of the provisions
of FIN 46, as revised by FIN 46(R), will not have a material effect on our
financial condition or results of operations.
In November 2003, the Emerging Issues Task Force (EITF) of the FASB
reached a consensus on one issue with respect to EITF Issue 03-1, "The Meaning
of Other-Than-Temporary Impairment and its Application to Certain Investments,"
thereby requiring certain quantitative and qualitative disclosures for
securities accounted for under SFAS No. 115, "Accounting for Certain Investments
in Debt and Equity
28
Securities," that are impaired at the balance sheet date but for which an
other-than-temporary impairment has not been recognized. Adoption of EITF Issue
03-1, which was effective for us on December 31, 2003, did not have a material
impact on our financial position, results of operations or cash flows. The
required disclosures have been considered in Note 3 to our consolidated
financial statements.
In December 2003, the Staff of the Securities and Exchange Commission
(SEC) issued Staff Accounting Bulletin (SAB) No. 104, "Revenue Recognition,"
w