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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
------------------
OR
[ ] 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: 0-25064
---------------
HEALTH FITNESS CORPORATION
(Exact name of registrant as specified in its charter)
Minnesota 41-1580506
- --------------------------------------------------------------------------------
(State of incorporation or organization) (I.R.S. Employer Identification No.)
3600 American Boulevard West, Bloomington, Minnesota 55431
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(952) 831-6830
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
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 past 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [X] Yes [ ] No
Indicate by check mark whether registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). [ ] Yes [X] No
The number of shares outstanding of each of the registrant's classes of
capital stock, as of November 7, 2003 was:
Common Stock, $0.01 par value, 12,351,084 shares
1
HEALTH FITNESS CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited)
Consolidated Balance Sheets as of September 30, 2003 and 3
December 31, 2002
Consolidated Statements of Earnings for the three and nine 4
months ended September 30, 2003 and 2002
Consolidated Statements of Cash Flows for the nine 5
months ended September 30, 2003 and 2002
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition 9
and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 12
Item 4. Controls and Procedures 12
PART II. OTHER INFORMATION 13
Item 1. Legal Proceedings
Items 2-5. Not Applicable
Item 6. Exhibits and Reports on Form 8-K
Signatures 14
Exhibit Index 15
2
HEALTH FITNESS CORPORATION
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
- --------------------------------------------------------------------------------
September 30, December 31,
2003 2002
------------ ------------
ASSETS
CURRENT ASSETS
Cash $ 744,480 $ 91,658
Trade and other accounts receivable, less allowances of $94,000 and $88,900 3,600,307 4,036,888
Prepaid expenses and other 207,105 266,734
Deferred tax assets 731,500 731,500
------------ ------------
Total current assets 5,283,392 5,126,780
PROPERTY AND EQUIPMENT, net 225,125 176,206
OTHER ASSETS
Cash held in escrow 5,250,000 -
Goodwill 5,308,761 5,308,761
Deferred tax assets 1,929,244 2,254,876
Other 609,616 89,188
------------ ------------
$ 18,606,138 $ 12,955,811
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Note payable $ - $ 304,589
Trade accounts payable 289,108 409,150
Accrued salaries, wages, and payroll taxes 1,606,228 1,072,982
Other accrued liabilities 293,917 415,856
Accrued self funded insurance 261,856 267,042
Deferred revenue 1,229,136 1,407,437
------------ ------------
Total current liabilities 3,680,245 3,877,056
LONG-TERM OBLIGATIONS, less current maturities 5,250,000 -
COMMITMENTS AND CONTINGENCIES - -
STOCKHOLDERS' EQUITY
Preferred stock, $0.01 par value; 5,000,000 shares authorized, none issued
or outstanding - -
Common stock, $0.01 par value; 25,000,000 shares authorized; 12,351,084 and
12,297,661 shares issued and outstanding 123,510 122,977
Additional paid-in capital 17,020,873 16,997,367
Accumulated deficit (7,468,490) (8,041,589)
------------ ------------
9,675,893 9,078,755
------------ ------------
$ 18,606,138 $ 12,955,811
============ ============
See notes to consolidated financial statements.
3
HEALTH FITNESS CORPORATION
CONSOLIDATED STATEMENTS OF EARNINGS
(UNAUDITED)
- --------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ------------------------------
2003 2002 2003 2002
------------------------------ ------------------------------
REVENUE $ 7,445,094 $ 6,934,758 $ 22,695,925 $ 20,308,959
COSTS OF REVENUE 5,979,326 5,514,309 17,994,616 15,960,684
------------------------------ ------------------------------
GROSS PROFIT 1,465,768 1,420,449 4,701,309 4,348,275
OPERATING EXPENSES
Salaries 834,781 702,243 2,407,539 2,058,319
Selling, general and administrative 393,018 463,824 1,223,937 1,293,757
------------------------------ ------------------------------
Total operating expenses 1,227,799 1,166,067 3,631,476 3,352,076
------------------------------ ------------------------------
OPERATING INCOME 237,969 254,382 1,069,833 996,199
OTHER EXPENSES
Interest expense (59,031) (100,586) (82,987) (298,710)
Other, net (32,949) (2,967) (34,808) (8,254)
------------------------------ ------------------------------
EARNINGS BEFORE INCOME TAXES 145,989 150,829 952,038 689,235
INCOME TAX EXPENSE (BENEFIT) 58,203 (626,636) 378,939 (1,646,739)
------------------------------ ------------------------------
NET EARNINGS $ 87,786 $ 777,465 $ 573,099 $ 2,335,974
============================== ==============================
NET EARNINGS PER SHARE:
Basic $ 0.01 $ 0.06 $ 0.05 $ 0.19
Diluted 0.01 0.06 0.05 0.19
WEIGHTED AVERAGE COMMON SHARES:
Basic 12,341,284 12,289,558 12,324,292 12,173,442
Diluted 12,743,441 12,413,530 12,542,024 12,332,195
See notes to consolidated financial statements.
4
HEALTH FITNESS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
- --------------------------------------------------------------------------------
Nine Months Ended
September 30,
--------------------------------
2003 2002
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 573,099 $ 2,335,974
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Depreciation and amortization 66,921 238,521
Deferred taxes 325,632 (1,654,300)
Changes in operating assets and liabilities:
Trade and other accounts receivable 436,581 (630,292)
Prepaid expenses and other 59,629 (19,926)
Other assets (439,320) 10,366
Trade accounts payable (120,042) 34,687
Accrued liabilities and other 406,121 619,542
Deferred revenue (178,301) 44,000
------------ ------------
Net cash provided by operating activities 1,130,320 978,572
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (107,515) (26,091)
------------ ------------
Net cash used in investing activities (107,515) (26,091)
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under note payable 2,252,934 19,728,215
Repayments of note payable (2,557,523) (20,734,334)
Proceeds from issuance of common stock 24,039 15,169
Proceeds from issuance of bridge note financing 3,000,000 -
Payment to cash escrow account (3,000,000) -
Payment of financing costs (89,433) (50,000)
------------ ------------
Net cash used in financing activities (369,983) (1,040,950)
------------ ------------
NET INCREASE (DECREASE) IN CASH 652,822 (88,469)
CASH AT BEGINNING OF PERIOD 91,658 221,008
------------ ------------
CASH AT END OF PERIOD $ 744,480 $ 132,539
============ ============
Supplemental disclosures of non-cash financing activities:
Proceeds from the Wells Loan (see note 3) escrowed
for pending acquisition 2,250,000 -
See notes to consolidated financial statements.
5
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United States
of America for interim financial information. They should be read in conjunction
with the annual financial statements included in the Company's Annual Report on
Form 10-K for the year ended December 31, 2002. In the opinion of management,
the interim consolidated financial statements include all adjustments necessary
for the fair presentation of the results for interim periods presented.
Operating results for the three and nine months ended September 30, 2003 are not
necessarily indicative of the operating results for the year ending December 31,
2003.
Certain reclassifications have been made to the consolidated financial
statements as of December 31, 2002 and for the three and nine months ended
September 30, 2002 to conform to the presentation used in 2003. Such
reclassifications had no effect on net earnings or stockholders' equity as
previously reported.
NOTE 2: PENDING ACQUISITION
On August 25, 2003, the Company signed an agreement to acquire the business
assets of the Health & Fitness Services Division (the "HFS Division") of Johnson
& Johnson Health Care Systems Inc. ("JJHCS"). Assets to be acquired consist
primarily of client contracts, in addition to proprietary wellness, lifestyle
and health promotion programs and services (the "Acquired Assets"). The
agreement between the Company and JJHCS also includes a three-year services
agreement with Johnson & Johnson Services, Inc. under which the Company will
manage corporate health fitness centers for Johnson & Johnson operating
companies and provide other health, wellness and fitness programs, products and
services.
As consideration for the Acquired Assets, the Company will pay up to $5,250,000
(the "Purchase Price"), which the Company has placed into escrow pending the
closing of the acquisition (the "Acquisition Closing"). The Purchase Price will
be reduced to not less than $4,500,000 to the extent that customers of the HFS
Division representing less than 90% of 2002 fixed fee revenue consent to the
assignment of their customer contract to the Company prior to the Acquisition
Closing or during the six months immediately thereafter.
NOTE 3. FINANCING ARRANGEMENTS
On August 22, 2003, the Company entered into a $7,500,000 Credit Agreement with
Wells Fargo Bank, N.A. ("Wells Fargo") to provide the Company with acquisition
financing and general working capital (the "Wells Loan"). The initial draw on
the Wells Loan was in the amount of $1,255,204, which was used to refinance the
revolving line of credit the Company previously maintained with Merrill Lynch
Business Financial Services, Inc. ("Merrill Lynch"). The Company repaid all
amounts owed to Merrill Lynch and canceled the Company's line of credit with
Merrill Lynch, which accrued interest at the one-month LIBOR rate plus 2.35%
(effective rate of 3.77% at December 31, 2002). On August 25, 2003, the Company
made a draw of $2,250,000 on the Wells Loan, the proceeds of which the Company
placed into escrow to fund a portion of the Purchase Price that will be payable
to JJHCS at the Acquisition Closing. Future advances from the Wells Loan will be
based upon a percentage of the Company's eligible accounts receivable, less any
amounts previously drawn. At the option of the Company, the Wells Loan bears
interest at prime or the one-month LIBOR plus a margin of 2.25% to 2.75% based
upon the Company's Senior Leverage Ratio. The availability of the Wells Loan
will decrease $250,000 on the last day of each calendar quarter, beginning
September 30, 2003, and will expire on June 30, 2007. Borrowings under the Wells
Loan are collateralized by substantially all of the Company's assets. The
Company is also required to comply with certain monthly financial covenants,
including a senior cash flow leverage ratio, senior leverage ratio and current
ratio. At September 30, 2003, the Company had $2,250,000 outstanding under the
Wells Loan, and was in compliance with all of its financial covenants.
On August 25, 2003, the Company entered into a $3,000,000 Securities Purchase
Agreement with Bayview Capital Partners LP ("Bayview") to provide the Company
with acquisition financing and general working capital (the "Bayview
Investment"). The Bayview Investment is secured by a subordinated security
interest in substantially all of the Company's assets. The Bayview Investment is
currently structured as a bridge note (the "Bridge Note"), the proceeds of which
the Company placed into escrow to fund a portion of the Purchase Price that will
be payable to JJHCS at the Acquisition Closing. The
6
Bridge Note bears interest at 12% per year, payable monthly, with the principal
due and payable on the earliest to occur of (i) the Acquisition Closing (see
note 2), and (ii) December 1, 2003. In the event the Acquisition Closing does
not occur prior to December 1, 2003, the Company's repayment of principal on
December 1, 2003 must be accompanied by a 5% premium. The Company is required to
comply with certain monthly financial covenants, including a senior cash flow
leverage ratio, senior leverage ratio and current ratio. At September 30, 2003,
the Company was in compliance with all of its financial covenants.
At the Acquisition Closing, the Bridge Note will convert into a $2,000,000 term
note (the "Term Note"), $1,000,000 in Series A Convertible Preferred Stock of
the Company (the "Preferred Stock") and a warrant to purchase common stock of
the Company (the "Warrant"). The Term Note will bear interest at 12% per year,
payable monthly, and will mature on the fifth anniversary of the Acquisition
Closing. The Term Note may be prepaid, in whole or in part, at any time,
provided that the prepayment is accompanied by a premium ranging from 5% in year
1 to 1% in year 5. The Company will be required to continue to comply under the
Term Note with the same monthly financial covenants, including a senior cash
flow leverage ratio, senior leverage ratio and current ratio, required under the
Bridge Note.
The Preferred Stock will be issued to Bayview at a price of $1.00 per share,
resulting in 1,000,000 shares to be issued at the Acquisition Closing. The
Preferred Stock has a stated dividend rate of 6% per year, computed on a simple
interest basis, paid in kind in the form of additional shares of Preferred Stock
using a price of $1.00 per share ("PIK Dividends"). At the option of the holder,
the Preferred Stock, including any PIK Dividends, may be converted into common
stock of the Company at a price of $0.50 per share.
The Warrant issued to Bayview at the acquisition closing will represent the
right to purchase 8% of the Company's common stock outstanding on a fully
diluted basis, excluding the common stock issuable to Bayview upon conversion of
the Preferred Stock. At September 30, 2003, the number of shares contingently
issuable under this Warrant is approximately 1,200,000. The Warrant will be
exercisable at any time for a period of ten years at an exercise price equal to
$0.50 per share.
The Company has agreed to register, upon the request of Bayview, the sale of all
shares of common stock issuable upon conversion of the Preferred Stock and upon
exercise of the Warrant under the Securities Act of 1933, as amended, within 360
days following the date of the Acquisition Closing.
NOTE 4. STOCK-BASED COMPENSATION
The Company utilizes the intrinsic value method of accounting for its stock
based employee compensation plans. All options granted had an exercise price
equal to the market value of the underlying common stock on the date of grant
and accordingly, no compensation cost is reflected in net earnings for the three
and nine months ended September 30, 2003 and 2002. The following table
illustrates the effect on net earnings and earnings per share if the Company had
applied the fair value method of accounting for stock options:
Three Months ended Nine Months ended
September 30, September 30,
--------------------------------- ---------------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
Net earnings, as reported $87,786 $777,465 $573,099 $2,335,974
Less: Compensation expense determined under the
fair value method, net of tax (17,810) (13,162) (55,116) (57,487)
------------- ------------- ------------- -------------
Proforma net earnings $69,976 $764,303 $517,983 $2,278,487
============= ============= ============= =============
Earnings per Share:
Basic, as reported $0.01 $0.06 $0.05 $0.19
============= ============= ============= =============
Basic, proforma $0.01 $0.06 $0.04 $0.19
============= ============= ============= =============
Diluted, as reported $0.01 $0.06 $0.05 $0.19
============= ============= ============= =============
Diluted, proforma $0.01 $0.06 $0.04 $0.18
============= ============= ============= =============
7
The proforma information above should be read in conjunction with the related
historical information.
The fair value of each option grant is estimated on the grant date using the
Black-Scholes option-pricing model with the following assumptions and results
for the grants:
2003 2002
-------------- ------------
Dividend yield None None
Expected volatility 90%-105% 105%
Expected life of option 1 to 4 years 1 to 4 years
Risk-free interest rate 2.9% 5.5%
Weighted average fair value of options
on grant date $0.24 $0.32
NOTE 5. INCOME TAXES
Income taxes are calculated based on management's estimate of the Company's
effective tax rate. Income taxes for the three and nine months ended September
30, 2002 differed from the effective rate due to benefits realized from a
reduction of the Company's deferred tax asset valuation allowance totaling
$625,300 and $1,875,900, respectively. The Company also recognized $30,000 of a
federal refund due to a tax law change in the third quarter of 2002. The refund,
federal and state income tax, and management's estimate of minimum state and
federal taxes due resulted in additional benefits of $1,300 and additional
expense of $229,200 for the three and nine months ended September 30, 2002,
respectively.
NOTE 6. RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board (FASB) issued
Financial Interpretations No. 46 (FIN 46), "Consolidation of Variable Interest
Entities." FIN 46 is an interpretation of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," and addresses consolidation by business
enterprises of variable interest entities. FIN 46 applies immediately to
variable interest entities created or obtained after January 31, 2003 and
applies in the first fiscal year or interim period beginning after June 15,
2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. This interpretation is not
anticipated to have an impact on the Company's consolidated financial position
or results of operations.
In April 2003, the FASB issued Statement 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. Statement 149 clarifies
implementation issues and amends Statement 133, to include the conclusions
reached by the FASB on certain FASB Staff Implementation Issues that, while
inconsistent with Statement 133's conclusions, were considered by the Board to
be preferable, amends discussion of financial guarantee contracts and the
application of the shortcut method to an interest-rate swap agreement that
includes an embedded option, and amends other pronouncements. Statement 149 is
effective to contracts entered into or modified, and hedging arrangements
designated after June 30, 2003, with various exceptions as outlined in the
statement. Adoption of Statement 149 is not anticipated to have an impact on the
Company's consolidated financial position or results of operations.
In May 2003, the FASB issued Statement 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. Statement 150
changes the classification in the statement of financial position of certain
common financial instruments from either equity or mezzanine presentation to
liabilities and requires an issuer of those financial statements to recognize
changes in fair value or redemption amount, as applicable, in earnings. SFAS 150
is effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. Adoption of Statement 150 is not anticipated to
have an impact on the Company's financial position or results of operations.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL. Health Fitness Corporation and its wholly owned subsidiaries (the
"Company"), provide fitness and wellness management services and programs to
corporations, hospitals, communities and universities located in the United
States of America and Canada. Fitness and wellness management services include
the development, marketing and management of corporate, hospital, community and
university based fitness centers, injury prevention and work-injury management
consulting, and on-site physical therapy and occupational health services.
Programs include wellness and health programs for individual customers,
including health risk assessments, nutrition and weight loss programs, smoking
cessation, massage therapy, back care and ergonomic injury prevention.
RESULTS OF OPERATIONS FOR THE QUARTER ENDED SEPTEMBER 30, 2003 AS COMPARED TO
THE QUARTER ENDED SEPTEMBER 30, 2002.
REVENUE. Revenue increased $510,000 or 7.4% to $7,445,000 for the three months
ended September 30, 2003, from $6,935,000 for the three months ended September
30, 2002. Fitness center management fee and consulting revenue increased
$410,000 or 6.1% and occupational health services revenue increased $100,000 or
37.8%. These increases are attributed to the addition of new contracts and
expansion of existing contracts.
GROSS PROFIT. Gross profit increased $46,000 or 3.2% to $1,466,000 for the three
months ended September 30, 2003, from $1,420,000 for the three months ended
September 30, 2002. Fitness center management fee and consulting gross profit
increased $10,000 or .8% while occupational health services gross profit
increased $35,000 or 57.5%. These increases are attributed to the addition of
new contracts and the expansion of existing contracts.
OPERATING EXPENSES AND OPERATING INCOME. Operating expenses increased $62,000 or
5.3% to $1,228,000 for the three months ended September 30, 2003 from $1,166,000
for the three months ended September 30, 2002. This increase is due to increased
salary expense of $133,000 offset by a reduction of $71,000 in selling, general
and administrative expenses. The increase in salary expense is primarily
attributed to increased employee benefit costs and an investment in additional
sales and marketing staff the Company made during 2002. The reduction in
selling, general and administrative expenses is due to decreased contract
services and other expenses. Operating expenses as a percent of revenue was
16.5% for the three months ended September 30, 2003 compared to 16.8% for the
three months ended September 30, 2002.
Operating income decreased $16,000 to $238,000 for the three months ended
September 30, 2003 from $254,000 for the three months ended September 30, 2002.
This decrease is the net result of the increase in operating expenses offset by
the increase in gross profit as previously discussed.
OTHER INCOME AND EXPENSE. Interest expense decreased $42,000 to $59,000 for the
three months ended September 30, 2003, compared to $101,000 for the same period
in 2002. This decrease is due to decreased levels of borrowing and a lower
interest rate. The Company's cost of borrowed funds decreased from an average of
9.0% for the third quarter of 2002 to 3.5% for the third quarter of 2003.
INCOME TAXES. Income taxes increased $685,000 to an expense of $58,000 for the
three months ended September 30, 2003 from a benefit of $627,000 for the three
months ended September 30, 2002. The increase is primarily due to the third
quarter of 2002 including a $625,000 deferred tax benefit related to the
reversal of a deferred tax asset valuation allowance.
NET EARNINGS. As a result of the above, net earnings decreased $689,000 to
$88,000 for the three months ended September 30, 2003 from $777,000 for the
three months ended September 30, 2002.
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AS COMPARED
TO THE NINE MONTHS ENDED SEPTEMBER 30, 2002.
REVENUE. Revenue increased $2,387,000 or 11.8% to $22,696,000 for the nine
months ended September 30, 2003, from $20,309,000 for the nine months ended
September 30, 2002. Fitness center management fee and consulting revenue
increased $2,094,000 or 10.7% and occupational health services revenue increased
$293,000 or 38.2%. These increases are attributed to the addition of new
contracts and the expansion of existing contracts.
9
GROSS PROFIT. Gross profit increased $353,000 or 8.1% to $4,701,000 for the nine
months ended September 30, 2003, from $4,348,000 for the nine months ended
September 30, 2002. Fitness center management fee and consulting gross profit
increased $221,000 or 5.3% while occupational health services gross profit
increased $132,000 or 76.3%. These increases are attributed to the addition of
new contracts and the expansion of existing contracts.
OPERATING EXPENSES AND OPERATING INCOME. Operating expenses increased $279,000
or 8.3% to $3,631,000 for the nine months ended September 30, 2003 from
$3,352,000 for the nine months ended September 30, 2002. This increase is due to
increased salary expense of $349,000 offset by a reduction of $70,000 in
selling, general and administrative expenses. The increase in salary expense is
primarily attributed to increased employee benefit costs and an investment in
additional sales and marketing staff the Company made during 2002. The reduction
in selling, general and administrative expenses is due to decreased depreciation
and amortization expense. Operating expenses as a percentage of revenue
decreased to 16.0% for the nine months ended September 30, 2003 compared to
16.5% for the nine months ended September 30, 2002.
Operating income increased $74,000 to $1,070,000 for the nine months ended
September 30, 2003 from $996,000 for the nine months ended September 30, 2002.
This increase is the net result of the increase in gross profit offset by the
decrease operating expenses as previously discussed.
OTHER INCOME AND EXPENSE. Interest expense decreased $216,000 to $83,000 for the
nine months ended September 30, 2003, compared to $299,000 for the same period
in 2002. This decrease is due to decreased levels of borrowing and a lower
interest rate. The Company's cost of borrowed funds decreased from an average of
9.0% for the nine months ended September 30, 2002 to 3.6% for the nine months
ended September 30, 2003.
INCOME TAXES. Income taxes increased $2,026,000 to an expense of $379,000 for
the nine months ended September 30, 2003 from a benefit of $1,647,000 for the
nine months ended September 30, 2002. The increase is primarily due to the first
nine months of 2002 including a $1,876,000 deferred tax benefit related to the
reversal of a deferred tax asset valuation allowance.
NET EARNINGS. As a result of the above, net earnings decreased $1,763,000 to
$573,000 for the nine months ended September 30, 2003 from $2,336,000 for the
nine months ended September 30, 2002.
LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of $1,603,000 at September 30, 2003, compared to
working capital of $1,250,000 at December 31, 2002. The increase in working
capital is primarily due to the repayment of working capital obligations.
On August 22, 2003, the Company entered into a $7,500,000 Credit Agreement with
Wells Fargo Bank, N.A. ("Wells Fargo") to provide the Company with acquisition
financing and general working capital (the "Wells Loan"). The initial draw on
the Wells Loan was in the amount of $1,255,204, which was used to refinance the
revolving line of credit the Company previously maintained with Merrill Lynch
Business Financial Services, Inc. ("Merrill Lynch"). The Company repaid all
amounts owed to Merrill Lynch and canceled the Company's line of credit with
Merrill Lynch, which accrued interest at the one-month LIBOR rate plus 2.35%
(effective rate of 3.77% at December 31, 2002). On August 25, 2003, the Company
made a draw of $2,250,000 on the Wells Loan, the proceeds of which the Company
placed into escrow to fund a portion of the Purchase Price that will be payable
to JJHCS at the Acquisition Closing. Future advances from the Wells Loan will be
based upon a percentage of the Company's eligible accounts receivable, less any
amounts previously drawn. At the option of the Company, the Wells Loan bears
interest at prime or the one-month LIBOR plus a margin of 2.25% to 2.75% based
upon the Company's Senior Leverage Ratio. The availability of the Wells Loan
will decrease $250,000 on the last day of each calendar quarter, beginning
September 30, 2003, and will expire on June 30, 2007. Borrowings under the Wells
Loan are collateralized by substantially all of the Company's assets. The
Company is also required to comply with certain monthly financial covenants,
including a senior cash flow leverage ratio, senior leverage ratio and current
ratio. At September 30, 2003, the Company had $2,250,000 outstanding under the
Wells Loan, and was in compliance with all of its financial covenants.
On August 25, 2003, the Company entered into a $3,000,000 Securities Purchase
Agreement with Bayview Capital Partners LP ("Bayview") to provide the Company
with acquisition financing and general working capital (the "Bayview
Investment"). The Bayview Investment is secured by a subordinated security
interest in substantially all of the Company's assets.
10
The Bayview Investment is currently structured as a bridge note (the "Bridge
Note"), the proceeds of which the Company placed into escrow to fund a portion
of the Purchase Price that will be payable to JJHCS at the Acquisition Closing.
The Bridge Note bears interest at 12% per year, payable monthly, with the
principal due and payable on the earliest to occur of (i) the Acquisition
Closing, and (ii) December 1, 2003. In the event the Acquisition Closing does
not occur prior to December 1, 2003, the Company's repayment of principal on
December 1, 2003 must be accompanied by a 5% premium. The Company is required to
comply with certain monthly financial covenants, including a senior cash flow
leverage ratio, senior leverage ratio and current ratio. At September 30, 2003,
the Company was in compliance with all of its financial covenants.
As of September 30, 2003, the Company has no off-balance sheet arrangements or
transactions with unconsolidated, limited purpose entities. Refer to the
footnotes in the Company's Annual Report on Form 10-K for the year ended
December 31, 2002 for disclosure related to the Company's "Commitments and
Contingencies."
On a short and long-term basis, the Company believes that sources of capital to
meet future obligations will be provided by cash generated through operations
and the Company's revolving line of credit. The Company does not believe that
inflation has had a significant impact on the results of its operations.
RECENTLY ISSUED ACCOUNTING POLICIES
As indicated in our notes to the financial statements, we are not aware of any
recently issued accounting pronouncements that will have a material impact on
the Company's financial position or results of operations.
CAUTIONARY STATEMENT
This Form 10-Q contains forward-looking statements within the meaning of federal
securities laws. These statements include statements regarding intent, belief,
or current expectations of the Company and its management and specifically
include the statement regarding cash expected to be available from operations.
These forward-looking statements are not guarantees of the future performance
and involve a number of risks and uncertainties that may cause the Company's
actual results to differ materially from the results discussed in these
statements. Please refer to Management's Discussion and Analysis contained
within the Company's Annual Report on Form 10-K for the year ended December 31,
2002, for cautionary statements on important factors to consider in evaluating
the forward-looking statements included in this Form 10-Q.
11
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has no history of, and does not anticipate in the future, investing
in derivative financial instruments, derivative commodity instruments or other
such financial instruments. Transactions with international customers are
entered into in U.S. dollars, precluding the need for foreign currency hedges.
As a result, the exposure to market risk is not material.
ITEM 4. CONTROLS AND PROCEDURES
The Company's Chief Executive Officer and Chief Financial Officer (collectively,
the "Certifying Officers") are responsible for establishing and maintaining
disclosure controls and procedures for the Company. The Certifying Officers have
concluded (based upon their evaluation of these controls and procedures as of
the end of the period covered by this report) that the Company's disclosure
controls and procedures are effective to ensure that information required to be
disclosed by the Company in reports that it files or submits under the Exchange
Act is recorded, processed, summarized and reported within the time periods
specified in the rules of the Securities and Exchange Commission. The Certifying
Officers also have indicated that there were no changes in the Company's
internal control over financial reporting that occurred during the period
covered by this report that have materially affected, or are reasonably likely
to materially affect, the Company's internal control over financial reporting.
12
PART II. - OTHER INFORMATION
Item 1. Legal Proceedings
In April 2000, HealthSouth Corporation filed a lawsuit against the Company and
two former employees in U.S. District Court in Minnesota arising out of
HealthSouth's purchase of several rehabilitation and physical therapy clinics
from the Company in May 1999. HealthSouth claimed that the two former employees
improperly diverted business away from the purchased clinics. HealthSouth
claimed damages in excess of $3,000,000, alleging misrepresentations and
breaches of warranties in the purchase agreement.
In February 2002, the U.S. District Court in Minneapolis dismissed all of
HealthSouth's claims in connection with a summary judgment motion filed by the
Company, and issued an order awarding the Company a judgment of $43,156 for its
counterclaim relating to certain accounts receivable. HealthSouth paid the
$43,156 counterclaim judgment in full, but appealed the dismissal of
HealthSouth's original claims. In June 2003, while awaiting the final outcome of
HealthSouth's appeal, the Company paid HealthSouth approximately $25,000 in
settlement of all of HealthSouth's remaining claims.
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
See Exhibit Index on page following signatures
(b) Reports on Form 8-K
The Company filed a Report on Form 8-K on August 8, 2003 to disclose that a
press release dated August 6, 2003 was issued to announce and furnish the
Company's results of operations and financial condition for the 2nd quarter of
2003.
The Company filed a Report on Form 8-K on August 26, 2003 to disclose that a
press release dated August 26, 2003 was issued to announce that the Company had
entered into an agreement to acquire certain assets of Johnson & Johnson Health
Care Systems Inc.
13
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this Report to be signed on its behalf
by the undersigned, thereunto duly authorized.
Dated: November 14, 2003 HEALTH FITNESS CORPORATION
By /s/ Jerry V. Noyce
-----------------------------------------------
Jerry V. Noyce
Chief Executive Officer
(Principal Executive Officer)
By /s/ Wesley W. Winnekins
-----------------------------------------------
Wesley W. Winnekins
Chief Financial Officer
(Principal Financial and Accounting Officer)
14
EXHIBIT INDEX
HEALTH FITNESS CORPORATION
FORM 10-Q
Exhibit No. Description
- ----------- -----------
3.1 Articles of Incorporation, as amended, of the Company -
incorporated by reference to the Company's Quarterly Report on
Form 10-QSB for the quarter ended June 30, 1997
3.2 Restated By-Laws of the Company - incorporated by reference to
the Company's Registration Statement on Form SB-2 No. 33-83784C
4.1 Specimen of Common Stock Certificate - incorporated by reference
to the Company's Registration Statement on Form SB-2 No.
33-83784C
**10.11 Credit Agreement, dated August 22, 2003, between the Company and
Wells Fargo Bank, National Association
**10.12 Securities Purchase Agreement, dated August 25, 2003, between
the Company and certain of its subsidiaries, on the one hand,
and Bayview Capital Partners LP, on the other hand
**10.13 Asset Purchase Agreement, dated August 25, 2003, between the
Company and Johnson & Johnson Health Care Systems Inc.
**10.14 Third Amendment, dated August 25, 2003, to Standard Office Lease
Agreement dated as of June 13, 1996, between the Company and
NEOC Holdings LLC
**11.0 Statement re: Computation of Earnings per Share
**31.1 Certification of Chief Executive Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
**31.2 Certification of Chief Financial Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
**32.1 Certification of Chief Executive Officer Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
**32.2 Certification of Chief Financial Officer Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
- ----------------------------
* Indicates management contract or compensatory plan or arrangement
** Filed herewith
15