UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
Commission File No. 333-36379
PACIFICHEALTH LABORATORIES, INC.
(Name of Small Business Issuer in Its Charter)
Delaware 22-3367588
(State or jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 Matawan Road, - Suite 420
Matawan, NJ 07747
(Address of principal executive offices)
732/739-2900
(Issuer's telephone number)
Internet Website: www.pacifichealthlabs.com
-------------------------
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act: Common Stock, par
value $.0025 per share.
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or
for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the
past 90 days. Yes |X| No |_|
Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of this
Form 10-KSB or any amendment to this Form 10-KSB. |_|
The issuer's revenues for its most recent fiscal year were $5,453,571.
As of March 24, 2004, the aggregate market value of the common stock held
by non-affiliates based on the closing sale price of Common Stock was
$6,251,974.
As of March 24, 2004, the issuer had 10,240,545 shares of common stock
outstanding.
Transitional Small Business Disclosure Format (check one): Yes |_| No |X|
PACIFICHEALTH LABORATORIES, INC.
FORM 10-KSB
Fiscal Year Ended December 31, 2003
TABLE OF CONTENTS
PART I
ITEM 1. BUSINESS..............................................................4
ITEM 2. DESCRIPTION OF PROPERTY..............................................14
ITEM 3. LEGAL PROCEEDINGS....................................................15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..................15
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.............15
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS..................................18
ITEM 7. FINANCIAL STATEMENTS.................................................22
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE..................................22
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT....................23
ITEM 10. EXECUTIVE COMPENSATION...............................................26
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.......31
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.......................33
ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K......34
ITEM 14. PRINCIPLE ACCOUNTANTS FEES AND SERVICES..............................35
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NOTE CONCERNING FORWARD-LOOKING STATEMENTS
This Report contains forward-looking statements concerning our
financial condition, results of operations and business, including, without
limitation, statements pertaining to:
o The development of new products and the expansion of the market
for our current products;
o Implementing aspects of our business plans;
o Financing goals and plans;
o Our existing cash and whether and how long these funds will be
sufficient to fund our operations; and
o Our raising of additional capital through future equity
financings.
These and other forward-looking statements are primarily in the
sections entitled "Management's Discussion and Analysis of Financial Conditions
and Results of Operations" and "Business." Generally, you can identify these
statements because they use phrases like "anticipates," "believes," "expects,"
"future," "intends," "plans," and similar terms. These statements are only
predictions. Although we do not make forward-looking statements unless we
believe we have a reasonable basis for doing so, we cannot guarantee their
accuracy, and actual results may differ materially from those we anticipated due
to a number of uncertainties, many of which are unforeseen. You should not place
undue reliance on these forward-looking statements, which apply only as of the
date of this prospectus. Our actual results could differ materially from those
anticipated in these forward-looking statements for many reasons, including
those stated in this Report.
We believe it is important to communicate our expectations to our
investors. There may be events in the future, however, that we are unable to
predict accurately or over which we have no control. Cautionary language in this
Report provides examples of risks, uncertainties and events that may cause our
actual results to differ materially from the expectations we describe in our
forward-looking statements.
We are not obligated to publicly update or revise any forward-looking
statement, whether as a result of new information, future events or otherwise,
except as otherwise required by law. In light of these risks, uncertainties and
assumptions, the forward-looking events discussed in this prospectus and other
statements made from time to time from us or our representatives might not
occur. For these statements, we claim the protection of the safe harbor for
forward-looking statements contained in the Private Securities Litigation Reform
Act of 1995.
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PART I
ITEM 1. BUSINESS.
1(a) Business Development
PacificHealth Laboratories, Inc. (hereinafter referred to as the
"Company") is a nutrition technology company that was incorporated in the State
of Delaware in April 1995. The Company researches, develops, and commercializes
functionally unique proprietary products for sports performance, weight loss,
and Type 2 diabetes which can be marketed without prior Food and Drug
Administration ("FDA") approval under current regulatory guidelines.
1(b) Business of the Issuer
The Company is a nutrition technology company strongly committed to
research and development of dietary and nutritional supplements that can enhance
health and well-being. The Company's three primary areas of research to date
have been sports performance, weight loss and Type 2 diabetes.
Sports Performance
The Company's first sports performance product, ENDUROX(R), was
introduced in March 1996 with commercial sales beginning in May 1996. In March
1997, the Company extended the ENDUROX line of products with ENDUROX EXCEL(R).
In February 1999, the Company introduced ENDUROX(R) R4(R) Performance/Recovery
Drink to be taken following exercise. In clinical studies performed or funded by
the Company, ENDUROX R4 has demonstrated a number of exercise-related benefits
including enhanced performance, extended endurance, and decreased post-exercise
muscle damage. In June 2001, the Company introduced ACCELERADE(R) Sports Drink,
to be taken during exercise using the same, patented technology as ENDUROX R4.
Research studies funded by the Company have shown that ACCELERADE is
significantly better than conventional sports drinks in improving endurance
during exercise. In 2003, the Company introduced a ready-to-drink form of
ACCELERADE into test market in the state of Colorado. In March 2004, the Company
introduced COUNTDOWN, the first product specifically engineered for immediate
post-workout intake by strength-training athletes.
Weight Loss
In weight loss, the Company has focused its research and development
efforts on development of novel nutritional compositions that stimulate the
body's major satiety peptide, or cholecystokinin (CCK). In April 2000, the
Company introduced our first weight loss product, SATIETROL(R), a natural
appetite control product based on this research. Clinical studies performed or
funded by the Company have shown that Satietrol, a pre meal beverage, can reduce
hunger up to 43% three and one-half hours after eating. In January 2001, the
Company extended our weight loss product line with the introduction of SATIETROL
COMPLETE(R), a 220-calorie meal replacement product that incorporates the
patented SATIETROL technology. In June 2001, the Company signed an exclusive
worldwide Licensing Agreement with GlaxoSmithKline ("GSK") for its SATIETROL
technology. Under the Agreement, the Company received an initial payment of
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$1,000,000 and received a subsequent milestone payment of $250,000. GSK
subsequently terminated the Licensing Agreement in September 2002 with all
rights reverting back to the Company. In the third quarter of 2003, the Company
funded clinical studies performed at a private research firm that showed a
statistically significant reduction in caloric intake in overweight individuals
using a new improved form of SATIETROL in both beverage and tablet form. The
Company will conduct additional studies on SATIETROL in 2004.
Type 2 Diabetes
Type 2 diabetes has become the fastest growing chronic condition in the
United States. Obesity and poor glucose regulation appear to be the primary
characteristics of Type 2 diabetes. Research has suggested that cholecystokinin
(CCK) may play a role in insulin release and glucose regulation. The Company's
research in this area has focused upon the development of nutritional products
that can help Type 2 diabetics lose weight by controlling appetite while
improving glucose regulation. The Company expects to initiate clinical trials on
a product for use by Type 2 diabetics in the future.
Strong Research
In December 2003, the Company acquired all of the outstanding shares of
Strong Research Corp. ("STRONG"), a research-based educational sports nutrition
company, in exchange for 150,000 shares of the Company's common stock. STRONG
had no material revenues but is actively involved in the scientific education of
athletes on proper nutrition utilizing leading Ph.D.-level scientists in sports
nutrition. Assets acquired include certain intellectual properties that we
expect to use in the marketing of new sports nutrition products geared towards
the strength-training athlete, including a provisional U.S. patent application
entitled Composition for Increasing Muscle Protein Synthesis. Greg Horn, a
Director of the Company, is the principal shareholder of STRONG and will
continue as a compensated advisor to STRONG and the Company.
All of the Company's existing products, and its proposed products, are
expected to be manufactured in the United States by third parties. See Item
1(b)(i) below.
1(b)(i) Principal Products and Markets
(a) ENDUROX(R) Product Line-Dietary Supplements
The Company's initial product, ENDUROX(R), is a dietary supplement of
which the principal ingredient is the herb ciwujia. Laboratory tests and trials
funded by the Company during 1995 at the University of North Texas Health
Science Center in Fort Worth, Texas and the Institute of Nutrition and Food in
China, have demonstrated that ENDUROX is effective in improving exercise
performance. The Company introduced ENDUROX in March 1996 and commenced
commercial sales of the product in May 1996. In December 1996, the Company was
issued patent #5,585,101 for its ENDUROX product. ENDUROX is sold in caplet
form.
ENDUROX EXCEL(R) was introduced in March 1997. ENDUROX EXCEL contains
50% more ciwujia than regular ENDUROX, plus vitamin E. It is targeted to
"serious" athletes, i.e., individuals who engage in competitive athletics or
whose exercise regimen is comparable to that of a competitive athlete.
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(b) ENDUROX(R)R4(TM) Recovery / Performance Drink
The Company launched ENDUROX R4 Performance / Recovery Drink in March
1999. Clinical trials funded by the Company during 1998 at the University of
North Texas Health Science Center in Fort Worth, Texas and the Human Performance
Lab at St. Cloud University in St. Cloud, Minnesota showed that when tested
against the nation's leading sports drink, ENDUROX R4 delivered equal hydration
effectiveness while enhancing performance and extending endurance by 55%,
decreasing post-exercise muscle stress by 36%, reducing free radical build-up by
69%, and increasing insulin levels by 70%. The results of these trials were
presented at the American College of Sports Medicine's national meeting in 1999.
In April 2000, the Company was issued patent #6,051,236 for ENDUROX R4
covering all 77 claims made in the application, including claims that the
product (a) increases endurance, (b) reduces post-exercise muscle damage, and
(c) speeds the replenishment of muscle carbohydrate stores. Patent office
acceptance of these claims does not necessarily permit the Company to make any
specific claims to the public regarding this product. The Company's ability to
make those claims is governed by the FDA, Federal Trade Commission, and other
federal government agency regulations and guidelines.
(c) SATIETROL(R)
SATIETROL, the Company's appetite control product, is based on the use
of nutritional ingredients to stimulate cholecystokinin (CCK), a protein
released after eating which has shown to be an important satiety signal in
humans.
In the early 1980's, researchers at Columbia University demonstrated
that CCK was an important satiety signal in humans. CCK causes individuals to
feel fuller even without eating. These studies have shown that an injection of
CCK reduced food intake by 16-22%. The release of CCK was shown to be stimulated
by the ingestion of protein and fat. When CCK is stimulated by ingestion of
food, it activates two negative feedback loops that inhibit continued release of
CCK. One mechanism involves the pancreas and the second involves the gall
bladder. When CCK is stimulated, the pancreas secretes protease enzymes, which
inactivates a protein called CCK Releasing Peptide (CCKRP). When this protein is
inactivated, release of CCK is halted. The second mechanism that controls CCK
release is the gall bladder. CCK stimulates the gall bladder to release bile
salts. Bile salts are powerful inhibitors of further CCK release. A major
problem with the direct use of CCK as a supplement is that it must be given by
injection since stomach enzymes activate it.
The Company's research efforts have focused on developing a calorically
efficient nutritional formula that can be taken orally which would stimulate CCK
release and extend its duration of action. Such a product would be highly useful
in control of weight by helping overweight individuals feel fuller or more
satiated while eating less food. This formulation became the basis for the
Company's first weight loss product, SATIETROL. The Company has developed a
number of SATIETROL formulas that stimulate and extend the action of CCK and has
filed a number of patents regarding this unique technology.
6
Clinical studies funded by the Company conducted in 2000 by the
Company's President, Dr. Portman, Abe Bakal of ABIC International ("ABIC"), and
Dr. Steven Peikin, Professor of Medicine, Robert Wood Johnson Medical School at
Camden Cooper Hospital/University Medical Center, Camden, NJ have shown that,
when taken as a pre meal beverage 10-15 minutes before eating, SATIETROL can
reduce hunger up to 40% three and one-half hours after eating and reduce caloric
consumption in a subsequent meal by 43%. These studies were presented at the
North American Association for the Study of Obesity (NAASO) 1999 national
meeting. In March 2001, the Company was issued patent #6,207,638 for all 72
claims made for SATIETROL, including its use for Type 2 diabetes as well as
conjunctive use with other products for treatment of bulimia. Studies conducted
or funded by the Company on CCK have also suggested that this agent may be
effective for treating Type 2 diabetes, one of the fastest growing chronic
diseases in the United States. The Company intends to conduct studies to
determine if SATIETROL would be of value in Type 2 diabetes.
Additional studies funded by the Company and conducted in the 4th
quarter of 2002 by Dr. Portman, and Mr. Bakal of ABIC, have shown that we can
significantly improve both the efficacy and versatility of SATIETROL. These new
studies show that the improved formulation of SATIETROL was, on average, 38%
more effective in reducing caloric intake than our existing product. In
addition, we have been able to reduce the caloric content from 80 calories to 15
calories, which is important for individuals who are on a calorie-restricted
diet.
Additional studies funded by the Company and conducted in 2003 by a
private research firm indicated that an improved form of SATIETROL is effective
in reducing food consumption in two new delivery forms: chewable tablets and
low-calorie beverages. Based on these findings, the Company may be able to
develop a totally new class of weight loss management products that naturally
reduce appetite and hunger.
The Company's objective is to develop a patent portfolio to protect its
proprietary technology involving the use of nutritional ingredients to stimulate
and extend the action of CCK. The Company has already received several patents
for SATIETROL and has several more patents pending (see 1(b)(vii) Patents and
Trademarks below)
In April 2000, the Company launched its first SATIETROL product.
SATIETROL is a powder that is mixed with 6-8 oz of water and taken 10-15 minutes
before a meal. It is the first weight loss product commercially available that
is designed to stimulate CCK, the body's own satiety mechanism. The market for
all types of weight loss products and services in the US exceeds $50 billion a
year and government figures estimate that 55% of adult Americans are overweight.
SATIETROL is available in chocolate and vanilla flavors.
In January 2001, the Company introduced SATIETROL COMPLETE, a
220-calorie meal replacement product that incorporates the SATIETROL technology.
Clinical studies funded by the Company and conducted in 2000 by Dr. Portman, Mr.
Bakal of ABIC, and Dr. Steven Peikin, Professor of Medicine, Robert Wood Johnson
Medical School at Camden Cooper Hospital/University Medical Center, Camden, NJ
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have shown that, versus the leading meal replacement product, SATIETROL COMPLETE
was more effective in reducing hunger over 5 hours and reducing caloric
consumption in a subsequent meal. These studies were presented at the NAASO
national meeting in 2000. The meal replacement market segment in the United
States exceeds $900 million. SATIETROL COMPLETE is a powder that is mixed with
skim, soy, or rice milk and is available in chocolate and vanilla flavors.
On June 1, 2001, the Company entered into an exclusive license
agreement with GlaxoSmithKline ("GSK"), one of the world's largest
pharmaceutical companies, for SATIETROL, the Company's appetite control product.
The agreement provided GSK with worldwide rights to the trademarks, technology,
patents, and know how for SATIETROL for the duration of the patents which expire
in 2017. Under the agreement, the Company received an initial payment of
$1,000,000 and received a subsequent milestone payment of $250,000. The
agreement permitted GSK to terminate the license agreement at any time for any
reason, provided that it pays all milestone payments earned prior to
termination. In the event the agreement was terminated, all rights to the
product would revert to the Company. GSK also purchased approximately 9% of the
Company's common stock for $1.5 million under a contemporaneous stock purchase
agreement. As of December 31, 2002, the Company received an aggregate of
$2,750,000 from GSK from the combined licensing and stock purchase agreements.
During the third quarter of 2002, GSK terminated the license agreement and the
Company is now free to explore other options for the SATIETROL technology with
other potential partners.
(d) ACCELERADE(R)
In June 2001, the Company introduced ACCELERADE Sports Drink, to be
taken during exercise, using the same, patented technology as ENDUROX R4.
Research studies funded by the Company and conducted in 2001 by Dr. John Ivy at
the University of Texas Department of Kinesiology and Health Education, Austin,
Texas have shown that ACCELERADE is significantly better than conventional
sports drinks in improving endurance during exercise. These studies showed that
subjects taking ACCELERADE increased endurance performance by 24% compared to
subjects drinking a conventional sports drink containing the same amount of
carbohydrates. ACCELERADE uses the ENDUROX R4 technology that features the
patented 4-1 ratio of carbohydrate to protein to speed the movement of
carbohydrate from the blood into the muscle during exercise. By increasing the
energy efficiency of every gram of carbohydrate an athlete consumes, ACCELERADE
spares muscle glycogen and improves endurance capacity. In 2003, the Company
commenced test marketing of our ready-to-drink form of ACCELERADE in the state
of Colorado. This test market will continue in 2004.
(e) COUNTDOWN(R)
As a result of its acquisition of STRONG in December 2003, the Company
has placed special emphasis on developing a line of products that focus on
infusing the body with certain critical nutrients at specific times during the
day to increase strength, endurance, and muscle mass. In March 2004, the Company
introduced COUNTDOWN, the first product specifically engineered for immediate
post workout intake by strength-training athletes. Independent researchers have
8
shown that the right combination of nutrients taken within 45 minutes after a
workout can turn on the cellular processes to rebuild and repair muscles,
resulting in greater gains in muscle strength and power. Independent and
company-funded studies conducted at various research facilities show the
COUNTDOWN formula increases protein synthesis 38% more than a conventional
protein drink, increases muscle glycogen levels 2.2 fold greater than a
conventional recovery drink and decreases muscle damage by 36%. The Company
expects to launch additional products geared towards the strength-training
athlete in mid-2004.
1(b)(ii) Distribution Methods
The Company has pursued a "multi-channel" distribution strategy in
marketing its ENDUROX, ENDUROX R4 and ACCELERADE lines of products. At the
present time, these products are being sold in over 9,000 retail outlets
including General Nutrition Centers ("GNC"), sports specialty stores,
independent health food retailers, independent bike retailers, health clubs,
catalogs, and Internet sites. ACCELERADE ready-to-drink will be primarily sold
through the convenience store channels of distribution. The Company does not
sell any of its other products through convenience stores and does not have any
experience in distributing products through convenience stores. As a result,
distribution of ACCELERADE ready-to-drink through convenience stores may
initially not be as effective as other means of distribution used by the
Company. COUNTDOWN, the first product in the Nutrient Timing System line of
products, is being sold exclusively in GNC stores.
The Company began distribution of ENDUROX in Canada in 1997 through an
independent distributor with the first retail sales made in April 1997. In 1998,
the Company began selling its ENDUROX products in South Africa with an
independent distributor on a non-exclusive basis. The Company now sells all of
its products in various foreign countries through independent distributors on a
non-exclusive basis.
SATIETROL currently is sold through Internet retailers and select
health food stores, although revenues are not significant.
To support its marketing efforts, the Company advertises in trade and
consumer sports and health food magazines that are intended to reach its
targeted consumer. In addition, the Company attends trade shows and exhibitions,
sponsors promotional programs/events and in-store promotions, and engages in an
extensive public relations effort that has resulted in articles in numerous
sports, health, fitness, trade and natural product publications, newspaper
coverage, and television spots. In addition, the Company utilizes a number of
paid endorsers to promote its sports nutrition line of products, including
several well-known athletes and a number of professional coaches from bicycling,
running, swimming, triathlete, hockey, and basketball.
In the twelve-month periods ended December 31, 2003 and December 31,
2002, the Company's expenditures for product advertising and promotion were
approximately $727,000 and $900,000, respectively.
9
1(b)(iii) Status of Publicly Announced New Products
The status of all products that have been the subject of or mentioned
in public announcements by the company in the past year are discussed above
under the caption "Principal Products and Markets".
1(b)(iv) Competition
Depending on the product category, the Company's competition varies.
The sports drink market in which Endurox R4 and ACCELERADE compete is
dominated by such brands as Gatorade and Powerade who sell ready-to-drink
products, as well as smaller companies such as Cytosport (Cytomax), which sell
powdered, ready-to-mix products. In addition, there are a number of new foreign
entries such as Enervit and Extran that have introduced sports drinks into the
U.S. focusing on the endurance athlete. Increased competitive activity from such
companies could make it more difficult for the Company to increase or keep
market share since such companies have greater financial and other resources
available to them and possess far more extensive manufacturing, distribution and
marketing capabilities than the Company. In addition, in the market for ready to
drink sports drinks, the Company must compete with large companies whose
products enjoy substantial name recognition. As a result, it may be more
difficult for the Company to earn market share in the market for ready-to-drink
sports drinks than in other markets.
The strength-training powder market in which COUNTDOWN competes is
dominated by brands from much larger companies such as MET-RX, EAS, and Optimum
Nutrition. Increased competitive activity from such companies could make it more
difficult for the Company to increase or keep market share since such companies
have greater financial and other resources available to them and possess far
more extensive manufacturing, distribution and marketing capabilities than the
Company.
The competitive market for weight loss products is divided into four
basic segments: herbal supplements (e.g., Metabolite), meal replacement products
(e.g., Slim Fast), food plans (e.g., Weight Watchers) and prescription products
(e.g., Xenical). Today, weight loss products are manufactured by dietary
supplement manufacturers, pharmaceutical manufacturers, diet food companies
(e.g. Slim Fast Foods Company), and over-the-counter drug companies. Intense
competitive activity in this market could make it difficult for the Company to
increase or keep market share, as most of the companies that have products in
this category have greater financial, marketing, sales, manufacturing, and
distribution resources than the Company.
Because the Company's products are based upon natural ingredients, its
competitors have access to the same ingredients and will be able to develop and
market products the same as or similar to the Company's products. Except to the
limited extent that the Company may obtain patent protection for certain uses of
ingredients in its products, its competitors' products may make the same claims
of benefits from use of the products that the Company makes.
The Company believes that long term success in the marketplace for any
of the Company's products is likely to be less dependent on the novelty of the
product than on such factors as distribution and marketing capabilities, and
10
whether or not the product enjoys some proprietary advantage, such as patent
protection, an established brand name, etc.
1(b)(v) Suppliers of Raw Materials
The Company does not have manufacturing facilities and has no present
intention to manufacture any products itself. It fulfills product needs through
relationships with independent manufacturers. The Company generally does not
have long-term contracts with any of these manufacturers. Competitors that do
their own manufacturing may have an advantage over the Company with respect to
pricing, availability of product and in other areas because of their control of
the manufacturing process.
Generally, the Company's contract manufacturers obtain raw materials
necessary for the manufacture of our products from numerous sources. The Company
generally does not have contracts with suppliers of materials required for the
production of its products. The Company obtains ciwujia for its ENDUROX caplet
line of products from suppliers in the Peoples Republic of China. At the present
time, the Company obtains all of its needs from one supplier in the People's
Republic of China, but believes that the Company could switch to a number of
alternative suppliers without significant effect. The Company has not entered
into any long-term supply agreements with this supplier. In addition, all other
raw materials used in the Company's existing products are available from
multiple sources.
There is no assurance that suppliers will provide the raw materials
needed by the Company in the quantities requested or at a price the Company is
willing to pay. Because the Company does not control the source of these raw
materials, it is also subject to delays caused by interruption in production of
materials based on conditions outside of its control.
1(b)(vi) Dependence on Major Customers
GNC and Performance, Inc. accounted for approximately 24% and 22%,
respectively, of net sales in fiscal 2003. The loss of these customers, a
significant reduction in purchase volume by these customers, or the financial
difficulty of such customers, for any reason, could significantly reduce our
revenues. The Company has no agreement with or commitment from either of these
customers with respect to future purchases.
1(b)(vii) Patents and Trademarks
The Company received a use patent, United States Patent No. 5,585,101
in December 1996 covering the use of ciwujia, the principal active herb in
ENDUROX, entitled Method to Improve Performance During Exercise Using the
Ciwujia Plant. This patent expires in December 2013.
The Company received a composition of matter patent, United States
Patent No. 6,051,236, in April 2000 for ENDUROX R4 entitled Composition for
Optimizing Muscle Performance During Exercise (see section 1(b)(i)(b)). This
patent expires in April 2017.
11
The Company received a composition of matter patent, United States
Patent No. 6,207,638, in March 2001 for SATIETROL entitled Nutritional
Intervention Composition for Enhancing and Extending Satiety (see section
1(b)(i)(c)). This patent expires in March 2018.
The Company received a use patent, United States Patent No. 6,429,190,
in August 2002 for SATIETROL entitled Method For Extending The Satiety Of Food
By Adding A Nutritional Composition Designed To Stimulate Cholecystokinin (CCK).
This patent expires in August 2019.
The Company received a composition of matter patent, United States
Patent No. 6,436,899, in August 2002 for SATIETROL entitled Nutritional
Intervention Composition for Enhancing and Extending Satiety. This patent
expires in August 2019.
The Company received a composition of matter patent, United States
Patent No. 6,468,962, in October 2002 for SATIETROL entitled Nutritional
Intervention Composition for Enhancing and Extending Satiety. This patent
expires in October 2019.
The Company received a Notice of Allowance on a composition of matter
patent in February 2003 for SATIETROL entitled Nutritional Intervention
Composition for Improving Efficacy of a Lipase Inhibitor.
The Company also has the following patents pending for its SATIETROL
technology:
---------------------------------------------------------------------------------------------------------
PATENTS PENDING DATE SUBMITTED
---------------------------------------------------------------------------------------------------------
Composition Containing Protease Inhibitor Extends Post Meal Satiety June 2001
---------------------------------------------------------------------------------------------------------
Nutritional Intervention Composition for Enhancing and Extending Satiety June 2002
---------------------------------------------------------------------------------------------------------
Composition for Reducing Caloric Intake October 2002
---------------------------------------------------------------------------------------------------------
In October 2003, STRONG, now a subsidiary of the Company, filed a
provisional U.S. patent application entitled Composition for Increasing Muscle
Protein Synthesis.
The patent holder for all patents other than the patent held by STRONG
is the Company's President, Dr. Robert Portman, and all patents are assigned to
the Company. To the extent the Company does not have patents on its products,
there can be no assurance that another company will not replicate one or more of
the Company's products, nor is there any assurance that patents that are
obtained will provide meaningful protection or significant competitive
advantages over competing products. For example, the Company's use patent on
ciwujia would not prevent the sale of a product containing that herb with a
claim or for a use that was not covered by the Company's patent.
The Company has federal trademark registrations for ENDUROX, ENDUROX
EXCEL, ENDUROX ProHeart, ENDUROX R4, SATIETROL, SATIETROL COMPLETE, and
ACCELERADE. We have also filed five trademark registration applications on names
relating to STRONG and its potential products. The Company also has filed its
trademarks in most Western European countries, Canada, Mexico and Japan. The
Company's policy is to pursue registrations for all of the trademarks associated
12
with its key products, and to protect its legal rights concerning the use of its
trademarks. The Company relies on common law trademark rights to protect its
unregistered trademarks.
1(b)(viii) and (ix) Governmental Regulation
The Company has determined that all of its existing and proposed
products, as described above, are nutritional or dietary supplements as defined
under federal statutes and regulations of the FDA. Neither nutritional
supplements nor dietary supplements require FDA or other governmental approval
prior to their marketing in the United States. No governmental agency or other
third party makes a determination as to whether our products qualify as
nutritional supplements, dietary supplements, or neither. The Company makes this
determination based on the ingredients contained in the products and the claims
made for the products. The processing, formulation, packaging, labeling and
advertising of such products, however, are subject to regulation by one or more
federal agencies including the FDA, the Federal Trade Commission, the Consumer
Products Safety Commission, the Department of Agriculture and the Environmental
Protection Agency. The Company's activities also are subject to regulation by
various agencies of the states and localities in which its products are sold.
The Company markets products that are covered under two types of FDA
regulations, Nutritional Supplements and Dietary Supplements. Nutritional
Supplements contain food and GRAS (Generally Regarded as Safe) ingredients and
do not require FDA approval or notification. Such products must follow labeling
guidelines outlined by the FDA.
Dietary Supplements is a classification of products resulting from the
enactment of the Dietary Supplement Health and Education Act of 1994 (the
"DSHEA") in October 1994. The DSHEA amended and modified the application of
certain provisions of the Federal Food, Drug and Cosmetics Act (the "FFDC Act")
as they relate to dietary supplements, and required the FDA to promulgate
regulations consistent with the DSHEA.
The DSHEA defines a dietary supplement to include (i) any product
intended to supplement the diet that bears or contains a vitamin, mineral, herb
or other botanical, an amino acid, a substance to supplement the diet by
increasing the total dietary intake, or any concentrate, constituent, extract,
or combination of any such ingredient, provided that such product is either
intended for ingestion in tablet, capsule, powder, softgel, gelcap, or liquid
droplet form or, if not intended to be ingested in such form, is not represented
for use as a conventional food or as a sole item of a meal or the diet, (ii) is
not represented for use as a conventional food or as a sole item of a meal or
the diet, and (iii) is labeled as a dietary supplement. The practical effect of
such an expansive definition is to ensure that the new protections and
requirements of the DSHEA will apply to a wide class of products.
Under the DSHEA, companies that manufacture and distribute dietary
supplements are allowed to make any of the following four types of statements
with regard to nutritional support on labeling without FDA approval: (i) a
statement that claims a benefit related to a classical nutrient deficiency
disease and discloses the prevalence of such disease in the United States; (ii)
a statement that describes the role of a nutrient or dietary ingredient intended
13
to affect structure or function in humans; (iii) a statement that characterizes
the documented mechanism by which a nutrient or dietary ingredient acts to
maintain or function; or (iv) a statement that "describes general well-being"
from consumption of a nutrient or dietary ingredient. In addition to making sure
that a statement meets one of these four criteria, a manufacturer of the dietary
supplement must have substantiation that such statement is truthful and not
misleading, must not claim to diagnose, mitigate, treat, cure, or prevent a
specific disease or class of diseases, and must contain the following
disclaimer, prominently displayed in boldface type: "This statement has not been
evaluated by the Food and Drug Administration. This product is not intended to
diagnose, treat, cure, or prevent any disease."
On February 6, 2000, the FDA issued new guidelines concerning
statements made for dietary supplements. These new regulations have important
implications for the marketing of weight loss products such as SATIETROL.
Previously the regulations made it clear that a product that made a claim for
obesity must be treated as a drug. Under the new regulations the FDA makes a
distinction between obesity and overweight. Overweight is no longer considered a
disease but rather a natural life process. Overweight is considered a condition
that affects the structure and function of the body. As now defined, dietary
supplements can make a claim for ordinary weight loss rather than as a treatment
for obesity. Furthermore, these regulations also permit the use of appetite
suppressant as a structure/function claim under DSHEA. The issuance of these
regulations will give SATIETROL greater latitude in the types of claims the
product can make as long as such claims are substantiated by the necessary
studies.
1(b)(x) Expenditures for Research and Development
The Company's research and development expenditures in the past two
fiscal years, exclusive of market research and marketing related expenditures,
were as follows: 2003 - $232,000; 2002 - $166,000.
1(b)(xi) Compliance with Environmental Laws
The Company is not aware of any "administrative" or other costs that it
incurs which are directly related to compliance with environmental laws.
1(b)(xii) Employees
At the present time, the Company has fifteen full time employees. Of
these, three employees are executive, eight are in sales and marketing, and four
are in accounting, operations and administrative. The Company employs a number
of consultants who devote limited portions of their time to the Company's
business. None of the Company's employees are represented by a union and the
Company believes that its employee relations are good.
ITEM 2. DESCRIPTION OF PROPERTY
In July 2003, the Company moved its headquarters from Woodbridge, NJ to
larger facilities located in Matawan, NJ. At this time, the Company entered into
a four-year (48-month) lease for approximately 5,500 square feet at a price of
$22.50 per square foot, including utilities, for an annual rent expense of
14
$123,750 for the first thirty-three (33) months. During the last fifteen (15)
months of the lease, the rent increases to $25.50 per square foot, including
utilities, for an aggregate annual rent expense of $140,250.
The Company does not intend to develop its own manufacturing
capabilities, because management believes that the availability of manufacturing
services from third parties on a contract basis is more than adequate to meet
the Company's needs in the foreseeable future.
The Company does not own any real property nor does it have any real
estate investments.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to, or involved in, any legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company did not submit any matters to a vote of its security
holders in the fourth quarter of the fiscal year ended December 31, 2003.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
5(a) Market Information.
The Company's common stock is currently traded on the over-the-counter
market on the OTC Bulletin Board, under the symbol "PHLI" and was traded on the
Nasdaq SmallCap Market, under the symbol "PHLIC" prior to August 20, 2003.
The following table sets forth, in dollars and cents (in lieu of
fractions), the high and low sales prices of the Company's common stock since
August 20, 2003, as reported by the OTC Bulletin Board. The prices in the table
may not represent actual transactions. These quotations reflect inter-dealer
prices, without retail mark up, mark down or commissions and may not represent
actual transactions.
Year ending December 31, 2003 High Low
----------------------------- ---- ---
August 20 to September 30 $1.01 $0.55
Fourth Quarter $1.18 $0.56
First Quarter 2004 through March 25, 2004 $0.95 $0.70
The following table sets forth, for the periods indicated, the high and
low reported sales prices per share of the common stock as reported on the
NASDAQ SmallCap Market for the applicable periods.
15
Year ending December 31, 2003 High Low
----------------------------- ---- ---
First Quarter $2.90 $0.74
Second Quarter $1.38 $0.65
July 1 to August 19 $1.13 $0.55
Year ended December 31, 2002
----------------------------
First Quarter $5.00 $2.51
Second Quarter $5.15 $3.61
Third Quarter $4.78 $0.91
Fourth Quarter $4.10 $0.93
On March 24, 2004, the closing price of our common stock as reported by
the OTC Bulletin Board was $0.80 per share.
5(b) Holders.
As of March 24, 2004, there were approximately 125 holders of record of
the Company's common stock. However, the Company believes that there are
significantly more beneficial holders of the Company's stock as many beneficial
holders have their stock in "street name".
5(c) Dividends.
The Company has never paid or declared dividends upon its common stock
and does not contemplate or anticipate paying any dividends on its common stock
in the foreseeable future.
5(d) Recent Sales of Unregistered Securities; Use of Proceeds from the Sale
of Registered Securities
5(d)(i) Recent Sales of Unregistered Securities.
August - September Private Placement
As reported in our Quarterly report on Form 10-QSB for the quarter
ended September 30, 2003, in August and September 2003, we sold 1,604,278 units
of securities ("Units") for cash at a price of $0.935 per Unit to an aggregate
of 50 investors pursuant to a confidential private offering memorandum. Each
Unit consisted of two shares of Common Stock and warrants to purchase one share
of Common Stock at an exercise price of $0.6325 per share. The aggregate gross
proceeds were $1,500,000.
The Company did not retain an underwriter or selling agent in
connection with this private placement. However, Fahnestock & Company, a
broker-dealer, received cash compensation of $51,110 and warrants exercisable
for 154,853 shares in connection with introducing certain prospective investors
to the Company. These warrants are identical to the warrants issued to investors
in the Units. Fahnestock subsequently assigned these warrants to certain of its
employees.
16
The Units were sold without registration under the Securities Act of
1933 in reliance upon the exemption from registration provided in Section 4(2)
thereof and Rule 506, Regulation D promulgated thereunder. No general
solicitation was made in connection with the placement. All securities sold were
acquired for investment, and appropriate restrictions were placed upon the
resale of any of the securities acquired in the placement, including restrictive
legends on the face of the securities and stop orders on our stock and warrant
registers. The shares contained in the Units, as well as the shares issuable
upon exercise of the warrants, were subsequently registered for resale under the
Securities Act of 1933
The proceeds are being used for working capital and general corporate
purposes.
Acquisition of Strong Research Corp.
On December 17, 2003, the Company issued 150,000 shares of our common
stock in exchange for all of the outstanding capital stock of STRONG. Prior to
the acquisition, Gregory Horn, a director of the Company, was the sole
shareholder of STRONG and therefore was the recipient of the shares. The Company
accounted for the transaction as a patent acquisition at a value of $112,500. In
connection with this transaction, the Company agreed to issue and did issue
52,000 shares subsequent to December 31, 2003 and has accounted for this
transaction as additional purchase price at fair value of the shares as of
December 31, 2003, which approximated $43,000. The Company will issue to Mr.
Horn an additional 150,000 shares if certain milestones are achieved.
These shares of common stock were issued without registration under the
Securities Act of 1933 in reliance upon the exemption from registration provided
in Section 4(2) thereof and Rule 506, Regulation D promulgated thereunder. No
general solicitation was made in connection with the transaction. All securities
were acquired for investment, and appropriate restrictions were placed upon the
resale of any of the securities acquired in the placement, including restrictive
legends on the face of the securities and stop orders on our stock and warrant
registers. These shares of common stock were subsequently registered for resale
under the Securities Act of 1933
December Private Placement.
In December 2003, the Company sold an aggregate of 357,144 units of
securities ("December Units") for cash at a price of $1.40 per December Unit to
two investors pursuant to a confidential private placement memorandum. Each
December Unit consisted of two shares of the Company's common stock and warrants
to purchase one share of the Company's common stock at an exercise price of
$0.85. The Company received aggregate proceeds of approximately $500,000. The
Company paid no brokers' or finders' fees in connection with this private
placement. The proceeds of this private placement are intended to be used for
working capital and general corporate purposes.
These securities were sold without registration under the Securities
Act of 1933 in reliance upon the exemption from registration provided in Section
4(2) thereof and Rule 506, Regulation D promulgated thereunder. No general
17
solicitation was made in connection with the placement. All securities sold were
acquired for investment, and appropriate restrictions were placed upon the
resale of any of the securities acquired in the placement, including restrictive
legends on the face of the securities and stop orders on our stock and warrant
registers. The shares of common stock contained in the December Units, as well
as the shares of common stock issuable upon exercise of the warrants, were
subsequently registered for resale under the Securities Act of 1933
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the Company's financial statements, including the notes thereto, appearing
elsewhere in this Report.
6(a) Introduction
The Company was incorporated in April 1995 to develop and market
dietary and nutritional supplements that improve and promote health and
well-being and can be offered for sale without prior approval by the FDA in
compliance with current regulatory guidelines. Our first product, ENDUROX was
introduced in March 1996, and commercial sales began in May 1996. In March 1997,
the Company extended the ENDUROX line of products with ENDUROX EXCEL. In March
1999, the Company launched ENDUROX R4 Performance/Recovery Drink, the latest in
our ENDUROX line of products, which demonstrated a number of exercise related
benefits in clinical studies, including enhanced performance and extended
endurance, decreased post-exercise muscle stress, and reduced free radical
build-up. In April 2000, the Company introduced a new product, SATIETROL, that
will compete in the approximately $50 billion market for weight loss and weight
control products, goods and services. In May of 2001, the Company launched
ACCELERADE, a new generation of sports drink products to be used during exercise
that uses the ENDUROX R4 patented technology. In 2003, the Company introduced a
ready-to-drink form of ACCELERADE in test market in the State of Colorado. In
December 2003, the Company acquired all of the outstanding shares of Strong
Research Corp., a research-based educational sports nutrition company actively
involved in the scientific education of athletes on proper nutrition useful in
the marketing of new sports nutrition products geared towards the
strength-training athlete. In March 2004, the Company introduced COUNTDOWN, the
first product specifically engineered for immediate post-workout use by
strength-training athletes.
6(b) Results of Operations - Years Ended December 31, 2003 and 2002
The Company generated a net loss of ($1,451,274) or ($0.20) per share
for the year ended December 31, 2003 compared to net loss of ($2,570,452) or
($0.42) per share for the year ended December 31, 2002. The decrease in net loss
for 2003 versus the net loss for the same period in 2002 is due primarily to the
$1,297,485 write-off of SATIETROL inventory in 2002 (see below).
18
Revenues for the year ended December 31, 2003 were $5,453,571 compared
to $5,120,353 for the same period in 2002. The increase in revenues in 2003 as
compared to 2002 was due primarily to a 30% increase in sales of our ACCELERADE
Sports Drink. The following table provides additional information concerning our
revenues in 2003 and 2002:
Revenues
----------------------------------------------
Sports Weight
Year Ended Performance Loss Total
---------------------------------------------------------------------------
December 31, 2003 $5,393,296 $ 60,275 $5,453,571
========== ======== ==========
December 31, 2002 $5,007,513 $112,840 $5,120,353
========== ======== ==========
Gross profit for the year ended December 31, 2003 was $2,654,109
compared to $1,355,260 for the year ended December 31, 2002, which includes a
$1,297,485 write off of excess SATIETROL inventory. Before this write off, gross
profit was $2,652,745. In the third quarter of 2002, we chose to focus our
resources on developing our sports drink business resulting in reduced SATIETROL
sales. The decision to write off the SATIETROL inventory was made in accordance
with generally accepted accounting principles.
Our gross profit margin on product sales increased to 48.7% in 2003
from 26.5% in 2002. The 26.5% gross profit margin for 2002 takes into account
the effect of the write off of excess SATIETROL inventory. Not including the
write off, our gross margin decreased to 48.7% for the year ended December 31,
2003 from 51.8% for the year ended December 31, 2002 (before the inventory write
off). The primary reason for the decrease in gross profit margin percent in 2003
compared to 2002 without the write off is that the Company sold inventory in the
fourth quarter of 2003 at a discount in order to facilitate the introduction of
its sports performance products with new packaging graphics and improved flavors
in early 2004.
In the above paragraphs, we have presented both our actual absolute
gross profit and our gross profit margin percentage, and with respect to 2002,
those figures excluding the effects of the SATIETROL inventory write off.
Excluding the write off increases our 2002 gross profit by $1,287,485 and
increases our gross profit margin from 26.5% to 48.9%. We believe that the gross
profit and margin figures provide meaningful information to shareholders because
write offs of that magnitude have been and will be extremely infrequent, and a
proper analysis of the Company's prospects requires information regarding our
performance that does not include the effect of a one time inventory write off
representing approximately 20% of revenues. We did not have a material inventory
write off in 2000, 2001, or 2003, and do not anticipate a material write off in
2004. In addition, comparing our actual 2002 and 2003 gross profit and gross
profit margin gives the impression that we greatly improved these two measures
in 2003, which was not the case.
Our selling, general, and administrative expenses ("S, G, & A")
increased $58,411 to $3,783,923 for the year ended December 31, 2003 from
$3,725,512 for the year ended December 31, 2002. The primary reason for the
increase in S, G, & A expenses is the additional marketing expenses associated
with the test market of the ready-to-drink form of ACCELERADE.
19
Research and development expenses increased $66,137 to $231,651 for the
year ended December 31, 2003 from $165,514 for the year ended December 31, 2002.
The primary reason for the increase in research and development expenses is due
to expenses associated with the test market of the ready-to-drink form of
ACCELERADE. We anticipate research and development expenses will increase as
additional clinical trials and studies are conducted on all current and newly
proposed products as we continue to seek out additional patents and claims.
The Company incurred interest expense of $58,709 for the year ended
December 31, 2003 versus interest expense of $3,019 for the year ended December
31, 2002. The increase is due to our accounts receivable funding described in
the Liquidity section below.
6(c) Liquidity and Capital Resources
At December 31, 2003, the Company's current assets exceeded its current
liabilities by approximately $2.55 million with a ratio of current assets to
current liabilities of approximately 4.0 to 1. At December 31, 2003, cash on
hand was $1,798,703, an increase of $1,170,267 from December 31, 2002, primarily
because of the completion of a series of private placements of the Company's
equity securities. Accounts receivable increased $334,081 to $669,300 at
December 31, 2003 from $335,219 at December 31, 2002 as a result of higher
fourth quarter revenues in 2003 than in 2002. Inventories decreased $799,722 to
$738,062 at December 31, 2003 from $1,537,784 at December 31, 2002 as a result
of the higher revenues in 2003 as well as the Company more efficiently turning
its inventory.
Notes payable increased $405,933 to $470,145 at December 31, 2003
primarily as a result of the use of our accounts receivable funding from USA
Funding that we did not have in the prior year. During the second quarter of
2003, the Company secured a $750,000 asset-based credit facility from USA
Funding of Dallas, TX. The amount of available credit is based on the value of
the Company's eligible receivables from time to time. This credit facility bears
interest at a rate of prime plus 2% as well as a 0.75% discount rate on all
advances. At December 31, 2003, we had approximately $125,000 of availability
under this credit facility and, as of February 27, 2004, we had approximately
$100,000 of availability. Accounts payable and accrued expenses increased
$96,309 to $376,693 at December 31, 2003 from $280,384 at December 31, 2002.
Other current liabilities decreased to $-0- at December 31, 2003 from $100,000
at December 31, 2002.
Because of our significantly reduced advertising and marketing
expenditures in the second half of 2003, the ability to borrow against our
credit facility as described above, and the equity raised in the private
placements, we believe we have sufficient cash availability to fund all of our
planned activities for at least the next twelve months.
6(d) Impact of Inflation
The Company expects to be able to pass inflationary increases for raw
materials and other costs on to its customers through price increases, as
required, and does not expect inflation to be a significant factor in its
business. However, the Company's operating history is very limited, and this
expectation is based more on observations of its competitors' historic
operations than its own experience.
20
6(e) Seasonality
Sports nutrition products tend to be seasonal, especially in the colder
climates. Lower sales are typically realized during the first and fourth
quarters and higher sales are typically realized during the second and third
fiscal quarters. We also plan our advertising and promotional campaigns for the
ENDUROX R4 and ACCELERADE products around these seasonal demands. Weight loss
products also have seasonality with greater sales seen in the first and second
quarters following New Year's resolutions and people getting in shape for the
summer. Similarly, advertising and promotional expenditures for SATIETROL are
designed to take advantage of this seasonality. The Company believes that the
impact of new product introductions and marketing expenses associated with the
introduction of new products will have a far greater impact on its operations
than industry and product seasonality.
6(f) Impact of Recently Issued Financial Accounting Standards
In November 2002, the FASB issued Interpretation No. 45 (the "FIN 45"),
Guarantor's Accounting and Disclosure Requirements for Guarantees, including
Indirect Guarantees of Indebtedness of Others. FIN 45 clarifies the requirements
of SFAS No. 5, Accounting for Contingencies, relating to a guarantor's
accounting for, and disclosure of, the issuance of certain types of guarantees.
For certain guarantees issued after December 31, 2002, FIN 45 requires a
guarantor to recognize, upon issuance of a guarantee, a liability for the fair
value of the obligations it assumes under the guarantee. Guarantees issued prior
to January 1, 2003 are not subject to liability recognition, but are subject to
expended disclosure requirements. We do not believe that the adoption of this
Interpretation will have a material impact on our financial position or
statement of operations.
In January 2003, FASB issued FIN 46, an interpretation of Accounting
Research Bulletin No. 51. FIN 46, requires us to consolidate variable interest
entities for which we are deemed to be the primary beneficiary and disclose
information about variable interest entities in which we have a significant
variable interest. FIN 46 became effective immediately for variable interest
entities formed after January 31, 2003 and will become effective in the third
quarter of 2003 for any variable interest entities formed prior to February 1,
2003. The adoption of this standard is expected to have no material effect on
the Company's financial statements.
6(g) Off-Balance Sheet Arrangements
There are no off-balance sheet arrangements between the Company and any
other entity that have, or are reasonably likely to have, a current or future
effect on the Company's financial condition, revenues or expenses, results of
operations, liquidity, capital expenditures, or capital resources.
21
6(h) Critical Accounting Policies
Our financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America.
Certain accounting policies have a significant impact on amounts reported in
financial statements. A summary of those significant accounting policies can be
found in Note A to our financial statements. We have not adopted any significant
new accounting policies during the period ended December 31, 2003.
In preparing financial statements in conformity with generally accepted
accounting principles in the United States of America, we are required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and revenues and expenses for the reporting period
covered thereby. Actual results could differ from those estimates.
Among such estimates made by management in the preparation of our
financial statements are the determinations of the allowance for doubtful
accounts, inventory valuations, and revenue recognition as it relates to
customer returns. The allowance for doubtful accounts is determined by assessing
the realizability of accounts receivable by taking into consideration the value
of past due accounts and collectability based on credit worthiness of such
customers. The Company assesses the realizability of inventories by reviewing
inventory to determine the value of items that are slow moving, lack
marketability, and by analysis of the shelf life of products. Estimates are made
for sales returns based on historical experience with actual returns. The
Company's financial statements have been prepared in accordance with accounting
principles generally accepted in the United States of America. Certain
accounting policies have a significant impact on amounts reported in financial
statements. A summary of those significant accounting policies can be found in
Note B to the Company's financial statements.
ITEM 7. FINANCIAL STATEMENTS
Financial information required in response to this Item of Form 10-KSB
is set forth at pages F-1 through F-15 of this Report.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On April 8, 2002, the Company filed a Current Report on Form 8-K dated
April 1, 2002, reporting, under Item 4, a change in the Company's independent
auditors from Larson, Allen, Weishair & Co., LLP to Eisner, LLP to serve as the
Company's independent public accountants to audit the financial statements for
the fiscal year ended December 31, 2002.
8(a) Evaluation of Disclosure Controls and Procedures
Based on their evaluation of the Company's disclosure controls and
procedures (as defined in Rules 13a-14(c) and 15d-14(c) promulgated under the
Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of a date
within 90 days of the filing date of this Annual Report on Form 10-KSB, the
Company's chief executive officer and chief financial officer have concluded
that the Company's disclosure controls and procedures are designed to ensure
22
that information required to be disclosed by the Company in the reports that it
files or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms and are
operating in an effective manner.
8(b) Changes in Internal Controls.
There were no significant changes in the Company's internal controls or
in other factors that could significantly affect these controls subsequent to
the date of their most recent evaluation.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
9(a) Directors and Executive Officers
The directors and executive officers of the Company as of the date of
this Report are as follows:
Name Position with the Company
---- -------------------------
Robert Portman, Ph.D. President and Chief Executive Officer, and
Chairman of the Board of Directors
Stephen P. Kuchen Vice President - Finance, Chief Financial
Officer, Treasurer, Assistant Secretary,
and Director
Bruce Bollinger Executive Vice-President of Marketing
David I. Portman Secretary and Director
Michael Cahr Director (1),(2)
Joseph Harris Director (1),(2)
Gregory T. Horn Director
(1) Member of Audit Committee
(2) Member of Compensation Committee
A former director of the Company, T. Colin Campbell, Ph.D., resigned
from the Board of Directors effective March 1, 2004.
DR. ROBERT PORTMAN, age 59, has served as President, Chief Executive
Officer, and Chairman of the Board of Directors of the Company since its
inception. Dr. Portman has a Ph.D. in Biochemistry and worked as a senior
scientist at Schering Laboratories before co-founding M.E.D. Communications in
1974 with his brother, David Portman. In 1987, Dr. Portman started a consumer
agency and, in 1993, he merged both agencies to form C&M Advertising. C&M
Advertising, with billings in excess of $100 million, handled national
advertising for such diverse accounts as Berlex Laboratories, Ortho-McNeil
Laboratories, Tetley Tea, Radisson Hotels and HIP of New Jersey. Effective June
1, 1995, Dr. Portman relinquished his responsibilities as Chairman of C&M
23
Advertising (which since has been renamed "The Sawtooth Group") to assume his
present positions with the Company on a full time basis, and, in September 1996,
Dr. Portman sold his interest in that company.
STEPHEN P. KUCHEN, age 43, has served as the Vice President - Finance,
Chief Financial Officer, Treasurer, Assistant Secretary and a Director, of the
Company since June 2000. Mr. Kuchen initially joined the Company in February of
2000 as Controller. Prior to joining the Company, Mr. Kuchen was employed from
1996 to 1999 as the Controller of Able Laboratories, a public company located in
South Plainfield, New Jersey that manufactures and sells generic
pharmaceuticals. Prior to his employment by Able Laboratories, Mr. Kuchen was
the Controller of Jerhel Plastics, a privately owned manufacturer of women's
compact cases from 1993 to 1996. Mr. Kuchen is a graduate of Seton Hall
University in South Orange, NJ, and is a Certified Management Accountant.
BRUCE BOLLINGER, age 44, has served as Executive Vice-President of
Marketing since November 2002. Mr. Bollinger most recently served as Vice
President of Marketing for Snapple Beverage Group, a division of Cadbury
Schweppes PLC, since November of 1999. At Snapple, he was instrumental in
greatly increasing the market share, revenues, and brand awareness for such
well-known brands as Orangina(TM), Yoo-hoo(TM), Mistic(TM) juices, and
Stewart's(TM) sodas. He brings to the Company more than 18 years of advertising,
brand management, marketing, and promotion experience from other consumer
products companies including Campbell Soup, Arm & Hammer - a division of Church
& Dwight, and Nabisco - a division of R.J. Reynolds Tobacco.
DAVID I. PORTMAN, age 63, has served as Secretary and a Director of the
Company from its inception. Mr. Portman has a BS in Pharmacy and an MBA. He
worked as a sales representative and marketing manager for Eli Lilly,
Beecham-Massengill, Winthrop Laboratories and Sandoz Pharmaceuticals before
co-founding M.E.D. Communications in 1974. In 1988, Mr. Portman sold his
interest in M.E.D. Communications to Robert Portman, and became President of
TRIAD Development, a real estate company that has numerous commercial and rental
properties in New Jersey, a position that he still holds. Mr. Portman served as
a director of First Montauk Securities Corp. from 1993 through December 31,
2002.
MICHAEL CAHR, age 64, was appointed to the Board of Directors in April
2002. Since April 1999, Mr. Cahr has served as President of Saxony Consultants,
a company that provides financial and marketing expertise to organizations in
the United States and abroad. Mr. Cahr was Chairman of Allscripts, Inc., the
leading developer of hand-held devices that provide physicians with real-time
access to health, drug and other critical information from September 1997
through March 1999 and President, CEO and Chairman from June 1994 to September
1997. Prior to Allscripts, Mr. Cahr was Venture Group Manager for Allstate
Venture Capital where he oversaw investments in technology, healthcare services,
biotech and medical services from October, 1987 to June 1994. Mr. Cahr serves as
a director of Lifecell Corporation, a Branchburg, New Jersey-based, publicly
traded tissue engineering company where he has been a board member since 1991.
He is also a director of Truswal Systems, an Arlington, Texas-based software
engineering firm.
24
JOSEPH HARRIS, age 57, was appointed to the Board of Directors in April
2002. Mr. Harris currently serves as Managing Partner of Conestoga Capital
Partners, LLC, a venture capital company primarily making investments in early
stage technology companies. From 2000 until 2002, Mr. Harris was Senior
Vice-President - Corporate Development of Cantel Medical Corporation, a
Nasdaq-listed medical device company. He was a Senior Vice-President and
Director - Corporate Strategy and Development for SmithKline Beecham plc, a
major pharmaceutical and healthcare company listed on both the New York Stock
Exchange and London Stock Exchange, from 1996 to 2000. From 1986 to 1996, Mr.
Harris served as Managing Director - Business Development and Director-Licensing
and Technology Development for Eastman Kodak Company. He served as General
Counsel, Secretary and Treasurer for Acme Electric Corporation, a New York Stock
Exchange company that manufactures electrical and electronic equipment. Mr.
Harris is licensed to practice law and is a certified public accountant in New
York. In these capacities, he has worked as an attorney for Mackenzie Lewis
Michelle & Hughes, a Syracuse, New York law firm and as an accountant on the tax
and audit staff for Coopers & Lybrand, an International Public Accounting Firm
based in Syracuse, New York. Mr. Harris also serves as a director of Diomed
Holdings, Inc., an Andover, MA-based publicly traded medical device company.
GREGORY T. HORN, age 38, was appointed to the Board of Directors in
September 2003. Mr. Horn currently serves as partner and managing director of
Lyric Capital, a venture capital firm. From 1991 through 2001, Mr. Horn was an
executive with General Nutrition, Inc., ("GNC") most recently as Chief Executive
Officer. GNC is a specialty retailer that has been our largest customer for
several years. After the purchase of GNC by Royal Numico, Mr. Horn served as
Group Director of Nutritional Supplements and an Executive Board member of Royal
Numico; a $4.5 billion global specialty nutrition company where he developed and
led the U.S. and European launch of innovative nutritional supplements. Mr. Horn
received an MBA from the University of California, Los Angeles in 1989 and a
B.A., Summa Cum Laude, in Management and Psychology from University of Redlands
in 1987.
Under the Company's Stock Purchase Agreement with Glaxo Wellcome
International, BV (an affiliate of GSK), Glaxo Wellcome has a right to designate
a nominee to the Company's board of directors, and, thereafter, so long as Glaxo
Wellcome and its affiliates own 10% or more of the Company's outstanding common
stock, it has the right to require the Company to include its designee as a
nominee in all elections of directors. The shares purchased under the Stock
Purchase Agreement constitute less than 10% of the outstanding shares of the
Company's common stock
9(b) Scientific Advisory Boards
The Company has established a Scientific Advisory Board to provide it
with on-going advice and counsel regarding research direction, product
development, analysis of data, and general counseling. As the need arises, the
Company consults with individual members of this board on a non-scheduled basis.
9(c) Family Relationships
Robert Portman and David Portman are brothers. There are no other
family relationships among the Company's directors, executive officers or
persons nominated or chosen to become directors or executive officers of the
Company.
25
9(d) Involvement in Certain Legal Proceedings
No events have occurred during the past five years that are required to
be disclosed pursuant to Item 401(d) of Regulation S-B.
9(e) Audit Committee Financial Expert
Joseph Harris, a current director and member of the Company's Audit
Committee of the Board of Directors, is the "Audit Committee Financial Expert"
as that term is defined in Item 401 of Regulation S-B. In addition, Mr. Harris
is "independent" as that term is defined in Item 7(d)(3)(iv) of Schedule 14A
under the Exchange Act.
9(f) Audit Committee
The Board of Directors of the Company has established a separately
designated, standing Audit Committee. The Audit Committee, which was established
in December 1997, met five times during fiscal year ended December 31, 2003. The
Audit Committee reviews and discusses with the Company's management and its
independent auditors the audited and unaudited financial statements contained in
the Company's Annual Reports on Form 10-KSB and Quarterly reports on Form
10-QSB, respectively. Although the Company's management has the primary
responsibility for the financial statements and the reporting process, including
the system of internal controls and disclosure controls and procedures, the
Audit Committee reviews and discusses the reporting process with management on a
regular basis. The Audit Committee also discusses with the independent auditor
their judgments as to the quality of the Company's accounting principles, the
reasonableness of significant judgments reflected in the financial statements
and the clarity of disclosures in the financial statements as well as such other
matters as are required to be discussed with the Audit Committee under generally
accepted auditing standards. The Audit Committee amended its written charter on
March 16, 2004. The Charter is reproduced as Exhibit 99 to this Report. The
Audit Committee Charter will be available on the Company's website -
www.pacifichealthlabs.com.
During fiscal 2003, the Audit Committee was composed of Mr. Harris,
(who was the chairman of the Audit Committee,) Mr. Cahr and Mr. Campbell.
Because of Mr. Campbell's resignation on March 1, 2004, the Audit Committee
currently consists of Mr. Harris and Mr. Cahr, each of whom meet the criteria
for independence set forth in Rule 10A-3(b)(1) of the Securities and Exchange
Act of 1934, as amended.
9(g) Nomination of Directors
The Company currently does not have a nominating committee. Nominations
for the election of directors at annual meetings have generally been handled by
the full Board of Directors, which has never exceeded six members. Accordingly,
due to the small size of its Board of Directors, the Company does not foresee
the need to establish a separate nominating committee. Future candidates for
director will either be (i) recommended by a majority of the independent
26
directors for selection by the Board of Directors or (ii) discussed by the full
Board of Directors and approved for nomination by the affirmative vote of a
majority of the Board of Directors, including the affirmative vote of a majority
of the independent directors. A board resolution providing this nominating
process will be in place on the date of the Company's annual meeting.
Although the Company is not currently required to have a majority of
independent directors on its Board of Directors, the Company continues to search
for additional, highly qualified, individuals, who would be deemed independent,
to appoint to its Board of Directors. As a small company, the Company has
generally used an informal process to identify and evaluate director candidates.
Although the Company believes that identifying and nominating highly skilled and
experienced director candidates is critical to its future, the Company has not
engaged, nor does it believe that it is necessary at this time to engage, any
third party to assist it in identifying director candidates. The Company has
encouraged both independent directors and directors that are not independent to
identify nominees for the Board of Directors. The Company believes that as a
result, it is presented with a more diverse and experienced group of candidates
for discussion and consideration.
There have been no material changes to the procedures by which security
holders of the Company may recommend nominees to the Company's Board of
Directors.
9(h) Compensation Committee
The Board of Directors of the Company has established a separately
designated standing Compensation Committee. The Compensation Committee, which
was formed in June 2002, and took action by unanimous consent one time during
the fiscal year ended December 31, 2003. The Compensation Committee was formed
to set policies for compensation of the Chief Executive Officer and the other
executive officers of the Company. The Compensation Committee periodically
compares the Company's executive compensation levels with those of companies
with which the Company believes that it competes for attraction and retention of
senior caliber personnel. The Compensation Committee either determines or
recommends to the Board of Directors the compensation of all executive officers.
During fiscal 2003, the Compensation Committee was, and continues to be
composed of Mr. Harris and Mr. Cahr, each of whom are deemed independent.
9(i) Code of Ethics
The Board of Directors of the Company has adopted a code of ethics,
which applies to all directors, officers and employees of the Company. The
Company's code of ethics is intended to comply with the requirements of newly
adopted SEC rules and regulations.
The Company's code of ethics is posted on the Company's Internet
website. The Company's Internet address is www.pacifichealthlabs.com. The
Company will provide its code of ethics in print without charge to any
stockholder who makes a written request to: Corporate Secretary, PacificHealth
Laboratories, Inc., 100 Matawan Road, Suite 420, Matawan, NJ 07747. Any waivers
27
of the application, and any amendments to, the Company's code of ethics must be
made by the Company's Board of Directors. Any waivers of, and any amendments to,
the Company's code of ethics will be disclosed promptly on the Company's
Internet website, www.pacifichealthlabs.com.
ITEM 10. EXECUTIVE COMPENSATION
Dr. Robert Portman is the only executive officer of the Company with a
fixed-term employment agreement. Currently, Dr. Portman is employed by the
Company under a 2003 Employment Agreement that was effective as of January 1,
2003. Under the 2003 Employment Agreement, Dr. Portman receives a salary of
$275,000 per year. The 2003 Employment Agreement also provides that Dr. Portman
may request the Compensation Committee of the Board of Directors to renegotiate
his salary if the Company's financial situation improves. In addition, Dr.
Portman is entitled to a discretionary bonus upon the recommendation of the
Compensation Committee. Also pursuant to the 2003 Employment Agreement, Dr.
Portman received options to purchase up to 300,000 shares of Common Stock under
the Company's 2000 Stock Option Plan priced at $2.79 per share (the market price
of the Company's common stock at December 24, 2002). One-third of the options
vested on January 1, 2003, and one-third vested on January 1, 2004. The
remaining one-third vests on January 1, 2005, provided that Dr. Portman is
employed by the Company at such dates. To the extent not previously vested, the
options also will vest if Dr. Portman's employment is terminated by the Company
without cause or by Dr. Portman with cause.
The 2003 Employment Agreement has a term of two years, and will
terminate on December 31, 2004 unless terminated earlier by either Dr. Portman
or the Company. Dr. Portman has the right to terminate the 2003 Employment
Agreement without cause on thirty days prior written notice, or with cause (as
defined in the 2003 Employment Agreement). The Company has the right to
terminate the 2003 Employment Agreement for cause (as defined in the 2003
Employment Agreement). In addition, if Dr. Portman's employment is terminated
for any reason whatsoever (except by the Company with cause), Dr. Portman will
be entitled to receive a lump sum payment of an amount equal to the base salary
which would have been paid during the period beginning on the date of
termination of employment and ending on the earlier of (1) the scheduled
termination date or (2) the first anniversary date of the termination date. Upon
Dr. Portman's termination for any reason, including his voluntary termination,
Dr. Portman will not be bound by any non-competition agreement unless we
continue to pay his salary, in which case he will be subject to a one-year
non-competition agreement.
Under the Company's arrangement with Mr. Bollinger, in the event of a
sale, merger or change in control of the Company, if Mr. Bollinger is
subsequently terminated, if his compensation substantially changed, or if
certain other aspects of his employment are materially affected, Mr. Bollinger
would be entitled to double his ordinary severance of three months' salary, and
all of his options would become immediately vested.
The table below sets forth information concerning compensation paid to
Dr. Portman, Stephen Kuchen, Vice President - Finance and CFO, and Bruce
Bollinger, Executive Vice President - Marketing in 2003, 2002, and 2001. No
executive officers of the Company other than Dr. Portman, Mr. Kuchen, and Mr.
Bollinger received compensation of $100,000 or more in fiscal 2003, 2002, and
2001.
28
Summary Compensation Table
------------------------------------------------------------------------------------------------------------------------------
Annual Compensation Long Term Compensation
----------------------------------------- -----------------------------------------
Awards Payouts
------------------------------ ----------
Securities
Under-
Other Restricted lying All Other
Name and Annual Compen- Stock Options/ LTIP Compen-
Principal Salary Bonus sation Award(s) SARs Payouts sation
Position Year ($) ($) ($) ($) (#) ($) ($)
(a) (b) (c) (d) (e) (f) (g) (h) (i)
------------------------------------------------------------------------------------------------------------------------------
Dr. Robert
Portman, CEO and
President 2003 275,000 -0- (1) -0- -0- -0- -0-
--------------------------------------------------------------------------------------------------------
2002 275,000 -0- (1) -0- 300,000 -0- -0-
--------------------------------------------------------------------------------------------------------
2001 275,000 111,120 217,075 (2) -0- 1,160,000 (3) -0- -0-
------------------------------------------------------------------------------------------------------------------------------
Stephen Kuchen, 2003 115,000 500 (1) -0- 20,000 -0- -0-
VP - Finance & CFO
--------------------------------------------------------------------------------------------------------
2002 100,000 500 (1) -0- -0- -0- -0-
--------------------------------------------------------------------------------------------------------
2001 92,500 3,000 (1) -0- 25,000 -0- -0-
------------------------------------------------------------------------------------------------------------------------------
Bruce Bollinger, 2003 150,000 500 (1) -0- -0- -0- -0-
Executive VP-
Marketing
--------------------------------------------------------------------------------------------------------
2002 25,000 (4) 250 (1) -0- 105,000 -0- -0-
------------------------------------------------------------------------------------------------------------------------------
(1) Less than 10% of annual salary and bonus.
(2) Value of re-priced options on date of exercise by Dr. Portman.
(3) 475,000 of these options were re-priced options issued to Dr. Portman prior
to 1999, as discussed above and 225,000 of these options were replacements
for options that expired in 2001.
(4) Mr. Bollinger joined the Company in November 2002.
The following table sets forth certain information regarding options granted in
fiscal 2003:
Option/SAR Grants in Fiscal-Year 2003
(Individual Grants)
----------------------------------------------------------------------------------------------------------------------
Number of Percent Of Total
Securities Options/SARs
Underlying Granted to Exercise Or
Options/SARs Employees In Base Price
Name Granted (#) Fiscal Year ($/Share) Expiration Date
(a) (b) (c) (d) (e)
----------------------------------------------------------------------------------------------------------------------
Robert Portman -0- -0- - - - - - -
----------------------------------------------------------------------------------------------------------------------
Stephen Kuchen 20,000 (1) 43.5% $1.92 03/06/08
----------------------------------------------------------------------------------------------------------------------
Bruce Bollinger -0- -0- - - - - - -
----------------------------------------------------------------------------------------------------------------------
(1) Mr. Kuchen's options vest as to 10,000 shares at March 6, 2004 and 10,000
shares at March 6, 2005.
29
The following table sets forth information with respect to the number
of unexercised options and the value of unexercised "in-the-money" options held
by Robert Portman, Stephen Kuchen, and Bruce Bollinger at December 31, 2003.
Aggregated Option/SAR Exercises in Fiscal-Year 2003 and
Option/SAR Values at 12/31/03
----------------------------------------------------------------------------------------------------------------------
Number of Securities $ Value of Unexercised
Underlying Unexercised In-the-Money Options/SARs
Shares Options/SARs At 12/31/03 At 12/31/03
Acquired Value Exercisable/ Exercisable/
On Exercise Realized Unexercisable Unexercisable
Name (#) ($) (#) ($)
(a) (b) (c) (d) (e)
----------------------------------------------------------------------------------------------------------------------
Exercisable Unexercisable Exercisable Unexercisable
----------------------------------------------------------------------------------------------------------------------
Robert Portman -0- -0- 1,460,000 100,000 $ 322,870 -0-
----------------------------------------------------------------------------------------------------------------------
Stephen Kuchen -0- -0- 60,000 20,000 $ 6,970 -0-
----------------------------------------------------------------------------------------------------------------------
Bruce Bollinger -0- -0- 35,000 70,000 -0- -0-
----------------------------------------------------------------------------------------------------------------------
For the purpose of computing the value of "in-the-money" options at
December 31, 2003, in the above table, the fair market value of the Company's
common stock at such date is deemed to be $1.01 per share, the closing sale
price of the Common Stock on such date as reported by the OTC Bulletin Board.
Directors' Compensation in Fiscal-Year 2003
For the year ended December 31, 2003, the Company compensated
independent directors D. Portman, Campbell, Cahr, and Harris $4,000 each. All
directors other than Robert Portman and Stephen Kuchen were each granted options
to purchase shares at $0.85 per share in lieu of director's fees from September
1, 2003 through August 31, 2004. Director Horn was also granted 10,000 options
to purchase shares at $0.80 per share as an incentive to join the Board.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires that
the Company's directors and executive officers, and any persons who own more
than ten percent of the Company's common stock, file with the Securities and
Exchange Commission ("SEC") initial reports of ownership and reports of changes
in ownership of the common stock and other equity securities of the Company.
Such persons are required by SEC regulations to furnish the Company with copies
of all such reports that they file. To the knowledge of the Company, based upon
its review of these reports, all Section 16 reports required to be filed by
directors, executive officers and beneficial owners of the Company during the
fiscal year ended December 31, 2003 were filed on a timely basis.
30
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
As of March 24, 2004, the Company had 10,240,545 shares of common stock
outstanding. The following table sets forth information concerning the present
ownership of the Company's common stock by the Company's directors, executive
officers and each person known to the Company to be the beneficial owner of more
than five percent of the outstanding shares of the Company's common stock.
Common Stock (2) Common Stock (2)
Name and Address (1) Amount Beneficially Owned Percentage of Class
-------------------- ------------------------- -------------------
Robert Portman (3) 2,961,051 25.4%
President, Chief Executive Officer and
a Director
Stephen P. Kuchen (4) 86,044 *
Vice President, Chief Financial
Officer and a Director
Bruce Bollinger (5) 35,000 *
Executive Vice President- Marketing
David I. Portman (6) 468,928 4.5%
Secretary and a Director
Michael Cahr (7) 20,000 *
Director
Joseph Harris (8) 21,000 *
Director
Greg Horn (9) 811,711 7.7%
Director
Executive Officers and Directors as a 4,403,734 36.0%
group (7 persons)
GlaxoSmithKline PLC 541,711 5.3%
Glaxo Wellcome House
Berkeley Avenue
Greenford, Middlesex
England UB6 0NN
Matthew Smith
241 Central Park West
New York, NY 10024 636,096 6.2%
31
-------------
* Less than one percent
(1) Except as otherwise indicated, the address of each person named in the
above table is c/o PacificHealth Laboratories, Inc., 100 Matawan Road,
Suite 420, Matawan, NJ 07747.
(2) Common Stock which is issuable upon the exercise of a stock option
which is presently exercisable or which becomes exercisable within
sixty days is considered outstanding for the purpose of computing the
percentage ownership (x) of persons holding such options, and (y) of
officers and directors as a group with respect to all options held by
officers and directors.
(3) Includes 800,000 shares issuable upon the exercise of options granted
under the Company's 1995 Incentive Stock Option Plan ("1995 Plan");
460,000 shares issuable upon the exercise of options granted under the
Company's 2000 Incentive Stock Option Plan ("2000 Plan"); and 160,428
shares issuable upon the exercise of warrants issued pursuant to a 2003
Private Placement. Does not include 200,000 shares of Common Stock
owned by Jennifer Portman, Dr. Portman's wife, individually and as
Trustee for his and her minor children, as to which Dr. Portman
disclaims beneficial ownership.
(4) Includes 55,000 shares issuable upon the exercise of options granted
under the 1995 Plan; 15,000 shares issuable upon the exercise of
options granted under the 2000 Plan; and 5,348 shares issuable upon the
exercise of warrants issued pursuant to a 2003 Private Placement.
(5) Includes 35,000 shares issuable upon the exercise of options granted
under the 2000 Plan.
(6) Includes 20,000 shares issuable upon the exercise of options granted
under the Company's 1995 Plan; 53,476 shares issuable upon the exercise
of warrants granted pursuant to a 2003 Private Placement; and 100,000
shares issuable upon exercise of warrants issued pursuant to a 2001
debt financing.
(7) Includes 20,000 shares issuable upon the exercise of options granted
under the 1995 Plan
(8) Includes 20,000 shares issuable upon the exercise of options granted
under the 1995 Plan
(9) Includes 10,000 shares issuable upon the exercise of options granted
under the 1995 Plan; 10,000 shares issuable upon the exercise of
options granted under the 2000 Plan; and 213,904 shares issuable upon
the exercise of warrants issued pursuant to a 2003 Private Placement.
Does not include 53,476 shares of Common Stock owned by Mr. Horn's
mother and 357,143 shares of Common Stock owned by Mr. Horn's father as
to which Mr. Horn disclaims beneficial ownership.
32
Existing Stock Compensation Plans
The following table sets forth information regarding our existing
compensation plans and individual compensation arrangements pursuant to which
our equity securities are authorized for issuance to employees or non-employees
(such as directors, consultants and advisors) in exchange for consideration in
the form of services:
-------------------------------------------------------------------------------------------------------------------------
Number of securities
remaining available for
Number of securities to be future issuance under
issued upon exercise of Weighted-average exercise equity compensation plans
outstanding options, price of outstanding (excluding securities
Plan Category warrants and rights options, warrants and rights reflected in column (a))
-------------------------------------------------------------------------------------------------------------------------
(a) (b) (c)
-------------------------------------------------------------------------------------------------------------------------
Equity compensation plans 2,244,075 $1.68 755,925
approved by security holders
-------------------------------------------------------------------------------------------------------------------------
Equity compensation plans not N/A N/A
approved by security holders - 0 -
-------------------------------------------------------------------------------------------------------------------------
Total 2,244,075 $1.68 755,925
-------------------------------------------------------------------------------------------------------------------------
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
During the last two fiscal years, the Company has not entered into any
material transactions or series of transactions which, in the aggregate, would
be considered material in which any officer, director or beneficial owner of 5%
or more of any class of capital stock of the Company had a direct or indirect
material interest, nor are any such transactions presently proposed, except as
follows:
(a) In December 2003, the Company acquired all of the outstanding
capital stock of Strong Research Corp. ("STRONG") from the Company's director,
Gregory T. Horn. In exchange, the Company issued to Mr. Horn 150,000 shares of
the Company's common stock. The Company also will issue an additional 150,000
shares to Mr. Horn if certain milestones are achieved. In addition, the Company
issued 52,000 shares of its common stock to satisfy obligations of STRONG for
services rendered by consultants. All of the Company's independent directors
present at the board meeting where this transaction was approved, constituting 2
of the Company's 3 independent directors in office at the time, considered the
potential conflicts of interest and, based on information provided by the
officers, concluded that the transaction was in the best interest of the
Company, and that the terms of the transaction were fair and reasonable to the
Company and as favorable to the Company as if STRONG were controlled by an
unaffiliated party. On December 29, 2003, the Company filed with the SEC a
Current Report on form 8-K discussing this transaction.
33
(b) In an August and September 2003 private placement, the Company
issued an aggregate of 3,208,556 shares of its common stock, together with
warrants exercisable for an aggregate of 1,604,278 shares of its common stock.
The shares and warrants were issued in units of two shares and one warrant. Each
warrant is exercisable for one share of common stock. Investors paid $0.935 for
each unit, which price represented a 15% discount from the market price of two
shares, calculated over a ten day period as of the initial closing. Certain of
the Company's executive officers and directors participated in this transaction.
Dr. Robert Portman, David Portman and Stephen Kuchen, respectively, purchased
320,856, 106,952 and 10,696 shares, together with 160,428, 53,476 and 5,348
warrants, in this private placement, on the same price and terms as
non-affiliated investors. In addition, Mr. Horn, the Company's new director,
purchased 427,807 shares and 213,903 warrants on the same terms as other
investors. Mr. Horn committed to the purchase of such shares at approximately
the same time as he was elected director.
ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) A list of the financial statements and financial statement schedule filed as
a part of this report is set forth on page F-1 hereof. A list of the exhibits
filed as a part of this report is set forth in the Exhibit Index starting after
page F-17 hereof.
(b) Reports on Form 8-K
On September 4, 2003, the Company filed a Current Report on Form 8-K
dated August 28, 2003, reporting, on Item 5, the initial closing of a private
placement. The Company also filed, as Exhibit 99.1, a press release relating to
the closing.
On October 2, 2003, the Company filed a Current Report on Form 8-K
dated September 24, 2003 reporting, on Item 5, the election of Gregory T. Horn
to the board of directors and the second closing of the private placement. The
Company also filed, as Exhibit 99.1, a press release relating to the closing.
On November 7, 2003, the Company filed a Current Report of Form 8-K
dated November 6, 2003 reporting, on Item 12, that the Company had issued a
press release announcing certain financial results. The press release was filed
as Exhibit 99.1.
On December 29, 2003, the Company filed a Current Report of Form 8-K
dated December 17, 2003 reporting, on Item 5, the Company's acquisition of
STRONG Research. A press release announcing the acquisition was filed as Exhibit
99.1.
34
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
During the fiscal years ended December 31, 2002 and 2003, Eisner LLP,
the Company's independent auditors, billed the Company the fees set forth below
in connection with services rendered by the independent auditors to the Company:
Fee Category Fiscal 2002 Fiscal 2003
------------ ----------- -----------
Audit Fees(1) $ 18,175 $ 44,500
Audit-Related Fees(2) $ - 0 - $ 1,500
Tax Fees(3) $ - 0 - $ 4,000
All Other Fees(4) $ 2,000 $ - 0 -
-------- --------
TOTAL $ 20,175 $ 50,000
======== ========
(1) Audit fees consisted of fees for the audit of the Company's annual
financial statements and review of quarterly financial statements as well as
services normally provided in connection with statutory and regulatory filings
or engagements, comfort letters, consents and assistance with and review of
Company documents filed with the SEC.
(2) Audit-related fees consisted of fees for assurance and related
services, including primarily employee benefit plan audits, due diligence
related to acquisitions, accounting consultations in connection with
acquisitions, consultation concerning financial accounting and reporting
standards and consultation concerning matters related to Section 404 of the
Sarbanes Oxley Act of 2002.
(3) Tax fees consisted primarily of fees for tax compliance, tax advice
and tax planning services.
(4) Other fees consisted of transitional costs in connection with
changing auditors.
Policy for Pre-Approval of Audit and Non-Audit Services
The Audit Committee's policy is to pre-approve all audit services and
all non-audit services that the Company's independent auditor is permitted to
perform for the Company under applicable federal securities regulations. As
permitted by the applicable regulations, the Audit Committee's policy utilizes a
combination of specific pre-approval on a case-by-case basis of individual
engagements of the independent auditor and general pre-approval of certain
categories of engagements up to predetermined dollar thresholds that are
reviewed annually by the Audit Committee. Specific pre-approval is mandatory for
the annual financial statement audit engagement, among others.
The pre-approval policy was implemented effective as of March 16, 2004.
All engagements of the independent auditor to perform any audit services and
non-audit services since that date have been pre-approved by the Audit Committee
in accordance with the pre-approval policy. The policy has not been waived in
any instance. All engagements of the independent auditor to perform any audit
services and non-audit services prior to the date the pre-approval policy was
implemented were approved by the Audit Committee in accordance its normal
functions.
35
SUPPLEMENTAL INFORMATION
The Issuer has not sent an annual report or proxy statement to security
holders in respect of the fiscal year ending December 31, 2003. Such report and
proxy statement will be furnished to security holders in connection with the
Company's Annual Meeting, scheduled to be held in the second quarter of 2004.
Copies of such material will be furnished to the Commission when it is sent to
security holders.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
PacificHealth Laboratories, Inc.
By: s/Robert Portman
--------------------------------------------------
Robert Portman, President, Chief Executive Officer
Date: March 30, 2004
In accordance with the Securities Exchange Act of 1934 and the requirements of
Form 10-KSB, this Report has been signed below by the following persons on
behalf of the registrant and in the capacities and on the dated indicated.
s/Robert Portman Director and Chief March 30, 2004
------------------------ Executive Officer
Robert Portman
s/Stephen P. Kuchen Director and Principal March 30, 2004
------------------------ Financial and Accounting
Stephen P. Kuchen Officer
s/David I. Portman Director and Secretary March 30, 2004
------------------------
David I. Portman
s/Michael Cahr Director March 30, 2004
------------------------
Michael Cahr
s/Joseph Harris Director March 30, 2004
------------------------
Joseph Harris
s/Gregory Horn Director March 30, 2004
------------------------
Gregory Horn
EXHIBIT INDEX
-------------
36
PACIFICHEALTH LABORATORIES, INC.
FINANCIAL STATEMENTS
DECEMBER 31, 2003 and 2002
PACIFICHEALTH LABORATORIES, INC.
Contents
Page
----
Financial Statements
Independent auditors' report F-1
Balance sheets as of December 31, 2003 and 2002 F-2
Statements of operations for the years ended December 31, 2003 and 2002 F-3
Statements of changes in stockholders' equity for the years ended December 31, 2003 and 2002 F-4
Statements of cash flows for the years ended December 31, 2003 and 2002 F-5
Notes to financial statements F-6
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
PacificHealth Laboratories, Inc.
Matawan, New Jersey
We have audited the accompanying balance sheets of PacificHealth Laboratories,
Inc. as of December 31, 2003 and 2002, and the related statements of operations,
changes in stockholders' equity and cash flows for the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements enumerated above present fairly, in all
material respects, the financial position of PacificHealth Laboratories, Inc. as
of December 31, 2003 and 2002, and the results of its operations and its cash
flows for the years then ended, in conformity with accounting principles
generally accepted in the United States of America.
Eisner LLP
Florham Park, New Jersey
February 13, 2004
F-1
PACIFICHEALTH LABORATORIES, INC.
Balance Sheets
December 31,
-------------------------------
2003 2002
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,798,703 $ 628,436
Accounts receivable, net 669,300 335,219
Inventories 738,062 1,537,784
Prepaid expenses 191,859 142,865
------------- -------------
Total current assets 3,397,924 2,644,304
Property and equipment, net 60,307 66,835
Other assets 155,251
Deposits 10,895 3,991
------------- -------------
$ 3,624,377 $ 2,715,130
============= =============
LIABILITIES
Current liabilities:
Notes payable $ 470,145 $ 64,212
Accounts payable and accrued expenses 376,693 280,384
Other liabilities 100,000
------------- -------------
Total current liabilities 846,838 444,596
------------- -------------
Commitments (Note G)
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value, authorized 1,000,000 shares;
none issued and outstanding
Common stock, $.0025 par value, authorized 50,000,000 shares; issued and
outstanding 10,188,545 shares at December 31, 2003 and
6,114,703 shares at December 31, 2002; 52,000 shares issuable 25,471 15,287
Additional paid-in capital 15,788,068 13,839,973
Accumulated deficit (13,036,000) (11,584,726)
------------- -------------
Total stockholders' equity 2,777,539 2,270,534
------------- -------------
$ 3,624,377 $ 2,715,130
============= =============
See notes to financial statements F-2
PACIFICHEALTH LABORATORIES, INC.
Statements of Operations
Year Ended
December 31,
------------------------------
2003 2002
------------ -------------
Revenue:
Products $ 5,453,571 $ 5,120,353
------------ -------------
Cost of goods sold:
Product sales 2,799,462 2,467,608
Write-off of inventory 1,297,485
------------ -------------
2,799,462 3,765,093
------------ -------------
Gross profit 2,654,109 1,355,260
------------ -------------
Operating expenses:
Selling, general and administrative 3,783,923 3,725,512
Research and development 231,651 165,514
Depreciation 40,785 47,045
------------ -------------
4,056,359 3,938,071
------------ -------------
Loss from operations before other income (expense) (1,402,250) (2,582,811)
------------ -------------
Other income (expense):
Interest income 9,685 15,378
Interest expense (58,709) (3,019)
------------ -------------
(49,024) 12,359
------------ -------------
Net loss $ (1,451,274) $ (2,570,452)
============ =============
Net loss per share - basic $(0.20) $(0.42)
Net loss income per share - diluted $(0.20) $(0.42)
Weighted average shares outstanding:
Basic 7,094,334 6,081,753
Diluted 7,094,334 6,081,753
See notes to financial statements F-3
PACIFICHEALTH LABORATORIES, INC.
Statements of Changes in Stockholders' Equity
Common Stock Additional
---------------------- Paid-in Accumulated
Shares Amount Capital Deficit Total
---------- -------- ------------ ------------ -----------
Balance, January 1, 2002 6,039,203 $ 15,098 $ 13,674,479 $ (9,014,274) $ 4,675,303
Stock options exercised 75,500 189 136,562 136,751
Fair value of stock options issued to non-employees 28,932 28,932
Net loss (2,570,452) (2,570,452)
---------- -------- ------------ ------------ -----------
Balance, December 31, 2002 6,114,703 15,287 13,839,973 (11,584,726) 2,270,534
Stock options exercised 1,000 2 1,058 1,060
Fair value of stock options issued to non-employees 7,552 7,552
Stock issued in private placements, net of issuance costs 3,922,842 9,807 1,827,360 1,837,167
Stock issued in asset acquisition 150,000 375 112,125 112,500
Net loss (1,451,274) (1,451,274)
---------- -------- ------------ ------------ -----------
Balance, December 31, 2003 10,188,545 $ 25,471 $ 15,788,068 $(13,036,000) $ 2,777,539
========== ======== ============ ============ ===========
See notes to financial statements F-4
PACIFICHEALTH LABORATORIES, INC.
Statements of Cash Flows
Year Ended December 31,
--------------------------------
2003 2002
------------ ------------
Cash flows from operating activities:
Net loss $ (1,451,274) $ (2,570,452)
Adjustments to reconcile net loss net cash used in operating activities:
Depreciation 40,785 47,045
Fair value of non-employee stock options 7,552 28,932
Write-off of inventory 1,297,485
Changes in:
Accounts receivable (334,081) (142,591)
Prepaid expenses (48,994) 22,214
Inventories 799,722 (200,997)
Deposits (6,904) 104,331
Accounts payable and accrued expenses 53,558 (11,122)
Other liabilities (100,000) 100,000
------------ ------------
Net cash used in operating activities (1,039,636) (1,325,155)
------------ ------------
Cash flows from investing activity:
Purchase of property and equipment (34,257) (51,171)
------------ ------------
Cash flows from financing activities:
Issuance of common stock 1,837,167
Common stock options exercised 1,060 136,751
Proceeds of note payable 3,095,362 118,776
Repayment of note payable (2,689,429) (99,612)
------------ ------------
Net cash provided by financing activities 2,244,160 155,915
------------ ------------
Net increase (decrease) in cash and cash equivalents 1,170,267 (1,220,411)
Cash and cash equivalents at beginning of year 628,436 1,848,847
------------ ------------
Cash and cash equivalents at end of year $ 1,798,703 $ 628,436
============ ============
Supplemental disclosure of cash flow information:
Cash paid for:
Interest $ 58,709 $ 3,019
Noncash investing activity:
Stock-based consideration for acquisition of Strong Research, Inc. $ 155,251
See notes to financial statements F-5
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2003 and 2002
NOTE A - THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES
[1] The Company:
PacificHealth Laboratories, Inc. (the "Company" or "PHLI") was incorporated
in April 1995 to develop and market dietary supplement products that improve
and promote health and well-being and can be offered for sale without prior
approval by the Food and Drug Administration under current regulatory
guidelines. The Company currently markets two lines of products which may
utilize its proprietary patented technology. The Company utilizes
third-party contractors to manufacture all products.
[2] Cash and cash equivalents:
The Company considers all highly liquid investments with a maturity of three
months or less at the date of purchase to be cash equivalents.
[3] Allowance for doubtful accounts:
The Company provides an allowance for uncollectible accounts receivable
based on management's evaluation of collectibility of outstanding accounts
receivable.
[4] Inventories:
Inventories are recorded at the lower of cost or market using the first-in,
first-out ("FIFO") method.
[5] Property and equipment:
Property and equipment are stated at cost and are depreciated using the
straight-line method over their estimated useful lives ranging from 2 to 5
years.
[6] Earnings per share:
Basic earnings per share is computed by dividing net income by the weighted
average number of common shares outstanding during the year. Diluted
earnings per share gives effect to all dilutive potential common shares
outstanding during the year. The dilutive effect of the outstanding stock
warrants and options was computed using the treasury stock method. For the
years ended December 31, 2003 and 2002, diluted earnings per share did not
include the effect of 2,244,075 and 2,238,575 of options outstanding and
2,238,275 and 122,000 of warrants outstanding, respectively, at such dates
as this effect would be anti-dilutive.
F-6
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2003 and 2002
NOTE A - THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[7] Revenue recognition:
Revenue from product sales is recognized upon shipment to customers, title
passing and satisfaction of all obligations of the Company. Generally sales
contracts do not provide for product returns, rebates, discounts or other
adjustments. Infrequent customer contracts, while unusual, provide for
contractual discounts, rebates, return allowances and other adjustments. A
provision for these adjustments is made in the same period the related
sales are recorded. These provisions have historically been insignificant.
Except for the occasional contractual adjustments and product recalls, the
Company generally does not accept product returns or make other
adjustments. When the Company recalls or discontinues a product, subsequent
to the initial sale, an allowance is provided when the recall or
discontinuance becomes known.
Consigned sales are not recorded until the product is re-sold and payment
from the consignee is received. There were no outstanding consigned sales
at December 31, 2003 and 2002.
[8] Research and development:
Costs of research and development activities are expensed as incurred.
[9] Advertising costs:
Advertising costs are expressed as incurred. During 2003 and 2002, the
Company recorded advertising expense of $727,425 and $900,396,
respectively.
[10] Stock-based compensation:
The Company accounts for stock-based employee compensation under Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees", and related interpretations. The Company has adopted the
disclosure-only provisions of Statement of Financial Accounting Standards
("SFAS") No. 123, "Accounting for Stock-Based Compensation" and SFAS No.
148, "Accounting for Stock-Based Compensation - Transition and Disclosure",
which was released in December 2002 as an amendment of SFAS No. 123. The
Company's stock option plans are described in Note I. The following table
illustrates the effect on net (loss) income and earnings per share if the
fair value based method had been applied to all awards.
Year Ended December 31,
-----------------------------
2003 2002
------------ ------------
Reported net loss $ (1,451,274) $ (2,570,452)
Stock-based employee compensation determined under the
fair value based method, net of related tax effects (246,870) (267,377)
------------ ------------
Pro forma net loss $ (1,698,144) $ (2,837,829)
============ ============
Basic loss per share:
As reported $(.20) $(.42)
===== =====
Pro forma $(.24) $(.47)
===== =====
Diluted loss per share:
As reported $(.20) $(.42)
===== =====
Pro forma $(.24) $(.47)
===== =====
F-7
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2003 and 2002
NOTE A - THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[10] Stock-based compensation: (continued)
The fair value of each option grant on the date of grant is estimated using
the Black-Scholes option-pricing model with a volatility of 142% for 2003
and 132% for 2002, expected life of options of 5 years, risk-free interest
rate of approximately 3% in 2003 and 2002 and a dividend yield of 0%. The
weighted average fair values of options granted during the years ended
December 31, 2003 and 2002 were $1.68 and $2.17, respectively.
[11] Segment information:
The Company operates in one business segment: the design, development and
marketing of dietary and nutritional supplements that enhance health and
well-being.
[12] Income taxes:
The Company recognizes deferred tax liabilities and assets for the expected
future tax consequences of events that have been included in the financial
statements or tax returns. Under this method, deferred tax liabilities and
assets are determined on the basis of the differences between the tax basis
of assets and liabilities and their respective financial reporting amounts
("temporary differences") at enacted tax rates in effect for the years in
which the differences are expected to reverse. Any resulting deferred tax
asset is reduced, if necessary, by a valuation allowance for any tax
benefits, which are not expected to be realized.
[13] Comprehensive income:
Other than net loss the Company does not have any comprehensive income
items at December 31, 2003 and 2002.
[14] Recent accounting pronouncements:
In November 2002, the FASB issued Interpretation No. 45 (the "FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
including Indirect Guarantees of Indebtedness of Others." FIN 45 clarifies
the requirements of SFAS No. 5, "Accounting for Contingencies," relating to
a guarantor's accounting for, and disclosure of, the issuance of certain
types of guarantees. For certain guarantees issued after December 31, 2002,
FIN 45 requires a guarantor to recognize, upon issuance of a guarantee, a
liability for the fair value of the obligations it assumes under the
guarantee. Guarantees issued prior to January 1, 2003, are not subject to
liability recognition, but are subject to expended disclosure requirements.
The adoption of this interpretation did not have a material impact on our
financial position or statements of operations.
In December 2003, FASB issued FIN 46R, an interpretation of Accounting
Research Bulletin No. 51. FIN 46R requires consolidation of variable
interest entities for which the Company is deemed to be the primary
beneficiary and disclose information about variable interest entities in
which the Company has a significant variable interest. FIN 46R has a
variety of effective dates. The adoption of this standard is not expected
to have a material effect on the Company's financial statements.
F-8
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2003 and 2002
NOTE A - THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
[15] Use of estimates:
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make certain estimates and assumptions that affect the
reported amounts of assets, liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported
amount of revenue and expenses during the reporting period. Actual results
may differ from these estimates.
NOTE B - INVENTORIES
Inventories which are held at third party warehouses consist of the following:
2003 2002
--------- -----------
Raw materials $ 14,841 $ 3,228
Packaging supplies 33,127 39,341
Finished goods 690,094 1,495,215
--------- -----------
$ 738,062 $ 1,537,784
========= ===========
NOTE C - PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
2003 2002
--------- ---------
Furniture and equipment $ 297,451 $ 270,609
Molds and dies 91,150 83,735
--------- ---------
388,601 354,344
Less accumulated depreciation 328,294 287,509
--------- ---------
$ 60,307 $ 66,835
========= =========
Depreciation expense aggregated $40,785 and $47,045 for the years ended December
31, 2003 and 2002, respectively.
NOTE D - OTHER ASSETS
In December 2003, the Company acquired all of the outstanding shares of Strong
Research, Inc. ("Strong"), a research-based educational sports nutrition
company, owned by one of the Company's directors. In connection with this
transaction, the Company issued 150,000 common shares valued at $112,500 at the
date of the transaction. The Company ascribed the entire value to a pending
patent. Such patent will be amortized over an estimated useful life of three
years. Strong is a development stage company and has not commenced planned
principal operations, the acquisition was accounted for as an acquisition of
assets and not a business combination.
F-9
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2003 and 2002
NOTE D - OTHER ASSETS (CONTINUED)
In addition, the Company agreed to settle certain liabilities of Strong and
issued 52,000 common shares in January 2004. The Company has recorded this
additional cost of approximately $42,000 as of December 31, 2003.
Further, the Company is contingently obligated to issue a one time additional
150,000 common shares to the seller if certain products developed as a result of
the acquisition reach $4 million in revenue for any twelve consecutive months.
The issuance of such shares will result in an increase to the purchase price of
assets acquired based upon the fair value of such shares at the date the
milestone is achieved.
NOTE E - NOTES PAYABLE
Included in notes payable at December 31, 2003 is a $400,827 balance payable.
During the second quarter of 2003, the Company obtained a $750,000 revolving
asset-based credit facility. This facility is for one year commencing on June 1,
2003. The amount of available credit is based on the value of the Company's
eligible receivables from time to time. Eligible receivables include those
receivables that have payment terms equal to or less than net 45 days or have
been outstanding for less than 90 days. The receivables are financed with
recourse. The credit facility bears interest at a rate of prime plus 2% as well
as a 0.75% discount rate on all advances.
In addition, the Company has a note payable as follows:
2003 2002
-------- --------
Installment note payable to insurance finance company
due in monthly installments of $7,343, including
interest at 6% through September 2004 $ 67,318
Installment note payable to insurance finance company
due in monthly installments of $7,343, including
interest at 6.95% through September 2003 $ 64,212
NOTE F - STOCKHOLDERS' EQUITY
The total number of shares of all classes of stock which the Company has
authority to issue is 51,000,000 shares, consisting of (a) fifty million
(50,000,000) shares of common stock, par value $.0025 per share, and (b) one
million (1,000,000) shares of preferred stock, par value $.01 per share. The
preferred stock may be issued in one or more series, and may have such voting
powers, full or limited, or no voting powers, and such designations and
preferences as shall be stated in the resolution or resolutions providing for
the issue thereof adopted by the Board of Directors of the Company, from time to
time.
During 2003, the Company issued 3,922,842 shares of common stock in two separate
private placements. The first private placement took place during August and
September 2003, in which the Company issued 1,604,278 units at $.935 per unit
with each unit consisting of 2 shares of common stock and a warrant to purchase
1 share of common stock at an exercise price of $.6325 per share. In connection
with this transaction, the Company issued 154,853 warrants to a third party for
investment banking services. The second private placement took place in December
2003 in which the Company issued 357,144 units at $1.40 per unit with each unit
consisting of 2 shares of common stock and 1 warrant to purchase 1 share of
common stock at $.85 per share.
F-10
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2003 and 2002
NOTE G - COMMITMENTS
[1] Employment agreement:
The Company entered into a two-year employment contract on January 1, 2003,
with the individual who is a stockholder, Chairman of the Board and CEO
that provides for minimum annual compensation of $275,000. The Company is
the beneficiary of a keyman life insurance policy (on the Chairman's life)
for $2,000,000.
[2] Lease:
Effective July 1, 2003, the Company entered into a new lease agreement for
office space which expires June 2007. The lease provides for the rental of
5,500 square feet.
The future minimum lease payments due under the leases are as follows:
Year Ending
December 31,
------------
2004 $ 123,750
2005 123,750
2006 136,125
2007 70,125
---------
$ 453,750
=========
Rent expense amounted to $102,507 and $68,031 in 2003 and 2002,
respectively.
NOTE H - STOCK OPTION PLANS AND WARRANTS
The Company has two stock option plans (the "Plans") under which 2,244,075
shares of common stock are reserved for issuance under the Plans. In 1995, the
Company established an incentive stock option plan (the "Plan") in which options
to purchase the common stock of the Company may be awarded to employees. In
2000, the Company established another stock option plan to increase the number
of options under the Plans.
Stock options may be granted as either incentive stock options intended to
qualify under Section 422 of the Internal Revenue Code of 1986, as amended (the
"Code"), or as options not qualified under Section 422 of the Code. All options
are issued with an exercise price at or above 100% of the fair market value of
the common stock on the date of grant. Incentive stock option plan awards of
restricted stock are intended to qualify as deductible performance-based
compensation under Section 162(m) of the Code. Incentive stock option awards of
unrestricted stock are not designed, to be deductible by the Company under
Section 162(m). The Board of Directors determines the option price (not to be
less than fair market value for incentive options) at the date of grant. The
options have a maximum term of 5 years and outstanding options expire from
February 2003 through November 2011. Vesting generally occurs over five years.
F-11
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2003 and 2002
NOTE H - STOCK OPTION PLANS AND WARRANTS (CONTINUED)
Stock option transactions for employees during 2003 and 2002 were as follows:
Weighted
Exercise Average
Price Per Exercise Price
Option Vested Common Per Share
Shares Shares Share Outstanding
--------- ---------- -------------- --------------
Balance, January 1, 2002 1,487,500 931,000 $0.313 - $4.75 $1.49
Granted/vested during the year 469,200 308,167 $0.98 - $4.88 2.52
Exercised during the year (61,000) (61,000) $1.00 - $2.00 1.98
--------- ---------
Balance, December 31, 2002 1,895,700 1,178,167 $0.313 - $4.88 1.68
Granted/vested during the year 106,000 488,617 $0.80 - $1.92 1.15
Cancelled during the year (24,000) (24,000) $3.77 - $4.75 4.38
--------- ---------
Balance, December 31, 2003 1,977,700 1,642,784 $0.313 - $4.88 1.58
========= =========
Information with respect to employee stock options outstanding and employee
stock options exercisable at December 31, 2003 is as follows:
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life (in Years) Price Exercisable Price
----------------- ----------- --------------- -------- ----------- --------
$ 0.313 - $2.00 1,041,700 2.85 $0.77 923,700 $0.73
$ 2.01 - $4.00 906,000 2.13 $2.64 688,584 2.58
$ 4.01 - $4.88 30,000 3.13 $4.57 30,000 4.57
--------- ---- ----- --------- -----
1,977,700 2.53 $1.68 1,642,284 $1.57
========= ==== ===== ========= =====
In addition to options granted to employees under the plans, the Company issued
stock options pursuant to contractual agreements to non-employees. Options
granted under these agreements are expenses when the related service or product
is provided. The Company recognized an expense of $7,552 and $28,932 for such
options issued in 2003 and 2002, respectively.
F-12
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2003 and 2002
NOTE H - STOCK OPTION PLANS AND WARRANTS (CONTINUED)
Stock option transactions for non-employees during 2003 and 2002 were as
follows:
Weighted
Exercise Average
Price Per Exercise Price
Option Vested Common Per Share
Shares Shares Share Outstanding
-------- ------- --------------- --------------
Balance, January 1, 2002 393,075 246,075 $ 0.313 - $6.30 $2.11
Granted/vested during the year 15,500 137,000 $ 1.00 - $3.80 1.24
Exercised during the year (15,000) (14,500) $ 1.00 - $1.25 1.08
Expired during the year (40,700) (40,700) $ 4.25 - $6.00 5.37
------- -------
Balance, December 31, 2002 352,875 327,875 $ 0.313 - $6.30 1.79
Granted/vested during the year 4,500 29,500 $ 0.80 - $2.15 0.90
Exercised during the year (1,000) (1,000) $ 1.06 1.06
Expired during the year (20,000) (20,000) $ 2.00 - $5.00 3.56
Cancelled during the year (70,000) (70,000) $ 0.313 - $3.89 1.38
------- -------
Balance, December 31, 2003 266,375 266,375 $ 0.313 - $6.30 1.57
======= =======
Information with respect to non-employee stock options outstanding and
non-employee stock options exercisable at December 31, 2003 is as follows:
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life (in Years) Price Exercisable Price
----------------- ----------- --------------- -------- ----------- ---------
$0.313 - $2.00 153,000 1.79 $1.03 153,000 $1.03
$2.01 - $4.00 106,875 1.04 2.33 106,875 2.33
$4.01 - $6.30 6,500 2.66 5.33 6,500 5.33
------- ---- ----- ------- -----
266,375 1.49 $1.68 266,375 $1.68
======= ==== ===== ======= =====
F-13
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2003 and 2002
NOTE H - STOCK OPTION PLANS AND WARRANTS (CONTINUED)
Stock warrant transactions during 2003 and 2002 were as follows:
Weighted
Average
Exercise Price Exercise Price
Per Per
Warrants Common Share Common Share
---------- --------------- --------------
Balance, January 1, 2002 298,875 $ 0.875 - $8.70 $4.75
Expired during the year (176,875) $ 0.875 - $8.70 7.11
---------
Balance, December 31, 2002 122,000 $ 0.875 - $3.48 1.35
Issued during the year 2,116,275 $ 0.633 - $0.85 0.67
---------
Balance, December 31, 2003 2,238,275 $ 0.633 - $3.48 0.71
=========
NOTE I - INCOME TAXES
The difference between the statutory federal income tax rate on the Company's
pre-tax income and the Company's effective income tax rate is summarized as
follows:
2003 2002
----------------------- -----------------------
Amount Percent Amount Percent
--------- ------- --------- -------
U.S. Federal income tax provision (benefit)
at federal statutory rate $(507,946) 35% $(899,658) 35%
Change in valuation allowance 463,345 (32) 883,101 (34)%
Other 44,601 (3) 16,557 (1)%
--------- --- --------- ---
$ 0 0% $ 0 0%
========= === ========= ===
At December 31, 2003, the Company has $12,262,000 in federal net operating loss
carryovers, which can be used to offset future taxable income. The net operating
loss carryforwards expire through the year 2023.
The components of the Company's deferred tax assets are as follows:
2003 2002
----------- -----------
Net operating loss carryforwards $ 4,830,000 $ 4,066,000
Deferred charges 45,000
Valuation allowance (4,830,000) (4,111,000)
----------- -----------
Deferred tax asset $ 0 $ 0
=========== ===========
The increase in the valuation allowance is attributable to the increase
in net loss during 2003.
F-14
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2003 and 2002
NOTE J - MAJOR CUSTOMERS AND CONCENTRATIONS OF CREDIT RISKS
[1] Concentrations of credit risk:
Financial instruments, which potentially subject the Company to
concentrations of credit risk, consist primarily of cash, cash equivalents
and trade accounts receivable.
The Company has concentrated its credit risk for cash by maintaining
substantially all of its depository accounts in a single financial
institution which exceeded the Federal Deposit Insurance Corporation
("FDIC") guarantee. The financial institution has a strong credit rating,
and management believes that credit risk relating to these deposits is
minimal.
The Company does not require collateral on its trade accounts receivable.
Historically, the Company has not suffered significant losses with respect
to trade accounts receivable.
[2] Fair value of financial instruments:
Cash, cash equivalents, accounts receivable, accounts payable and note
payable approximate their fair values due to the short maturity of these
instruments.
[3] Major customers:
For the years ended December 31, the Company had revenue from two customers
which accounted for approximately 24% and 22% in 2003 and 30% and 23% in
2002, of total revenue. Accounts receivable outstanding related to these
customers at December 31, 2003 and 2002 were $368,829 and $123,444,
respectively, which amounted to 24% and 31% in 2003 and 15% and 22% in 2002
of total receivables.
NOTE K - SEGMENT AND RELATED INFORMATION
At 2003 and 2002, the Company has one reportable segment:
Dietary and nutritional supplements.
The following table presents revenues by region:
2003 2002
----------- -----------
United States $ 5,174,339 $ 4,809,660
Canada 108,128 173,025
Other 171,107 137,668
Revenue by product line are as follows:
Sports Weight
Performance Loss Total
------------- --------- -----------
2003 $5,393,296 $ 60,275 $ 5,453,571
2002 $5,007,513 $ 112,840 $ 5,120,353
Sales revenue for the years ended December 31, 2003 and 2002 are net of credits
of $188,043 and $175,319, respectively, for the return of certain products.
These credits primarily relate to the sports performance product line.
F-15
EXHIBIT INDEX
Incorporated
Exhibit No. Description by Reference
----------- ----------- ------------
3.1 -- Certificate of Incorporation of the Company and
all amendments thereto A
3.2 -- Amended and Restated Bylaws of the Company C
3.3 -- Certificate of Amendment of Certificate of H
Incorporation of PacificHealth Laboratories, Inc.
4.1 -- Specimen Common Stock Certificate C
4.2 -- Stock Purchase Agreement dated June 1, 2001
between Pacific Health Laboratories, Inc. and
Glaxo Wellcome International B.V. E
4.3 -- Underwriter's Warrant Agreement and Form of
Warrant C
10.1 -- Incentive Stock Option Plan of 1995 A
10.2 -- Employment Agreement between the Company
and Robert Portman effective January 1, 1998 C
10.3 -- Strategic Alliance Agreement between the Company
and the Institute of Nutrition and Food Hygiene A
10.4 -- Exclusive Licensing Agreement between the
Company and the INFH A
10.5 -- Shareholders Agreement A
10.6 -- 2000 Incentive Stock Option Plan D
10.7 -- Employment Agreement between the Company
and Robert Portman effective January 1, 2001 F
10.8 -- License Agreement dated June 1, 2001 between
Pacific Health Laboratories, Inc. and SmithKline
Beecham PLC (d/b/a/ GlaxoSmithKline), redacted
to omit trade secret and confidential commercial
and financial information G
23.1 -- Consent of Eisner LLP *
37
31.1 -- Certification of Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002. *
31.2 -- Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002. *
32 -- Certifications of Chief Executive Officer and
Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002. *
99 -- Audit Committee Charter *
-------------------
* Filed herewith
A Filed with Registration Statement on Form SB-2 (Registration No.
333-36379) (the "1997 SB-2") on September 25, 1997.
B Filed with Amendment No. 1 to the 1997 SB-2 on October 23, 1997.
C Filed with Amendment No. 3 to the 1997 SB-2 on December 17, 1997.
D Filed with Definitive Proxy Statement (Schedule 14A) for annual meeting
held on August 16, 2000, filed on July 11, 2000.
E Filed with Current Report on Form 8-K dated June 1, 2001, filed on June
14, 2001.
F Filed with Annual Report on Form 10-KSB for the year ended December 31,
2001.
G Filed with Amendment to Current Report on Form 8-K dated June 1, 2001,
filed July 5, 2001.
H Filed with Annual Report on Form 10-KSB for the year ended December 31,
2002.
38