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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ____________to____________
Commission File Number: 001-13343
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ADVANTAGE MARKETING SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Oklahoma 73-1016728
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2601 Northwest Expressway, Suite 1210W
Oklahoma City, Oklahoma 73112
(Address of principal executive offices) (Zip code)
REGISTRANT'S TELEPHONE NUMBER INCLUDING AREA CODE: (405) 842-0131
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
Name of each exchange on
Title of each class which registered
------------------------------- ------------------------
Common Stock, $0.0001 Par Value American Stock Exchange
Redeemable Common Stock Purchase Warrants American Stock Exchange
1997-A Warrants American Stock Exchange
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
Common Stock, $0.0001 Par Value
Redeemable Common Stock Purchase Warrants
1997-A Warrants
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes [ ] No [X]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [ ].
On June 28, 2002, the aggregate market value of the voting and
non-voting common equity held by non-affiliates computed by reference to the
price at which the common equity was last sold, or the average bid and asked
prices of such common equity was $9,113,190.
As of March 24, 2003 there were 4,424,314 shares of Common Stock, par
value $0.0001 per share, outstanding.
Documents incorporated by reference: The information called for by Part
III is incorporated by reference to the definitive proxy statement for the
registrant's 2003 annual meeting of stockholders, which will be filed with the
Securities and Exchange Commission not later than 120 days after December 31,
2002.
ADVANTAGE MARKETING SYSTEMS, INC.
FORM 10-K
For the Fiscal Year Ended December 31, 2002
TABLE OF CONTENTS
Part I.
Item 1. Business.................................................................................. 3
Item 2. Properties................................................................................ 17
Item 3. Legal Proceedings......................................................................... 17
Item 4. Submission of Matters to a Vote of Security Holders....................................... 17
Part II.
Item 5. Market for Common Equity and Related Stockholder Matters.................................. 18
Item 6. Selected Financial Data................................................................... 19
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation...... 20
Item 7A. Quantitative and Qualitative Disclosures About Market Risk................................ 29
Item 8. Financial Statements and Supplementary Data............................................... 30
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure...... 30
Part III. **
Item 14. Controls and Procedures................................................................... 30
Part IV.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K........................... 30
** Information required by Items 10, 11, 12 and 13 of Part III is incorporated
by reference from the Company's definitive proxy statements for its 2003 annual
meeting of shareholders.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Certain statements under the captions "Item 1. Business," "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operation," and elsewhere in this report constitute "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Certain, but not
necessarily all, of such forward-looking statements can be identified by the use
of forward-looking terminology such as "anticipates," "believes," "expects,"
"may," "will," or "should" or other variations thereon, or by discussions of
strategies that involve risks and uncertainties. Our actual results or industry
results may be materially different from any future results expressed or implied
by such forward-looking statements. Factors that could cause actual results to
differ materially include general economic and business conditions; our ability
to implement our business and acquisition strategies; changes in the network
marketing industry and changes in consumer preferences; competition;
availability of key personnel; increasing operating costs; unsuccessful
advertising and promotional efforts; changes in brand awareness; acceptance of
new product offerings; changes in, or the failure to comply with, government
regulations (especially food and drug laws and regulations); our ability to
obtain financing for future acquisitions and other factors.
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PART I
ITEM 1. BUSINESS
Advantage Marketing Systems, Inc., or AMS, began operations in 1987,
and through a corporate reorganization in 1995, became an Oklahoma corporation.
We market a product line consisting of approximately one hundred products in
three categories; weight management, dietary supplement and personal care
products. These products are marketed through a network marketing organization
in which independent associates purchase products for resale to retail customers
as well as for their own personal use.
The associates in our network are encouraged to recruit interested
people to become new associates for our products. New associates are placed
beneath the recruiting associate in the "network" and are referred to as being
in that associate's "downline" organization. Our marketing plan is designed to
provide incentives to build, maintain and motivate an organization of recruited
associates in their downline organization to maximize their earning potential.
Associates generate income by purchasing our products at wholesale prices and
reselling them at retail prices. They also earn bonuses on product purchases
generated by the associates in their downline organization. See "--Network
Marketing."
On an ongoing basis, we review our product line for duplication and
sales movement and make adjustments accordingly. As of December 31, 2002, our
primary product line consisted of:
- 11 weight management products;
- 33 dietary supplement products; and
- 42 personal care products consisting primarily of skin care products.
Our products are manufactured by various manufacturers pursuant to formulations
developed for us and are sold to our independent associates located in all 50
states, the District of Columbia and Canada.
We believe that our network marketing system is ideally suited to
market weight management, dietary supplement and personal care products because
sales of such products are strengthened by ongoing personal contact between
associates and their customers. Our network marketing system appeals to a broad
cross-section of people, particularly those looking to supplement family income
or seeking part-time work. Associates are given the opportunity through
sponsored events and training sessions to network with other associates, develop
selling skills and establish personal goals. We supplement monetary incentives
with other forms of recognition in order to further motivate and foster an
atmosphere of excitement throughout our associate network.
ACQUISITION OF LIFESCIENCE TECHNOLOGIES, INC. ("LST")
Effective January 4, 2001, we purchased the LST group of companies for
$1.2 million and a five-year payment of $41,667 per month or 5% of the gross
sales of LST products, whichever is greater. The seller has the option to take
up to 860,000 shares of common stock in lieu of cash at an option price of $3.00
per share. As a result of the acquisition, we added 14 products and over 5,000
associates.
KEY OPERATING STRENGTHS
We believe the source of our success is our support of and compensation
program for our associates. We provide high-quality products and a highly
attractive bonus program, along with extensive training and motivational events
and services. We believe that we have established a strong operating platform to
support associates and facilitate future growth. The key components of this
platform include the following:
- Quality products, many of which emphasize herbs and other natural
ingredients to appeal to consumer demand for products that contribute
to a healthy lifestyle;
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- A compensation program that permits associates to earn income from
profits on the resale of products and residual income from reorder
bonuses on product purchases within an associate's downline
organization, as well as to participate in various non-cash awards,
such as vacations, offered through promotional programs;
- A superior communications and training program that effectively and
efficiently communicates with associates by utilizing new technologies
and marketing techniques, as well as motivational events and training
seminars; and
- The employment of information technology to provide timely and accurate
product order processing, weekly bonus payment processing, detailed
associate earnings statements, and inventory management.
GROWTH STRATEGY
Our growth strategy is redirecting our product and business focus to
capitalize on our performance-based nutrition, anti-aging and weight loss
products, where AMS owns or controls proprietary formulations and exclusive
worldwide distribution rights. This redirection, along with the addition of
state of the art internet marketing technology, should increase our network of
independent associates. An increase in the number of associates generally
results in increased sales volume, and new products create enthusiasm among
associates, serve as a promotional tool in selling other products, and attract
new associates. Since 1995, we have introduced many new products to our product
line in the weight management, dietary supplement and personal care categories,
primarily through the acquisition of:
- Miracle Mountain International, Inc. in May 1996;
- Chambre International, Inc. in January 1997;
- The assets of Stay 'N Shape International, Inc., Solution Products
International, Inc., Nation of Winners, Inc., and Now International,
Inc. in April 1997;
- All rights, including formulations and trademarks for the ToppFast,
ToppStamina and ToppFitt products from ToppMed, Inc. in July 1998; and
- Proprietary formulations and trademarks for LifeScience Technologies
including the adaptogen products, Prime One and Breckman's Gold in
January 2001.
We also seek to increase sales through initiatives designed to enhance
sales in our existing markets. These initiatives include increasing the number
of training and motivational events and teleconferences, hiring additional
associate support personnel and establishing more convenient regional support
centers in targeted geographic markets.
As noted above, we seek to grow through acquisitions. The network
marketing industry is fragmented, has relatively low barriers to entry, and
includes a number of small marketing companies, many of which are being acquired
by larger companies. Our strategy is to capitalize on these market
characteristics to achieve additional growth, both in terms of associates and
product line enhancement, through the acquisition of additional network
marketing companies or the assets of such companies.
The principal objective of our acquisition strategy is to acquire other
network marketing organizations that can be combined with our network marketing
organization, resulting in increased sales volume with minimal additional
administrative cost. We will not consummate an acquisition unless, at the time,
we anticipate that such acquisition will contribute to profitability and provide
positive cash flows from operations. There is no assurance, however, that we
will in the future be able to acquire other network marketing organizations, or
that such acquisitions will result in increased profitability and cash flows.
Our growth strategy requires expanded associate services and support,
increased personnel, expanded operational and financial systems and
implementation of additional control procedures. There is no assurance
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that we will be able to manage expanded operations effectively. Furthermore,
failure to implement financial, information management, and other systems and to
add control procedures could have a material adverse effect on our results of
operations and financial condition. Our acquisitions could involve a number of
risks including:
- The diversion of management's attention to the assimilation of the
acquired companies or assets; and
- The possibility that the acquired company or assets will not contribute
to our cash flows and profitability as expected.
Although we intend to focus principally on the expansion of sales
within the United States, we are preparing for expansion into markets in other
countries. We have products approved for sale in Japan and are reviewing other
countries, such as the United Kingdom, Australia, the Philippines and Taiwan. We
believe there are numerous additional international markets in which our network
marketing organization and products could prove successful.
INDUSTRY OVERVIEW
Network Marketing. We believe that network marketing is one of the
fastest growing channels of distribution for certain types of goods and
services.
Weight Management and Dietary Supplement Products. We believe that the
weight management and dietary supplement category is expanding because of
heightened public awareness of reports about the positive effects of weight
management and dietary supplements on health. Many individuals also use dietary
supplements as a means of preventative health care. We believe several factors
account for the steady growth of the dietary supplement category, including
increased public awareness of the reported health benefits of dietary
supplements and favorable demographic trends toward older Americans who are more
likely to consume dietary supplements.
Over the past several years, widely publicized reports and medical
research findings have suggested a correlation between the consumption of
dietary supplements and the reduced incidence of certain diseases. The United
States government and universities generally have increased sponsorship of
research relating to dietary supplements. In addition, Congress has established
the Office of Alternative Medicine within the National Institute of Health to
foster research into alternative medical treatments, which may include natural
remedies. Congress also recently established the Office of Dietary Supplements
in the National Institute of Health to conduct and coordinate research into the
role of dietary supplements in maintaining health and preventing disease.
In addition, we believe that the aging of the United States population,
together with an increased focus on preventative health care measures, will
continue to result in increased demand for dietary supplement products. We
believe these trends have helped fuel the growth of the dietary supplement
category. To meet the increased demand for dietary supplements, we and others
have introduced a number of successful dietary supplement products the past
several years, including function specific products for weight loss, sports
nutrition, menopause, energy and mental alertness. In addition, the use of a
number of ingredients, such as chromium picolinate, shark cartilage,
proanthocyanidins, citrin and colloidal minerals, have created opportunities for
us and others to offer new products.
Personal Care Products. We believe that the personal care products
market is a mature category that has been historically immune to swings in the
economy. Manufacturers and associates of personal care products must continually
improve existing products, introduce new products and communicate product
advantages to consumers. With the aging population, there appears to be a
growing demand for a wide spectrum of new products in the area of skin care.
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PRODUCTS
Our product line consists of products in the categories of weight
management, dietary supplements and personal care. We currently market
approximately one hundred products, exclusive of variations in product size,
colors or similar variations of our basic product line.
Weight Management Category. During the years ended December
31, 2002, 2001 and 2000, 51.8%, 54.7% and 67.6% of our net sales were derived
from the 11 products in the weight management category that we market under the
Advantage Marketing Systems label. The following products represent the majority
of our product sales in the weight management category:
- AM-300--A specialized blend of herbs, including an ephedra herb
concentrate and chromium picolinate; and
- AS-200--A specialized blend of herbs and nutrients in addition to
citrin and chromium picolinate.
Dietary Supplement Category. During the years ended December 31, 2002,
2001 and 2000, 40.2%, 38.9% and 25.3% of our net sales were derived from the 33
products in the dietary supplement category, which contain herbs, vitamins,
minerals and other natural ingredients. They are sold under the Advantage
Marketing Systems label. The following products represent the majority of our
product sales in the dietary supplement category:
- Prime One and Breckman's Gold--A liquid nutritional containing natural
adaptogens, considered to be the number one performance enhancing,
health restorative and stress reliever in the world;
- Shark Cartilage Complex--Manufactured from shark fin cartilage and a
blend of curcumin, boswellia and vanadium;
- Colloidal Silver--Contains essential elements required by plants,
animals and man that we once naturally obtained from organic soils via
fruits, vegetables, nuts, grains and legumes;
- Spark of Life--A liquid nutritional drink containing a blend of herbs,
vitamins, minerals, amino acids and essential fatty acids; and
- Chlorella--Fresh water green algae containing amino acids of protein,
nucleic acids, fibers, vitamins and minerals.
Personal Care Category. In January 1997, we expanded and improved our
product line by acquiring Chambre International and its line of skin care, hair
care, family care and cosmetic products. Chambre International had been
marketing its products for over 24 years. During the years ended December 31,
2002,2001and 2000, 2.9%, 1.5% and 1.3% of our net sales were derived from the 42
personal care products marketed primarily under the Chambre label in the
personal care category. The following products represent the majority of our
product sales in the personal care category:
- NH2 Lift System--A three-part skin-care system combining enzymatic
exfoliation and isometric action to firm the skin, build muscle tone
and lift the face;
- Skin Care Collections--Include cleansing lotion, skin freshener,
oatmeal scrub, night treatment, moisturizer and protein or moisture
masque; and
- Hair Care Systems--Include keratin shampoo, conditioning rinse,
reconstructor, hair hold and style and set.
Promotional Materials. We also derive revenues from the sale of various
educational and promotional materials designed to aid our associates in
maintaining and building their businesses. Such materials include various sales
aids, informational videotapes and cassette recordings, and product and
marketing brochures.
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Other Products and Services. Prior to focusing on weight management,
dietary supplement and personal care products in October 1993, we marketed
various packages of consumer benefit services provided by third-party providers.
The only remaining benefit service we offer is a pre-paid legal service. The
pre-paid legal services are provided by Pre-Paid Legal Services, Inc. This
program membership represented less than 1% of our net sales during 2002, 2001
and 2000.
New Product Identification. We expand our product line through the
development and acquisition of new products. New product ideas are derived from
a number of sources, including trade publications, scientific and health
journals, our management, consultants, associates and other outside parties.
Potential product acquisitions are identified in a similar manner. Prior to
introducing new products, we investigate product formulation as it relates to
regulatory compliance and other issues.
We do not maintain a product development staff, but rely upon Chemins
Company, Inc. and other manufacturers, independent researchers, vendor research
departments and others for such services. When a new product concept is
identified or when an existing product must be reformulated, the new product
concept or reformulation project is generally submitted to Chemins for technical
development and implementation. We continually review our existing products for
potential enhancements to improve their effectiveness and marketability. While
we consider our product formulations to be proprietary trade secrets, such
formulations are not patented. Accordingly, there is no assurance that another
company will not replicate one or more of our products.
Product Procurement and Distribution; Insurance. Essentially all of our
product line in the weight management and dietary supplement categories is
manufactured by Chemins Company, Inc. utilizing our product formulations.
Essentially all of our product line in the personal care category is
manufactured by GDMI, Inc. and Columbia Cosmetics, Inc. Naturtech manufactures
our adaptogen product line from our LifeScience Technologies acquisition.
We have not generally entered into long-term supply agreements with the
manufacturers of our product line or the third-party providers of our consumer
benefit services. However, we customarily enter into contracts with our
manufacturers and suppliers to establish the terms and conditions of purchases.
Our arrangements with Chemins Company, Inc. may be terminated by either party
upon the completion of any outstanding purchase orders. Therefore, there can be
no assurance that Chemins will continue to manufacture our products or provide
research, development and formulation services. In the event the relationship
with any of our manufacturers becomes impaired, we will be required to obtain
alternative manufacturing sources for our products. In such event, there is no
assurance that the manufacturing processes of our current manufacturers can be
replicated by another manufacturer. Although we have not previously experienced
product unavailability or supply interruptions, we believe that we would be able
to obtain alternative sources for our weight management, dietary supplement and
personal care products. A significant delay or reduction in availability of
products, however, could have a material adverse effect on our business,
operating results and financial condition.
We, like other marketers of products that are intended to be ingested,
face an inherent risk of exposure to product liability claims in the event that
the use of our products results in injury. We maintain a claims made policy,
with limited product liability insurance with coverage limits of $1,000,000 per
occurrence and $2,000,000 in the aggregate. Products containing ephedra, which
represented 49% of our 2002 net revenue, are not covered by our product
liability insurance. Although we do not obtain contractual indemnification, our
product manufacturers carry product liability insurance that covers our
products. Product liability claims in excess of insurance coverage may result in
significant losses, which would adversely affect product sales, results of our
operations, financial condition and the value of our common stock.
All of the items in our product line include a customer satisfaction
guarantee. Within 30 days of purchase, any retail customer or associate who is
not satisfied with our product for any reason may return it or any unused
portion to the associate from whom it was purchased or to us for a full refund
or credit toward the purchase of another product. Associates may obtain
replacements from us for products returned to them by retail customers if they
return such products on a timely basis. Furthermore, in most jurisdictions, we
maintain a buy-back program. Under this program, we will repurchase products
sold to an associate, subject to a 10% restocking charge, provided the associate
resigns and returns the product in marketable condition within 12
7
months of original purchase, or longer where required by applicable state law or
regulations. We believe this buy-back program addresses a number of the
regulatory compliance issues pertaining to network marketing systems. For the
years ended December 31, 2002, 2001 and 2000, the cost of products returned to
us was 0.6%, 1% and 2% of gross sales.
Our product line is distributed principally from our facilities in
Oklahoma City or from our regional support centers. Products are warehoused in
Oklahoma City and at selected regional support centers.
NETWORK MARKETING
We market our product line through independent associates in a network
marketing organization. At December 31, 2002, we had approximately 39,223
"active" associates. To be considered "active" an associate must have purchased
$50 in products or $22 on autoship of our products within the preceding 12
months. Our associates are independent contractors who purchase products
directly from us for resale to retail consumers. Associates may elect to work on
a full-time or part-time basis. We believe our network marketing system appeals
to a broad cross-section of people, particularly those seeking to:
- Supplement family income;
- Start a home business; or
- Pursue employment opportunities other than conventional, full-time
employment.
A majority of our associates therefore sell our products on a part-time basis.
We believe that our network marketing system is ideally suited to
market our product line because sales of such products are strengthened by
ongoing personal contact between retail consumers and associates, many of whom
use our products themselves. Sales are made through direct personal sales
presentations as well as presentations made to groups in a format known as
"opportunity meetings." These sales methods are designed to encourage
individuals to purchase our products by informing potential customers and
associates of our product line and results of personal use, and the potential
financial benefits of becoming an associate. The objective of the marketing
program is to develop a broad based network marketing organization within a
relatively short period. Our marketing efforts are typically focused on
middle-income families and individuals.
Our network marketing program encourages individuals to develop their
own downline network marketing organizations. Each new associate is either
linked to:
- The existing associate that personally enrolled the new associate into
our network marketing organization; or
- The existing associate in the enrolling associate's downline as
specified at the time of enrollment.
Growth of an associate's downline organization is dependent on the recruiting
and enrollment of additional associates within such associate's downline
organization.
Associates are encouraged to assume responsibility for training and
motivation of others within their downline organization and to conduct
opportunity meetings as soon as they are appropriately trained. We strive to
maintain a high level of motivation, morale, enthusiasm and integrity among the
members of our network marketing organization. We believe this result is
achieved through a combination of products, sales incentives, personal
recognition of outstanding achievement and quality promotional materials. Under
our network marketing program, associates purchase sales aids and brochures from
us and assume the costs of advertising and marketing our product line to their
customers as well as the direct cost of recruiting new associates. We believe
that this form of sales organization is cost efficient because our direct sales
expenses are primarily limited to the payment of bonuses, which are only
incurred when products are sold.
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We continually strive to improve our marketing strategies, including
the compensation structure within our network marketing organization and the
variety and mix of products in our line, to attract and motivate associates.
These efforts are designed to increase monthly product sales and the recruiting
of new associates.
To aid associates in easily meeting the monthly personal product
purchase requirement to qualify for bonuses, we developed the "autoship" in
1994. Under the autoship purchasing arrangement, associates establish a standing
product order for an amount in excess of $22 that is automatically charged to
their credit cards or deducted from their bank accounts for goods shipped that
month. At December 31, 2002, 2001, and 2000, we had approximately 23,051,
27,912, and 29,761 associates participating in the autoship.
Growth of our network marketing organization is in part attributable to
our bonus structure which provides for payment of bonuses on product purchases
made by other associates in an associate's downline organization. Associates
derive income from several sources:
- First, associates earn profits by purchasing from our product line at
wholesale prices (which are discounted up to 40% from suggested retail
prices) and selling to customers at retail.
- Second, associates who establish their own downline organization may
earn bonuses of up to 40% on product purchases by associates within the
first four levels of their downline organization.
- Third, associates who have personally enrolled three active associates
and have (i) $300 per month of autoship product purchases by personally
enrolled associates on their first level and (ii) $300 per month of
autoship product purchases on their second level, become directors and
have the opportunity to build an additional director downline
organization and receive additional bonuses of 4% on product purchases
by such downline organization.
- Fourth, associates who have personally enrolled six active associates
and have (i) $600 per month of autoship product purchases by personally
enrolled associates on their first level and (ii) $600 per month of
autoship product purchases on their second level and have a total of
$2,500 wholesale volume monthly in their downline, become silver
directors and have the opportunity to build an additional silver
director downline organization and receive additional bonuses of 5% on
product purchases by such downline organization.
- Fifth, silver directors who have personally enrolled 12 active
associates and have (i) $1,200 per month of autoship product purchases
by personally enrolled associates on their first level and (ii) $1,200
per month of autoship product purchases on their second level and have
a total of $5,000 wholesale volume monthly in their downline, become
gold directors and have the opportunity to receive an additional bonus
of 3% on product purchases by their silver director downline
organization. In addition, gold directors have the opportunity to
receive generation bonuses of up to 3% on the product purchases by
associates of silver director downline organizations that originate
from their silver director downline organization through four
generations.
- Sixth, gold directors who maintain the gold director requirements and
develop four gold directors, each one from a separate leg of their
downline organization plus $40,000 wholesale volume in downline
organization, become platinum directors and have the opportunity to
build an additional platinum director downline organization and receive
additional bonuses of 5% on product purchases by such downline
organization.
Combining these levels of bonuses, our total "pay-out" on products
subject to bonuses is approximately 67% of the bonus value of product sales.
Each associate in our network marketing organization has a director, a
silver director, a gold director and a platinum director. Each director has a
silver director, a gold director and a platinum director. Each silver director
has a gold director and a platinum director. Each gold director has a platinum
director. As of December 31, 2002, we had 186 silver directors, 116 gold
directors and 45 platinum directors.
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Under our regional support center program, we designate associates to
serve as regional support center directors and provide them special training and
support. Each regional support center director functions as a product
distribution center for our products. As of December 31, 2002, we had 58
regional support center directors.
We maintain a computerized system for processing associate orders and
calculating bonus payments which enable us to remit such payments promptly. We
believe that prompt and accurate remittance of bonuses is vital to recruiting
and maintaining associates, as well as increasing their motivation and loyalty
to us. We make weekly bonus payments based upon the previous week's product
purchases, while most network marketing companies only make monthly bonus
payments. During 2002, 2001 and 2000, we paid bonuses to 8,909, 11,814 and
11,902 associates, in the aggregate amounts of $9,414,421, $11,403,519 and
$11,271,109.
We are committed to providing the best possible support to our
associates. Associates in our network marketing organization are provided
training guides and are given the opportunity to participate in our training
programs. We sponsor regularly scheduled conference calls for our platinum
directors which include testimonials from successful associates and satisfied
customers as well as current product and promotional information. We produce a
monthly newsletter which provides information on our products and network
marketing system. The newsletter is designed to help recruit new associates by
answering commonly asked questions and includes product information and business
building information. The newsletter also provides a forum for additional
recognition of associates for outstanding performance. In addition, we regularly
sponsor training sessions for our associates across the United States. At these
training sessions associates are provided the opportunity to learn more about
our product line and selling techniques so they can build their businesses more
rapidly. We produce comprehensive and attractive four color catalogues and
brochures that display and describe our product line. We maintain a web page at
www.amsonline.com, which provides general company information along with product
line and network marketing system information.
Furthermore, in order to facilitate our continued growth and support
associate activities, we continually upgrade our management information and
telecommunications systems. These systems are designed to provide, among other
things, financial and operating data for management, timely and accurate product
ordering, bonus payment processing, inventory management and detailed associate
records. Since 1994, we have invested more than $2,590,293 to enhance our
computer and telecommunications systems.
REGULATION
In the United States, as well as in any foreign markets in which we may
sell our products, we are subject to laws, regulations, administrative
determinations, court decisions and similar constraints at the federal, state
and local levels, collectively known as regulations. These regulations include
and pertain to, among other things:
- The formulation, manufacturing, packaging, labeling, advertising,
distribution, importation, sale and storage of our products;
- Our product claims and advertising, including direct claims and
advertising as well as claims and advertising by associates, for which
we may be held responsible; and
- Our network marketing organization.
Products. The formulation, manufacturing, packaging, labeling,
advertising, distribution and sale and storage of our products are subject to
regulation by a number of governmental agencies. The federal agencies include
the Food and Drug Administration, or FDA, the Federal Trade Commission, the
Consumer Product Safety Commission, the United States Department of Agriculture
and the Environmental Protection Agency. Our activities are also regulated by
various agencies of the states, localities and foreign countries in which our
products are or may be manufactured, distributed or sold. The FDA, in
particular, regulates the formulation, manufacturing and labeling of dietary
supplements, cosmetics and skin care products, including some of our products.
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The Dietary Supplement Health and Education Act of 1994, or DSHEA,
revised the provisions of the Federal Food, Drug and Cosmetic Act, or FFDCA,
concerning the composition and labeling of dietary supplements, which we believe
is generally favorable to the dietary supplement industry. DSHEA created a new
statutory class of "dietary supplements." This new class includes vitamins,
minerals, herbs, amino acids and other dietary substances for human use to
supplement the diet. However, DSHEA grandfathered, with certain limitations,
dietary ingredients that were on the market before October 15, 1994. A dietary
supplement containing a new dietary ingredient and placed on the market on or
after October 15, 1994 must have a history of use or other evidence establishing
a basis for expected safety. Manufacturers of dietary supplements having a
"structure-function" statement must have substantiation that the statement is
truthful and not misleading.
The majority of our sales come from products that are classified as
dietary supplements under the FFDCA. The labeling requirements for dietary
supplements have been set forth in final regulations with respect to labels
affixed to containers beginning after March 23, 1999. These regulations include
how to declare nutrient content information, and the proper detail and format
required for the "supplement facts" box. During 1999, we revised our product
labels in compliance with these regulations. Many states have also recently
become active in the regulations of dietary supplement products. These states
may require modification of labeling or formulation of certain of our products
sold in these states.
In addition, on January 6, 2000, the FDA published a Final Rule on
permissible structure/function statements to be placed on labels and in
brochures. Structure/function statements are claims of the benefit or effect of
a product or an ingredient on the body's structure or function. This regulation
does not significantly change the way that the FDA interprets structure/function
statements. Thus, we did not make any substantial label revisions based on this
regulation regarding any of our structure/function product statements.
As a marketer of products that are ingested by consumers, we are
subject to the risk that one or more of the ingredients in our products may
become the subject of adverse regulatory action. For example, one of the
ingredients in our AM-300 product is ephedra, an herb that contains
naturally-occurring ephedrine alkaloids. Our manufacturer uses a powdered
extract of that herb when manufacturing AM-300. We market AM-300 principally as
an aid in weight management. The extract is an 8% extract, which means that
every 100 milligrams of the powdered extract contains approximately eight
milligrams of naturally occurring ephedrine alkaloids. In addition, our Sine-Eze
product, used as a food supplement to relieve symptoms associated with
allergies, contains ephedrine alkaloids. Ephedrine-containing dietary
supplements have been the subject of adverse publicity in the United States and
other countries relating to alleged harmful effects.
On April 10, 1996, the FDA issued a statement warning consumers not to
purchase or ingest dietary supplements containing ephedrine that are claimed to
produce certain effects. These effects include euphoria, heightened awareness,
increased sexual sensations or increased energy. The FDA cautions that these
products pose significant adverse health risks, including dizziness, headache,
gastrointestinal distress, irregular heartbeat, heart palpitations, heart
attack, strokes, seizures, psychosis and death.
The FDA published a proposed rule in the Federal Register on June 4,
1997 that proposed significant limitations on the sale of ephedrine-containing
dietary supplements. The proposed rule would have significantly limited our
ability to sell products containing ephedra if it had been made effective. On
April 3, 2000, the FDA withdrew most of the provisions of its proposed rule.
This action was prompted largely by a report issued by the United States General
Accounting Office, or GAO, in which the GAO criticized the scientific basis for
the proposed rule and the FDA's evaluation of approximately 900 reports of
adverse events supposedly related to the consumption of dietary supplements
containing ephedrine alkaloids. The FDA has made available for public inspection
most of these adverse event reports.
On March 7, 2003, the FDA published a notice in the Federal Register,
which indicates that it will be taking final action on the 1997 proposed rule in
the near future. The FDA re-opened the public comment period, until April 7,
2003, to allow for additional public input on the two proposed limitations on
the sale of ephedrine-containing dietary supplements that remained after the
FDA's action of April 3, 2000. One
11
proposed limitation is a warning that would be required to appear on the label
of all ephedrine-containing supplements. The other proposed limitation is that
ephedrine-containing supplements may not contain other substances that are known
to have stimulant effects (e.g., caffeine). The proposed warning addresses
potential health risks allegedly associated with ephedrine-containing dietary
supplements. It is similar, but not identical, to mandatory warnings that have
been required by Texas law since 1999 and California law since January 1, 2003.
AM-300 and our other ephedrine-containing supplements comply with these state
law requirements. However, some of our ephedrine-containing products, like
AM-300, contain caffeine or other stimulants. Therefore, if the proposed rule is
made final in its current form, it will prohibit the sale of some of our
products.
On March 13, 2003, the FDA published a proposed rule in the Federal
Register which proposes comprehensive requirements for the manufacturing,
packing and holding dietary supplements, also known as good manufacturing
practices, or GMPs. The FDA is accepting public comments on the proposed GMPs
until June 11, 2003; final GMPs will be promulgated after the FDA has reviewed
the public comments. Once final GMP regulations become effective, our
manufacturer will be required to adhere to them. The FDA will most likely
institute an effective date for the GMPs which will allow our manufacturer a
reasonable amount of time to conduct this review and, if necessary, revise its
manufacturing operations to comply with the final GMP regulations.
The Texas Department of Health promulgated a new regulation, which
became effective on January 1, 2001. The regulation requires a warning to appear
on the product label indicating that the sale of ephedra-containing products to
minors is illegal. Our AM-300 labels comply with this regulation.
In foreign markets, prior to commencing operations and prior to making
or permitting sales of our products, we may be required to obtain an approval,
license or certification from the country's ministry of health or comparable
agency. Prior to entering a new market in which a formal approval, license or
certificate is required, we are required to work extensively with local
authorities to obtain the requisite approvals. The approval process generally
requires us to present each product and product ingredient to appropriate
regulators and, in some instances, arrange for testing of products by local
technicians for ingredient analysis. Such approvals may be conditioned on
reformulation of our products or may be unavailable with respect to certain
products or ingredients.
Product Claims and Advertising. The Federal Trade Commission and
certain states regulate advertising, product claims and other consumer matters,
including advertising of our products. All advertising, promotional and
solicitation materials used by associates require our approval prior to use. The
Federal Trade Commission has instituted enforcement actions against several
dietary supplement companies for false or deceptive advertising, including the
use of testimonials.
We provide no assurance that:
- The Federal Trade Commission will not question our past or future
advertising or other operations; or
- A state will not interpret product claims presumptively valid under
federal law as illegal under that state's regulations.
Also, our associates and their customers may file actions on their own
behalf, as a class or otherwise, and may file complaints with the Federal Trade
Commission or state or local consumer affairs offices. These agencies may take
action on their own initiative or on a referral from associates, consumers or
others. If taken, these actions may result in:
- Entries of consent decrees;
- Refunds of amounts paid by the complaining associate or consumer;
- Refunds to an entire class of associates or customers;
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- Other damages; and
- Changes in our method of doing business.
A complaint based on the practice of one associate, whether or not such
activities were authorized by us, could result in an order affecting some or all
associates in a particular state, and an order in one state could influence
courts or government agencies in other states. Enforcement proceedings resulting
from these complaints may result in significant defense costs, settlement
payments or judgments and could have a material adverse effect on our results of
operations or financial condition.
Compliance Efforts. We attempt to remain in full compliance with all
applicable laws and regulations governing the manufacture, labeling, sale,
distribution, and advertising of our dietary supplements. We retain special
legal counsel for advice on both Food and Drug Administration and Federal Trade
Commission legal issues. In particular, we work closely with special legal
counsel who specializes in Dietary Supplement Health and Education Act
regulations for label revisions, content of structure/function statements,
advertising copy, and also the position of the Food and Drug Administration on
ephedra-containing products.
Network Marketing System. Our network marketing system is subject to
federal and state laws and regulations administered by the Federal Trade
Commission and various state agencies. These laws and regulations include
securities, franchise investment, business opportunity and criminal laws
prohibiting the use of "pyramid" or "endless chain" types of selling
organizations. These regulations are generally directed at ensuring that product
sales are ultimately made to consumers (as opposed to other associates) and that
advancement within the network marketing system is based on sales of products,
rather than investment in the company or other non-retail sales related
criteria.
The compensation structure of a network marketing system is very
complex. Compliance with all of the applicable regulations and laws is uncertain
because of the evolving interpretations of existing laws and regulations and the
enactment of new laws and regulations pertaining in general to network marketing
systems and product distribution. We have an ongoing compliance program with
assistance from legal counsel experienced in the laws and regulations pertaining
to network sales organizations. We are not aware of any legal actions pending or
threatened by any governmental authority against us regarding the legality of
our network marketing operations.
We currently have independent associates in all 50 states, the District
of Columbia and Canada. We review the requirements of various states as well as
seek legal advice regarding the structure and operation of our selling
organization to ensure that it complies with all of the applicable laws and
regulations pertaining to network sales organizations. On the basis of these
efforts and the experience of our management, we believe that we are in
compliance with all applicable federal and state regulatory requirements. We
have not obtained any no-action letters or advance rulings from any federal or
state security regulator or other governmental agency concerning the legality of
our operations, nor are we relying on a formal opinion of counsel to this
effect. Accordingly, there is the risk that our network marketing system could
be found to be in noncompliance with applicable laws and regulations, which
could then:
- Result in enforcement action and imposition of penalties;
- Require modification of our network marketing system;
- Result in negative publicity; or
- Have a negative effect on associate morale and loyalty.
Any of these consequences could have a material adverse effect on our sales as
well as our financial condition.
We are subject to the risk of challenges to the legality of our network
marketing system by our associates, both individually and as a class. Generally
such challenges would be based on claims that our network marketing system was
operated as an illegal "pyramid scheme" in violation of federal securities laws,
state unfair practice and fraud laws and the Racketeer Influenced and Corrupt
Organizations Act.
13
Two important Federal Trade Commission cases have established legal
precedent for determining whether a network marketing system constitutes an
illegal pyramid scheme. The first, IN RE KOSCOT INTERPLANETARY, INC., 86 F.T.C.
1106 (1975), set forth a standard for determining whether a marketing system
constituted a pyramid scheme. Under the KOSCOT standard, a pyramid scheme is
characterized by the participants' payment of money to a company in return for:
- The right to sell a product; and
- The right to receive, in return for recruiting other participants into
the program, rewards that are unrelated to sales of the product to
ultimate users.
Applying the KOSCOT standard in IN RE AMWAY CORP., 93 F.T.C. 618 (1979), the
Federal Trade Commission determined that a company will not be classified as
operating a pyramid scheme if the company adopts and enforces policies that in
fact encourage retail sales to consumers and prevent "inventory loading".
Inventory loading occurs when associates purchase large quantities of
non-returnable inventory to obtain the full amount of compensation available
under the system. In AMWAY, the Federal Trade Commission found that the
marketing system of Amway Corporation did not constitute a pyramid scheme,
noting the following Amway policies:
- Participants were required to buy back, from any person they recruited,
any saleable, unsold inventory upon the recruit leaving Amway;
- Every participant was required to sell at wholesale or retail at least
70% of the products bought in a given month in order to receive a bonus
for that month; and
- In order to receive a bonus in a month, each participant was required
to submit proof of retail sales made to 10 different consumers.
We believe that our network marketing system is not classified as a
pyramid scheme under the standards set forth in KOSCOT, AMWAY, and other
applicable law. In particular, in most jurisdictions, we maintain an inventory
buy-back program to address the problem of inventory loading. Pursuant to this
program, we repurchase products sold to an associate (subject to a 10%
restocking charge) provided that the associate:
- Resigns; and
- Returns the product in marketable condition within 12 months of
original purchase, or longer where required by applicable state law or
regulations.
Our literature provided to associates describes our buy-back program. In
addition, pursuant to agreements with our associates, each associate represents
that at least 70% of the products he or she buys will be sold to non-associates.
However, as is the case with other network marketing companies, the bonuses paid
by us to our associates are based on product purchases including purchases of
products that are personally consumed by the downline associates. Basing bonuses
on sales of personally consumed products may be considered an inventory loading
purchase. Furthermore, associates' bonuses are based on the wholesale prices
received by us on product purchases or, in some cases based upon the particular
product purchased, on prices less than the wholesale prices.
In the event of challenges to the legality of our network marketing
system by associates, we would be required to:
- Demonstrate that our network marketing policies are enforced; and
- That the network marketing system and associates' compensation
thereunder serve as safeguards to deter inventory loading and encourage
retail sales to the ultimate consumers.
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In WEBSTER V. OMNITRITION INTERNATIONAL, INC., 79 F.3d 776 (9th Cir.
1996), the United States Court of Appeals held that a class action brought
against Omnitrition International, Inc., a multilevel marketing seller of
nutritional supplements and skin care products, should be allowed to proceed to
trial. The plaintiffs, former associates of Omnitrition's products, alleged that
Omnitrition's selling program was an illegal pyramid scheme and claimed
violations of Racketeer Influenced and Corrupt Organizations Act and several
federal and state fraud and securities laws. Despite evidence that Omnitrition
complied with the AMWAY standards, the court ruled that a jury would have to
decide whether Omnitrition's policies, many of which apparently were similar to
compliance policies adopted by us, were adequate to ensure that Omnitrition's
marketing efforts resulted in a legitimate product marketing and distribution
structure and not an illegal pyramid scheme. We believe that our marketing and
sales programs differ in significant respects from those of Omnitrition, and
that our marketing program complies with applicable law. The two most
significant differences are:
- The Omnitrition marketing plan required associates to purchase $2,000
in merchandise in order to qualify for bonuses as compared to $22 on
autoship under our marketing program; and
- The Omnitrition inventory repurchase policy was limited to products
that were less than three months old as compared to one year under our
inventory repurchase policy.
Lessons from the OMNITRITION case are that:
- A selling program which operates to generate only the minimum purchases
necessary to qualify for bonuses is suspect; and
- A selling program must operate to generate purchases independently of
the payment of bonuses in order to have a legitimate product marketing
and distribution structure.
We believe that our selling program operates to generate significant purchases
"for intrinsic value" as demonstrated by our sales figures. During the month of
December 2002, 19,639 of our associates placed a total of 24,201 orders
averaging $58 in size while only a single $22 on autoship per month is necessary
to qualify for bonuses. In view of the holding of the court of appeals in the
OMNITRITION case, however, there is no assurance that, if challenged, we would
prevail against private plaintiffs alleging violations of anti-pyramid and
securities laws. A final ruling against us in such a suit could result in the
imposition of a material liability against us. Moreover, even if we were
successful in defending against such suit, the costs of such defense, both in
dollars spent and in management time, could be material and adversely affect our
operating results. In addition, the negative publicity of such a suit could
adversely affect our sales and ability to attract and retain associates.
Nutrition for Life International, Inc., one of our competitors and a
multilevel seller of personal care and nutritional supplements, announced in
January 1997, that it had settled class action litigation brought by associates
alleging fraud in connection with the operation of a pyramid scheme. Nutrition
for Life paid in excess of $3 million to settle claims brought on behalf of its
associates, and related securities fraud claims brought on behalf of certain
purchasers of its stock.
We believe that our marketing program is significantly different from
the program allegedly promoted by Nutrition for Life and that our marketing
program is not in violation of anti-pyramid laws or regulations. Two issues in
the Nutrition for Life matter were a $1,000 buy-in urged on new recruits, and
the paying of commissions on product vouchers prior to the actual delivery of
product. By design, our marketing program offers no incentive to anyone to make
a large personal purchase nor do we use product vouchers. Actual average order
size in December 2002 was $58. However, there is no assurance that claims
similar to the claims brought against Nutrition for Life and other multilevel
marketing organizations will not be brought against us, or that we will prevail
in the event any such claims were made. Furthermore, even if we were successful
in defending against any such claims, the cost of conducting such a defense,
both in dollars spent and in management time, could be material and adversely
affect our operating results and financial condition. In addition, the negative
publicity of such a suit could adversely affect our sales and ability to attract
and retain associates.
15
INTELLECTUAL PROPERTY
We use several trademarks and trade names in connection with our
products and operations. As of December 31, 2002, we had 52 federal trademark
registrations with the United States Patent and Trademark Office. We rely on
common law trademark rights to protect our unregistered trademarks. Common law
trademark rights do not provide us with the same level of protection as afforded
by a United States federal registration of a trademark. Also, common law
trademark rights are limited to the geographic area in which the trademark is
actually used. In addition, our product formulations are not protected by
patents and are not patentable. Therefore, there can be no assurance that
another company will not replicate one or more of our products.
COMPETITION
We are subject to significant competition in recruiting associates from
other network marketing organizations, including those that market products in
the weight management, dietary supplement and personal care categories, as well
as other types of products. There are over 300 companies worldwide that utilize
network marketing techniques, many of which are substantially larger, offer a
greater variety of products, and have available considerably greater financial
resources than us. Our ability to remain competitive depends, in significant
part, on our success in recruiting and retaining associates through an
attractive bonus plan and other incentives. We believe that our bonus plan and
incentive programs provide our associates with significant income potential.
However, there can be no assurance that our programs for recruitment and
retention of associates will continue to be successful.
In addition, the business of marketing products in the weight
management, dietary supplement and personal care categories is highly
competitive. This market segment includes numerous manufacturers, other network
marketing companies, catalog companies, associates, marketers, retailers and
physicians that actively compete in the sale of such products. We also compete
with other providers of such products, especially retail outlets, based upon
convenience of purchase and immediate availability of the purchased product. The
market is highly sensitive to the introduction of new products or weight
management plans, including various prescription drugs, which may rapidly
capture a significant share of the market. As a result, our ability to remain
competitive depends in part upon the successful introduction and addition of new
products to our line.
Our network marketing competitors include small, privately held
companies, as well as larger, publicly held companies with greater financial
resources and greater product and market diversification and distribution. Our
competitors include Shaklee Corporation, Market America, Inc., The A.L. Williams
Corporation, Mary Kay Cosmetics, Inc., Amway Corporation, and Nutrition for Life
International, Inc.
EMPLOYEES
As of December 31, 2002, we had 67 full-time and 11 part-time
employees, consisting of 5 executive officers, 23 involved in administrative
activities, 9 involved in marketing activities, 15 involved in customer service
activities, 11 involved in business development activities and 15 involved in
shipping activities. Our employees are not represented by a labor organization.
We consider our employee relations to be good.
AVAILABILITY OF INFORMATION
We file periodic reports and proxy statements with the Securities and
Exchange Commission, or SEC. The public may read and copy any materials we file
with the SEC at the SEC's Public Reference Room at 450 Fifth Street, N.W.,
Washington, D.C. 20549. The public may obtain information about the operation of
the Public Reference Room by calling the SEC at 1-800-SEC-0330. We file our
reports with the SEC electronically. The SEC maintains an Internet site that
contains reports, proxy and information statements, and other information
regarding issuers that file electronically with the SEC. The address of this
site is http://www.sec.gov.
Our internet address is www.amsonline.com. We make available on our
website, free of charge, copies of our annual report of Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K and
16
amendments to those reports filed or furnished pursuant to Section 13(a) of the
Exchange Act as soon as reasonably possible after we electronically file such
material with, or furnish to, the SEC.
ITEM 2. PROPERTIES
We maintain our executive office in 10,003 square feet at 2601
Northwest Expressway, Suites 1210W and 1120W, Oklahoma City, Oklahoma
73112-7293. These premises are occupied pursuant to long-term leases which
expire on May 31, 2003 and January 31, 2005, and which require monthly rental
payments of $7,986 and $2,530. Both leases have been extended for terms to
expire on May 31, 2008. In addition we have our prior warehouse facility, at
4000 N. Lindsay in Oklahoma City, under a lease expiring May 31, 2003, with
monthly lease payments of $5,601. In June 2001, we completed our new warehouse
and distribution facility. The 23,346 square foot, $1.3 million facility is
subject to a mortgage. All our properties are in good condition.
ITEM 3. LEGAL PROCEEDINGS
The case of Ronald Potter et al v. Advantage Marketing Systems, Inc. et
al, a products liability claim, was filed in the Oklahoma County District Court
in March 2003. The Plaintiffs claim that the ingestion of ephedra included in
AM-300 resulted in the death of Pamela Sue Potter. An answer to the petition is
due by April 30, 2003. As such, we have not had sufficient time to either
investigate the facts of this case or analyze appropriate defenses to the
allegations. We will deny any wrongdoing and intend to vigorously defend the
claim. The amount of damages sought is unknown, but include compensatory and
punitive damages.
The case of In re Jose Garcia v. Advantage Marketing Systems, Inc., a
products liability claim, was filed in the Superior Court of California, San
Bernardino County, in February 2003. The Plaintiff claims personal injury and
lost wages resulting from the ingestion of ephedra included in AM-300. An answer
to the petition is due by April 23, 2003. As such, we have not had sufficient
time to either investigate the facts of this case or analyze appropriate
defenses to the allegations. We will deny any wrongdoing and intend to
vigorously defend the claim. The amount of damages sought is unknown.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of our fiscal year ended December 31, 2002.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
From November 6, 1997 to June 14, 1999, our common stock was traded on
the Nasdaq SmallCap Market under the symbol "AMSO." On June 15, 1999, our common
stock began trading on the American Stock Exchange under the symbol "AMM."
On March 24, 2003, the closing sale price of our common stock on the
American Stock Exchange was $1.51. We believe there are approximately 1,606
holders of our common stock. The following table sets forth the high and low
closing sale price of our common stock on the American Stock Exchange.
COMMON STOCK
CLOSING BID PRICES
------------------
HIGH LOW
---- ---
2002--CALENDAR QUARTER ENDED:
March 31...................................................... $2.60 $1.95
June 30....................................................... $3.05 $1.96
September 30.................................................. $2.35 $1.90
December 31................................................... $2.00 $1.20
2001--CALENDAR QUARTER ENDED:
March 31...................................................... $3.30 $2.00
June 30....................................................... $3.24 $2.50
September 30.................................................. $3.06 $2.70
December 31................................................... $2.99 $2.40
No cash dividends were declared as of December 31, 2002 or are anticipated.
Equity Compensation Plan Information
(a) (b) (c)
Number of securities
remaining available
for future issuance
under equity
Number of securities to Weighted-average compensation plans
be issued upon exercise exercise price of (excluding securities
of outstanding options, outstanding options, reflected in
Plan Category warrants and rights warrants and rights column (a))
- ------------- ----------------------- -------------------- --------------------
Equity plans approved by security
holders............................. 1,083,403 $2.66 41,597
Equity compensation plan not
approved by security holders........ 673,250 $1.95 -
------------ -------
Total............................... 1,756,653 $2.36 41,597
============ =======
Prior to approval of the 1995 Stock Option Plan, the Company issued 673,250
incentive stock options to employees and associates. These options have a term
of 10 years, are exercisable, in whole or in part, at any time prior to the
termination date, and have an exercise price of $1.75 to $2.00 per share. The
options may be assigned or transferred, in whole or in part, so long as such
assignment or transfer is in accordance with and subject to the provisions of
the Securities Act of 1933, as amended, and the rules promulgated thereunder.
18
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial and statistical data,
computed as a percentage of net sales, for the years ended December 31, 2002,
2001, 2000, 1999 and 1998. The selected financial data are derived from our
audited consolidated financial statements and should be read in conjunction with
them and the Notes thereto. The results of operations for the periods presented
are not necessarily indicative of our future operations.
YEAR ENDED DECEMBER 31,
-----------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
INCOME STATEMENT DATA:
Net sales ............................ $ 22,303,581 $ 28,440,920 $ 26,707,936 $ 22,427,551 $ 13,287,824
Cost of sales ........................ 15,126,983 19,231,150 17,929,701 15,610,941 8,999,229
------------ ------------ ------------ ------------ ------------
Gross profit ...................... 7,176,598 9,209,770 8,778,235 6,816,610 4,288,595
Marketing, distribution and
administrative expenses:
Marketing ......................... 2,487,006 2,304,922 2,981,372 1,691,978 904,198
Distribution and administrative ... 5,768,245 6,875,871 5,076,436 3,544,960 2,644,574
------------ ------------ ------------ ------------ ------------
Total marketing, distribution and
administrative expenses ........... 8,255,251 9,180,793 8,057,808 5,236,938 3,548,772
Goodwill impairment .................. 3,788,374 -- -- -- --
------------ ------------ ------------ ------------ ------------
Income (loss) from operations ..... (4,867,027) 28,977 720,427 1,579,672 739,823
Other income (expense):
Interest and dividends, net ....... (53,984) (31,800) 310,599 364,270 309,908
Other income (expense) ............ (39,170) 16,841 (81,560) 7,866 39,280
Settlement of additional tax
liability........................ -- -- -- -- (421,623)
------------ ------------ ------------ ------------ ------------
Total other income (expense) ......... (93,065) (14,959) 229,039 372,136 (72,435)
------------ ------------ ------------ ------------ ------------
Income (loss) before income taxes .... (4,960,092) 14,018 949,466 1,951,808 667,388
Income tax (benefit) ................. (1,755,057) 5,467 456,532 676,025 253,340
------------ ------------ ------------ ------------ ------------
Net income (loss) .................... $ (3,205,035) $ 8,551 $ 492,934 $ 1,275,783 $ 414,048
============ ============ ============ ============ ============
Net income (loss) per common
share - basic .................... $ (0.73) $ -- $ 0.12 $ 0.31 $ 0.10
============ ============ ============ ============ ============
Net income (loss) per common
share - assuming dilution ........ $ (0.73) $ -- $ 0.09 $ 0.27 $ 0.09
============ ============ ============ ============ ============
Weighted average common shares
outstanding - basic ............... 4,419,196 4,379,486 4,283,461 4,139,706 4,191,760
============ ============ ============ ============ ============
Weighted average common shares
outstanding - assuming dilution ... 4,419,196 4,692,298 5,476,277 4,778,576 4,503,411
============ ============ ============ ============ ============
STATISTICAL DATA:
Total cost of sales ............... 67.8 % 67.6% 67.1% 69.6% 67.7%
Gross profit ...................... 32.2 % 32.4% 32.9% 30.4% 32.3%
Total marketing, distribution and
administrative expense .......... 37.0 % 32.3% 30.2% 23.4% 26.7%
Net income (loss) ................. (14.4)% 0.0% 1.8% 5.7% 3.1%
CASH FLOW DATA:
Net cash provided by (used in)
operating activities .............. $ 694,712 $ 1,508,177 $ (62,480) $ 2,370,939 $ 1,242,254
19
Net cash provided by (used in)
investing activities .............. 68,193 (1,383,960) (885,350) (5,473,205) (996,283)
Net cash provided by (used in)
financing activities .............. (537,795) 781,284 (638,377) (524,057) (732,030)
BALANCE SHEET DATA:
Total assets ...................... $ 10,686,269 $ 14,672,404 $ 11,690,250 $ 12,160,383 $ 10,717,483
Total liabilities ................. 3,355,840 4,127,226 1,266,345 1,928,400 1,494,871
Stockholders' equity .............. 7,330,429 10,545,178 10,423,905 10,231,983 9,222,612
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
The following discussion should be read in conjunction with our consolidated
financial statements and notes thereto under Item 8 below.
GENERAL
Our business and operations during the last five years have been
significantly affected by the acquisitions of Miracle Mountain International,
Inc. in May 1996, Chambre International, Inc. in January 1997, the assets of
Stay 'N Shape International, Inc., Solution Products International, Inc., Nation
of Winners, Inc., and Now International, Inc. in April 1997, ToppMed Inc. in
July 1998 and LifeScience Technologies Inc. in January 2001. As a result of
these acquisitions and asset purchases, we acquired 11,790 associates and added
129 products to our product line.
Miracle Mountain Acquisition. Effective May 31, 1996, Miracle Mountain
International, Inc. became one of our wholly owned subsidiaries. Miracle
Mountain was a network marketer of various third-party manufactured nutritional
supplement products. In connection with the Miracle Mountain acquisition, we
issued 20,000 shares of our common stock. As a result of the Miracle Mountain
acquisition, we added one product to our line and 1,690 additional associates.
Chambre Acquisition. Effective January 31, 1997, Chambre International,
Inc. became one of our wholly owned subsidiaries. Chambre International was a
network marketer of various third-party manufactured cosmetic, skin care and
hair care products. In connection with the Chambre acquisition, we issued 14,000
shares of our common stock. As a result of the Chambre acquisition, we added 74
products to our line, 68 in the personal care category and six in the dietary
supplement category, and 2,100 additional associates.
Stay 'N Shape International Asset Purchase. We purchased all of the
assets, including the network marketing organizations, of Stay 'N Shape
International, Inc., Solution Products International, Inc., Nation of Winners,
Inc., and Now International, Inc. on April 16, 1997. In connection with this
asset purchase, we paid cash of $1,174,441 and issued 125,984 shares of our
common stock. As a result of this asset purchase, we added 39 products to our
line, 38 in the weight management and dietary supplement categories and one in
the personal care category, and 3,000 additional associates.
ToppMed Asset Purchase. On July 31, 1998, we acquired all rights,
including formulations and trademarks, for the ToppFast, ToppStamina and
ToppFitt products from ToppMed, Inc. for $192,000.
LifeScience Technologies Acquisition. On January 4, 2001, we purchased
the LifeScience Technologies, or LST, group of companies for $1.2 million and a
five year payment of $41,667 per month or 5% of the gross sales of LifeScience
Technologies products, whichever is greater. The seller has the option to take
up to 860,000 shares of our common stock in lieu of cash at an option price of
$3.00 per share. As a result of this acquisition, we added 14 products and over
5,000 associates.
Critical Accounting Policies. We prepare our consolidated financial
statements in conformity with accounting principles generally accepted in the
United States, which require us to make estimates and
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assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the year.
Actual results could differ from those estimates. We consider the following
policies to be most critical in understanding the judgments that are involved in
preparing our financial statements and the uncertainties that could impact our
results of operations, financial condition and cash flows.
Throughout this report, "net sales" represents the gross sales amounts
reflected on our invoices to our associates less associate discounts, sales
returns, and freight income. Beginning June 1, 2001, we adopted a new billing
policy, which requires billing customers a portion of freight costs, which is
included in net sales. All of our products include a customer satisfaction
guarantee. Our products may be returned within 30 days of purchase for a full
refund or credit toward the purchase of another product. We also have a buy-back
program whereby we repurchase products sold to an independent associate (subject
to a restocking fee), provided the associate terminates his/her associateship
agreement with us and returns the product within 12 months of original purchase
in marketable condition. We receive our net sales price in cash or through
credit card payments upon receipt of orders from associates.
Our "gross profit" consists of net sales less:
- Commissions and bonuses, consisting of commission payments to
associates based on their current associate level within their
organization, and other one-time incentive cash bonuses to
qualifying associates;
- Cost of products, consisting of the prices we pay to our
manufacturers for products and royalty overrides earned by
qualifying associates on sales within their associate organizations;
and
- Cost of shipping, consisting of costs related to shipments, duties
and tariffs, freight expenses relating to shipment of products to
associates, and similar expenses.
We recognize revenue upon shipment of products, training aids and promotional
material to the independent associates. All of our customers pay for sales in
advance of shipment. As such, we have no trade receivables. Loans to associates
are repayable in five years or less; are secured by commissions controlled by
us; and are no longer allowed. Interest rates on loans are typically two percent
or more above the Prime rate and are fixed. All loans and receivables are
secured by guaranteed payment sources that are within our control. As such,
management believes there is no need for an allowance for doubtful accounts.
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 142, "Goodwill and Other Intangible
Assets". This standard requires companies to stop amortizing existing goodwill
and intangible assets with indefinite lives effective January 1, 2002. Under the
new rules, companies would only adjust the carrying amount of goodwill or
indefinite life intangible assets upon an impairment of the goodwill or
indefinite life intangible assets. We implemented these standards effective
January 1, 2002. Based on an evaluation of goodwill at October 31, 2002, we
determined that goodwill of approximately $3,800,000 was 100% impaired and
should be written off in its entirety.
We write down our inventory to provide for estimated obsolete or
unsalable inventory based on assumptions about future demand for our products
and market conditions. If future demand and market conditions are less favorable
than management's assumptions, additional inventory write-downs could be
required. Likewise, favorable future demand and market conditions could
positively impact future operating results if written-off inventory is sold.
We account for contingencies in accordance with SFAS No. 5, "Accounting
for Contingencies". SFAS 5 requires that we record an estimated loss from a loss
contingency when information available prior to issuance of our financial
statements indicates that it is probable than an asset has been impaired or a
liability has been incurred at the date of the financial statements and the
amount of the loss can be reasonable estimated. Accounting for contingencies
such as legal and income tax matters requires us to use our judgment. Many legal
and tax contingencies can take years to resolve. Generally, as the time period
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increases over which the uncertainties are resolved, the likelihood of changes
to the estimate of the ultimate outcome increases. However, an adverse outcome
in these matters could have a material impact on our results of operations,
financial condition and cash flows.
Units Offering. On November 12, 1997, we completed the offering of
1,495,000 units, each consisting of one share of common stock and one redeemable
common stock purchase warrant. As a result of this offering, we received
proceeds of $6,050,000. Each redeemable common stock purchase warrant is
exercisable for the purchase of one share of our common stock for $3.40 on or
before November 6, 2002. In connection with this offering, we sold to the
underwriters, Paulson Investment Company, Inc. and Joseph Charles & Assoc.,
Inc., warrants exercisable for the purchase of 130,000 units for $5.40 per unit
on or before November 6, 2002. On September 16, 2002, we extended the exercise
period for the redeemable stock purchase warrants and the underwriter warrants
from November 6, 2002 to November 6, 2003.
Warrant Modification Offering and Rights Offering. In January 1997, we
distributed non-transferable rights to our common stock shareholders. These
rights entitled the holders to subscribe for and purchase up to 2,148,191 units,
each unit consisting of one share of our common stock and one 1997-A warrant,
for the price of $6.80 per unit.
Concurrently, we called and redeemed our outstanding class A and class
B common stock purchase warrants for $.0008 per warrant on March 17, 1997.
However, in connection with the warrant redemption, we offered to the holders of
the class A and class B warrants the right to purchase units, each comprised of
one share of common stock and one 1997-A warrant, at an exercise price of $6.00
per unit.
Each 1997-A warrant is exercisable on or before November 6, 2002, to
purchase one share of common stock for $3.40, subject to adjustment in certain
events. We may redeem the 1997-A warrants at any time upon 30 days notice, at a
price of $.0001 per 1997-A warrant. On September 16, 2002, we extended the
exercise period for the 1997-A warrants from November 6, 2002 to November 6,
2003.
We received proceeds from these two offerings of $2,154,357.
Accumulated offering costs of $323,076 were charged against the net proceeds
from these offerings. Pursuant to these offerings we issued 337,211 shares of
common stock and the same number of 1997-A warrants.
Associate Stock Purchase Plan. We registered 5,000,000 stock purchase
plan participation interests in the Advantage Marketing Systems, Inc. 1998
Associate Stock Purchase Plan. The participation interests are offered to the
associates of our products and services in lots of five participation interests.
A participant in this plan is entitled through purchase of the participation
interests to purchase in the open market through the plan, shares of our common
stock. The participation interests are non-transferable. Other than an annual
service fee of $5.00 per participant and a transaction fee of $1.25 per month,
we do not receive any proceeds from the purchase of the common stock by the
plan. The offering price of each participation interest is $1.00, and each
participant is initially required to purchase a minimum of 25 participation
interests.
RESULTS OF OPERATIONS
Comparison of 2002 and 2001
Our net sales during the year ended December 31, 2002, decreased by
$6,137,339, or 21.6%, to $22,303,581 from $28,440,920 during the year ended
December 31, 2001. During 2002, we made sales to approximately 40,000
associates, compared to sales during 2001 to approximately 71,597 associates.
Associates at December 31, 2002 were down from 2001 due to decreased recruiting
activity. At December 31, 2002, we had approximately 39,000 "active" associates
compared to approximately 69,700 at December 31, 2001. An associate is
considered to be "active" if he or she has made a product purchase of $50 or
more from us or is enrolled in our autoship program within the previous 12
months. Sales per associate per month increased to $58 for 2002, compared to $28
for 2001.
Our cost of sales during 2002 decreased by $4,104,167, or 21.3%, to
$15,126,983 from $19,231,150 during 2001. This decrease was attributable to:
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- A decrease of $2,432,420 in associate commissions and bonuses;
- A decrease of $1,279,169 in the cost of products sold; and
- A decrease of $391,582 in shipping costs.
Total cost of sales as a percentage of net sales increased to 67.8% during the
year ended December 31, 2002, from 67.6% during the same period in 2001. This
was primarily due to an increase in cost of shipping to 7.5% of net sales from
7.3%, which was due to increased rates and an increase in commissions and
bonuses to 41.5% of net sales from 41.1%. This increase was partially offset by
a decrease in cost of products sold to 18.8% of net sales from 19.2% due to
efficiency in inventory purchasing and carrying cost.
Our gross profit decreased $2,033,172, or 22.1%, to $7,176,598 during
2002 from $9,209,770 during 2001. The gross profit decreased as a percentage of
net sales to 32.2% in 2002 from 32.4% in 2001, as reflected in our cost of goods
sold decrease.
Marketing, distribution and administrative expenses decreased $925,542,
or 10.1%, to $8,255,251 during the year ended December 31, 2002, from $9,180,793
during the same period in 2001. This decrease was primarily attributable to:
- Non-recurring expenses in 2001 of approximately $255,000 related to
the operation of the LifeScience Technologies California warehouse
in January and February of 2001, plus the transition costs related
to the LifeScience Technologies acquisition in January 2001;
- A decrease in depreciation and amortization expense of approximately
$167,000, due to the cessation of goodwill amortization in 2002 per
FASB 142 (See Note 1 to our financial statements);
- A decrease in professional services expense of approximately
$300,000 due to the buyout of options in 2001, and a change in
auditing firm in 2002, saving us approximately $76,000; and
- A decrease in contract services from 2001 of $193,600 incurred to
supplement our technical staff during the LifeScience Technologies
acquisition transition.
The marketing, distribution and administrative expenses as a percentage
of net sales increased to 37.0% in 2002, from 32.3% in 2001.
In July 2001, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 142, "Goodwill and Other Intangible
Assets". This standard required companies to stop amortizing existing goodwill
and other intangible assets with indefinite lives effective January 1, 2002.
Under the new rules, companies would only adjust the carrying amount of goodwill
or indefinite life intangible assets upon an impairment of the goodwill or
indefinite life intangible assets. We implemented this standard effective
January 1, 2002. Upon an evaluation at October 31, 2002, we determined that
goodwill was impaired and should be written off in its entirety. This resulted
in a one-time impairment charge of $3,788,374, or 17.0% of net sales for 2002.
Our net other expense increased by $78,106 to net other expense of
$93,065 during 2002, from a net other expense of $14,959 during the same period
in 2001. This increase was primarily due to:
- A decrease in investment income of $28,000 related to marketable
securities offset by an increase in interest income of $22,000;
- A decrease in collection of written off accounts receivable of
$11,000 related to collection of old, outstanding debt;
- A loss on sale of marketable securities of $30,000; and
- A loss on sale of assets of $17,500.
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Our income (loss) before taxes decreased $4,974,110, to a loss of
$4,960,092 during 2002, from income of $14,018 during 2001. Income (loss) before
taxes as a percentage of net sales was (22.2%) and 0.0% during 2002 and 2001.
Income tax expense (benefit) during 2002 and 2001 was $(1,755,057) and $5,467.
Our net income (loss) decreased $3,213,586, to a net loss of $3,205,035 during
2002, from a net income of $8,551 during 2001. This decrease in net income
(loss) was attributable to:
- The increase in interest expense net of interest income of $78,106
to net other expense of $93,065 during 2002 from net other expense
of $14,959 during 2001;
- The decrease in gross profit of $2,033,172 to $7,176,598 during 2002
from $9,209,770 during 2001;
- The impairment of goodwill of $3,788,374; and
- The decrease in marketing, distribution and administrative expense
of $925,542 to $8,255,251 during 2002 from $9,180,793 during 2001.
Net income as a percentage of net sales decreased to (14.4%) during 2002, from
0.0% during 2001.
Comparison of 2001 and 2000
Our net sales during the year ended December 31, 2001, increased by
$1,732,984, or 6.5%, to $28,440,920 from $26,707,936 during the year ended
December 31, 2000. During 2001, we made sales to 71,597 associates, compared to
sales during 2000 to 79,500 associates. At December 31, 2001, we had
approximately 69,700 "active" associates compared to approximately 76,600 at
December 31, 2000. Sales per associate per month increased from $28 to $33 for
2001, compared to 2000.
Our cost of sales during 2001 increased by $1,301,449, or 7.3%, to
$19,231,150 from $17,929,701 during 2000. This increase was attributable to:
- An increase of $725,608 in associate commissions and bonuses due to
increased sales;
- A decrease of $220,503 in the cost of products sold due to the
consolidation of product lines; and
- An increase of $796,344 in shipping costs primarily due to increased
shipping rates by U.P.S. and U.S.P.S.
Total cost of sales, as a percentage of net sales increased to 67.6% during the
year ended December 31, 2001, from 67.1% during the same period in 2000. This
was due to an increase in cost of shipping to 7.3% of net sales from 4.8%, due
to increased rates. The increase was partially offset by a decrease in cost of
products sold to 19.2% of net sales from 21.3% due to efficiency in inventory
purchasing and carrying cost.
Our gross profit increased $431,535, or 4.9%, to $9,209,770 during 2001
from $8,778,235 during 2000. The gross profit decreased as a percentage of net
sales to 32.4% of net sales from 32.9%, reflected in our cost of goods sold
decrease.
Marketing, distribution and administrative expenses increased
$1,122,985, or 13.9%, to $9,180,793 during the year ended December 31, 2001,
from $8,057,810 during the same period in 2000. This increase was primarily
attributable to:
- A decrease in promotion costs of approximately $460,000;
- An increase in staffing and related payroll cost of approximately
$375,000 necessary to support our expected increase in sales
activity and improve internal programs;
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- Non-recurring expenses of approximately $255,000 related to the
operation of the LifeScience Technologies California warehouse in
January and February of 2001, which facilities have now been closed,
plus the transition costs related to the LifeScience Technologies
acquisition in January 2001;
- An increase in depreciation and amortization expense of
approximately $335,000, including amortization of goodwill resulting
from the LifeScience Technologies acquisition in the amount of
$125,440;
- An increase in professional services cost of $120,000 due to the
buyout of options;
- An increase in contract services of $245,000 incurred to supplement
our technical staff during the LifeScience Technologies acquisition
transition; and
- An increase in insurance expense of $245,000 due to policy premium
increases on general liability and director and officer insurance,
as well as higher levels of activity and corresponding increases in
other variable costs, such as postage, telephone, newsletter, bank
card service charges and supplies.
The marketing, distribution and administrative expenses as a percentage
of net sales increased to 32.3% in 2001, from 30.2% in 2000.
Our net other income decreased by $243,998 to net other expense of
$14,959 during 2001, from a net other income of $229,039 during the same period
in 2000. This decrease was primarily attributable to a decrease in investment
income of approximately $131,000 related to marketable securities, along with an
increase in interest expense of $144,000 related to the LST note payable.
Our income before taxes decreased $935,447, or 98.5%, to $38,019 during
2001, from $949,466 during 2000. Income before taxes as a percentage of net
sales was 0.0% and 3.6% during 2001 and 2000. Income taxes during 2001 and 2000
were $5,467 and $456,532. Our net income decreased $484,383, or 98.3%, to $8,551
during 2001, from $492,934 during 2000. This decrease in net income was
attributable to:
- The decrease in interest income net of interest expense of $243,998,
or 14.7%, to net other expense of $14,959 during 2001 from net other
income of $229,039 during 2000;
- The increase in the marketing, distribution and administrative
expenses; and
- The increase in gross profit of $431,535 to $9,209,770 during 2001
from $8,778,235 during 2000.
Net income as a percentage of net sales decreased to 0.0% during 2001, from 1.8%
during 2000.
Seasonality
No pattern of seasonal fluctuations exists due to the growth patterns
that we are currently experiencing. However, there is no assurance that we will
not become subject to seasonal fluctuations in operations.
ACCOUNTING STANDARDS TO BE ADOPTED
In April 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (SFAS) No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical
Corrections", that, among other things, rescinded SFAS No. 4, "Reporting Gains
and Losses from Extinguishment of Debt". With the rescission of SFAS No. 4, the
early extinguishments of debt generally will no longer be classified as an
extraordinary item for financial statement presentation purposes. The provision
is effective for fiscal years beginning after May 15, 2002. We do not anticipate
that the adoption of SFAS No. 145 will have a material effect on our financial
position or results of operations.
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In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities", which replaces Emerging Issues
Task Force Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity" (including Certain
Costs Incurred in a Restructuring). The new standard required companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
The statement is to be applied prospectively to exit or disposal activities
initiated after December 31, 2002. We do not anticipate that the adoption of
SFAS No. 146 will have a material effect on our financial position or results of
operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure", which amended SFAS No. 123,
"Accounting for Stock-Based Compensation". The new standard provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. Additionally, the statement
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in the annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used in reported results. This statement is effective for financial statements
for fiscal years ending after December 15, 2002. In compliance with SFAS No.
148, we have elected to continue to follow the intrinsic value method in
accounting for our stock-based employee compensation arrangement as defined by
APB No. 25.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirement for Guarantees, Including Indirect
Guarantees of Indebtedness of Others", or FIN 45. For a guarantee subject to
FASB Interpretation No. 45, a guarantor is required to measure and recognize the
fair value of the guarantee liability at inception. For many guarantees, fair
value will likely be determined using the expected present value method
described FASB Concepts Statement 7, "Using Cash Flow Information and Present
Value in Accounting Measurements". In addition, FIN 45 provides new disclosure
requirements. We adopted the disclosure requirements of FIN 45 as of December
31, 2002. The measurement and liability recognition provisions are applied
prospectively to guarantees or modifications after December 31, 2002. We
anticipate that FIN 45 will not have a material impact on our financial
statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities", or FIN 46. Subject to certain criteria defined
in the Interpretation, FIN 46 will require consolidation by business enterprises
of variable interest entities if the enterprise has a variable interest that
will absorb the majority of the entity's expected losses, receive the majority
of it's expected returns, or both. The provisions of FIN 46 are effective
immediately for interests acquired in variable interest entities after January
31, 2003, and at the beginning of the first interim or annual period beginning
after June 15, 2003, for interests acquired in variable interest entities before
February 1, 2003. We will adopt FIN 46 in the third quarter of 2003. Certain
disclosures concerning variable interest entities are required in financial
statements initially issued after January 31, 2003. We are evaluating the effect
of FIN 46 but do not believe FIN 46 will have a material impact on our financial
statements.
COMMITMENTS AND CONTINGENCIES
Recent Regulatory Developments - A significant portion of our net sales
continues to be dependent upon our AM-300 product. Our net sales of AM-300
represented 48.8% and 52.0% of net sales for the years ended December 31, 2002
and 2001. One of the ingredients in our AM-300 products is ephedra, an herb that
contains naturally occurring ephedrine. Our manufacturer uses a powdered extract
of that herb when manufacturing AM-300. We market AM-300 principally as an aid
in weight management. The extract is an 8% extract, which means that every 100
milligrams of the powdered extract contains approximately eight milligrams of
naturally occurring ephedrine alkaloids. In addition, our Sine-Eze product, used
as a food supplement to relieve symptoms associated with allergies, contains
ephedrine alkaloids. Ephedrine containing products have been the subject of
adverse publicity in the United States and other countries relating to alleged
harmful effects.
The FDA published a proposed rule in the Federal Register on June 4,
1997, which proposed significant limitations on the sale of ephedrine-containing
dietary supplements. The proposed rule would have significantly limited our
ability to sell products containing ephedra if it had been made effective. On
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April 3, 2000, the FDA withdrew most of the provisions of its proposed rule.
This action was prompted largely by a report issued by the United States General
Accounting Office, or GAO, in which the GAO criticized the scientific basis for
the proposed rule and the FDA's evaluation of approximately 900 reports of
adverse events supposedly related to the consumption of dietary supplements
containing ephedrine alkaloids. The FDA has made available for public inspection
most of these adverse event reports.
On March 7, 2003, the FDA published a notice in the Federal Register,
which indicates that it will be taking final action on the 1997 proposed rule in
the near future. The FDA re-opened the public comment period, until April 7,
2003, to allow for additional public input on the two proposed limitations on
the sale of ephedrine-containing dietary supplements that remained after the
FDA's action of April 3, 2000. One proposed limitation is a warning that would
be required to appear on the label of all ephedrine-containing supplements. The
other proposed limitation is that ephedrine-containing supplements may not
contain other substances that are known to have stimulant effects (e.g.,
caffeine). The proposed warning addresses potential health risks allegedly
associated with ephedrine-containing dietary supplements. It is similar, but not
identical, to mandatory warnings that have been required by Texas law since 1999
and California law since January 1, 2003. AM-300 and our other
ephedrine-containing supplements comply with these state law requirements.
However, some of our ephedrine-containing products, like AM-300, contain
caffeine or other stimulants. Therefore, if the proposed rule is made final in
its current form, it will prohibit the sale of some of our products in their
present formulations.
On March 13, 2003, the FDA published a proposed rule in the Federal
Register which proposes comprehensive requirements for the manufacturing,
packing and holding dietary supplements, also known as good manufacturing
practices. The FDA is accepting public comments on the proposed GMPs until June
11, 2003; final GMPs will be promulgated after the FDA has reviewed the public
comments. Once final GMP regulations become effective, our manufacturer will be
required to adhere to them. The FDA will most likely institute an effective date
for the GMPs which will allow our manufacturer a reasonable amount of time to
conduct this review and, if necessary, revise its manufacturing operations to
comply with the final GMP regulations.
Product Liability - We, like other marketers of products that are
intended to be ingested, face the inherent risk of exposure to product liability
claims in the event that the use of our products results in injury. We maintain
limited product liability insurance coverage with limits of $1,000,000 per
occurrence and $2,000,000 in the aggregate. Products containing ephedra, which
represented approximately 49% of our 2002 net revenue, are not covered by our
product liability insurance. We generally do not obtain contractual
indemnification from our product manufacturers. However, all of our product
manufacturers carry product liability insurance, which covers our products. A
product liability claim could result in material losses.
Legal Proceedings - We are currently involved in two products liability
suits related to the ingestion of our ephedra-based products. Answers to these
petitions are due April 23 and 30, 2003. As such, we have not had sufficient
time to either investigate the facts of these cases or analyze appropriate
defenses to the allegations. We will deny any wrongdoing and intend to
vigorously defend the claims. The amounts of damages sought are unknown, but
include compensatory and punitive damages.
LIQUIDITY AND CAPITAL RESOURCES
Our primary source of liquidity has been cash provided by sales of our
common stock, marketable securities and operating activities. At December 31,
2002, we had working capital of $3,186,584 compared to $3,110,607 at December
31, 2001. We believe our cash and cash equivalents and cash flows from
operations will be sufficient to fund our working capital needs over the next 12
months. During the year ended December 31, 2002, net cash provided by operating
activities was $694,712, net cash provided by investing activities was $68,193,
and net cash used in financing activities was $537,795. We had a net increase in
cash during this period of $225,111, primarily as a result of operations. Our
working capital needs over the next 12 months consist primarily of marketing,
distribution and administrative expenses.
In 2001, we completed construction of a 23,346 square foot distribution
and call center facility in Oklahoma City. This project was funded, in part,
with bank loans of $980,000 for the land and building and
27
$166,216 for the warehouse equipment. Both loans are with Bank One Oklahoma,
N.A. and accrue interest at an annual rate of .25% under the prime rate.
The loans contain covenants restricting us from various activities
without written consent of Bank One, the most significant of which restrict us
from:
- Transferring, selling or otherwise disposing of any assets;
- Making any loans to any persons or entity in excess of $500,000 in the
aggregate;
- Engaging in any merger or acquisition in which we are not the surviving
corporation;
- Changing executive management personnel; and
- Purchasing or acquiring any interest in any other entity.
The loans also contain financial covenants requiring us to maintain:
- Tangible Net Worth, consisting of total assets excluding intangible
assets less total liabilities excluding subordinated debt, of at least
$5,500,000;
- Debt coverage ratio, consisting of net income plus amortization,
depreciation and interest expense, divided by current maturities of
long term debt and capital leases plus interest expense, of at least
125%; and
- Debt to EBITDA ratio, consisting of current and long term maturities of
debt and capital leases, divided by net income plus amortization,
depreciation, income tax and interest expense, of less than 250%
through December 31, 2002, less than 225% for 2003 and less than 200%
thereafter.
At December 31, 2002, we were not in compliance with our debt coverage
ratio or the debt to EBITDA ratio. Per letter dated February 18, 2003, Bank One
Oklahoma, N.A. granted a waiver for the covenant violations for the period ended
December 31, 2002. We have negotiated a new agreement with Bank One, whereby the
debt is secured by marketable securities. As such, the debt will no longer be
subject to financial covenants.
The following summarizes our contractual obligations at December 31,
2002 and the effect such obligations are expected to have on our liquidity and
cash flow in future periods.
LESS THAN 3-5
TOTAL 1 YEAR 1-3 YEARS YEARS
----- ------ --------- -----
Bank loans and notes (1) ... $2,444,628 $ 455,296 $1,140,439 $ 848,893
Capital lease obligations .. 257,500 109,898 147,602 --
Operating leases ........... 137,332 102,000 35,332 --
---------- ---------- ---------- ----------
Total ...................... $2,839,460 $ 667,194 $1,323,373 $ 848,893
========== ========== ========== ==========
(1) See Note 4 to our financial statements.
At December 31, 2002, we had marketable debt and equity securities of
$1,621,143 compared to $1,663,650 at December 31, 2001. All of our securities
are unrestricted investments.
During the first quarter of 1998, we agreed to loan John W. Hail, our
Chief Executive Officer and a major shareholder, up to $250,000. Subsequently we
also agreed to loan up to an additional $75,000. In 2000, an additional $200,000
was approved. On January 1, 2001 the outstanding balance on all the notes plus
interest were combined into one note payable in monthly installments. Our board
of directors unanimously approved the loans and extension. These loans are
collateralized by stock and property, and bear interest at 8% per annum. As of
December 31, 2002, the balance due on these loans plus interest was $63,561.
These loans will be paid in full in 2003. No new loans will be made to our
officers or directors.
28
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our balance sheet includes marketable securities, which we believe are
a conservative blend of income and growth investments resulting in moderate
market risk. We invest in equity marketable securities to generate capital
growth, and fixed-income marketable securities to provide current income.
Because of the nature of these investments, both current interest rates and
equity market movements will affect total return and risk. Our fixed income
investments of approximately $820,000 are subject to interest risk and market
value risk. We have approximately $800,000 of equity investments that are
exposed to market risk.
Interest Rate Risk. We currently maintain an investment portfolio of
high-quality fixed-income marketable securities. All securities are available
for sale and recorded in the balance sheet at fair value with fluctuations in
fair value reported as a component of accumulated other comprehensive income in
stockholders equity. We do not hedge our investment portfolio or our outstanding
credit facility or other long-term indebtedness. Fixed-income investments with a
maturity date of three months or less at the date of purchase are deemed to be
cash equivalents. Any remaining fixed-income securities are considered
short-term and mainly consist of investments in U.S. Treasury notes and bonds.
The following table lists our cash equivalents and our short-term
fixed-income marketable securities at December 31, 2002 and December 31, 2001:
DECEMBER 31, 2002 DECEMBER 31, 2001
----------------- -----------------
AVERAGE AVERAGE
INTEREST FAIR INTEREST RATE FAIR
RATE(1) COST VALUE (1) COST VALUE
-------- ---- ----- ------------- ---- -----
Cash equivalents ... --% $ 18,208 $ 18,208 --% $ 975,835 $ 975,835
Short-term
Investments ...... 6.00% 787,180 801,339 6.45% 418,269 429,965
-------- -------- ---------- ----------
$805,388 $819,547 $1,394,104 $1,405,800
======== ======== ========== ==========
(1) Average interest rate is calculated by taking the individual security
interest rates multiplied by each investments' weighted average share of the
total fixed-income marketable securities.
Average interest rates for the year ended December 31, 2002 decreased .45%
from December 31, 2001 due to the redemption of 100,000 units of 7.52% U.S.
Government Agency securities in the first quarter, 100,000 units of 6.14% U.S.
Government Agency securities in the third quarter and 95,000 units of 6.29% U.S.
Government Agency securities in the fourth quarter 2002. These securities
represented 70% of our total fixed-income marketable securities at December 31,
2001.
Fair value of the cash equivalents and fixed-income marketable
securities decreased $586,253 during the year ended December 31, 2002 to
$819,547 from $1,405,800 at December 31, 2001. This decrease was primarily due
to the reinvestment of approximately $957,000 of cash equivalents to equity
securities, partially offset by an increase in short-term investments of
approximately $371,000.
Equity Market Risks. We currently maintain an investment portfolio of
equity securities. All securities are available for sale and recorded in the
balance sheet at fair value with fluctuations in fair value reported as a
component of accumulated other comprehensive income in stockholders equity. We
do not engage in hedging our equity portfolio or otherwise purchase derivative
securities. Because of the quality of our portfolio and liquid nature of our
equity investments, we do not consider the market risk related to these
investments to be material. At December 31, 2002, our equity investments had a
value of $801,595 compared to $257,850 at December 31, 2001, primarily due to
the purchase of mutual fund equity investments in the second, third and fourth
quarters of 2002.
We attempt to manage our interest and market risk by evaluating and
purchasing what we believe to be the best investment securities and rates of
return available.
29
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements are set forth beginning on page
F-1 hereof.
ITEM 9. CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
In accordance with the provisions of General Instruction G (3), information
required by Items 10, 11, 12 and 13 of Form 10-K are incorporated herein by
reference to our Proxy Statement for the Annual Meeting of Shareholders to be
filed prior to April 30, 2003.
ITEM 14. CONTROLS AND PROCEDURES
Within the 90-day period prior to the filing of this report, an evaluation
was carried out under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of
1934). Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the design and operation of these disclosure
controls and procedures were effective. No significant changes were made in our
internal controls or in other factors that could significantly affect these
controls subsequent to the date of their evaluation.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) The following financial statements of Advantage Marketing
Systems, Inc. are included in Item 8:
Report of Independent Certified Public Accountants.................................................. F-2
Independent Auditors' Report........................................................................ F-3
Consolidated Balance Sheets as of December 31, 2002 and 2001........................................ F-4
Consolidated Statements of Operations for Years Ended December 31, 2002, 2001 and 2000.............. F-5
Consolidated Statements of Stockholders' Equity for Years Ended December 31, 2002, 2001 and
2000.............................................................................................. F-6
Consolidated Statements of Cash Flows for Years Ended December 31, 2002, 2001 and 2000.............. F-7
Notes to Consolidated Financial Statements for Years Ended December 31, 2002 2001 and 2000.......... F-8
(a)(2) Financial Statement Schedules
All other schedules have been omitted since the required information is
not present, or not present in amounts sufficient to require submission of the
schedule, or because the information required is included in the consolidated
financial statements or notes thereto.
(a)(3) Exhibits
EXHIBIT NO. DESCRIPTION
- ----------- -----------
3.1 The Registrant's Certificate of Incorporation, incorporated by
reference to the Registration Statement on Form SB-2
(Registration No. 333-47801) filed with the commission on
March 11, 1998.
30
3.2 The Registrant's Bylaws, incorporated by reference to the
Registration Statement on Form SB-2 (Registration No.
333-47801) filed with the commission on March 11, 1998.
10.1 Warrant Agreement between Registrant and U.S. Stock Transfer
Inc., dated as of January 16, 1997, as amended and restated
January 8, 1998, incorporated by reference to Amendment No. 2
to Form 8-A Registration Statement, filed with the Commission
on January 13, 1998.
10.2 Unit and Warrant Agreement between Registrant and U.S. Stock
Transfer Inc., dated as of November 6, 1997, as amended and
restated January 8, 1998, incorporated by reference to
Amendment No. 1 to Form 8-A Registration Statement, filed with
the Commission on January 15, 1998.
10.3 * The Advantage Marketing Systems, Inc. 1998 Distributor Stock
Purchase Plan, incorporated by reference to Amendment No. 1 to
Registration Statement on Form SB-2 (Registration No.
333-47801) filed with the commission on October 7, 1998.
10.4 * The form of Advantage Marketing Systems, Inc. 1998 Distributor
Stock Purchase Plan Stock Purchase Agreement, incorporated by
reference to Amendment No. 1 to Registration Statement on Form
SB-2 (Registration No. 333-47801) filed with the commission on
October 7, 1998.
10.5 Purchase and Assignment Agreement by and among Advantage
Marketing Systems, Inc., LifeScience Technologies Holdings,
Inc., GHI Holdings, Inc., LifeScience Technologies, Inc. and
RMS Limited Partnership, dated as of January 3, 2001,
incorporated by reference to Form 8-K filed with the
Commission on January 8, 2001.
10.6 Promissory Note dated January 3, 2001, to RMS Limited
Partnership by Advantage Marketing Systems, Inc., LifeScience
Technologies Holdings, Inc., LifeScience Technologies Holdings
Limited Partnership, LifeScience Technologies Holdings, Inc.,
LifeScience Technologies of Japan and LST Fulfillment Limited
Partnership, incorporated by reference to Form 8-K filed with
the Commission on January 8, 2001.
10.7 Stock Option Agreement of Advantage Marketing Systems dated
January 3, 2001, incorporated by reference to Form 8-K filed
with the Commission on January 8, 2001.
10.8 Joint Marketing Agreement with PrimeBuy Network.com, Inc.,
dated August 30, 2002, incorporated by reference to Form 10-Q
filed with the Commission on November 1, 2002.
10.9 Promissory Note executed by PrimeBuy Network.com, Inc., dated
August 2, 2002, incorporated by reference to Form 10-Q filed
with the Commission on November 1, 2002.
10.10 * The Advantage Marketing Systems, Inc. 1995 Stock Option Plan,
incorporated by reference to Form SB-2 Registration Statement
(No. 33-80629), filed with the Commission on November 20,
1996.
10.11 * Employment Agreement by and between David D'Arcangelo and
Registrant dated effective as of November 25, 2002, filed
herewith.
10.12 * Non-Qualified Stock Option Agreement by and between David
D'Arcangelo and Registrant dated effective as of December 2,
2002, filed herewith.
21 Subsidiaries, incorporated by reference to Form 10-K filed
with the Commission on April 17, 2001.
23.1 Consent of Grant Thornton LLP, filed herewith.
23.2 Consent of Deloitte & Touche LLP, filed herewith.
31
99.1 Chief Executive Officer Certification, filed herewith.
99.2 Chief Financial Officer Certification, filed herewith.
* Designates a compensatory plan.
(b) Reports on Form 8-K.
- On November 4, 2002, the registrant filed an 8-K
reporting the filing of CEO and CFO certifications
relating to its 3rd Quarter Form 10-Q as required by
Section 906 of the Sarbanes Oxley Act of 2002.
- On October 24, 2002, the registrant filed an 8-K
reporting the resignation of its president.
32
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
REGISTRANT:
ADVANTAGE MARKETING SYSTEMS, INC.
Date: March 31, 2003 By: /S/ JOHN W. HAIL
------------------------------------
John W. Hail, Chief Executive Officer,
Chairman of the Board and Director
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Date: March 31, 2003 By: /S/ JOHN W. HAIL
------------------------------------
John W. Hail, Chief Executive Officer,
Chairman of the Board and Director
Date: March 31, 2003 By: /S/ DAVID D. D'ARCANGELO
------------------------------------
David D. D'Arcangelo, President and
Director
Date: March 31, 2003 By: /S/ DENNIS LONEY
------------------------------------
Dennis Loney, Chief Operational Officer
Date: March 31, 2003 By: /S/ REGGIE COOK
------------------------------------
Reggie Cook, Chief Financial Officer
and Secretary Treasurer
Date: March 31, 2003 By: /S/ M. THOMAS BUXTON III
------------------------------------
M. Thomas Buxton III, Director
Date: March 31, 2003 By: /S/ STEVEN M. DICKEY
------------------------------------
Steven M. Dickey, Director
Date: March 31, 2003 By: /S/ HARLAND C. STONECIPHER
------------------------------------
Harland C. Stonecipher, Director
Date: March 31, 2003 By: /S/ STEVEN R. HAGUE
------------------------------------
Steven R. Hague, Director
33
I, John W. Hail, Chief Executive Officer, certify that:
1. I have reviewed this annual report on Form 10-K of Advantage
Marketing Systems, Inc. (the "registrant");
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for, the
periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrant and have:
(a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries, is
made known to us by others within those entities,
particularly during the period in which this annual
report is being prepared;
(b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within 90
days prior to the filing date of this annual report (the
"Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
(a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Advantage Marketing Systems, Inc.
Date: March 31, 2003 By: /S/ JOHN W. HAIL
----------------
John W. Hail
Chairman and Chief Executive Officer
34
I, Reggie B. Cook, Chief Financial Officer, certify that:
1. I have reviewed this annual report on Form 10-K of Advantage
Marketing Systems, Inc. (the "registrant");
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for, the
periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrant and have:
(d) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries, is
made known to us by others within those entities,
particularly during the period in which this annual
report is being prepared;
(e) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within 90
days prior to the filing date of this annual report (the
"Evaluation Date"); and
(f) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
(a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Advantage Marketing Systems, Inc.
Date: March 31, 2003 By: /S/ REGGIE B. COOK
--------------------------------
Reggie B. Cook
Chief Financial Officer
35
INDEX TO FINANCIAL STATEMENTS
PAGE
----
ADVANTAGE MARKETING SYSTEMS, INC. AND SUBSIDIARIES
AUDITED CONSOLIDATED FINANCIAL STATEMENTS:
Report of Independent Certified Public Accountants................................................ F-2
Independent Auditors' Report...................................................................... F-3
Consolidated Balance Sheets as of December 31, 2002 and 2001...................................... F-4
Consolidated Statements of Operations for Years Ended December 31, 2002, 2001 and 2000............ F-5
Consolidated Statements of Stockholders' Equity for Years Ended December 31, 2002, 2001 and
2000............................................................................................ F-6
Consolidated Statements of Cash Flows for Years Ended December 31, 2002, 2001 and 2000............ F-7
Notes to Consolidated Financial Statements for Years Ended December 31, 2002 2001 and 2000........ F-8
F-1
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Stockholders of
Advantage Marketing Systems, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Advantage
Marketing Systems, Inc. and Subsidiaries as of December 31, 2002 and 2001, and
the related consolidated statements of operations, 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Advantage Marketing
Systems, Inc. and Subsidiaries as of December 31, 2002 and 2001, and the results
of their operations and their cash flows for the years then ended, in conformity
with accounting principles generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, the Company
adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangibles, on January 1, 2002.
GRANT THORNTON LLP
Oklahoma City, Oklahoma
February 22, 2003
F-2
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Advantage Marketing Systems, Inc. and Subsidiaries
Oklahoma City, Oklahoma
We have audited the accompanying consolidated balance sheet of Advantage
Marketing Systems, Inc. and subsidiaries (the "Company") as of December 31,
2000, (not presented herein) and the related consolidated statements of income,
stockholders' equity, and cash flows for the year then ended. These consolidated
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, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of December 31,
2000, (not presented herein) and the results of its operations and its cash
flows for the year then ended, in conformity with accounting principles
generally accepted in the United States of America.
DELOITTE & TOUCHE LLP
Oklahoma City, Oklahoma
April 12, 2001
F-3
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2002 AND 2001
2002 2001
---- ----
ASSETS
CURRENT ASSETS:
Cash and cash equivalents .................................................... $ 1,207,299 $ 982,188
Marketable securities, available for sale, at fair value ..................... 1,621,143 1,663,650
Receivable - net of allowance of $0 and $92,931 respectively ................. 123,838 331,961
Receivable from affiliates ................................................... 63,561 100,000
Prepaid taxes and income tax receivable ...................................... 464,975 99,120
Inventory .................................................................... 798,153 1,335,451
Deferred income taxes ........................................................ 120,343 65,546
Other assets ................................................................. 31,215 81,830
------------ ------------
Total current assets ...................................................... 4,430,527 4,659,746
RECEIVABLES, Net, $433,035 from related party in 2001 .......................... 338,839 850,371
PROPERTY AND EQUIPMENT, Net .................................................... 3,905,432 4,345,374
GOODWILL, Net .................................................................. -- 3,788,374
COVENANTS NOT TO COMPETE and other intangibles, Net ............................ 635,821 713,638
DEFERRED INCOME TAXES .......................................................... 1,276,859 --
OTHER ASSETS ................................................................... 98,791 314,901
------------ ------------
TOTAL $ 10,686,269 $ 14,672,404
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ............................................................. $ 219,533 $ 29,509
Accrued commissions and bonuses .............................................. 171,310 438,515
Accrued other expenses ....................................................... 151,289 147,044
Accrued sales tax liability .................................................. 136,618 244,485
Notes payable ................................................................ 455,296 579,860
Capital lease obligations .................................................... 109,898 109,726
------------ ------------
Total current liabilities ................................................. 1,243,944 1,549,139
LONG-TERM LIABILITES:
Notes payable ................................................................ 1,989,332 2,320,063
Capital lease obligations .................................................... 122,564 234,385
Deferred taxes ............................................................... -- 23,639
------------ ------------
Total liabilities ......................................................... 3,355,840 4,127,226
------------ ------------
COMMITMENTS AND CONTINGENCIES (Notes 5 and 12)
STOCKHOLDERS' EQUITY:
Common stock - $.0001 par value; authorized 495,000,000 shares; issued
4,896,674 and 4,882,174 shares; outstanding 4,424,314 and 4,409,814 shares,
respectively .............................................................. 490 488
Paid-in capital .............................................................. 11,793,240 11,764,182
Notes receivable for exercise of options ..................................... (31,000) (31,088)
Retained earnings (accumulated deficit) ...................................... (2,118,857) 1,086,178
Accumulated other comprehensive loss, net of tax ............................. (68,968) (30,106)
------------ ------------
Total capital and retained earnings (accumulated deficit) ................ 9,574,905 12,789,654
Less cost of treasury stock (472,795 shares) ................................. (2,244,476) (2,244,476)
------------ ------------
Total stockholders' equity ................................................ 7,330,429 10,545,178
------------ ------------
TOTAL .......................................................................... $ 10,686,269 $ 14,672,404
============ ============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-4
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
2002 2001 2000
---- ---- ----
Net sales ............................................................. $22,303,581 $28,440,920 $26,707,936
Cost of sales ......................................................... 15,126,983 19,231,150 17,929,701
----------- ----------- -----------
Gross profit ........................................................ 7,176,598 9,209,770 8,778,235
Marketing, distribution and administrative expenses:
Marketing ......................................................... 2,487,006 2,304,922 2,981,372
Distribution and administration ................................... 5,768,245 6,875,871 5,076,436
----------- ----------- -----------
Total marketing, distribution and administrative expenses ............. 8,255,251 9,180,793 8,057,808
Goodwill impairment ................................................... 3,788,374 -- --
----------- ----------- -----------
Income (loss) from operations ....................................... (4,867,027) 28,977 720,427
Other income (expense):
Interest and dividends, net ........................................... (53,895) (31,800) 310,599
Other income (expense), net ........................................... (39,170) 16,841 (81,560)
----------- ----------- -----------
Total other income (expense) ........................................ (93,065) (14,959) 229,039
----------- ----------- -----------
INCOME (LOSS) BEFORE TAXES ............................................ (4,960,092) 14,018 949,466
INCOME TAX EXPENSE (BENEFIT) .......................................... (1,755,057) 5,467 456,532
----------- ----------- -----------
NET INCOME (LOSS) ..................................................... $(3,205,035) $ 8,551 $ 492,934
=========== =========== ===========
Net income (loss) per common share - basic ............................ $ (.73) $ -- $ .12
=========== =========== ===========
Net income (loss) per common share - assuming dilution ................ $ (.73) $ -- $ .09
=========== =========== ===========
Weighted average common shares outstanding - basic .................... 4,419,196 4,379,486 4,283,461
=========== =========== ===========
Weighted average common shares - assuming dilution .................... 4,419,196 4,692,298 5,476,277
=========== =========== ===========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-5
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
NOTES RETAINED
RECEIVABLE EARNINGS
SHARES FOR (ACCUMU-
(SEE COMMON PAID-IN EXERCISE LATED
NOTE 6) STOCK CAPITAL OF OPTIONS DEFICIT)
------- ------ ------- ---------- ---------
BALANCE,
JANUARY 1, 2000 4,083,238 $ 428 $ 10,232,700 $ (50,999) $ 759,692
Payments on notes
receivable ........... -- -- -- 19,911 --
Options exercised with
cash ................. 373,504 37 843,480 -- --
Options exercised by
tendering mature
shares, net .......... 76,239 8 -- -- --
1997-A Warrants
exercised ............ 28,443 3 96,703 -- --
Redeemable common
stock purchase
warrants exercised ... 59,000 6 200,594 -- --
Purchases of treasury
stock, at cost ....... (271,610) -- -- -- --
Tax benefit from
exercise of
non-qualified
options .............. -- -- 268,711 -- --
Purchase and
cancellation of
warrants.............. -- -- -- -- (174,999)
Comprehensive Income:
Net Income ............. -- -- -- -- 492,934
Unrealized loss on
available for sale
securities, net of
tax................... -- -- -- -- --
Comprehensive income.... -- -- -- -- --
--------- ------ ----------- ----------- -----------
BALANCE,
DECEMBER 31, 2000..... 4,348,814 $ 482 $11,642,188 $ (31,088) $ 1,077,627
Options exercised with
cash ................. 61,000 6 121,994 -- --
Comprehensive Income:
Net Income ............. -- -- -- -- 8,551
Unrealized loss on
available for sale
securities, net of
tax................... -- -- -- -- --
Comprehensive Income ... -- -- -- -- --
--------- ------ ----------- ----------- -----------
BALANCE,
DECEMBER 31, 2001..... 4,409,814 $ 488 $11,764,182 $ (31,088) $ 1,086,178
Options exercised with
cash ................. 14,500 2 29,058 -- --
Payments of notes
receivable ........... -- -- -- 88 --
Comprehensive Income:
Net Loss ............... -- -- -- -- (3,205,035)
Unrealized loss on
available for sale
securities, net of
tax................... -- -- -- -- --
Comprehensive Income
(Loss) ................. -- -- -- -- --
--------- ------ ----------- ----------- -----------
BALANCE,
DECEMBER 31, 2002..... 4,424,314 $ 490 $11,793,240 $ (31,000) $(2,118,857)
========= ====== =========== =========== ===========
ACCUMU-
LATED
OTHER COM-
PREHENSIVE
COMPRE- INCOME TOTAL
HENSIVE (LOSS), STOCK-
INCOME NET TREASURY HOLDERS'
(LOSS) OF TAX STOCK EQUITY
------- ---------- -------- --------
BALANCE,
JANUARY 1, 2000 $ (10,531) $ (699,307) $10,231,983
Payments on notes
receivable ........... -- -- -- 19,911
Options exercised with
cash ................. -- -- -- 843,517
Options exercised by
tendering mature
shares, net .......... -- -- -- 8
1997-A Warrants
exercised ............ -- -- -- 96,706
Redeemable common
stock purchase
warrants exercised ... -- -- -- 200,600
Purchases of treasury
stock, at cost ....... -- -- (1,545,169) (1,545,169)
Tax benefit from
exercise
of non-qualified
options .............. -- -- -- 268,711
Purchase and
cancellation of
warrants.............. -- -- -- (174,999)
Comprehensive Income:
Net Income ............. $ 492,934 -- -- 492,934
Unrealized loss on
available for sale
securities, net of
tax................... (10,297) (10,297) -- (10,297)
---------
Comprehensive income.... $ 482,637 -- -- --
=========== --------- ----------- -----------
BALANCE,
DECEMBER 31, 2000..... $ (20,828) $(2,244,476) $10,423,905
Options exercised with
cash ................. -- -- -- 122,000
Comprehensive Income:
Net Income ............. 8,551 -- -- 8,551
Unrealized loss on
available for sale
securities, net
of tax................ (9,278) (9,278) -- (9,278)
-----------
Comprehensive Income ... $ (727) -- -- --
=========== --------- ----------- -----------
BALANCE,
DECEMBER 31, 2001..... $ (30,106) $(2,244,476) $10,545,178
Options exercised with
cash ................. -- -- -- 29,060
Payments of notes
receivable ........... -- -- -- 88
Comprehensive Income:
Net Loss ............... (3,205,035) -- -- (3,205,035)
Unrealized loss on
available for sale
securities, net of
tax................... (38,862) (38,862) -- (38,862)
-----------
Comprehensive Income
(Loss) ................. $(3,243,897) -- -- --
=========== --------- ----------- -----------
BALANCE,
DECEMBER 31, 2002..... $ (68,968) $(2,244,476) $7,330,429
========= =========== ===========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-6
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
2002 2001 2000
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITES:
Net income ................................................................... $(3,205,035) $ 8,551 $ 492,934
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization ............................................ 1,016,260 1,112,870 799,969
Goodwill impairment ...................................................... 3,788,374 -- --
Deferred taxes ........................................................... (1,331,778) 43,189 5,522
Provision for bad debts................................................... -- -- 102,472
(Gain) loss on sale of assets ............................................ 17,568 (7,904) (3,120)
Realized (gain) loss on sale of marketable securities..................... 33,841 (3,714) 34,369
Impairment of Inventory & other Assets ................................... 116,143 -- --
Changes in assets and liabilities which provided (used) cash:
Receivables ............................................................ 200,988 57,561 (543,490)
Inventory .............................................................. 421,156 466,112 (80,343)
Prepaid taxes and income tax receivable ................................ (365,855) 183,241 (13,650)
Other assets ........................................................... 183,853 (764) (51,668)
Accounts payable and accrued expenses .................................. (180,803) (350,965) (805,475)
----------- ---------- ----------
Net cash provided by (used in) operating activities .................. 694,712 1,508,177 (62,480)
----------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment .......................................... (717,515) (1,798,899) (1,164,945)
Sales of property and equipment .............................................. 284,438 26,442 --
Advances to affiliates ....................................................... 36,438 -- (280,670)
Advances to notes receivable ................................................. -- (24,864) --
Receipts on notes receivable.................................................. 85,631 105,167 --
Proceeds from sale of assets.................................................. -- -- 29,826
Repayment of related party receivables ....................................... 433,036 61,360 36
Purchase of marketable securities, available for sale ........................ (1,817,520) (15,259) (1,510,538)
Purchase of marketable securities, held to maturity .......................... -- -- (1,301,151)
Sale of marketable securities, available for sale ............................ 1,763,685 1,840,067 1,956,092
Maturity of marketable securities, held to maturity........................... -- -- 1,386,000
Purchase of other intangibles ................................................ -- (428,338) --
Acquisition of new business, net of cash acquired ............................ -- (1,149,636) --
----------- ---------- ----------
Net cash provided by (used in) in investing activities ............... 68,193 (1,383,960) (885,350)
----------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock........................................ 29,061 122,000 1,140,823
Proceeds from notes payable................................................... -- 1,146,216 25,248
Purchase of treasury stock ................................................... -- -- (1,545,169)
Purchase and cancellation of other warrants .................................. -- -- (174,999)
Repayments of notes receivable for exercise of stock options.................. 88 -- 20,220
Payment of notes payable ..................................................... (455,295) (348,454) (2,826)
Principal payment on capital lease obligations ............................... (111,649) (138,478) (101,674)
----------- ---------- ---------
Net cash provided by (used in) financing activities .................. (537,795) 781,284 (638,377)
----------- ---------- ----------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS .................................................................... 225,111 905,501 (1,586,207)
CASH AND CASH EQUIVALENTS, BEGINNING ........................................... 982,188 76,687 1,662,894
----------- ---------- ----------
CASH AND CASH EQUIVALENTS, ENDING .............................................. $ 1,207,299 $ 982,188 $ 76,687
=========== ========== ==========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-7
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements
include the accounts of Advantage Marketing Systems, Inc. and its
wholly owned subsidiaries, Miracle Mountain International, Inc. and
Chambre' International, Inc. (the "Company"). All significant
intercompany accounts have been eliminated.
NATURE OF BUSINESS - The Company markets a product line of consumer
oriented products in the weight management, dietary supplement and
personal care categories that are produced by various manufacturers.
The Company sells its product line through a network of full and
part-time independent associates developed by the Company.
The Company also sells supplies and materials to its independent
associates.
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 estimates and assumptions
that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
REVENUE RECOGNITION - The Company recognizes revenue upon shipment of
products, training aids and promotional material to the independent
associates.
LOANS AND TRADE RECEIVABLES - All of the Company's customers pay for
sales in advance of shipment. As such, the Company has no trade
receivables. Loans to associates are repayable in five years or less;
are secured by commissions controlled by the Company; and are no longer
allowed. Interest rates on loans are typically two percent or more
above the Prime rate and are fixed.
CREDIT LOSSES AND DOUBTFUL ACCOUNTS - All loans and receivables are
secured by guaranteed payment sources that are within the Company's
control. As such, management believes there is no need for an allowance
for doubtful accounts.
SALES RETURNS - All of the Company's products include a customer
satisfaction guarantee. Company products may be returned within 30 days
of purchase for a full refund or credit toward the purchase of another
Company product. The Company also has a buy-back program whereby it
will repurchase products sold to an independent associate (subject to a
restocking fee) provided that the associate terminates his/her
associateship agreement with the Company and returns the product within
12 months of original purchase in marketable condition. The cost of
products returned to the Company is included in net sales. For the
years ended December 31, 2002 and 2001, the cost of products returned
to the Company was less than one percent of gross sales. For the year
ended December 31, 2000, the cost of products returned to the Company
was less than two percent of gross sales.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents consist of cash
in banks and all short term investments with initial maturities of
three months or less. The Company maintains its cash and cash
equivalents in accounts that may not be federally insured. The Company
has not experienced any losses in such accounts and believes it is not
exposed to any significant credit risk.
MARKETABLE SECURITIES - All of the Company's marketable securities are
classified as available for sale and reported at fair value. The
related unrealized gains and losses are excluded from earnings and
F-8
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
reported net of income tax as a separate component of stockholders'
equity until realized. Realized gains and losses on sales of securities
are based on the specific identification method. Declines in the fair
value of investment securities below their carrying value that are
other than temporary are recognized in earnings.
INVENTORY - Inventory consists of consumer product inventory and
training and promotional material such as video tapes, cassette tapes
and paper supplies held for sale to customers and independent
associates. Inventory is stated at the lower of cost or market. Cost is
determined on a first-in, first-out method.
SHIPPING AND HANDLING COSTS - Shipping and handling costs are included
as a component of cost of goods sold. Fees charged to customers are
included in sales.
INTANGIBLES - Intangible assets consist of covenants not to compete and
other intangibles, which have a significant residual value. Covenants
not to compete are being amortized over the life of the contracts.
The table below details the gross carrying amount and accumulated
amortization:
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------
2002 2001 2000
---- ---- ----
Non-compete covenants, gross ...... $ 644,000 $ 644,000 $ 644,000
Other intangibles, gross .......... 428,338 428,338 --
---------- ---------- ----------
Total intangibles, gross ...... $1,072,338 $1,072,338 $ 644,000
========== ========== ==========
Accumulated amortization, non-
compete covenants ............... $ 393,683 $ 337,283 $ 280,883
Accumulated amortization, other
intangibles ..................... 42,884 21,417 --
---------- ---------- ----------
Total accumulated amortization $ 436,517 $ 358,700 $ 280,883
========== ========== ==========
Intangible amortization for the years ended December 31, 2002, 2001 and
2000, was $77,817, $77,817 and $73,729, respectively. Estimated
amortization expense for the years 2003, 2004, 2005 and 2006 is $77,817
and estimated amortization expense for the year 2007 is $46,134.
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost or,
in the case of leased assets under capital leases, at the fair value of
the leased property and equipment, less accumulated depreciation and
amortization. Property and equipment are depreciated using the
straight-line method over the estimated useful lives of the assets of
three to 20 years. Assets under capital leases and leasehold
improvements are amortized over the lesser of the term of the lease or
the life of the asset.
LONG-LIVED ASSETS - Management of the Company assesses recoverability
of its long-lived assets whenever events or changes in circumstances
indicate that the carrying value of the asset may not be recoverable
through future cash flows generated by that asset. Recoverability is
assessed and measured on long-lived assets using an estimate of the
undiscounted future cash flows attributable to the asset. Impairment is
measured based on future cash flows discounted at an appropriate rate.
F-9
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
FAIR VALUE DISCLOSURE - The Company's financial instruments include
cash and cash equivalents, marketable securities, receivables,
short-term payables, notes payable and capital lease obligations. The
carrying amounts of cash and cash equivalents, receivables and
short-term payables approximate fair value due to their short-term
nature. Marketable securities held for sale are carried at fair value.
The carrying amounts of capital lease obligations approximate fair
value based on borrowing rates currently available to the Company.
Notes payable with carrying amounts of $2,444,628 and $2,899,923 had
fair values of approximately $2,520,000 and $2,900,000 at December 31,
2002 and 2001, respectively.
EARNINGS PER SHARE - Earnings per common share is computed based upon
net income divided by the weighted average number of common shares
outstanding during each period. Earnings per common share-assuming
dilution is computed based upon net income divided by the weighted
average number of common shares outstanding during each period adjusted
for the effect of dilutive potential common shares calculated using the
treasury stock method. The following is a reconciliation of the common
shares used in the calculations of earnings per common share and
earnings per common share - assuming dilution:
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
For the year ended December 31, 2002:
Earnings (loss) per common share:
Income (loss) available to common stockholders ................... $(3,205,035) $ (.73)
========
Weighted average common shares outstanding ....................... 4,419,196
Earnings (loss) per common share - assuming dilution:
Options........................................................... -- --
----------- ----------
Income (loss) available to common stockholders
plus assumed conversions ....................................... $(3,205,035) 4,419,196 $ (.73)
=========== ========== ========
For the year ended December 31, 2001:
Earnings per common share:
Income available to common stockholders ........................... $ 8,551 $ --
========
Weighted average common shares outstanding ........................ $4,379,486
Earnings per common share - assuming dilution:
Options ........................................................... -- 312,812
Warrants .......................................................... -- --
----------- ----------
Income available to common stockholders plus
assumed conversions ............................................. $ 8,551 4,692,298 $ --
=========== ========== ========
For the year ended December 31, 2000:
Earnings per common share:
Income available to common stockholders ........................... $ 492,934 $ .12
========
Weighted average common shares outstanding ........................ 4,283,461
Earnings per common share - assuming dilution:
Options ........................................................... -- 706,786
Warrants .......................................................... -- 486,030
----------- ----------
Income available to common stockholders plus
assumed conversions ............................................. $ 492,934 5,476,277 $ .09
=========== ========== ========
Options to purchase 1,756,653 shares of common stock at exercise prices
ranging from $1.31 to $6.13 per share were outstanding at December 31,
2002 but were not included in the computation of earnings per common
share-assuming dilution because such inclusion would not be dilutive.
At December 31, 2002, 526,664 common shares issuable pursuant to the
terms of a convertible acquisition note payable
F-10
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
were excluded from the determination of diluted earnings per share
under the if-converted method, because the effect of inclusion was
antidilutive.
Options to purchase 1,193,691 shares of common stock at exercise prices
ranging from $2.95 to $6.13 per share were outstanding at December 31,
2001 but were not included in the computation of earnings per common
share-assuming dilution because the options' exercise price was greater
than the average market price of the common shares. At December 31,
2001, 693,332 common shares issuable pursuant to the terms of a
convertible acquisition note payable were excluded from the
determination of diluted earnings per share under the if converted
method because the effect of inclusion was antidilutive.
Options to purchase 138,005 shares of common stock at exercise prices
ranging from $4.75 to $6.13 per share were outstanding at December 31,
2000 but were not included in the computation of earnings per common
share - assuming dilution because the options' exercise price was
greater than the average market price of the common shares.
Warrants to purchase 1,874,768 shares of common stock at exercise
prices ranging from $3.40 to $5.40 per share at December 31, 2002 and
2001, and warrants to purchase 130,000 shares of common stock at $5.40
per share at December 31, 2000 were outstanding but were not included
in the computation of earnings per common share-assuming dilution
because the warrants' exercise price was greater than the average
market price of the common shares.
ACCOUNTING STANDARDS YET TO BE ADOPTED - In April 2002, the Financial
Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standard (SFAS) No. 145, "Rescission of FASB Statements No.
4, 44 and 64, Amendment of FASB Statement No. 13 and Technical
Corrections", that, among other things, rescinded SFAS No. 4,
"Reporting Gains and Losses from Extinguishment of Debt". With the
rescission of SFAS No. 4, the early extinguishments of debt generally
will no longer be classified as an extraordinary item for financial
statement presentation purposes. The provision is effective for fiscal
years beginning after May 15, 2002. The Company does not anticipate
that the adoption of SFAS No. 145 will have a material effect on its
financial position or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities", which replaces Emerging
Issues Task Force Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity"
(including Certain Costs Incurred in a Restructuring). The new standard
required companies to recognize costs associated with exit or disposal
activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. The statement is to be applied
prospectively to exit or disposal activities initiated after December
31, 2002. The Company does not anticipate that the adoption of SFAS No.
146 will have a material effect on its financial position or results of
operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure", which amended SFAS
No. 123, "Accounting for Stock-Based Compensation". The new standard
provides alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee
compensation. Additionally, the statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in the
annual and interim financial statements about the method of accounting
for stock-based employee compensation and the effect of the method used
in reported results. This statement is effective for financial
statements for fiscal years ending after December 15, 2002. However,
certain disclosures are effective for the Company's year ended December
31, 2002. In compliance with SFAS No. 148, the
F-11
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Company has elected to continue to follow the intrinsic value method in
accounting for its stock-based employee compensation arrangement as
defined by APB No. 25.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirement for Guarantees, Including
Indirect Guarantees of Indebtedness of Others", or FIN 45. For a
guarantee subject to FASB Interpretation No. 45, a guarantor is
required to measure and recognize the fair value of the guarantee
liability at inception. For many guarantees, fair value will likely be
determined using the expected present value method described FASB
Concepts Statement 7, "Using Cash Flow Information and Present Value in
Accounting Measurements". In addition, FIN 45 provides new disclosure
requirements. The disclosure requirements of FIN 45 were effective for
the Company as of December 31, 2002. The measurement and liability
recognition provisions are applied prospectively to guarantees or
modifications after December 31, 2002. The Company anticipates that FIN
45 will not have a material impact on the financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities", or FIN 46. Subject to certain criteria
defined in the Interpretation, FIN 46 will require consolidation by
business enterprises of variable interest entities if the enterprise
has a variable interest that will absorb the majority of the entity's
expected losses, receive the majority of it's expected returns, or
both. The provisions of FIN 46 are effective immediately for interests
acquired in variable interest entities after January 31, 2003, and at
the beginning of the first interim or annual period beginning after
June 15, 2003, for interests acquired in variable interest entities
before February 1, 2003. The Company will adopt FIN 46 in the third
quarter of 2003. Certain disclosures concerning variable interest
entities are required in financial statements initially issued after
January 31, 2003. The Company is evaluating the effect of FIN 46 but
does not believe FIN 46 will have a material impact on its financial
statements.
COMPREHENSIVE INCOME - The Company classifies other comprehensive
income items by their nature in the financial statements and displays
the accumulated balance of other comprehensive income separately in the
stockholders' equity section of the balance sheet. The Company's only
other comprehensive income item is related to unrealized gains on
investment securities classified as available for sale.
2002 2001 2000
---- ---- ----
Unrealized gain (loss) on investment arising during
the period................................................ $ (69,299) $ (5,564) $ 44,072
Less reclassification adjustment for gains (losses)
included in net earnings.................................. (30,437) 3,714 54,369
--------- -------- ---------
Unrealized gain (loss) on investment, net of income
taxes of $23,517, $5,615 and $6,301, respectively......... $ (38,862) $ (9,278) $ (10,297)
========= ======== =========
INCOME TAXES - The Company uses an asset and liability approach to
account for income taxes. Deferred income taxes are recognized for the
tax consequences of temporary differences and carryforwards by applying
enacted tax rates applicable to future years to differences between the
financial statement amounts and the tax bases of existing assets and
liabilities. A valuation allowance is established if, in management's
opinion, it is more likely than not that some portion of the deferred
tax asset will not be realized.
RECLASSIFICATIONS - Certain reclassifications have been made to prior
year balances to conform to the presentation for the current period.
F-12
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
GOODWILL - During 2001 and 2000, goodwill was amortized using the
straight-line method over 7 to 20 years and the Company assessed the
recoverability of goodwill by determining whether the amortization of
the asset balance over its remaining life could be recovered through
the undiscounted future operating cash flows of the acquired operation.
The amount of impairment, if any, was measured based on projected
discounted future operating cash flows. Effective January 1, 2002, the
Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets"
and ceased amortizing goodwill. Major provisions of this statement are
as follows:
- Intangible assets acquired in a business combination must
be recorded separately from goodwill if they arise from
contractual or other legal rights or are separable from
the acquired entity and can be sold, transferred,
licensed, rented, or exchanged, either individually or as
a part of a related contract, asset, or liability;
- Goodwill and intangible assets with indefinite lives are
not amortized but are tested for impairment at least
annually, except in certain circumstances, and whenever
there is an impairment indicator; and
- All acquired goodwill must be assigned to reporting units
for purposes of impairment testing and segment reporting.
The following table reconciles reported net income (loss) and related
per share amounts to amounts that would have been presented exclusive
of amortization expense recognized for goodwill that is no longer being
amortized (tax-effected):
YEARS ENDED DECEMBER 31,
------------------------
2002 2001 2000
---- ---- ----
Reported net income (loss)..................... $ (3,205,035) $ 8,551 $ 492,934
Add back: Goodwill amortization............... -- 141,733 65,214
------------ --------- ---------
Adjusted net income (loss)..................... $ (3,205,035) $ 150,284 $ 558,148
============ ========= =========
BASIC EARNINGS (LOSS) PER SHARE:
Reported net income (loss)................... $ (.73) $ .00 $ .12
Goodwill amortization........................ -- .03 .02
------------ --------- ---------
Adjusted net income (loss)................... $ (.73) $ .03 $ .14
============ ========= =========
DILUTED EARNINGS (LOSS) PER SHARE:
Reported net income (loss)................... $ (.73) $ .00 $ .09
Goodwill amortization........................ -- .03 .01
------------ --------- ---------
Adjusted net income (loss)................... $ (.73) $ .03 $ .10
============ ========= =========
The Company evaluated its goodwill as of the adoption of SFAS No. 142
on January 1, 2002 and determined that there were no indicators of
impairment since the Company's market capitalization was in excess of
the value of identifiable net assets as of January 1, 2002. The Company
obtained a valuation from an independent third-party appraiser.
The Company updated its analysis of goodwill impairment as of October
31, 2002 and determined that there was an indicator of impairment of
its recorded goodwill; accordingly, the Company completed the second
phase of impairment testing. Based on the impairment test, the Company
F-13
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
recognized an impairment of approximately $3.8 million as of December
31, 2002, which eliminated goodwill in its entirety.
The impairment was required because economic conditions at the time of
testing reduced the market capitalization of the Company to a level
below the value of identifiable net assets. Under SFAS No. 142, an
impairment adjustment recognized after adoption is required to be
recognized as an operating expense.
ADVERTISING COSTS - The Company expenses the cost of advertising the
first time advertising takes place. Advertising expense for the years
ended December 31, 2002, 2001 and 2000 was approximately $2,254,
$38,704 and $3,675, respectively.
STOCK-BASED COMPENSATION - The Company applies Accounting Principles
Board Opinion No. 25 and related interpretations in accounting for its
stock-based compensation awards. Accordingly, no compensation cost has
been recognized for stock options granted in the accompanying
consolidated financial statements. The following pro forma data is
calculated net of tax as if compensation cost for the Company's
stock-based compensation awards (see also Note 6) was determined based
upon the fair value at the grant date consistent with the methodology
prescribed under SFAS No. 123.
YEARS ENDED DECEMBER 31,
------------------------
2002 2001 2000
---- ---- ----
Net income as reported............................. $(3,205,035) $ 8,551 $ 492,934
Adjustment, net of tax........................... (141,610) (426,941) (167,293)
----------- ---------- -----------
Proforma net income (loss)......................... $(3,346,645) $ (418,390) $ 325,641
Net income (loss) per common share as reported..... $ (.73) $ -- $ .12
Adjustment, net of tax........................... (.03) (.10) (.04)
----------- ---------- -----------
Proforma net income (loss) per common share........ $ (.76) $ (.10) $ .08
Proforma net income (loss) per common share -
assuming dilution................................ $ (.76) $ (.09) $ .06
Weighted average common shares outstanding......... 4,419,196 4,379,486 4,283,461
Weighted average common shares outstanding -
assuming dilution................................ 4,419,196 4,379,486 5,476,277
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following
weighted average assumptions used for grants in 2002, 2001 and 2000,
respectively: risk-free interest rates of 2.92, 4.86 and 6.14 percent;
no dividend yield or assumed forfeitures; expected lives of 5.0 years;
and volatility of 55, 63 and 66 percent. The pro forma amounts above
are not likely to be representative of future years because there is no
assurance that additional awards will be made each year.
2. MARKETABLE SECURITIES
Investments in securities are summarized as follows:
DECEMBER 31, 2002
-----------------
COST/ GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
Type of investment COST GAINS LOSSES VALUE
------------------ ---- ----- ------ -----
Short term investments - available for sale .......... $ 18,208 $ -- $ -- $18,208
=========== =========== =========== =======
F-14
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Debt securities - available for sale
U.S. Treasury and other U.S. government
corporations and agencies ......................... $ 100,250 $ 344 $ -- $ 100,594
Foreign bonds, notes and debentures .................. 24,930 -- (148) 24,782
Mutual Funds ......................................... 662,000 14,057 (94) 675,963
----------- ----------- ----------- -----------
$ 787,180 $ 14,401 $ (242) $ 801,339
=========== =========== =========== ===========
Equities - available for sale
Preferred Stock ...................................... $ 38,089 $ 4,457 $ (312) $ 42,234
Mutual Funds ......................................... 892,804 -- (133,442) 759,362
----------- ----------- ----------- -----------
$ 930,893 $ 4,457 $ (133,754) $ 801,596
=========== =========== =========== ===========
$ 1,736,281 $ 18,858 $ (133,996) $ 1,621,143
=========== =========== =========== ===========
DECEMBER 31, 2001
-----------------
COST/ GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
Type of investment COST GAINS LOSSES VALUE
------------------ --------- ---------- ---------- ---------
Short term investments - available for sale ............. $ 975,835 $ -- $ -- $ 975,835
=========== =========== =========== ===========
Debt securities - available for sale
U.S. Treasury and other U.S. government
corporations and agencies ........................... $ 393,339 $ 12,424 $ -- $ 405,763
Foreign bonds, notes and debentures ................... 24,930 -- (728) 24,202
----------- ----------- ----------- -----------
$ 418,269 $ 12,424 $ (728) $ 429,965
=========== =========== =========== ===========
Equities - available for sale
Preferred Stock ....................................... $ 43,669 $ 2,774 $ (2,553) $ 43,890
Mutual Funds .......................................... 278,636 7,145 (71,821) 213,960
----------- ----------- ----------- -----------
$ 322,305 $ 9,919 $ (74,374) $ 257,850
=========== =========== =========== ===========
$ 1,716,409 $ 22,343 $ (75,102) $ 1,663,650
=========== =========== =========== ===========
The amortized cost and estimated fair values of debt securities, by
contractual maturity, at December 31, 2002 are shown below. Actual
maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call
prepayment penalties.
AVAILABLE FOR SALE
------------------
AMORTIZED ESTIMATED
COST FAIR VALUE
--------- ----------
Due within one year ............... $110,349 $110,693
Due one to five years ............. 14,831 14,683
-------- --------
$125,180 $125,376
======== ========
Proceeds from sales of available for sale securities were $1,763,685,
$1,840,000 and $8,075 for 2002, 2001 and 2000, respectively. Gross
gains of $2,161, $10,031 and $11 and gross losses of $32,598, $6,317
and $254 for 2002, 2001 and 2000, respectively, were realized on those
sales.
F-15
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
For the years ended December 31, 2002, 2001 and 2000, interest income
for available for sale securities was $29,066, $77,618 and $100,
respectively. Dividend income for available for sales securities for
the years ended December 31, 2002, 2001 and 2000 was $29,437, $8,443
and $2,192, respectively.
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31:
2002 2001
---- ----
Office furniture, fixtures and equipment $ 4,362,068 $ 4,069,450
Vehicles ................................ 842,081 801,109
Leasehold improvements .................. 62,793 62,793
Building ................................ 1,521,083 1,521,083
Land .................................... 148,308 148,308
----------- -----------
6,936,333 6,602,743
Accumulated depreciation and amortization (3,030,901) (2,257,369)
----------- -----------
Total property and equipment, net ....... $ 3,905,432 $ 4,345,374
=========== ===========
Depreciation expense for the years ended December 31, 2002, 2001 and
2000 was $855,570, $790,115, and $548,661, respectively.
During 2001, the Company completed construction of a state-of-the-art
distribution and call center facility in Oklahoma City. The 23,346
square foot facility has the capability of handling warehouse volumes
of up to $100 million in annual sales, and up to 100 employees in the
call center. The Company funded this project, in part, with bank loans
of $980,000 for the land and building and $166,216 for warehouse
equipment. The interest rate on both loans is the Prime Rate minus
.25%, which was 4.0% as of December 31, 2002, and requires 60 monthly
principal and interest payments of $9,570, with the remaining balance
due on September 30, 2006.
4. DEBT
Notes payable and long-term debt consisted of the following at December
31:
2002 2001
---- ----
Note payable to bank, with interest at prime less .25% (4.0%
and 4.5% at December 31, 2002 and 2001, respectively),
payable in monthly installments of principal and interest, due
on September 30, 2006, collateralized by warehouse and
equipment....................................................................... $ 911,686 $ 967,559
Note payable to bank, with interest at prime less .25% (4.0 %
and 4.5% at December 31, 2002 and 2001, respectively),
payable in monthly installments of principal and interest, due
on September 30, 2006, collateralized by certain
assets.......................................................................... 154,630 164,106
Note payable to RMS Limited Partnership, 7.5% effective
rate, payable in 60 monthly installments net of discount of
$169,070 and $287,676 at December 31, 2002 and 2001,
respectively (See Note 10)..................................................... 1,372,610 1,754,007
F-16
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
9% note payable to Ford Credit, payable in monthly
installments of $720.13........................................................ 5,702 14,251
----------- -----------
2,444,628 2,899,923
Less current maturities...................................................... 455,296 579,860
----------- -----------
$ 1,989,332 $ 2,320,063
=========== ===========
Interest expense for the year ended December 31, 2002, 2001 and 2000
was approximately $167,000, $199,000 and $54. Under the bank notes, the
Company is subject to various covenants, which include minimum tangible
net worth, minimum debt service coverage ratio, and maximum debt to
EBITDA ratio requirements.
At December 31, 2002, the Company was not in compliance with its debt
coverage ratio or the debt to EBITDA ratio. Per letter dated February
18, 2003, Bank One Oklahoma, N.A. granted a waiver for the covenant
violations for the period ended December 31, 2002. We have negotiated a
new agreement with Bank One, whereby the debt is secured by marketable
securities. As such, the debt will no longer be subject to financial
covenants.
Future maturities of long-term debt consists of the following at
December 31, 2002:
2003....................................... $ 455,296
2004....................................... 573,377
2005....................................... 567,062
2006....................................... 848,893
----------
$2,444,628
==========
5. LEASE AGREEMENTS
The Company has various capital leases for office equipment. The lease
terms range from 24 to 60 months. Additionally, annual lease rental
payments for each lease range from $700 to $40,000 per year. The
schedule of future minimum lease payments below reflects all payments
under the leases.
The property and equipment accounts include $718,554 and $690,547 for
leases that have been capitalized at December 31, 2002 and 2001,
respectively. Related accumulated amortization amounted to $473,109 and
$337,461 at December 31, 2002 and 2001, respectively.
The Company leases office and warehouse space under noncancellable
operating leases. Future annual minimum lease payments under capital
leases and noncancellable operating leases with initial or remaining
terms of one year or more at December 31, 2002 are as follows:
CAPITAL OPERATING
LEASES LEASES TOTAL
------ ------ -----
Year ending:
2003 .......................................... $109,898 $102,000 $248,796
2004 .......................................... 102,339 32,607 98,048
2005 .......................................... 45,263 2,725 47,988
-------- -------- --------
Total minimum lease payments .................. $257,500 $137,332 $394,832
======== ========
Less amount representing interest.............. 25,038
--------
F-17
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Present value of net minimum lease payments.... 232,462
Less current portion........................... 109,898
---------
Long-term capital lease obligations............ $ 122,564
=========
Rental expense under operating leases for the years ended December 31,
2002, 2001 and 2000 was $202,122, $202,951, and $218,738, respectively.
6. STOCKHOLDERS' EQUITY
Common Stock - On March 4, 1998, the Company announced its intent to
repurchase up to one million shares of the Company's common stock in
the open market for cash. In connection with such repurchase, the
Company filed with the Securities and Exchange Commission pursuant to
Section 13(e)(1) of the Securities Exchange Act of 1934, as amended, an
Issuer Tender Offer Statement on March 4, 1998. As of December 31,
2002, the Company had repurchased 472,795 shares of the common stock at
a total cost of $2,244,476.
Common Stock Options and Other Warrants - During 2002, the Company
granted 325,982 options to employees at exercise prices ranging from
$1.31 per share to $2.28 per share. Options were granted primarily for
services rendered and to ensure the future availability of those
services to the Company. During 2002, 14,500 prior options were
exercised for cash. In addition, during the period, 97,714 options were
canceled and 13,870 options expired.
During 2001, the Company granted 388,694 options to employees at
exercise prices ranging from $2.60 per share to $3.00 per share.
Options were granted primarily for services rendered and to ensure the
future availability of those services to the Company. None of the
options granted during 2001 were exercisable at December 31, 2001 due
to a one year minimum vesting period. During 2001, 61,000 prior options
were exercised for cash. In addition, during the period 257,976 options
were canceled and no options expired.
During 2000, the Company granted 428,450 options at exercise prices
ranging from $2.75 per share to $6.13 per share. Options were granted
primarily for services rendered and to ensure the future availability
of those services to the Company. A total of 122,750 and 100,000 of the
options granted during 2000 were unexercisable at December 31, 2000 due
to a six month vesting period and a contingency requirement,
respectively. During 2000, 107,375 options were exercised with 31,136
mature shares (shares owned by the optionee in excess of six months as
of the date of exercise). In addition, during the period, 215,059
options were canceled and 14,750 options expired.
The following table summarizes the Company's employee stock option and
other warrants activity for the years ended December 31, 2002, 2001 and
2000:
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
2002 PRICE 2001 PRICE 2000 PRICE
---- ----- ---- ----- ---- -----
Options and other
warrants outstanding
beginning of year............ 1,556,755 $ 2.54 1,487,037 $ 2.62 1,769,275 $ 2.22
Options and other
warrants issued
F-18
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
during the year.............. 325,982 1.60 388,694 2.71 428,450 4.57
Options and other
warrants exercised
during the year.............. (14,500) 2.00 (61,000) 2.00 (480,879) 2.20
Option and other
warrants cancelled
during the year.............. (97,714) 2.74 (257,976) 3.40 (215,059) 4.16
Options and other
warrants expired
during the year.............. (13,870) 2.24 -- -- (14,750) 2.00
-------- ------ --------- ------ --------- ------
Options and other
warrants outstanding,
end of year.................. 1,756,653 $ 2.36 1,556,755 $ 2.54 1,487,037 $ 2.62
========= ====== ========= ====== ========= ======
The weighted average grant-date fair value of options and other
warrants granted during 2002, 2001 and 2000 was $0.73, $1.80 and $2.83
per share, respectively.
Options and Other Warrants Options and Other Warrants
Outstanding Exercisable
----------- -----------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED-
NUMBER REMAINING AVERAGE NUMBER AVERAGE
RANGE OF OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
EXERCISE PRICES AT 12/31/02 LIFE PRICE AT 12/31/02 PRICE
- --------------- ----------- ---- ----- ----------- -----
$1.75 - $2.95 1,430,104 2.47 years $2.01 811,595 $1.87
$3.00 - $4.75 272,088 2.81 years $3.67 110,826 $3.73
$5.25 - $6.13 54,461 2.24 years $5.82 21,784 $5.81
--------- -------
1,756,653 944,205 $2.18
========= =======
Common Stock Warrants - The following table summarizes the Company's
common stock warrants and their activity for the years ended December
31, 2002, 2001 and 2000:
WARRANTS
ISSUED AND EXERCISE
OUTSTANDING PRICE EXERCISE PERIOD
----------- ----- ---------------
December 31, 2002:
1997-A Warrants, beginning of the year ....... 308,768 $ 3.40 1/31/97-11/06/03
1997-A Warrants, exercised during the
year ....................................... --
-------
1997-A Warrants, end of the year ............. 308,768 $ 3.40 1/31/97-11/06/03
=========
Redeemable Common Stock Purchase
Warrants ................................... 1,436,000 $ 3.40 11/06/97-11/06/03
=========
Underwriters' Warrants ....................... 130,000 $ 5.40 11/12/98-11/12/03
=========
December 31, 2001:
1997-A Warrants, beginning of the year ....... 308,768 $ 3.40 1/31/97-11/06/02
1997-A Warrants, exercised during the
year ....................................... --
---------
1997-A Warrants, end of the year ............. 308,768 $ 3.40 1/31/97-11/06/02
=========
F-19
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Redeemable Common Stock Purchase
Warrants, beginning of the year ............ 1,436,000 $ 3.40 11/06/97-11/06/02
Redeemable Common Stock Purchase
Warrants, exercised during the year ........ --
---------
Redeemable Common Stock Purchase
Warrants, end of the year .................. 1,436,000 $ 3.40 11/06/97-11/06/02
=========
Underwriters' Warrants ....................... 130,000 $ 5.40 11/12/98-11/12/02
=========
December 31, 2000:
1997-A Warrants .............................. 308,768 $ 3.40 1/31/97-11/06/02
=========
Redeemable Common Stock Purchase
Warrants ................................... 1,436,000 $ 3.40 11/06/97-11/06/02
=========
Underwriters' Warrants ....................... 130,000 $ 5.40 11/12/98-11/12/02
=========
Each warrant entitles the holder to purchase one share of common stock.
As of January 8, 1998, the Company reduced the exercise price of the
1997-A Warrants from $12.00 to $3.40 and extended the exercise period
from January 31, 1999 to November 6, 2002, to correspond more closely
to the terms of the Redeemable Common Stock Purchase Warrants. In
addition, on September 16, 2002 the Company extended the exercise
period from November 6, 2002 to November 6, 2003.
As of January 6, 1998, the exercise price of the Redeemable Common
Stock Purchase Warrants was adjusted from $5.40 to $3.40. In addition,
on September 16, 2002 the Company extended the exercise period from
November 6, 2002 to November 6, 2003.
There was no expense recognized in the Company's financial statements
relating to either of the warrant exercise price reductions as the
changes only affected allocations of additional paid-in capital because
the Redeemable Common Stock Purchase Warrants and the 1997-A Warrants
were issued in conjunction with an equity offering of the Company. The
reduced exercise prices exceeded the market value of the Company's
common stock on the date of the reduction. In addition, there was no
expense recognized in the Company's financial statements relating to
the extension of the exercise period for either the 1997-A Warrants or
the Redeemable Common Stock Purchase Warrants.
The Redeemable Common Stock Purchase Warrants are subject to redemption
by the Company at $0.25 per warrant. All of the outstanding Redeemable
Common Stock Purchase Warrants must be redeemed if any are redeemed.
The Company may redeem the 1997-A Warrants for $0.0001 per warrant. Any
redemption of unexercised 1997-A Warrants would be for all such
outstanding warrants. The Underwriters' Warrants were issued in
connection with the sale of common stock and Redeemable Warrants in
November 1997 and were in addition to other fees paid to the
underwriters. The Underwriters' Warrants entitle the holder to purchase
one unit consisting of one share of the Company's common stock and one
Redeemable Common Stock Purchase Warrant.
7. STOCK OPTION PLAN
During 1995, the Company approved the 1995 Stock Option Plan (the
"Plan"). Under this Plan, options available for grant can consist of
(i) nonqualified stock options, (ii) nonqualified stock options with
stock appreciation rights attached, (iii) incentive stock options, and
(iv) incentive stock options with stock appreciation rights attached.
The Company has reserved 1,125,000 shares of the Company's common stock
$.0001 par value, for the Plan. The Plan limits participation to
employees, independent contractors, and consultants. Non-employee
directors are excluded from Plan participation. The option price for
shares of stock subject to this Plan is set by the Stock Option
Committee of the Board of Directors at a price not less than 85% of the
market value of the stock on the date of grant. No stock
F-20
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
options may be exercised within six months from the date of grant,
unless under a Plan exception, nor more than ten years after the date
of grant. The Plan provides for the grant of stock appreciation rights,
which allow the holder to receive in cash, stock or combination
thereof, the difference between the exercise price and the fair value
of the stock at date of exercise. The fair value of stock appreciation
rights is charged to compensation expense. The stock appreciation right
is not separable from the underlying stock option or incentive stock
option originally granted and can only be exercised in tandem with the
stock option. No stock appreciation rights are attached to any options
outstanding. During the years ended December 31, 2002 and 2001 the
Company issued 325,982 and 388,694 options, respectively under the
Plan. At December 31, 2002 and 2001, the Company had 1,756,653 and
1,556,755, respectively, stock options outstanding of which only
1,083,403 and 883,505, respectively, were issued pursuant to the plan.
8. RELATED PARTIES
During 2002, 2001 and 2000, the Company received approximately $7,069,
$15,231 and $5,931, respectively, from Pre-Paid Legal Services, Inc.
("Pre-Paid Legal"), a shareholder, for commissions on sales of
memberships for the services provided by Pre-Paid Legal. As of July 1,
2000, the Company began offering the Company's employees access to the
services provided by Pre-Paid Legal through an employee benefit option.
The Company pays half of the cost for each employee electing to
participate in the plan. During 2002, 2001 and 2000, the Company paid
$6,934, $7,593 and $5,059, respectively, to Pre-Paid Legal for these
services. The Company's Chairman of the Board and Chief Executive
Officer, John W. Hail, is a director of Pre-Paid Legal.
On October 8, 1998, John W. Hail, an affiliate, surrendered an option
to purchase 100,000 shares of the Company's common stock for $2.70 per
share with an expiration date of May 20, 2007 in exchange for an option
having the same terms other than an exercise price of $1.75 per share
of common stock, which was equal to the fair value of the common stock
on the date of exchange. These options became exercisable on April 8,
1999.
During the first quarter of 1998, the Company agreed to loan John W.
Hail up to $250,000. Subsequently the Company also agreed to loan up to
an additional $75,000. In 2000, an additional $200,000 was approved. On
January 1, 2001 the outstanding balance on all the notes were combined
into one note payable in monthly installments. The loans and extension
were unanimously approved by the board of directors. These loans are
collateralized by stock and property, and bear interest at 8% per
annum. As of December 31, 2002, the balance due on these loans was
$63,561 plus interest, which is included in receivables from affiliate.
Also during 2002, 2001 and 2000, the Company paid Mr. Loney and his
wife sales bonuses of $30,887, $38,028 and $24,709, respectively. These
bonuses were based upon purchases by them and their downline associates
in accordance with the Company's network marketing program applicable
to all independent associates in effect at the time of the sales. Mr.
Loney's wife is the daughter of John W. Hail.
9. INCOME TAXES
Income taxes for 2002, 2001 and 2000 are comprised of current tax
(benefit) expense of $(423,279), $(37,722) and $444,710 and deferred
taxes of $(1,331,778), $43,189 and $11,822, respectively. A
reconciliation of the statutory Federal income tax rate to the
effective income tax rate for the years ended December 31, 2002, 2001,
and 2000 is as follows:
F-21
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
2002 2001 2000
---- ---- ----
Statutory federal income tax rate .............. (34.0)% 34.0% 34.0%
State tax effective rate ....................... (4.0) 4.0 4.0
Permanent differences .......................... 2.1 2.1 8.9
Benefit of graduated tax rates ................. 0.2 - (0.6)
Prior year assessments finalized ............... - (1.5) 7.0
Other .......................................... 0.3 0.4 (5.2)
----- ---- ----
(35.4)% 39.0% 48.1%
===== ==== ====
The change in the total deferred tax net assets from December 31, 2001
to December 31, 2002 was $1,355,295. This difference is allocated as
$1,331,778 included in tax expense reduced by $23,517 classified in
stockholders' equity, respectively.
Deferred tax liabilities and assets at December 31, 2002 and 2001 are
comprised of the following:
DECEMBER 31,
------------
2002 2001
---- ----
Deferred tax liabilities:
Depreciation.............................................. $ (178,789) $(147,742)
Other..................................................... - (27,605)
---------- ---------
Total deferred tax liabilities...................... (178,789) (175,347)
---------- ---------
Deferred tax assets:
Goodwill impairment....................................... 1,276,895 -
Net operating loss carryforwards.......................... 151,371 87,806
Receivables............................................... - 35,072
Inventory................................................. 60,518 30,474
Unrealized losses......................................... 43,448 20,778
Other..................................................... 43,759 43,124
---------- ---------
Total deferred tax assets........................... 1,575,991 217,254
---------- ---------
Net deferred taxes.......................................... 1,397,202 41,907
Less current portion of net deferred tax assets............. 120,343 65,546
---------- ---------
Noncurrent portion of deferred tax asset (liability)........ $1,276,859 $ (23,639)
========== =========
On a regular basis, management evaluates all available evidence, both
positive and negative, regarding the ultimate realization of the tax
benefits of its deferred tax assets. Management has concluded that it
is more likely than not that a tax benefit will be realized from its
deferred tax assets. The Company has net operating loss carryforwards
of $401,136 available to reduce future taxable income, which will begin
to expire in 2009. Net operating loss carryforwards of $196,000 are
limited in usage.
10. ACQUISITIONS
On January 4, 2001, the Company and one of its wholly owned
subsidiaries, LifeScience Technologies Holdings, acquired LifeScience
Technologies Holding Limited Partnership, LifeScience Technologies
Limited, LifeScience Technologies of Japan, LST Fulfillment limited
Partnership and LifeScience Technologies of Canada, Inc. (the
"LifeScience Technologies Acquisition"). The purchase price to the
Company was approximately $1.2 million cash plus $41,667 per month or
5% of LifeScience Technology product sales, whichever is greater,
payable for 60 months commencing in January 2001. The seller, at its
option, has the right to take shares of the Company's common stock at
an option price of $3.00 per share in lieu of cash for the monthly
payment. However, such option is limited to a total of
F-22
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
860,000 shares and shares not taken in a month are not cumulative. No
shares have been issued under the agreement at December 31, 2002.
The estimated fair value of assets acquired and liabilities assumed at
acquisition are as follows:
Estimated Fair value of assets
Cash...................................................... $ 76,760
Inventory................................................. 793,629
Property and equipment.................................... 283,924
Goodwill and other intangibles............................ 2,508,805
----------
Total fair value of assets.............................. 3,663,118
Liabilities assumed
Accounts payable.......................................... 176,060
Accrued expenses.......................................... 181,223
----------
Estimated fair value of acquisition..................... $3,305,835
==========
The LifeScience Technologies Acquisition was accounted for as a
purchase under Accounting Principles Board Opinion No. 16 ("APB No.
16"). In accordance with APB No. 16, the company allocated the purchase
price of the LifeScience Technologies acquisition based on the fair
value of the assets acquired and liabilities assumed.
The following summarized pro forma unaudited information assumes the
acquisition occurred on January 1, 2000.
YEAR ENDED DECEMBER 31, 2000
----------------------------
Revenues.................................................... $33,588,695
Loss........................................................ (802,790)
Loss per share, basic and diluted........................... (.19)
11. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
YEAR ENDED DECEMBER 31,
-----------------------
2002 2001 2000
---- ---- ----
Cash paid during the year for:
Interest.................................................. $ 194,386 $ 198,740 $ 33,339
Income taxes - net of refund.............................. (56,912) (288,598) 480,000
Noncash financing and investing activities:
Property and equipment acquired by capital lease.......... -- 92,202 89,894
LifeScience Technologies Acquisition:
Fair value of tangible net assets acquired................ $ -- $ 797,030 $ --
Purchase price in excess of tangible net assets
acquired................................................ -- 2,508,805 --
Present value of future payments required................. -- (2,079,439) --
Cash included in tangible net assets acquired............. -- (76,760) --
---------- ------------- ---------
Cash paid for acquisition, net of cash acquired........... $ -- $ 1,149,636 $ --
========== ============= =========
F-23
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
12. COMMITMENTS, CONTINGENCIES AND GUARANTEES
RECENT REGULATORY DEVELOPMENTS - A significant portion of the Company's
net sales continues to be dependent upon the Company's AM-300 product.
The Company's net sales of AM-300 represented 48.8% and 52.0% of net
sales for the years ended December 31, 2002 and 2001, respectively. One
of the ingredients in the Company's AM-300 products is ephedra, an herb
that contains naturally- occurring ephedrine. The Company's
manufacturer used a powdered extract of that herb when manufacturing
AM-300. The Company markets AM-300 principally as an aid in weight
management. The extract is an 8% extract, which means that every 100
milligrams of the powdered extract contains approximately eight
milligrams of naturally occurring ephedrine alkaloids. In addition, our
Sine-Eze product, used as a food supplement to relieve symptoms
associated with allergies, contains ephedrine alkaloids. Ephedrine
containing products have been the subject of adverse publicity in the
United States and other countries relating to alleged harmful effects.
The FDA published a proposed rule in the Federal Register on June 4,
1997, which proposed significant limitations on the sale of
ephedrine-containing dietary supplements. The proposed rule would have
significantly limited the Company's ability to sell products containing
ephedra if it had been made effective. On April 3, 2000, the FDA
withdrew most of the provisions of its proposed rule. This action was
prompted largely by a report issued by the United States General
Accounting Office ("GAO") in which the GAO criticized the scientific
basis for the proposed rule and the FDA's evaluation of approximately
900 reports of adverse events supposedly related to the consumption of
dietary supplements containing ephedrine alkaloids. The FDA has made
available for public inspection most of these adverse event reports.
On March 7, 2003, the FDA published a notice in the Federal Register,
which indicates that it will be taking final action on the 1997
proposed rule in the near future. The FDA re-opened the public comment
period, until April 7, 2003, to allow for additional public input on
the two proposed limitations on the sale of ephedrine-containing
dietary supplements that remained after the FDA's action of April 3,
2000. One proposed limitation is a warning that would be required to
appear on the label of all ephedrine-containing supplements. The other
proposed limitation is that ephedrine-containing supplements may not
contain other substances that are known to have stimulant effects
(e.g., caffeine). The proposed warning addresses potential health risks
allegedly associated with ephedrine-containing dietary supplements. It
is similar, but not identical, to mandatory warnings that have been
required by Texas law since 1999 and California law since January 1,
2003. AM-300 and the Company's other ephedrine-containing supplements
comply with these state law requirements. However, some of the
Company's ephedrine-containing products, like AM-300, contain caffeine
or other stimulants. Therefore, if the proposed rule is made final in
its current form, it will prohibit the sale of some of the Company's
products.
On March 13, 2003, the FDA published a proposed rule in the Federal
Register which proposes comprehensive requirements for the
manufacturing, packing and holding dietary supplements, also known as
good manufacturing practices ("GMP" or "GMPs"). The FDA is accepting
public comments on the proposed GMPs until June 11, 2003; final GMPs
will be promulgated after the FDA has reviewed the public comments.
Once final GMP regulations become effective, the Company's manufacturer
will be required to adhere to them. The FDA will most likely institute
an effective date for the GMPs which will allow the Company's
manufacturer a reasonable amount of time to conduct this review and, if
necessary, revise its manufacturing operations to comply with the final
GMP regulations.
F-24
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
The Company is currently involved in two products liability suits
related to the ingestion of its ephedra-based products. Answers to
these petitions are due April 23 and 30, 2003. As such, the Company has
not had sufficient time to either investigate the facts of these cases
or analyze appropriate defenses to the allegations. The Company will
deny any wrongdoing and intends to vigorously defend the claims. The
amounts of damages sought are unknown, but include compensatory and
punitive damages.
The Company's certificate of incorporation and bylaws provide that the
Company will indemnify its directors and officers to the fullest extent
permitted by the Oklahoma General Corporation Act. Under such
provisions, any director or officer, who in his capacity as such, is
made or threatened to be made, a party to any suit or proceeding, may
be indemnified if the Company's board of directors determines such
director or officer acted in good faith and in a manner he reasonably
believed to be in or not opposed to its best interests.
The Company's certificate of incorporation and bylaws and the Oklahoma
General Corporation Act further provide that such indemnification is
not exclusive of any other rights to which such individuals may be
entitled under its certificate, its bylaws, an agreement, vote of
shareholders or disinterested directors or otherwise. Insofar as
indemnification for liabilities arising under the Securities Act of
1933 may be permitted to the Company's directors and officers pursuant
to the foregoing provisions, or otherwise, the Company has been advised
that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy and is, therefore,
unenforceable.
The Company, like other marketers of products that are intended to be
ingested, faces an inherent risk of exposure to product liability
claims in the event that the use of its products results in injury. The
Company maintains a claims made policy, with limited liability
insurance coverage. The limits of this coverage are $1,000,000 per
occurrence and $2,000,000 in the aggregate. Products containing
ephedra, which represented approximately 49% of the Company's 2002 net
revenue, are not covered by the Company's product liability insurance.
The Company generally does not obtain contractual indemnification from
parties manufacturing its products. However, all of the manufacturers
of the Company's products carry product liability insurance, which
covers the Company's products. Although the Company has never had a
product liability claim, such claims against the Company could result
in material losses to the Company.
13. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the quarterly results of operations for
the years ended December 31, 2002 and 2001.
2002
---------------------------------------------------------------
DECEMBER 31 SEPTEMBER 30 JUNE 30 MARCH 31
----------- ------------ ------- --------
Revenues.............................. $ 4,630,657 $ 5,525,701 $ 5,865,850 $ 6,281,373
Costs and expenses.................... 9,547,803 5,845,558 5,738,921 6,131,391
------------ ------------ ----------- -----------
Income (loss) before
income taxes..................... (4,917,146) (319,857) 126,929 149,982
Income tax expense
(benefit)........................... (1,738,308) (124,744) 49,502 58,493
------------ ------------ ----------- -----------
Net income (loss).................. $ (3,178,838) $ (195,113) $ 77,427 $ 91,489
============ ============ =========== ===========
Net income (loss) per
F-25
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
common share -
basic............................... $ (0.73) $ (0.04) $ 0.02 $ 0.02
============ ============ =========== ===========
Net income (loss) per
common share -
assuming dilution................... $ (0.73) $ (0.04) $ 0.02 $ 0.02
============ ============ =========== ===========
Net Income (loss) per share is computed independently for each of the
quarters presented; therefore, the sum of the quarterly income (loss)
per share does not necessarily equal the total for the year.
2001
--------------------------------------------------------------
DECEMBER 31 SEPTEMBER 30 JUNE 30 MARCH 31
----------- ------------ ------- --------
Revenues.............................. $ 7,062,205 $ 7,142,367 $ 7,140,458 $ 7,095,890
Costs and expenses.................... 7,376,134 7,114,239 6,867,377 7,069,152
------------ ------------ ------------ -----------
Income (loss) before
income taxes..................... (313,929) 28,128 273,081 26,738
Income tax expense
(benefit)........................... (127,769) 16,423 107,722 9,091
------------ ------------ ------------ -----------
Net income (loss).................. $ (186,160) $ 11,705 $ 165,359 $ 17,647
============ ============ ============ ===========
Net income (loss) per
common share -
basic............................... $ (0.04) $ -- $ 0.04 $ --
============ ============ ============ ===========
Net income (loss) per
common share -
assuming dilution................... $ (0.04) $ -- $ 0.04 $ --
============ ============ ============ ===========
Net Income (loss) per share is computed independently for each of the
quarters presented; therefore, the sum of the quarterly income (loss)
per share does not necessarily equal the total for the year.
14. YEAR-END ADJUSTMENTS
The Company made certain year-end adjustments in 2002 resulting from
the impairment of goodwill, the write off of obsolete fixed assets and
the creation of an inventory reserve for obsolete items that were
material to the results of the fourth quarter. These adjustments, after
applicable income tax effects, reduced net income (loss) as follows:
Goodwill impairment................... $ 2,310,908
Write off of obsolete fixed assets.... 136,583
Inventory reserve..................... 70,848
-----------
$ 2,518,339
===========
These adjustments reduced fourth quarter basic income (loss) per share
by $0.57.
F-26
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
15. VALUATION AND QUALIFYING ACCOUNTS
The table below shows the beginning balance, activity and ending
balance for the Company's reserves and allowances deducted from asset
accounts:
Additions
------------------------
Balance at Charged to Charged to
Beginning of Costs and Other Balance at
Description Period Expenses Accounts Deductions End of Period
- ----------------------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2002:
Reserves and allowances deducted
from asset accounts:
Allowance for doubtful accounts.... $ 92,931 $ 92,931 $ --
Allowance for obsolete inventory... -- 116,143 116,143
YEAR ENDED DECEMBER 31, 2001:
Reserves and allowances deducted
from asset accounts:
Allowance for doubtful accounts.... $ 157,804 $ 64,873 $ 92,931
Allowance for obsolete inventory... -- -- --
YEAR ENDED DECEMBER 31, 2000:
Reserves and allowances deducted
from asset accounts:
Allowance for doubtful accounts.... $ 55,332 $179,334 $ 76,862 $ 157,804
Allowance for obsolete inventory... -- -- --
* * * * * *
F-27
Exhibit Index
3.1 The Registrant's Certificate of Incorporation, incorporated by
reference to the Registration Statement on Form SB-2 (Registration
No. 333-47801) filed with the commission on March 11, 1998.
3.2 The Registrant's Bylaws, incorporated by reference to the
Registration Statement on Form SB-2 (Registration No. 333-47801)
filed with the commission on March 11, 1998.
10.1 Warrant Agreement between Registrant and U.S. Stock Transfer
Inc., dated as of January 16, 1997, as amended and restated
January 8, 1998, incorporated by reference to Amendment No. 2 to
Form 8-A Registration Statement, filed with the Commission on
January 13, 1998.
10.2 Unit and Warrant Agreement between Registrant and U.S. Stock
Transfer Inc., dated as of November 6, 1997, as amended and
restated January 8, 1998, incorporated by reference to Amendment
No. 1 to Form 8-A Registration Statement, filed with the
Commission on January 15, 1998.
10.3 * The Advantage Marketing Systems, Inc. 1998 Associate Stock
Purchase Plan, incorporated by reference to Amendment No. 1 to
Registration Statement on Form SB-2 (Registration No. 333-47801)
filed with the commission on October 7, 1998.
10.4 * The form of Advantage Marketing Systems, Inc. 1998 Associate Stock
Purchase Plan Stock Purchase Agreement, incorporated by reference
to Amendment No. 1 to Registration Statement on Form SB-2
(Registration No. 333-47801) filed with the commission on October
7, 1998.
10.5 Purchase and Assignment Agreement by and among Advantage Marketing
Systems, Inc., LifeScience Technologies Holdings, Inc., GHI
Holdings, Inc., LifeScience Technologies, Inc. and RMS Limited
Partnership, dated as of January 3, 2001, incorporated by
reference to Form 8-K filed with the Commission on January 8,
2001.
10.6 Promissory Note dated January 3, 2001, to RMS Limited Partnership
by Advantage Marketing Systems, Inc., LifeScience Technologies
Holdings, Inc., LifeScience Technologies Holdings Limited
Partnership, LifeScience Technologies Holdings, Inc., LifeScience
Technologies of Japan and LST Fulfillment Limited Partnership,
incorporated by reference to Form 8-K filed with the Commission on
January 8, 2001.
10.7 Stock Option Agreement of Advantage Marketing Systems dated
January 3, 2001, incorporated by reference to Form 8-K filed with
the Commission on January 8, 2001.
10.8 Joint Marketing Agreement with PrimeBuy Network.com, Inc., dated
August 30, 2002, incorporated by reference to Form 10-Q filed with
the Commission on November 1, 2002.
10.9 Promissory Note executed by PrimeBuy Network.com, Inc., dated
August 2, 2002, incorporated by reference to Form 10-Q filed with
the Commission on November 1, 2002.
10.10 * The Advantage Marketing Systems, Inc. 1995 Stock Option Plan,
incorporated by reference to Form SB-2 Registration Statement (No.
33-80629), filed with the Commission on November 20, 1996.
10.11 * Employment Agreement by and between David D'Arcangelo and
Registrant dated effective as of November 25, 2002, filed
herewith.
10.12 * Non-Qualified Stock Option Agreement by and between David
D'Arcangelo and Registrant dated effective as of December 2, 2002,
filed herewith.
21 Subsidiaries, incorporated by reference to Form 10-K filed with
the Commission on April 17, 2001.
23.1 Consent of Grant Thornton LLP, filed herewith.
23.2 Consent of Deloitte & Touche LLP, filed herewith.
99.1 Chief Executive Officer Certification, filed herewith.
99.2 Chief Financial Officer Certification, filed herewith.
* Designates a compensatory plan.