U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
or
( ) TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE 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 73-1323256
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2601 NW Expressway, Suite 1210W
Oklahoma City, Oklahoma 73112
(Address of principal executive offices) (Zip Code)
(405) 842-0131
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) 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 Exchange Act).
Yes [ ] No [X]
On October 31, 2002, we had outstanding 4,423,879 shares of our common stock,
$.0001 par value.
ADVANTAGE MARKETING SYSTEMS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002
Table of Contents
Part I -- Financial Information.......................................................... 3
Item 1. Financial Statements........................................................... 3
Condensed Consolidated Balance Sheets.......................................... 3
Condensed Consolidated Statements of Operations................................ 4
Condensed Consolidated Statements of Cash Flows................................ 5
Notes to Condensed Consolidated Financial Statements........................... 6
Report of Independent Certified Public Accountants............................. 13
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations..................................................................... 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk..................... 19
Item 4. Controls and Procedures........................................................ 20
Part II -- Other Information.............................................................. 21
Item 1. Legal Proceedings.............................................................. 21
Item 2. Changes in Securities and Use of Proceeds...................................... 21
Item 3. Defaults Upon Senior Securities................................................ 21
Item 4. Submission of Matters to a Vote of Security Holders............................ 21
Item 5. Other Information.............................................................. 21
Item 6. Exhibits and Reports on Form 8-K............................................... 21
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Certain statements under the caption "Item 2 -- Management's Discussion and
Analysis of Financial Condition and Results of Operations" 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. The actual results of the Company 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; the ability of the
Company to implement its 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); the ability of the
Company to obtain financing for future acquisitions; and other factors.
2
PART I --FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2002 AND DECEMBER 31, 2001
ASSETS SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents ................................................... $ 1,462,613 $ 982,188
Marketable securities, available for sale, at fair value .................... 1,581,354 1,663,650
Receivables -- net of allowance of $0 and $92,931, respectively ............. 396,468 331,961
Receivable from affiliates .................................................. 100,000 100,000
Prepaid income taxes ........................................................ 113,905 99,120
Inventory ................................................................... 1,031,427 1,335,451
Deferred income taxes ....................................................... 65,546 65,546
Other assets ................................................................ 265,892 81,830
----------- -----------
Total current assets ........................................... 5,017,205 4,659,746
RECEIVABLES, Net ............................................................ 524,433 850,371
PROPERTY AND EQUIPMENT, Net ................................................. 3,937,154 4,345,374
GOODWILL, Net ............................................................... 3,788,374 4,195,295
OTHER INTANGIBLES, Net ...................................................... 655,275 306,717
OTHER ASSETS ................................................................ 324,271 314,901
----------- -----------
TOTAL ....................................................................... $14,246,712 $14,672,404
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ............................................................ $ 149,957 $ 29,509
Accrued commissions and bonuses ............................................. 378,602 438,515
Accrued other expenses ...................................................... 246,472 147,044
Accrued sales tax liability ................................................. 145,545 244,485
Notes payable ............................................................... 603,038 579,860
Capital lease obligations ................................................... 112,118 109,726
----------- -----------
Total current liabilities .......................................... 1,635,732 1,549,139
LONG-TERM LIABILITIES:
Notes payable ............................................................... 1,958,895 2,320,063
Capital lease obligations ................................................... 151,173 234,385
Deferred income taxes ....................................................... 23,639 23,639
----------- -----------
Total liabilities ................................................... 3,769,439 4,127,226
----------- -----------
COMMITMENTS AND CONTINGENCIES (NOTES 7 & 8)
STOCKHOLDERS' EQUITY
Common stock - $.0001 par value; authorized 495,000,000 shares; issued
4,896,674 and 4,882,174 shares, outstanding 4,423,879 and 4,409,379
shares, respectively ................................................... 490 488
Paid-in capital ............................................................. 11,793,241 11,764,182
Notes receivable for exercise of options .................................... (31,088) (31,088)
Retained earnings ........................................................... 1,059,980 1,086,178
Accumulated other comprehensive loss, net of tax ............................ (100,874) (30,106)
----------- -----------
Total capital and retained earnings ................................ 12,721,749 12,789,654
Less cost of treasury stock (472,795 shares, common) ........................ (2,244,476) (2,244,476)
----------- -----------
Total stockholders' equity ......................................... 10,477,273 10,545,178
----------- -----------
TOTAL ........................................................................ $14,246,712 $14,672,404
=========== ===========
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
3
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE PERIODS ENDED SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- -----------------------------
2002 2001 2002 2001
---------- ---------- ----------- -----------
Net sales .......................................... $5,525,701 $7,142,367 $17,672,924 $21,839,062
Cost of sales ...................................... 3,850,247 4,735,504 11,915,537 14,733,102
---------- ---------- ----------- -----------
Gross profit .................................. 1,675,454 2,406,863 5,757,387 7,105,960
Marketing, distribution and administrative expenses:
Marketing ........................................ 612,114 697,592 1,579,183 1,576,023
Distribution and administrative .................. 1,376,142 1,671,928 4,164,873 5,201,070
---------- ---------- ----------- -----------
Total marketing, distribution and administrative
expenses ..................................... 1,988,256 2,369,520 5,744,056 6,777,093
---------- ---------- ----------- -----------
Income (loss) from operations ................. (312,802) 37,343 13,331 328,867
Other income (expense):
Interest and dividends, net ........................ (4,355) (16,018) (44,466) (13,404)
Other, net ......................................... (2,700) 6,803 (11,812) 12,485
---------- ---------- ----------- -----------
Total other income (expense) ................. (7,055) (9,215) (56,278) (919)
---------- ---------- ----------- -----------
Income (loss) before taxes ......................... (319,857) 28,128 (42,947) 327,948
Income tax expense (benefit) ...................... (124,744) 16,423 (16,749) 133,236
---------- ---------- ----------- -----------
Net income (loss) ................................. $ (195,113) $ 11,705 $ (26,198) $ 194,712
========== ========== =========== ===========
Net income (loss) per common share -- basic ........ $ (.04) $ .00 $ (.01) $ .04
========== ========== =========== ===========
Net income (loss) per common share -- assuming
dilution ....................................... $ (.04) $ .00 $ (.01) $ .04
========== ========== =========== ===========
Weighted average common shares outstanding --
basic .......................................... 4,423,879 4,393,059 4,417,037 4,369,438
========== ========== =========== ===========
Weighted average common shares outstanding --
assuming dilution .............................. 4,423,879 4,737,747 4,417,037 4,692,763
========== ========== =========== ===========
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
4
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
SEPTEMBER 30,
-----------------------------
2002 2001
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ...................................................... $ (26,198) $ 194,712
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization ................................... 704,409 775,250
Realized loss on sale of marketable securities .................. 6,862 7,844
Deferred taxes .................................................. -- 14,730
(Gain) loss on sale of property and equipment ................... 17,448 (1,771)
Changes in assets and liabilities which provided (used) cash (not
including the effect of business acquisition):
Receivables ................................................... 111,432 (1,959)
Prepaid taxes ................................................. 1,964 (90,000)
Inventory ..................................................... 304,024 343,914
Other assets .................................................. (156,670) (320,338)
Accounts payable and accrued expenses ......................... 44,273 (82,126)
----------- -----------
Net cash provided by operating activities ................ 1,007,544 840,256
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment .................................... (533,648) (1,778,055)
Sales of property and equipment ........................................ 284,438 2,229
Purchases of marketable securities, available for sale ................. (1,271,579) (71,567)
Sales of marketable securities, available for sale ..................... 1,233,419 1,950,000
Acquisition of business, net of cash acquired .......................... -- (1,149,637)
Payments of acquisition costs .......................................... -- (371,450)
Advances on notes receivable ........................................... (190,000) --
Repayment of receivable from affiliates ................................ 340,000 61,255
----------- -----------
Net cash used in investing activities .................... (137,370) (1,357,225)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock ................................. 29,061 209,500
Purchase of treasury stock ............................................. -- (153,000)
Proceeds from note payable ............................................. -- 1,090,811
Principal payment on notes payable ..................................... (337,991) (240,801)
Principal payment on capital lease obligations ......................... (80,819) (11,170)
----------- -----------
Net cash provided by (used in) financing activities ...... (389,749) 895,340
----------- -----------
NET INCREASE IN CASH AND CASH EQUIVALENTS ............................... 480,425 378,371
CASH AND CASH EQUIVALENTS, BEGINNING ..................................... 982,188 76,687
----------- -----------
CASH AND CASH EQUIVALENTS, ENDING ........................................ $ 1,462,613 $ 455,058
=========== ===========
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
5
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
1. UNAUDITED INTERIM FINANCIAL STATEMENTS
The unaudited condensed consolidated financial statements and
related notes have been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission. Accordingly,
certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have
been omitted pursuant to such rules and regulations. The accompanying
condensed consolidated financial statements and related notes should
be read in conjunction with the audited consolidated financial
statements of the Company, and notes thereto, for the year ended
December 31, 2001.
The information furnished reflects, in the opinion of management,
all adjustments, consisting of normal recurring accruals, necessary
for a fair presentation of the results of the interim periods
presented. Operating results of the interim period are not
necessarily indicative of the amounts that will be reported for the
year ending December 31, 2002.
2. SIGNIFICANT ACCOUNTING POLICIES
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. The Company implemented these standards
effective January 1, 2002. No impairment of goodwill resulted from
this implementation, and there was no material impact on consolidated
results of operations, financial position or cash flows.
The table below shows the reconciliation between reported net
income (loss) and earnings (loss) per share and adjusted net income
(loss) and earnings (loss) per share, adjusted for goodwill
amortization (tax-effected):
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- --------------------------
2002 2001 2002 2001
--------- ------- -------- --------
Reported net income (loss) ....... $(195,113) $11,705 $(26,198) $194,712
Add back: Goodwill amortization .. -- 58,087 -- 174,261
--------- ------- -------- --------
Adjusted net income (loss) ....... $(195,113) $69,792 $(26,198) $368,973
========= ======= ======== ========
BASIC EARNINGS (LOSS) PER SHARE:
Reported net income (loss) .... $ (.04) $ .00 $ (.01) $ .04
Goodwill amortization .......... -- .01 -- .04
--------- ------- -------- --------
Adjusted net income (loss) .... $ (.04) $ .01 $ (.01) $ .08
========= ======= ======== ========
DILUTED EARNINGS (LOSS) PER SHARE:
Reported net income (loss) .... $ (.04) $ .00 $ (.01) $ .04
Goodwill amortization .......... -- .01 -- .04
--------- ------- -------- --------
Adjusted net income (loss) .... $ (.04) $ .01 $ (.01) $ .08
========= ======= ======== ========
6
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
In August 2001, SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets", was issued and is effective for
fiscal years beginning after December 15, 2001. SFAS No. 144
addresses accounting and reporting for the impairment or disposal of
long-lived assets. SFAS No. 144 supersedes SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of" and Accounting Principles Board ("APB") Opinion No.
30, "Reporting the Results of Operations-Reporting the Effects of
Disposal of a Segment of a Business". SFAS No. 144 retains the
fundamental provisions of SFAS No. 121 and expands the reporting of
discontinued operations to include all components of an entity with
operations that can be distinguished from the rest of the entity and
that will be eliminated from the ongoing operations of the entity in
a disposal transaction. The Company implemented this standard
effective January 1, 2002. Implementation did not have a material
impact on consolidated results of operations, financial position, or
cash flows.
3. MARKETABLE SECURITIES
Securities are classified as available for sale with the related
unrealized gains and losses excluded from earnings and reported net
of income tax as a separate component of stockholders' equity until
realized. Realized gains and losses on sales of securities are based
on the specific identification method. Declines in the fair value of
investment securities below their carrying value that are other than
temporary are recognized in earnings.
Net unrealized loss, net of tax, included in accumulated other
comprehensive loss for the three and nine months ended September 30,
2002 was $54,658 and $70,768, respectively.
4. ACQUISITION
On January 4, 2001 the Company and one of its wholly owned
subsidiaries, LifeScience Technologies Holdings, acquired LifeScience
Technologies Holding Limited Partnership, LifeScience Technologies
Limited, LifeScience Technologies of Japan, LST Fullfillment Limited
Partnership, and LifeScience Technologies of Canada, Inc. (the
"LifeScience Technologies Acquisition"). The purchase price to the
Company was approximately $1.2 million cash plus $41,667 per month or
5 % of LifeScience Technology product sales, whichever is greater,
payable for 60 months commencing in January 2001. The seller, at its
option, has the right to take shares of the Company's common stock at
an option price of $3.00 per share in lieu of cash for the monthly
payment. However, such option is limited to a total of 860,000
shares. No shares were taken as of September 30, 2002.
The LifeScience Technologies Acquisition was accounted for as a
purchase under Accounting Principles Board Opinion No. 16 ("APB No.
16"). In accordance with APB No. 16, the Company allocated the
purchase price of the LifeScience Technologies Acquisition based on
the fair value of the assets acquired and liabilities assumed.
7
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
5. NOTES PAYABLE
Notes payable consists of the following:
SEPTEMBER 30, DECEMBER 31,
2002 2001
------------- ------------
Notes payable to RMS Limited Partnership, 7.5%
effective rate, payable in 60 monthly installments (See
Note 4) .............................................. $1,470,649 $1,754,007
Note payable to bank, with interest at prime less .25%
(4.5% at September 30, 2002 and December 31, 2001),
payable in monthly installments of principal and
interest, due on September 30, 2006, collateralized by
warehouse and equipment ............................... 1,083,436 1,131,665
Other ................................................... 7,848 14,251
---------- ----------
Total ................................................... 2,561,933 2,899,923
Less: current maturities ................................ 603,038 579,860
---------- ----------
Long-term notes payable ................................. $1,958,895 $2,320,063
========== ==========
6. EARNINGS (LOSS) PER SHARE
Earnings (loss) per common share -- basic is computed based upon
net income (loss) divided by the weighted average number of common
shares outstanding during each period. Earnings (loss) per common
share -- assuming dilution is computed based upon net income (loss)
divided by the weighted average number of common shares outstanding
during each period adjusted for the effect of dilutive potential
common shares calculated using the treasury stock method.
8
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
The following is a reconciliation of the common shares used in
the calculations of earnings (loss) per common share -- basic and
earnings (loss) per common share -- assuming dilution:
INCOME (LOSS) SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
------------- ------------- ----------
For the three months ended September 30, 2002:
Loss per common share:
Loss available to common stockholders ......... $(195,113) 4,423,879 $(.04)
=====
Loss per common share -- assuming dilution:
Options .................................... -- -- $ --
--------- --------- -----
Loss available to common stockholders plus
assumed conversions ..................... $(195,113) 4,423,879 $(.04)
========= ========= =====
For the three months ended September 30, 2001:
Earnings per common share:
Income available to common stockholders .... $ 11,705 4,393,059 $ --
=====
Earnings per common share -- assuming dilution:
Options .................................... -- 344,688 $ --
--------- --------- -----
Income available to common stockholders plus
assumed conversions ..................... $ 11,705 4,737,747 $ --
========= ========= =====
For the nine months ended September 30, 2002:
Loss per common share:
Loss available to common stockholders ...... $ (26,198) 4,417,037 $(.01)
=====
Loss per common share -- assuming dilution:
Options .................................... -- -- $ --
--------- --------- -----
Loss available to common stockholders plus
assumed conversions ..................... $ (26,198) 4,417,037 $(.01)
========= ========= =====
For the nine months ended September 30, 2001:
Earnings per common share:
Income available to common stockholders .... $ 194,712 4,369,438 $ .04
=====
Earnings per common share -- assuming dilution:
Options .................................... -- 323,325 $ --
--------- --------- -----
Income available to common stockholders plus
assumed conversions ..................... $ 194,712 4,692,763 $ .04
========= ========= =====
Options to purchase 1,183,691 shares of common stock at exercise
prices ranging from $3.00 to $6.13 per share were outstanding at
September 30, 2001, but were not included in the computation of
earnings per common share -- assuming dilution for the three months
ended because the options' exercise price was greater than the
average market price of the common shares.
Options to purchase 1,193,691 shares of common stock at exercise
prices ranging from $3.00 to $6.13 per share were outstanding at
September 30, 2001, but were not included in the computation of
earnings per common share - assuming dilution for the nine months
ended because the options' exercise price was greater than the
average market price of the common shares.
For the three and nine months ended September 30, 2002, all
options were antidilutive and therefore, not included in the
computation of loss per common share or loss per common share --
assuming dilution.
9
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
Warrants to purchase 1,874,768 shares of common stock at
exercise prices ranging from $3.40 to $5.40 per share were
outstanding at September 30, 2002 and 2001 but were not included in
the computation of earnings per common share - assuming dilution for
the three or nine months ended because the warrants' exercise price
was greater than the average market price of the common shares.
As part of the LifeScience Technologies Acquisition, the sellers
receive monthly cash payments in an amount equal to the greater of
$41,667 or 5% of LifeScience Technologies product sales. The sellers
may elect to take each monthly payment in shares of common stock
rather than cash at $3.00 per share exercise price, but cannot
acquire more than 860,000 shares pursuant to elections. To date the
sellers have not elected to take stock rather than cash. None of the
shares of common stock subject to this election right were included
in the computation of earnings per common share -- assuming dilution
for the three or nine months ended September 30, 2002 or 2001 because
the exercise price was greater than the average market price of the
common shares.
7. COMMITMENTS AND CONTINGENCIES
RECENT REGULATORY DEVELOPMENTS - A significant portion of the
Company's net sales continues to be dependent upon the Company's
AM-300 product. The Company's net sales of AM-300 represented 44.0%
and 52.8% of net sales for the nine months ended September 30, 2002
and 2001, respectively. One of the ingredients in the Company's
AM-300 products is ephedra, an herb which contains
naturally-occurring ephedrine. The Company's manufacturer uses a
powdered extract of that herb when manufacturing AM-300. The Company
markets 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 products have
been the subject of adverse publicity in the United States and other
countries relating to alleged harmful effects.
On April 3, 2000, the FDA withdrew most of the provisions of its
proposed rule regarding dietary supplements that contain ephedrine
alkaloids. The proposed rule, which was published on September 4,
1997, would have significantly limited the Company's ability to sell
AM-300 if it had been made effective. The FDA's withdrawal of the
provisions removed most, but not all, of the limitations. This action
was prompted largely by a report issued by the United States General
Accounting Office ("GAO") in which the GAO criticized the scientific
basis for the proposed rule and the FDA's evaluation of approximately
900 reports of adverse events supposedly related to the consumption
of dietary supplements containing ephedrine alkaloids. The FDA made
available for public inspection most of the adverse event reports on
April 3, 2000.
On October 25, 2000, several trade organizations for the dietary
supplement industry submitted a petition to the FDA which concerned
the remaining provisions of the proposed rule regarding dietary
supplements that contain ephedrine alkaloids. The petition requested
the FDA to: (1) withdraw the remaining provisions of the proposed
rule, and (2) adopt new standards for dietary supplements that
contain ephedrine alkaloids, which were set forth in the petition.
The FDA has not publicly responded to this petition.
The FDA will, most likely, attempt to issue a new proposed rule
with respect to dietary supplements that contain ephedrine alkaloids.
However, it is uncertain what restrictions the new proposed rule
might contain or when a new proposed rule will be issued. In the
Company's opinion, it is unlikely that a final regulation will be
issued by the FDA during 2002. Consequently, management is unable at
the present time to predict the ultimate resolution of these issues,
nor their ultimate impact on the Company's results of operations or
financial condition.
10
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
PRODUCT LIABILITY - The Company, like other marketers of products
that are intended to be ingested, faces the inherent risk of exposure
to product liability claims in the event that the use of our products
results in injury. The Company maintains a claims-made policy, with
limited (excluding ephedra) product liability insurance coverage. The
limits of this coverage are $1,000,000 per occurrence and $4,000,000
in the aggregate. The Company generally does not obtain contractual
indemnification from parties manufacturing its products. However, all
of the Company's product manufacturers carry product liability
insurance which covers the Company's products. The Company has agreed
to indemnify a supplier against claims arising from claims made by
associates for products manufactured by the supplier and marketed by
the Company. Although product liability claims have been asserted
against the Company, none have resulted in material losses. Future
product liability claims could result in material losses.
LEGAL PROCEEDINGS - The Company was sued in Feather v.
LifeScience Technologies, Ltd., Case No. C10-01-422, Circuit Court of
the Ninth Judicial Circuit in and for Orange County, Florida, on
January 16, 2001. Plaintiff alleged that LifeScience Technologies
breached a contract between the parties requiring LifeScience
Technologies to pay plaintiff a master distributor fee and a monthly
royalty fee upon LifeScience Technologies sales of adaptogen
products. Plaintiff additionally alleged that LifeScience
Technologies breached the contract by assigning the contract to the
Company without his express written consent. On February 8, 2002, the
Company executed a settlement agreement regarding this litigation
with Mr. Feather. Pursuant to the settlement agreement, Mr. Feather
will continue to receive a monthly royalty fee equal to 5% of the
gross wholesale revenue derived from adaptogen products. No other
payments have been or will be made to Mr. Feather. The case was
dismissed with prejudice on July 3, 2002.
8. JOINT MARKETING AGREEMENT
On August 30, 2002, the Company entered into a joint marketing
agreement with PrimeBuy Network.com, Inc. ("PrimeBuy") for a period
of two years, after which either party may terminate the agreement
with thirty days written notice. The terms of the agreement are as
follow:
- PrimeBuy associates will be enrolled as the Company's
associates, subject to the same policies, procedures, rules
and compensation plans;
- PrimeBuy will market and sell the Company's products to
fulfill PrimeBuy's monthly autoship requirements;
- The PrimeBuy downline will be maintained independently, with
PrimeBuy being the first level of record associate to the
Company;
- The Company's customer service and warehouse personnel will
process all orders and paper work necessary to add PrimeBuy
associates to the Company's system, and fulfill autoships and
other orders; and
- In the event of default by PrimeBuy, no attempt will be made
by PrimeBuy, its affiliates, employees or any other related
party to remove, cross sponsor or cancel any autoships of the
PrimeBuy downline.
In consideration for these efforts, PrimeBuy will be paid a
monthly marketing fee for the Company's products sold through the
PrimeBuy downline. This monthly fee will be 8.25% of wholesale volume
on sales up to $250,000; 10.0% of wholesale volume on sales from
$250,000 to $500,000; and 12.5% of wholesale volume on sales over
$500,000.
11
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
In addition to the joint marketing agreement, PrimeBuy borrowed
$200,000 from the Company, the obligation for which is evidenced by a
promissory note secured by the tangible assets of PrimeBuy. This note
has a term of eighteen months, and accrues interest at an annual rate
of 6%, with monthly principal and interest payments due commencing
October 31, 2002, and continuing on the same day each calendar month
thereafter. At September 30, 2002, the balance of this note
receivable was $190,000, with interest accrued and payable of $940.
******
12
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders
Advantage Marketing Systems, Inc.
We have reviewed the accompanying condensed consolidated balance sheet of
Advantage Marketing Systems, Inc. and Subsidiaries as of September 30, 2002, and
the related condensed consolidated statements of operations for the three- and
nine-month periods ended September 30, 2002 and 2001, and the statement of cash
flows for the nine months ended September 30, 2002 and 2001. These financial
statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and of making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with auditing standards generally accepted in the United States of
America, the objective of which is the expression of an opinion regarding the
financial statements taken as a whole. Accordingly, we do not express such an
opinion.
Based on our review, we are not aware of any material modifications that
should be made to the condensed consolidated financial statements for them to be
in conformity with accounting principles generally accepted in the United States
of America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of
Advantage Marketing Systems, Inc. and Subsidiaries as of December 31, 2001 and
the consolidated statements of income, stockholders' equity and cash flows for
the year then ended (not presented herein) and, in our report dated February 22,
2002, we expressed an unqualified opinion on those statements. In our opinion,
the information set forth in the accompanying condensed consolidated balance
sheet as of December 31, 2001 is fairly stated, in all material respects.
GRANT THORNTON LLP
Oklahoma City, Oklahoma
October 16, 2002
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
We market a product line consisting of approximately one hundred products in
three categories; weight management, dietary supplement and personal care
products. These products are marketed through a network marketing organization
in which independent associates purchase products for resale to retail customers
as well as for their own personal use.
On January 4, 2001, we purchased the LifeScience Technologies group of
companies for $1.2 million in cash and a five year payment of $41,667 per month
or 5% of the gross sales of LifeScience Technologies products, whichever is
greater. The seller has the option to take up to 860,000 shares of 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 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 freight income. Beginning June 1, 2001, we adopted a new billing
policy, which requires billing customers a portion of freight costs, which is
included in net sales. All of our products include a customer satisfaction
guarantee. Our products may be returned within 30 days of purchase for a full
refund or credit toward the purchase of another product. We also have a buy-back
program whereby we repurchase products sold to an independent associate (subject
to a restocking fee), provided the associate terminates his/her associateship
agreement with us and returns the product within 12 months of original purchase
in marketable condition. We receive our net sales price in cash or through
credit card payments upon receipt of orders from associates. Our "gross profit"
consists of net sales less (1) "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, (2) "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 (3) "cost of shipping",
consisting of costs related to shipments, duties and tariffs, freight expenses
relating to shipment of products to associates, and similar expenses.
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. No
impairment of goodwill resulted from this implementation, and there was no
material impact on consolidated results of operations, financial position or
cash flows.
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, a 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
14
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.
RESULTS OF OPERATIONS
The following table sets forth, as a percentage of our net sales, selected
results of operations for the three and nine months ended September 30, 2002 and
2001. The selected results of operations are derived from our unaudited
condensed consolidated financial statements. The results of operations for the
periods presented are not necessarily indicative of our future operations.
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------------------- ---------------------------------------------
2002 2001 2002 2001
--------------------- --------------------- --------------------- ---------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------------ ------- ------------ ------- ------------ ------- ------------ -------
Net Sales .......................... $ 5,525,701 100.0% $ 7,142,367 100.0% $ 17,672,924 100.0% $ 21,839,062 100.0%
------------ ----- ------------ ----- ------------ ----- ------------ -----
Cost of sales:
Commissions and bonuses .......... 2,296,013 41.6 2,949,372 41.3 7,273,909 41.1 8,927,405 40.9
Cost of products ................. 1,103,507 20.0 1,275,776 17.9 3,315,367 18.8 4,285,031 19.6
Cost of shipping ................. 450,727 8.1 510,356 7.1 1,326,261 7.5 1,520,666 7.0
------------ ----- ------------ ----- ------------ ----- ------------ -----
Total cost of sales ............ 3,850,247 69.7 4,735,504 66.3 11,915,537 67.4 14,733,102 67.5
------------ ----- ------------ ----- ------------ ----- ------------ -----
Gross profit ..................... 1,675,454 30.3 2,406,863 33.7 5,757,387 32.6 7,105,960 32.5
Marketing, distribution and
administrative expenses:
Marketing ........................ 612,114 11.1 697,592 9.8 1,579,183 8.9 1,576,023 7.2
Distribution and
administrative ................. 1,376,142 24.9 1,671,928 23.4 4,164,873 23.6 5,201,070 23.8
------------ ----- ------------ ----- ------------ ----- ------------ -----
Total marketing, distribution
and administrative expenses .... 1,988,256 36.0 2,369,520 33.2 5,744,056 32.5 6,777,093 31.0
------------ ----- ------------ ----- ------------ ----- ------------ -----
Income (loss) from operations .... (312,802) (5.7) 37,343 0.5 13,331 0.1 328,867 1.5
Other income (expense):
Interest, net ...................... (4,355) (0.1) (16,018) (0.2) (44,466) (0.2) (13,404) (0.1)
Other income (expense) ............ (2,700) (0.0) 6,803 0.1 (11,812) (0.1) 12,485 0.1
------------ ----- ------------ ----- ------------ ----- ------------ -----
Total other income (expense) ..... (7,055) (0.1) (9,215) (0.1) (56,278) (0.3) (919) 0.0
------------ ----- ------------ ----- ------------ ----- ------------ -----
Income (loss) before taxes ......... (319,857) (5.8) 28,128 0.4 (42,947) (0.2) 327,948 1.5
Tax expense (benefit) .............. (124,744) (2.3) 16,423 0.2 (16,749) (0.1) 133,236 0.6
------------ ----- ------------ ----- ------------ ----- ------------ -----
Net income (loss) ................. $ (195,113) (3.5)% $ 11,705 0.2% $ (26,198) (0.1)% $ 194,712 0.9%
============ ===== ============ ===== ============ ===== ============ =====
We expect to continue to expand our network of independent associates, which
may result in increased sales volume. However, there is no assurance that
increased sales volume will be achieved through expansion of our network of
independent associates or that, if sales volume increases, we will realize
increased profitability.
COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
Our net sales during the three months ended September 30, 2002 decreased by
$1,616,666, or 22.6%, to $5,525,701 from $7,142,367 during the three months
ended September 30, 2001. The sales decrease is due to the decrease in
recruiting experienced by the Company in 2002. The Company is currently
developing and implementing a new marketing strategy to reverse the downward
recruiting trend, and increase sales.
Our cost of sales during the three months ended September 30, 2001 decreased
by $885,257, or 18.7%, to $3,850,247 from $4,735,504 during the same period in
2001. Total cost of sales, as a percentage of net sales, increased to 69.7%
during the three months ended September 30, 2002 from 66.3% during the same
period in 2001. As revenue decreases, the ratio of fixed to variable costs will
cause an increase in cost of sales as a percentage of net sales. The decrease in
cost of sales was attributable to:
- A decrease of $653,359 in associate commissions and bonuses due to the
decreased level of sales;
15
- A decrease of $172,269 in the cost of products sold due to the
consolidation of product lines; and
- A decrease of $59,629 in shipping costs primarily due to the decreased
level of sales.
The factors discussed above resulted in a decrease in gross profit of
$731,409, or 30.4%, to $1,675,454 for the three months ended September 30, 2002
from $2,406,863 for the same period in 2001.
Marketing, distribution and administrative expenses decreased $381,264, or
16.1%, to $1,988,256 during the three months ended September 30, 2002, from
$2,369,520 during the same period in 2001. This decrease was primarily
attributable to:
- A decrease in promotion costs of approximately $97,000;
- A decrease in depreciation and amortization expense of approximately
$58,000 due to cessation of goodwill amortization in 2002 per FASB 142
(See Note 2 to our financial statements);
- A decrease in contract services of $106,000 from 2001, due to an
increase in 2001 of our technical staff during the LifeScience
Technologies acquisition transition; and
- A decrease of approximately $130,000 in other variable costs such as
postage, telephone, bank service charges and supplies.
The marketing, distribution and administrative expenses as a percentage of
net sales increased to 36.0% during the three months ended September 30, 2002
from 33.2% during the same period in 2001. Management expects marketing,
distribution and administrative expenses to continue at or near the current
level through year-end.
Our other expense (reduced by other income) decreased by $2,160 to net other
expense of $7,055 for the three months ended September 30, 2002, from a net
other expense of $9,215 during the same period in 2001. This decrease was
primarily due to an increase in interest income net of interest expense of
approximately $1,400.
COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
Our net sales during the nine months ended September 30, 2002 decreased by
$4,166,138, or 19.1%, to $17,672,924 from $21,839,062 during the nine months
ended September 30, 2001. The sales decrease is due to the decrease in
recruiting experienced by the Company in 2002. The Company is currently
developing and implementing a new marketing strategy to reverse the downward
recruiting trend, and increase sales.
Our cost of sales during the nine months ended September 30, 2002 decreased
by $2,817,565, or 19.1%, to $11,915,537 from $14,733,102 during the same period
in 2001. Total cost of sales, as a percentage of net sales remained virtually
flat at 67.4% during the nine months ended September 30, 2002, compared to 67.5%
during the same period in 2001. This decrease was attributed to:
- A decrease of $1,653,496 in distributor commissions and bonuses due to
the decreased level of sales;
- A decrease of $969,664 in the cost of products sold due to the
consolidation of product lines; and
- A decrease of $194,405 in shipping expenses primarily due to the
decreased level of sales.
The factors discussed above resulted in a decrease in gross profit of
$1,348,573, or 19.0%, to $5,757,387 for the nine months ended September 30, 2002
from $7,105,960 for the same period in 2001.
Marketing, distribution and administrative expenses decreased $1,033,037, or
15.2%, to $5,744,056 during the nine months ended September 30, 2002, from
$6,777,093 during the same period in 2001. This decrease was primarily
attributable to:
- A decrease in promotion costs of approximately $200,000;
16
- A decrease in staffing and related payroll cost of approximately
$251,000 due to a reduction in staff related to the LifeScience
Technologies acquisition;
- Non-recurring expenses in 2001 of approximately $255,000 related to the
operation of the LifeScience Technologies Florida offices and
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
$102,000, due to cessation of goodwill amortization in 2002 per FASB 142
(See Note 2 to our financial statements);
- A decrease in contract services for 2001 of approximately $172,000
incurred to supplement the Company's technical staff during the
LifeScience Technologies acquisition transition; and
- A decrease of approximately $130,000 in other variable costs such as
postage, telephone, bank service charges and supplies.
The marketing, distribution and administrative expenses as a percentage of
net sales increased to 32.5% during the nine months ended September 30, 2002
from 31.0% during the same period in 2001. Management expects marketing,
distribution and administrative expenses to continue at or near the current
level through year-end.
Our other expense (reduced by other income) increased by $55,359 to net
other expense of $56,278 for the nine months ended September 30, 2002, from a
net other expense of $919 during the same period in 2001. This increase was
primarily due to:
- A decrease in investment income of $33,000 related to marketable
securities offset by an increase in interest income of $19,000;
- A decrease in collection of written off accounts receivable of $9,000
related to collection of old, outstanding debt;
- An increase in interest expense of $8,000 related to the warehouse and
equipment loans (See Note 5 to our financial statements); and
- A loss on sale of assets of $21,000.
RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard 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. The Company implemented these standards effective January 1,
2002. No impairment of goodwill resulted from this implementation, and there was
no material impact on consolidated results of operations, financial position or
cash flows.
17
The table below shows the reconciliation between reported net income (loss)
and earnings (loss) per share and adjusted net income (loss) and earnings (loss)
per share, adjusted for goodwill amortization (tax-effected):
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Reported net income (loss) ........... $ (195,113) $ 11,705 $ (26,198) $ 194,712
Add back: Goodwill amortization ..... -- 58,087 -- 174,261
---------- ---------- ---------- ----------
Adjusted net income (loss) ........... $ (195,113) $ 69,792 $ (26,198) $ 368,973
========== ========== ========== ==========
BASIC EARNINGS (LOSS) PER SHARE:
Reported net income (loss) ......... $ (.04) $ .00 $ (.01) $ .04
Goodwill amortization .............. -- .01 -- .04
---------- ---------- ---------- ----------
Adjusted net income (loss) ......... $ (.04) $ .01 $ (.01) $ .08
========== ========== ========== ==========
DILUTED EARNINGS (LOSS) PER SHARE:
Reported net income (loss) ......... $ (.04) $ .00 $ (.01) $ .04
Goodwill amortization .............. -- .01 -- .04
---------- ---------- ---------- ----------
Adjusted net income (loss) ......... $ (.04) $ .01 $ (.01) $ .08
========== ========== ========== ==========
In August 2001, SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets", was issued and is effective for fiscal years beginning after
December 15, 2001. SFAS No. 144 addresses accounting and reporting for the
impairment or disposal of long-lived assets. SFAS No. 144 supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of" and Accounting Principles Board ("APB") Opinion No.
30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a
Segment of a Business". SFAS No. 144 retains the fundamental provisions of SFAS
No. 121 and expands the reporting of discontinued operations to include all
components of an entity with operations that can be distinguished from the rest
of the entity and that will be eliminated from the ongoing operations of the
entity in a disposal transaction. The Company implemented this standard
effective January 1, 2002. Implementation did not have a material impact on
consolidated results of operations, financial position, or cash flows.
SEASONALITY
No pattern of seasonal fluctuations exists due to the patterns that we are
currently experiencing. However, there is no assurance that we will not become
subject to seasonal fluctuations in operations.
LIQUIDITY AND CAPITAL RESOURCES
Our primary source of liquidity has been cash provided by our operating
activities, sales of our common stock, and sales of our marketable securities.
At September 30, 2002, we had working capital of $3,381,473, compared to
$3,110,607 at December 31, 2001. We believe our cash and cash equivalents,
current marketable securities, cash flows from operations and expected cash
flows from financing activities will be sufficient to fund our working capital
and capital expenditure needs over the foreseeable future. During the nine
months ended September 30, 2002, net cash provided by operating activities was
$1,007,544, net cash used in investing activities was $137,370 and net cash used
in financing activities was $389,749. This represented a net increase in cash
during this period of $480,425. Our working capital needs over the next 12
months consist primarily of marketing, distribution and administrative expenses.
In 2001, we completed construction of a 23,346 square foot distribution and
call center facility in Oklahoma City. This project was funded, in part, with
bank loans of $980,000 for the land and building and $166,216 for the warehouse
equipment. Both loans are with Bank One Oklahoma, N.A. and accrue interest at an
annual rate of .25% under the prime rate.
The loans contain covenants restricting us from various activities without
written consent of Bank One, the most significant of which restrict us from:
- Transferring, selling or otherwise disposing of any assets;
18
- Making any loans to any persons or entity in excess of $500,000 in the
aggregate;
- Engaging in any merger or acquisition in which we are not the surviving
corporation;
- Changing executive management personnel; and
- Purchasing or acquiring any interest in any other entity.
The loans also contain financial covenants requiring us to maintain:
- Tangible Net Worth (total assets excluding intangible assets less total
liabilities excluding subordinated debt) of at least $5,500,000;
- Debt coverage ratio (net income plus amortization, depreciation and
interest expense, divided by current maturities of long term debt and
capital leases plus interest expense) of at least 125%; and
- Debt to EBITDA ratio (current and long term maturities of debt and
capital leases, divided by net income plus amortization, depreciation,
income tax and interest expense) of less than 250% through December 31,
2002, less than 225% for 2003 and less than 200% thereafter.
The following summarizes our contractual obligations at September 30, 2002
and the effect such obligations are expected to have on our liquidity and cash
flow in future periods.
2006 AND
TOTAL 2002 2003 2004 2005 THEREAFTER
---------- ---------- ---------- ---------- ---------- ----------
Bank Loans and Notes (1) ...... $2,561,932 $ 241,869 $ 645,355 $ 682,061 $ 727,428 $ 265,219
Capital Lease Obligations ..... 314,046 64,476 143,344 61,824 44,402 0
Operating Leases .............. 175,067 40,361 99,375 32,607 2,724 0
---------- ---------- ---------- ---------- ---------- ----------
Total ......................... $3,051,045 $ 346,706 $ 888,074 $ 776,492 $ 774,554 $ 265,219
========== ========== ========== ========== ========== ==========
(1) See Note 5 to our financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our balance sheet includes marketable securities, which we believe are a
conservative blend of income and growth investments resulting in moderate market
risk. We invest in equity marketable securities to generate capital growth, and
fixed-income marketable securities to provide current income. Because of the
nature of these investments, total return and risk will be affected by both
current interest rates and equity market movements. Our fixed income investments
of approximately $1,000,000 are subject to interest risk and market value risk.
We have approximately $580,000 of equity investments that are exposed to market
risk.
INTEREST RATE RISK. We currently maintain an investment portfolio of
high-quality fixed-income marketable securities. All securities are available
for sale and recorded in the balance sheet at fair value with fluctuations in
fair value reported as a component of accumulated other comprehensive income in
stockholders equity. We do not hedge our investment portfolio or our outstanding
credit facility or other long-term indebtedness. Fixed-income investments with a
maturity date of three months or less at the date of purchase are deemed to be
cash equivalents. Any remaining fixed-income securities are considered
short-term and mainly consist of investments in U.S. Treasury notes and bonds.
The following table lists our cash equivalents and our short-term
fixed-income marketable securities at September 30, 2002 and December 31, 2001:
SEPTEMBER 30, 2002 DECEMBER 31, 2001
-------------------------------------- --------------------------------------
AVERAGE AVERAGE
INTEREST INTEREST
RATE FAIR RATE FAIR
(1) COST VALUE (1) COST VALUE
-------- ---------- ---------- -------- ---------- ----------
Cash equivalents ...... --% $ 200,037 $ 200,037 --% $ 975,835 $ 975,835
Short-term
Investments ......... 6.12% 789,385 806,698 6.45% 418,269 429,965
---------- ---------- ---------- ----------
$ 989,422 $1,006,735 $1,394,104 $1,405,800
========== ========== ========== ==========
(1) Average interest rate is calculated by taking the individual security
interest rates multiplied by each investments' weighted average share of the
total fixed-income marketable securities.
19
Average interest rates for the nine months ended September 30, 2002
decreased .33% from December 31, 2001 due to the redemption of 100,000 units of
7.52% U.S. Government Agency securities in the first quarter 2002, which
represented 25% of our total fixed-income marketable securities at December 31,
2001.
Fair value of the cash equivalents and fixed-income marketable securities
decreased $399,065 during the nine months ended September 30, 2002 to $1,006,735
from $1,405,800 at December 31, 2001. This decrease was primarily due to the
reinvestment of approximately $776,000 of cash equivalents to equity securities,
partially offset by a gain in short-term investments of approximately $377,000.
EQUITY MARKET RISKS. We currently maintain an investment portfolio of equity
securities. All securities are available for sale and recorded in the balance
sheet at fair value with fluctuations in fair value reported as a component of
accumulated other comprehensive income in stockholders equity. We do not engage
in hedging our equity portfolio or otherwise purchase derivative securities.
Because of the quality of our portfolio and liquid nature of our equity
investments, we do not consider the market risk related to these investments to
be material. At September 30, 2002, our equity investments had a value of
$574,620 compared to $257,850 at December 31, 2001, primarily due to the
purchase of mutual fund equity investments in the second and third quarters of
2002.
We attempt to manage our interest and market risk by evaluating and
purchasing what we believe to be the best investment securities and rates of
return available.
ITEM 4. CONTROLS AND PROCEDURES
Within the 90-day period prior to the filing of this report, an
evaluation was carried out under the supervision and with the participation of
our management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rule 13a-14(c) under the Securities
Exchange Act of 1934). Based upon that evaluation, the Chief Executive Officer
and Chief Financial Officer concluded that the design and operation of these
disclosure controls and procedures were effective. No significant changes were
made in our internal controls or in other factors that could significantly
affect these controls subsequent to the date of their evaluation.
20
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company was sued in Feather v. LifeScience Technologies, Ltd., Case
No. C10-01-422, Circuit Court of the Ninth Judicial Circuit in and for
Orange County, Florida, on January 16, 2001. Plaintiff alleged that
LifeScience Technologies breached a contract between the parties
requiring LifeScience Technologies to pay plaintiff a master distributor
fee and a monthly royalty fee upon LifeScience Technologies sales of
adaptogen products. Plaintiff additionally alleged that LifeScience
Technologies breached the contract by assigning the contract to the
Company without his express written consent. On February 8, 2002, the
Company executed a settlement agreement regarding this litigation with
Mr. Feather. Pursuant to the settlement agreement, Mr. Feather will
continue to receive a monthly royalty fee equal to 5% of the gross
wholesale revenue derived from adaptogen products. No other payments
have been or will be made to Mr. Feather. The case was dismissed with
prejudice on July 3, 2002.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On September 16, 2002 our Board of Directors approved the extension of
the exercise period of our 1997-A Warrants, our Redeemable Common Stock
Purchase Warrants and all of our outstanding Underwriter's Warrants from
November 6, 2002 or, in the case of the Underwriter's Warrants, from
November 12, 2002, to November 12, 2003. We filed a Form 8-K with the
Commission dated September 16, 2002.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At our annual meeting held July 6, 2002, Harland C. Stonecipher was
re-elected a director for a three-year term and Grant Thornton LLP was
ratified as our independent auditor for the 2002 fiscal year. A total of
2,615,021 shares were cast in favor of Mr. Stonecipher's re-election and
110 shares were cast against. Abstentions were 17,300. A total of
2,627,240 shares were cast in favor of Grant Thornton ratification and
3,207 shares were cast against. Abstentions were 1,984. Messrs. John
Hail, Reggie Cook and M. Thomas Buxton III continued as directors
following our annual meeting.
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
3.1 The Registrant's Certificate of Incorporation, incorporated by reference
to the Registration Statement on Form SB-2 (Registration No. 333-47801)
filed with the commission on March 11, 1998.
3.2 The Registrant's Bylaws, incorporated by reference to the Registration
Statement on Form SB-2 (Registration No. 333-47801) filed with the
commission on March 11, 1998.
10.8 Joint Marketing Agreement with PrimeBuy Network.com, Inc., dated August
30, 2002.
10.9 Promissory Note executed by PrimeBuy Network.com, Inc., dated August 2,
2002.
15 Letter of independent accountants as to unaudited interim financial
information.
(b) Form 8-K
We filed the following Form 8-Ks during the third quarter of 2002:
- September 16, 2002 -- Item 9 filing disclosing the extension of
outstanding warrant exercise periods.
- August 15, 2002 -- Item 9 filing disclosing Chief Executive Officer
and Chief Financial Officer certifications of second quarter
financial information pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
- July 5, 2002 -- Item 5 filing disclosing the text of John Hail's
speech to shareholders at our 2002 annual meeting.
21
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
ADVANTAGE MARKETING SYSTEMS, INC.
Dated: November 1, 2002 By: /S/ REGGIE B. COOK
---------------- ------------------------------------------
Reggie B. Cook, Vice President and
Chief Financial Officer
(Duly Authorized Officer of Registrant and
Principal Financial Officer)
22
I, John W. Hail, Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Advantage
Marketing Systems, Inc. (the "registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
Advantage Marketing Systems, Inc.
Date: November 1, 2002 By: /S/ JOHN W. HAIL
---------------- ------------------------------------
John W. Hail
Chairman and Chief Executive Officer
23
I, Reggie Cook, Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Advantage
Marketing Systems, Inc. (the "registrant");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
(d) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
(e) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
Advantage Marketing Systems, Inc.
Date: November 1, 2002 By: /S/ REGGIE B. COOK
---------------- -----------------------------------
Reggie B. Cook
Chief Financial Officer
24
Index of Exhibits
3.1 The Registrant's Certificate of Incorporation, incorporated by reference
to the Registration Statement on Form SB-2 (Registration No. 333-47801)
filed with the commission on March 11, 1998.
3.2 The Registrant's Bylaws, incorporated by reference to the Registration
Statement on Form SB-2 (Registration No. 333-47801) filed with the
commission on March 11, 1998.
10.8 Joint Marketing Agreement with PrimeBuy Network.com, Inc., dated August
30, 2002.
10.9 Promissory Note executed by PrimeBuy Network.com, Inc., dated August 2,
2002.
15 Letter of independent accountants as to unaudited interim financial
information.