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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 March 31, 2004
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
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(State of incorporation or organization) (I.R.S. Employer Identification No.)
3600 American Boulevard W., Suite 560, Bloomington, Minnesota 55431
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(Address of principal executive offices) (Zip Code)
(952) 831-6830
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(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 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 Exchange Act Rule 12b-2). Yes [ ] No [X]
The number of shares outstanding of each of the registrant's classes of
capital stock, as of May 3, 2004 was:
Common Stock, $0.01 par value, 12,461,995 shares
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 March 31, 2004 and 2
December 31, 2003
Consolidated Statements of Earnings for the three- 3
months ended March 31, 2004 and 2003
Consolidated Statements of Cash Flows for the three 4
months ended March 31, 2004 and 2003
Notes to Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition 11
and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 14
Item 4. Controls and Procedures 14
PART II. OTHER INFORMATION 15
Item 1. Legal Proceedings
Items 2-5. Not Applicable
Item 6. Exhibits and reports on Form 8-K
Signatures 16
Exhibit Index 17
1
HEALTH FITNESS CORPORATION
CONSOLIDATED BALANCE SHEETS
(Unaudited)
March 31, December 31,
2004 2003
----------------- --------------
ASSETS
CURRENT ASSETS
Cash $ 907,64 $ 281,294
Trade and other accounts receivable, less allowances of $141,000 and
$131,000 8,162,549 5,218,224
Prepaid expenses and other 270,810 187,347
Deferred tax assets 850,300 850,300
----------------- --------------
Total current assets 10,191,305 6,537,165
PROPERTY AND EQUIPMENT, net 192,734 177,217
OTHER ASSETS
Goodwill 8,915,280 8,725,574
Customer contracts, less accumulated amortization of $269,400 and 1,460,555 1,662,639
$67,400
Trademark, less accumulated amortization of $23,300 and $5,800 326,666 344,166
Other intangible assets, less accumulated amortization of $11,700 and 131,051 138,582
$4,200
Cash held in escrow 473,103 471,999
Deferred tax assets 1,509,033 1,686,301
Other 63,467 64,458
----------------- --------------
$ 23,263,194 $ 19,808,101
================= ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Trade accounts payable $ 462,781 $ 569,730
Accrued salaries, wages, and payroll taxes 2,434,589 1,607,157
Other accrued liabilities 521,837 450,255
Accrued self funded insurance 588,025 228,084
Deferred revenue 1,474,686 1,427,057
----------------- --------------
Total current liabilities 5,481,918 4,282,283
LONG-TERM OBLIGATIONS 6,220,759 4,350,012
COMMITMENTS AND CONTINGENCIES - -
CUMMULATIVE CONVERTIBLE PREFERRED STOCK, 5,000,000 shares authorized,
1,018,833 and 1,003,833 issued and outstanding 1,458,833 1,443,833
STOCKHOLDERS' EQUITY
Common stock, $0.01 par value; 25,000,000 shares authorized;
12,438,245 and 12,357,334 shares issued and outstanding 124,382 123,573
Additional paid-in capital 17,705,004 17,671,536
Accumulated comprehensive income 4,434 5,707
Accumulated deficit (7,732,136) (8,068,843)
----------------- --------------
10,101,684 9,731,973
----------------- --------------
$ 23,263,194 $ 19,808,101
================= ==============
See notes to consolidated financial statements.
2
HEALTH FITNESS CORPORATION
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Three Months Ended
March 31,
-----------------------------
2004 2003
------------ ------------
REVENUE $ 12,666,374 $ 7,518,205
COSTS OF REVENUE 9,579,437 5,863,806
------------ ------------
GROSS PROFIT 3,086,937 1,654,399
OPERATING EXPENSES
Salaries 1,342,709 783,542
Other selling, general and administrative 830,106 409,314
Amortization of acquired intangible assets 219,584 -
------------ ------------
Total operating expenses 2,392,399 1,192,856
------------ ------------
OPERATING INCOME 694,538 461,543
OTHER INCOME (EXPENSE)
Interest expense (134,252) (10,505)
Other, net 921 (1,028)
------------ ------------
EARNINGS BEFORE INCOME TAX EXPENSE 561,207 450,010
INCOME TAX EXPENSE 209,500 182,030
------------ ------------
NET EARNINGS 351,707 267,980
Dividend to preferred shareholders 15,000 -
------------ ------------
NET EARNINGS APPLICABLE TO COMMON SHAREHOLDERS $ 336,707 $ 267,980
============ ============
NET EARNINGS PER COMMON SHARE:
Basic $ 0.03 $ 0.02
Diluted 0.02 0.02
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
Basic 12,409,619 12,308,321
Diluted 16,038,913 12,404,312
See notes to consolidated financial statements
3
HEALTH FITNESS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
March 31,
--------------------------------
2004 2003
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 351,707 $ 267,980
Adjustments to reconcile net earnings to net cash used in operating
activities, net of acquired assets:
Depreciation 24,170 18,270
Amortization 248,724 -
Deferred taxes 177,268 153,004
Change in assets and liabilities:
Trade and other accounts receivable (2,944,325) (256,246)
Prepaid expenses and other (83,463) (21,063)
Other assets (113) (123,556)
Trade accounts payable (108,222) (130,469)
Accrued liabilities and other 1,258,955 131,851
Deferred revenue 47,629 (162,389)
----------- -----------
Net cash used in operating activities (1,027,670) (122,618)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (39,687) (26,490)
Acquisition of business (189,706) -
----------- -----------
Net cash used in investing activities (229,393) (26,490)
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under long-term obligations 2,450,000 811,940
Repayments of long-term obligations (600,862) (679,000)
Proceeds from the issuance of common stock 13,277 11,360
Proceeds from the exercise of stock options 21,000 -
----------- -----------
Net cash provided by financing activities 1,883,415 144,300
----------- -----------
NET INCREASE (DECREASE) IN CASH 626,352 (4,808)
CASH AT BEGINNING OF PERIOD 281,294 91,658
----------- -----------
CASH AT END OF PERIOD $ 907,646 $ 86,850
=========== ===========
See notes to consolidated financial statements.
4
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, 2003. In the opinion of management,
the interim consolidated financial statements include all adjustments
(consisting of normal recurring accruals) necessary for the fair presentation of
the results for interim periods presented. Operating results for the three
months ended March 31, 2004 are not necessarily indicative of the operating
results for the year ended December 31, 2004.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business - 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 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. 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.
Consolidation - The consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All intercompany balances and
transactions have been eliminated in consolidation.
Cash - The Company maintains cash balances at several financial institutions,
and at times, such balances exceed insured limits. The Company has not
experienced any losses in such accounts and believes it is not exposed to any
significant credit risk on cash.
Trade and Other Accounts Receivable - Trade and other accounts receivable
represent amounts due from companies and individuals for services and products.
The Company grants credit to customers in the ordinary course of business, but
generally does not require collateral or any other security to support amounts
due. Management performs ongoing credit evaluations of customers. The Company
determines its allowance for discounts and doubtful accounts by considering a
number of factors, including the length of time trade accounts receivable are
past due, the Company's previous loss history, the customer's current ability to
pay its obligation to the Company, and the condition of the general economy and
the industry as a whole. The Company writes off accounts receivable when they
become uncollectible, and payments subsequently received on such receivable are
credited to the allowance. Concentrations of credit risk with respect to trade
receivables are limited due to the large number of customers and their
geographic dispersion.
Property and Equipment - Property and equipment is stated at cost. Depreciation
and amortization are computed using both straight-line for book purposes and
accelerated methods for tax purposes over the useful lives of the assets.
Goodwill - Goodwill represents the excess of the purchase price and related
costs over the fair value of net assets of businesses acquired. The carrying
value of goodwill is not amortized, but is tested for impairment on an annual
basis or when factors indicating impairment are present. Projected discounted
cash flows are used in assessing these assets.
5
Intangible Assets - The Company's intangible assets include customer contracts,
trademark, and deferred financing costs and are amortized on a straight-line
basis. Customer contracts represent the fair value assigned to acquired
management contracts and are amortized over the remaining life of the contracts,
approximately 25-35 months. Trademark represents the value assigned to an
acquired trademark and is amortized over a period of five years. Deferred
financing costs are amortized over the term of the related credit agreement.
Cash Held In Escrow - Cash held in escrow represents the funds remaining after
payment of the purchase price for the Company's acquisition (see Note 3). Such
funds will remain in escrow until all parties subject to the escrow agreement
agree that all conditions related to the acquisition have been satisfied. At
that time, any funds remaining in escrow will be used to pay down the Company's
long-term obligations.
Revenue Recognition - Revenue is recognized at the time the service is provided
to the customer. For annual contracts, monthly amounts are recognized ratably
over the term of the contract. Certain services provided to the customer may
vary on a periodic basis and are invoiced to the customer in arrears. The
revenues relating to theses services are estimated in the month that the service
is performed.
Amounts received from customers in advance of providing the services of the
contract are treated as deferred revenue and recognized when the services are
provided.
The Company has contracts with third-parties to provide ancillary services in
connection with their fitness and wellness management services and programs.
Under such arrangements the third-parties invoice and receive payments from the
Company based on transactions with the ultimate customer. The Company does not
recognize revenues related to such transactions as the ultimate customer assumes
the risk and rewards of the contract and the amounts billed to the customer are
either at cost or with a fixed markup.
Comprehensive Income - Comprehensive income represents net earnings adjusted for
foreign currency translation adjustments. Comprehensive income is disclosed in
the consolidated statement of stockholders' equity.
Net Earnings Per Common Share - Basic net earnings per common share is computed
by dividing net earnings by the number of weighted average common shares
outstanding. Diluted net earnings per common share is computed by dividing net
earnings plus dividends to preferred shareholders by the number of weighted
average common shares outstanding, and common share equivalents relating to
stock options and stock warrants, when dilutive.
Fair Values of Financial Instruments - Due to their short-term nature, the
carrying value of the Company's current financial assets and liabilities
approximates their fair values. The fair value of long-term obligations, if
recalculated based on current interest rates, would not significantly differ
from the recorded amounts.
Use of Estimates - Preparing consolidated financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make certain estimates and assumptions that affect the
reported amounts of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
6
NOTE 3. PURCHASE OF ASSETS
On December 8, 2003 (the "Effective Date"), the Company purchased the business
assets of the Health & Fitness Services Business of Johnson & Johnson Health
Care Systems Inc. ("JJHCS"). Assets acquired by the Company consist primarily of
client contracts, proprietary wellness, lifestyle and health promotion programs,
software, and other health and wellness services. As part of the transaction,
the Company entered into a multi-year management contract with another
subsidiary of Johnson & Johnson whereby the Company will manage more than 50
Johnson & Johnson affiliate fitness center sites. The Company also entered into
a one-year agreement to use 660 square feet of office space of JJHCS for a fee
of $1,500 per month.
The acquisition has been accounted for using the purchase method of accounting.
The fair market value of the assets acquired resulted in the following purchase
price allocation:
Cash price paid for assets $4,927,500
Acquisition costs incurred 833,019
----------
Total purchase price $5,760,519
==========
Purchase Price Allocation
Inventory $ 40,000
Property and equipment 34,000
Customer contracts 1,730,000
Trademark 350,000
Excess of cost over assets acquired 3,606,519
----------
$5,760,519
==========
During the three months ended March 31, 2004, an additional $142,111 was paid to
JJHCS for two contract assignments. The Company also incurred an additional
$47,595 of acquisition related costs. These payments were recorded entirely to
goodwill.
NOTE 4. FINANCING
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 totaled $1,255,204, which was used to refinance the revolving
line of credit ("Merrill Lynch Loan") 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 line of credit, 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 were placed into escrow to fund a
portion of the JJHCS asset purchase.
Working capital advances from the Wells Loan are 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 (effective rate of 4% at March 31, 2004 and December 31, 2003).
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. Availability of the Wells Loan totaled $6,750,000 and $7,000,000 at March
31, 2004 and December 31, 2003. Borrowings under the Wells Loan are
collateralized by substantially all of the Company's assets. 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 March 31,
2004, the Company had $4,624,138 outstanding under the Wells Loan. Beginning on
January 31, 2004 and continuing throughout the remainder of the period ending
March 31, 2004, the Company was not in compliance with certain covenants
relating to the
7
Wells Loan. On May 14, 2004, Wells Fargo agreed to waive the noncompliance and
amend the loan covenants, effective as of January 31, 2004. The Company believes
that the new loan covenants are more appropriate after taking into consideration
the Company's actual financial position following the acquisition of the
business assets of JJHCS. Wells Fargo was made aware of the noncompliance
shortly after January 31, 2004 and agreed to continue making capital advances
available to the Company throughout the period as new loan covenants were
negotiated. Therefore, the noncompliance had no impact on the Company's
liquidity, capital resources or results of operations.
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 was initially structured as a bridge note
(the "Bridge Note"), the proceeds of which were placed into escrow to fund a
portion of the JJHCS asset purchase.
On December 8, 2003 (the "Effective Date"), the $3,000,000 Bridge Note issued to
Bayview was converted into a $2,000,000 term note (the "Term Note"), $1,000,000
in Series A Convertible Preferred Stock, 0.01 par value (the "Preferred Stock")
and a warrant to purchase common stock of the Company (the "Warrant") per the
terms set forth in the August 25, 2003 Securities Purchase Agreement. The Term
Note bears interest at 12% per year, payable monthly, and will mature on the
fifth anniversary of the Effective Date. 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 Bayview Investment is
secured by a subordinated security interest in substantially all of the
Company's assets. The Bayview Investment contained identical financial covenants
to those in the Wells Loan described above, and on May 14, 2004 Bayview agreed
to join with Wells Fargo in waiving this noncompliance and amending the
covenants. The noncompliance with these financial covenants had no impact on the
Company's liquidity, capital resources or results of operations, and the Company
believes the amended covenants are more appropriate after taking into
consideration the Company's actual financial position following the acquisition
of the business assets of JJHCS.
The Preferred Stock was issued to Bayview at a price of $1.00 per share,
resulting in 1,000,000 shares issued on the Effective Date. 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, at any time and from time
to time, into common stock of the Company at a price of $0.50 per share. In
addition, Bayview may require redemption of the Preferred Stock and PIK
Dividends upon a change of control or default (including default under the Term
Note).
The Warrant issued to Bayview on the Effective Date represents the right to
purchase 1,210,320 shares of common stock, which represented 8% of the Company's
outstanding common stock on a fully diluted basis at the Effective Date,
excluding the common stock issuable to Bayview upon conversion of the Preferred
Stock. The Warrant is exercisable at any time for a period of 10 years at an
exercise price equal to $0.50 per share, and the shares obtainable upon exercise
of the Warrant may be put to the Company at fair market value (net of the
exercise price) upon a change of control or default.
The investment proceeds received from Bayview were allocated based upon the
relative fair value of each instrument, which resulted in the following
allocation:
Value assigned to Preferred Stock $ 783,904
Value assigned to Warrants 648,288
Value assigned to Term Note 1,567,808
----------
$3,000,000
==========
The $432,192 difference between the $2,000,000 face value of the Term Note and
its assigned relative fair value is being amortized as interest expense over the
5-year term of the Term Note. Balances of long-term obligations are as follows:
8
March 31, December 31,
2004 2003
------------- -------------
Wells Loan $ 4,624,138 $ 2,775,000
Bayview Term Note 2,000,000 2,000,000
------------ ------------
6,624,138 4,775,000
Discount on Bayview Term Note (403,379) (424,988)
------------ ------------
$ 6,220,759 $ 4,350,012
============ ============
Outstanding principal balances on the Wells Loan and Bayview Term Note mature in
June 2007 and August 2008, respectively.
NOTE 5. 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
months ended March 31, 2004 and 2003. 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
March 31,
---------------------------
2004 2003
---------- ----------
Net earnings applicable to common shareholders - basic $ 336,707 $ 267,980
Add: Dividends to preferred shareholders 15,000 --
--------- ---------
Net earnings - diluted 351,707 267,980
--------- ---------
Less: Compensation expense determined under the fair value method, net of tax (23,621) (12,170)
--------- ---------
Proforma net earnings - basic 313,086 255,810
========= =========
Proforma net earnings - diluted 328,086 255,810
========= =========
Earnings per Share:
Basic-as reported $ 0.03 $ 0.02
========= =========
Basic-proforma $ 0.03 $ 0.02
========= =========
Diluted-as reported $ 0.02 $ 0.02
========= =========
Diluted-proforma $ 0.02 $ 0.02
========= =========
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:
2004 2003
------- -------
Dividend yield None None
Expected volatility 88.43% 90%
Expected life of option 4 years 4 years
Risk-free interest rate 3.27% 2.9%
Weighted average fair value of options on grant date $1.34 $0.26
9
NOTE 6. INCOME TAXES
Deferred income taxes are provided for temporary differences between the
financial reporting and tax basis of assets and liabilities and federal
operating loss carryforwards. Deferred tax assets and liabilities are adjusted
for the effects of changes in tax laws and rates on the date of the enactment.
Income taxes are calculated based on management's estimate of the Company's
effective tax rate, which takes into consideration a federal tax rate of 34% and
a state tax rate of 6%.
NOTE 7. STOCK OPTIONS
The Company maintains a stock option plan for the benefit of certain eligible
employees and directors of the Company. A total of 149,000 shares of common
stock are reserved for additional grants of options under the plan at March 31,
2004. Generally, the options outstanding (1) are granted at prices equal to the
market value of the stock on the date of grant, (2) vest over various terms and,
(3) expire over a period of five or ten years from the date of grant.
A summary of stock option activity for the quarter ended March 31, 2004 is as
follows:
Weighted
Number of Average
Shares Exercise Price
-------------- --------------
Outstanding at December 31, 2003 1,710,900 $0.88
Granted 165,100 2.07
Exercised (59,750) 0.53
Forfeited (31,250) 0.44
------------ -----
Outstanding at March 31, 2004 1,785,000 $1.01
============ =====
10
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 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 MARCH 31, 2004 COMPARED TO THE
QUARTER ENDED MARCH 31, 2003.
REVENUE. Revenues increased $5,148,000 or 68.5% to $12,666,000 for the three
months ended March 31, 2004, from $7,518,000 for the three months ended March
31, 2003. This increase is primarily attributed to the acquisition of the
business assets of the Health & Fitness Services Business of Johnson & Johnson
Health Care Systems Inc. ("JJHCS"), which acquired business contributed revenue
of $5,113,000.
GROSS PROFIT. Gross profit increased $1,433,000 or 86.6% to $3,087,000 for the
three months ended March 31, 2004, from $1,654,000 for the three months ended
March 31, 2003. This increase is primarily attributed to the acquisition of
JJHCS. In addition, the JJHCS acquisition improved gross profit as a percent of
revenue, increasing to 24.4% for the three months ended March 31, 2004 compared
to 22.0% for the three months ended March 31, 2003.
OPERATING EXPENSES AND OPERATING INCOME. Operating expenses increased $1,199,000
to $2,392,000 for the three months ended March 31, 2004 from $1,193,000 for the
three months ended March 31, 2003. Of this increase, $219,000 represents a
non-cash expense related to the amortization of acquired intangible assets. The
remaining increase of $980,000 represents the cost of salaries, benefits and
other expenses of the management team of JJHCS.
OTHER INCOME AND EXPENSE. Interest expense increased $123,000 to $134,000 for
the three months ended March 31, 2004, compared to $11,000 for the same period
in 2003. This increase is due to debt facilities the company secured to finance
the JJHCS acquisition and to provide working capital for the combined company.
The Company's cost of borrowed funds increased to 6.6% for the first quarter of
2004 from 3.8% for the first quarter of 2003.
INCOME TAXES. Income tax expense increased $27,000 to $209,000 for the three
months ended March 31, 2004 compared to $182,000 for the same period in 2003.
The increase is primarily due to the increase in operating profit.
DIVIDENDS TO PREFERRED SHAREHOLDERS. To finance the Company's acquisition of the
JJHCS, the Company sold $1,000,000 in Series A Convertible Preferred Stock (the
"Preferred Stock") to Bayview Capital Partners LP ("Bayview"). The Preferred
Stock was issued to Bayview at a price of $1.00 per share, resulting in the
issuance of 1,000,000 shares. 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"). For the quarter ended March 31, 2004, the Company accrued dividends
of $15,000.
NET EARNINGS. As a result of the above, net earnings for the three months ended
March 31, 2004 increased $69,000 or 25.7% to $337,000 for the three months ended
March 31, 2004, compared to $268,000 for the same period in 2003.
11
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital increased $2,455,000 to $4,710,000 at March 31,
2004, compared to working capital of $2,255,000 at December 31, 2003. The
increase in working capital is primarily due to an increase in accounts
receivable resulting from the acquired JJHCS contracts.
On August 22, 2003, the Company entered into a $7,500,000 Credit Agreement with
Wells Fargo Bank, N.A. to provide the Company with acquisition financing and
general working capital (the "Wells Loan"). The initial draw on the Wells Loan
totaled $1,255,204, which was used to refinance the revolving line of credit
("Merrill Lynch Loan") 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 line of credit, 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 were placed into escrow to fund a portion
of the JJHCS asset purchase.
Working capital advances from the Wells Loan are 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 (effective rate of 4% at March 31, 2004 and December 31, 2003).
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. Availability of the Wells Loan totaled $6,750,000 and $7,000,000 at March
31, 2004 and December 31, 2003. Borrowings under the Wells Loan are
collateralized by substantially all of the Company's assets. The Company is
required to comply with certain monthly financial covenants, including a senior
cash flow leverage ratio, senior leverage ratio and current ratio. Beginning on
January 31, 2004 and continuing throughout the remainder of the period ending
March 31, 2004, the Company was not in compliance with certain covenants
relating to the Wells Loan. On May 14, 2004, Wells Fargo agreed to waive the
noncompliance and amend the loan covenants, effective as of January 31, 2004.
The Company believes that the new loan covenants are more appropriate after
taking into consideration the Company's actual financial position following the
acquisition of the business assets of JJHCS. Wells Fargo was made aware of the
noncompliance shortly after January 31, 2004 and agreed to continue making
capital advances available to the Company throughout the period as new loan
covenants were negotiated. Therefore, the noncompliance had no impact on the
Company's liquidity, capital resources or results of operations.
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 was initially structured as a bridge note
(the "Bridge Note"), the proceeds of which were placed into escrow to fund a
portion of the JJHCS asset purchase.
On December 8, 2003 (the "Effective Date"), the $3,000,000 Bridge Note issued to
Bayview was converted into a $2,000,000 term note (the "Term Note"), $1,000,000
in Series A Convertible Preferred Stock (the "Preferred Stock") and a warrant to
purchase common stock of the Company (the "Warrant") per the terms set forth in
the August 25, 2003 Securities Purchase Agreement. The Term Note bears interest
at 12% per year, payable monthly, and will mature on the fifth anniversary of
the Effective Date. 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 Bayview Investment is secured by a subordinated
security interest in substantially all of the Company's assets. The Bayview
Investment contained identical financial covenants to those in the Wells Loan
described above, and on May 14, 2004 Bayview agreed to join with Wells Fargo in
waiving this noncompliance and amending the covenants. The noncompliance with
these financial covenants had no impact on the Company's liquidity, capital
resources or results of operations, and the Company believes the amended
covenants are more appropriate after taking into consideration the Company's
actual financial position following the acquisition of the business assets of
JJHCS.
The Preferred Stock was issued to Bayview at a price of $1.00 per share,
resulting in 1,000,000 shares issued on the Effective Date. The Preferred Stock
has a stated dividend rate of 6% per year, computed on a simple interest
12
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, at any time and
from time to time, into common stock of the Company at a price of $0.50 per
share. In addition, Bayview may require redemption of the Preferred Stock and
PIK Dividends upon a change of control or default (including default under the
Term Note).
As of March 31, 2004, 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, 2003 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.
RECENTLY PASSED LEGISLATION
HIPPA. The Administrative Simplification provisions of the Health Insurance
Portability and Accountability Act of 1996 ("HIPAA") require group health plans
and health care providers who conduct certain administrative and financial
transactions electronically ("Standard Transactions") to (a) comply with a
certain data format and coding standards when conducting electronic
transactions; (b) use appropriate technologies to protect the security and
integrity of individually identifiable health information transmitted or
maintained in an electronic format; and (c) protect the privacy of patient
health information. The Company's occupational health line of business, which
accounts for approximately five percent of the Company's total revenue, and the
group health plan the Company sponsors for its employees are subject to HIPAA's
requirements. The Company expects to be in compliance with HIPPA requirements
within the timeline specified for the Company's affected business areas. The
Company's corporate, hospital, community and university based fitness center
management lines of business are not subject to the requirements of HIPAA.
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,
2003, for cautionary statements on important factors to consider in evaluating
the forward-looking statements included in this Form 10-Q.
13
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.
14
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Refer to Item 3 (Legal Proceedings) of the Company's Annual Report on Form 10-K
for the year ended December 31, 2003
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
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"). Beginning on January
31, 2004 and continuing throughout the remainder of the period ending March 31,
2004, the Company was not in compliance with certain covenants relating to the
Wells Loan. The Company also was not in compliance with the identical covenants
set forth in the Securities Purchase Agreement with Bayview Capital Partners LP
("Bayview") pertaining to a $2,000,000 term note and $1,000,000 of Series A
Convertible Preferred Stock issued to Bayview on December 8, 2003. Wells Fargo
continued to make working capital available throughout the period ending March
31, 2004, and on May 14, 2004, Wells Fargo and Bayview agreed to waive the
noncompliance and to amend the covenants. Therefore, the noncompliance has had
no impact on the Company's liquidity, capital resources or results of
operations.
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
On February 6, 2004, the Company filed an Amendment to its Form 8-K dated
December 8, 2003, providing financial statements and exhibits under Item 7 with
respect to the Company's acquisition of the Health & Fitness Services Business
of Johnson & Johnson Health Care Systems Inc.
15
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: May 17, 2004 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)
16
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
10.1 Standard Office Lease Agreement (Net) dated as of June 13, 1996 covering a portion of the Company's
headquarters - incorporated by reference to the Company's Annual Report on Form 10-KSB for the year
ended December 31, 1996
10.2 Amendment dated March 1, 2001 to Standard Office Lease Agreement (Net) dated as of June 13, 1996
covering a portion of the Company's headquarters-incorporated by reference to the Company's Form 10K
for the year ended December 31, 2000.
10.3 Second Amendment, dated June 12, 2002, to Standard Office Lease Agreement dated as of June 13, 1996-
incorporated by reference to the Company's Form 10-Q for the quarter ended June 30, 2002.
*10.4 Company's 1995 Stock Option Plan - incorporated by reference to the Company's Annual Report on Form
10-KSB for the year ended December 31, 1995
*10.5 Amendment to Company's 1995 Stock Option Plan - incorporated by reference to Part II, Item 4 of the
Company's Form 10-QSB for the quarter ended June 30, 1997
*10.6 Employment agreement dated November 30, 2000 between Company and Jerry V. Noyce-incorporated by
reference to the Company's Form 10-K for the year ended December 31, 2000.
*10.7 Employment agreement dated April 21, 1995 between the Company and James A. Narum, as amended October
19, 1999, November 2, 2000 and March 25, 2003-incorporated by reference to the Company's Form 10-K
for the year ended December 31, 2002.
*10.8 Employment agreement dated February 9, 2001 between Company and Wesley W. Winnekins-incorporated by
reference to the Company's Form 10K for the year ended December 31, 2000.
*10.9 Employment agreement dated March 1, 2003 between Company and Jeanne Crawford-incorporated by
reference to the Company's Form 10-K for the year ended December 31, 2002.
17
Exhibit No. Description
- ----------- ----------------------------------------------------------------------------------------------------
10.10 Agreement of Purchase and Sale of Stock of David W. Pickering, Inc. dated January 1, 2001 -
incorporated by reference to the Company's Quarterly Report on form 10-QSB for the quarter ended
September 30, 2001
10.11 WCMA Loan and Security Agreement dated October 31, 2002 between the Company and Merrill Lynch
Business Financial Services, Inc. incorporated by reference to the Company's Form 10Q for the
quarter ended September 30, 2002
10.12 Credit Agreement, dated August 22, 2003, between the Company and Wells Fargo Bank, National
Association - incorporated by reference to the Company's Quarterly Report on form 10-QSB for the
quarter ended September 30, 2003
10.13 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 - incorporated by
reference to the Company's Quarterly Report on form 10-QSB for the quarter ended September 30, 2003
10.14 Asset Purchase Agreement, dated August 25, 2003, between the Company and Johnson & Johnson Health
Care Systems Inc. - incorporated by reference to the Company's Quarterly Report on form 10-QSB for
the quarter ended September 30, 2003
10.15 Third Amendment, dated August 25, 2003, to Standard Office Lease Agreement dated as of June 13,
1996, between the Company and NEOC Holdings LLC - incorporated by reference to the Company's
Quarterly Report on form 10-QSB for the quarter ended September 30, 2003
**10.16 Second Amendment to Credit Agreement and Waiver of Defaults between the Company and Wells Fargo
Bank, N.A., dated May 14, 2004
**10.17 Amendment No. 2 to Securities Purchase Agreement between the Company and certain of its
subsidiaries, on the one hand, and Bayview Capital Partners LP, on the other hand, dated April 2,
2004
**10.18 Amendment No. 3 to Securities Purchase Agreement between the Company and certain of its
subsidiaries, on the one hand, and Bayview Capital Partners LP, on the other hand, dated May 14,
2004
**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
18