Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the Quarterly Period Ended June 30, 2003

For the Transition Period From                          to                         

Commission File Number 000-49871

HEALTHETECH, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (303) 526-5085

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 Exchange Act).  Yes  ¨  No  x

As of July 28, 2003, the number of shares outstanding of the registrant’s common stock, par value $0.001 per share, 19,615,292.

Table of Contents

INDEX

Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Unaudited Financial Statements

HEALTHETECH, INC.

Balance Sheets

Unaudited

The accompanying notes are an integral part of these unaudited financial statements.

1

Table of Contents

HEALTHETECH, INC.

Statements of Operations

Unaudited

The accompanying notes are an integral part of these unaudited financial statements.

2

Table of Contents

HEALTHETECH, INC.

Statements of Cash Flows

Unaudited

The accompanying notes are an integral part of these unaudited financial statements.

3

Table of Contents

HEALTHETECH, INC.

UNAUDITED NOTES TO FINANCIAL STATEMENTS

(1) Business and Basis of Financial Statement Presentation

HealtheTech, Inc. (the Company or HealtheTech) was incorporated in February 1998 under the laws of the State of Delaware. The Company operates in one segment and develops and markets health solutions designed to give consumers simple, informative ways to improve and maintain health and wellness.

The accompanying financial statements as of June 30, 2003 and for the three months and six months ended June 30, 2003 and 2002 are unaudited and have been prepared in accordance with generally accepted accounting principles on a basis consistent with the December 31, 2002 audited financial statements and include normal recurring adjustments which are, in the opinion of management, necessary for a fair statement of the results of these periods. These statements should be read in conjunction with our financial statements and notes thereto included in our Form 10-K (Commission File No. 000-49871), filed on February 25, 2003. Operating results for the three and six months ended June 30, 2003 are not necessarily indicative of the results that may be expected for the full year.

The preparation of financial statements in conformity with generally accepted accounting principles 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 consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ significantly from those estimates.

The Company’s financial statements are based on several significant estimates, including the reserve for warranty obligations and product returns, provision for excess and obsolete inventory, provision for doubtful accounts and the selection of estimated useful lives of long-lived assets, as well as the recoverability of the investment in long-lived assets.

(2) Significant Accounting Policies

(a) Cash and Cash Equivalents and Restricted Cash

All highly liquid investments purchased with original maturities of three months or less are considered to be cash equivalents. Restricted cash represents amounts the Company has pledged to collateralize letters of credit related to leases for office space and equipment.

(b) Investments

Investments consist of mutual funds concentrated in medium term U.S. governmental securities. Investments are stated at fair value and are classified as available for sale.

(c) Inventory

Inventory is stated at the lower of cost or market, using the first-in, first-out method and consists of purchased items or finished goods that were manufactured for the Company by contract manufacturers. The Company is contractually required to purchase from a manufacturer raw materials and work-in-process that such manufacturer has purchased or processed based on the Company’s initial forecasts, but which will not be utilized within 90 days due to subsequently revised forecasts. The Company normally leaves such inventory at the manufacturer, but can request it to be shipped to another location, and bears risk of loss due to obsolescence and other general inventory risk other than pilferage or mishandling by the manufacturer.

4

Table of Contents

(d) Intangible Assets

Intangible assets consist of purchased patents and legal fees to obtain patents and are recorded at cost. Amortization of intangible assets is calculated using the straight-line method over the estimated useful lives, generally five to ten years. Amortization expense was $132,244 and $77,602 for the three months ending June 30, 2003 and 2002, respectively and $276,490 and 161,479 for the six months ending June 30, 2003 and 2002, respectively. The Company periodically evaluates the recoverability of intangible assets and takes into account events or circumstances that warrant revised estimates of useful lives or that indicate that impairment exists. In conjunction with the Company’s change in business focus, the Company identified a number of patents and applications directed at products it has decided not to pursue and others that may not result in meaningful cash flow within the next several years. Using probability-adjusted cash flow projections and other methods, the Company wrote down the value of its intangible assets to management’s best estimate of fair value and recorded an impairment charge of approximately $1.6 million for the three months ended June 30, 2003. The impairment charge is included in restructuring and asset impairment on the accompanying statement of operations.

(e) Accrued liabilities

Accrued liabilities consists of the following:

(f) Deferred Revenue

Deferred revenue consists of payments received to maintain exclusivity and are recognized ratably over the contract period, the last of which is through December 31, 2004.

(g) Fair Value of Financial Instruments

The carrying amounts of certain of the Company’s financial instruments, including, cash and cash equivalents, restricted cash, short-term investments, accounts receivable, accounts payable and accrued expenses, approximate fair value due to their short-term nature.

(h) Research and Development Costs and Software Development Costs

Research and development costs are expensed as incurred and consist of salaries and other direct costs. SFAS No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased or Otherwise Marketed, (SFAS No. 86) requires the capitalization of certain software development costs once technological feasibility is established. The Company’s software is deemed to be technologically feasible at the point a working model of the software product is developed. Through June 30, 2003, the period between achieving technological feasibility and general availability of such software has been short. Consequently, software development costs qualifying for capitalization have been insignificant.

5

Table of Contents

(i) Revenue

The Company generates revenue from the sale of its products, software and licensing arrangements. Revenue from the sale of products is recognized when evidence of an arrangement exists, ownership transfers to the customer or distributor, the price is fixed and collectibility is probable. The software component of the Company’s products is considered incidental under Statement of Position (SOP) 97-2, Software Revenue Recognition.

Software fees are comprised of sales of prepackaged software that can be sold independently or in conjunction with product sales. Software fees are recognized according to the criteria of SOP 97-2, as amended. Revenue is recognized upon execution of a license agreement or signed written contract with fixed or determinable fees, shipment or electronic delivery of the product, and when collection of the receivable is probable. Software sales are to retail consumers who install the software themselves and pay via credit card prior to shipment. During the six months ended June 30, 2003, the Company also sold software to mass-market resellers and recognized revenue when the software was sold through to the end user. The Company made the decision to exit the mass market retail distribution channel in the second quarter of 2003.

Service revenue, including training and consulting services, is recognized as services are performed. Licensing fees are recognized ratably over the contract term.

Cost of product revenue consists primarily of purchases of products from contract manufacturers, warranty reserves and royalty payments, obsolescence reserves and costs of personnel directly related to managing the supply chain and related overhead. Cost of software revenue primarily consists of purchases of product. Additionally, costs of shipping are included in software and other cost of revenue.

The Company provides 30 day right of return on software sales and limited warranty on its software products for 90 days from date of purchase. However as returns and warranty claims have been insignificant, no reserve has been established.

In general, the Company does not provide price protection or right of return on health monitoring devices. The Company does provide limited warranty on its devices for periods of 12 to 15 months.

(j) Stock-Based Charges

The Company accounts for its stock option plan in accordance with the provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Generally, compensation expense is recorded for options issued to employees and directors on the date of grant only if the current estimated fair value of the underlying common stock exceeds the exercise price of the option, the intrinsic value method. SFAS No. 123, Accounting for Stock-Based Compensation, permits entities to recognize as expense, over the vesting period, the fair value of all stock-based awards on the date of the grant. Alternatively, SFAS No. 123 allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income or loss disclosures as if the fair value based method defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosures required by SFAS No. 123.

At June 30, 2003, the Company has one stock-based employee compensation plan, which is described more fully in Note 6. The following table illustrates the effect on net loss if the Company had applied the fair value based measurement and recognition provisions of SFAS No. 123 to stock-based employee compensation.

6

Table of Contents

The Company accounts for non-employee stock based awards in accordance with SFAS No. 123 and related interpretations. Stock options are valued using the Black-Scholes options pricing model. Prior to the Company’s initial public offering in July 2002, the fair value of equity instruments was determined by the Company’s Board of Directors. Subsequent to July 2002, the fair value is based on the closing price of the Company’s stock on the Nasdaq National Market.

(k) Income Taxes

The Company uses the asset and liability method of accounting for income taxes as prescribed by SFAS No. 109, Accounting for Income Taxes. Under the asset and liability method, deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The resulting deferred tax assets and liabilities are adjusted to reflect changes in tax laws or rates in the period of enactment.

(l) Advertising Costs

Advertising costs are expensed when media placements occur. Advertising expense was $0 and $17,124 for the three months ended June 30, 2003 and 2002, respectively and $3,332,100 and $39,569 for the six months ended June 30, 2003 and 2002, respectively.

(m) Loss Per Share

Loss per share is presented in accordance with the provisions of SFAS No. 128, Earnings Per Share, (SFAS No. 128). Under SFAS No. 128, basic loss per share (EPS) excludes dilution for potential common stock issuances and is computed by dividing net loss by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that would occur if securities or other contracts to issue common stock were exercised or converted into common stock. Basic and diluted EPS are the same for all periods, as all potential common stock instruments, consisting of common stock options and warrants and convertible preferred stock, are anti-dilutive due to the net losses for each period.

7

Table of Contents

The following is a reconciliation of the numerators and denominators of the basic and diluted EPS computations:

For the six months ending June 30, 2003 and 2002, 9,447,928 and 3,294,215 respectively, potential common stock equivalents consisting of options and warrants were excluded from the diluted loss per share calculation because their effect would be anti-dilutive.

(2) Restructuring Charge

During the second quarter of 2003, the Company decided to refocus its business on the medical markets and commercial weight loss markets and the products that support those markets. As a result of this refocus, the Company evaluated its operating expense levels and determined to restructure the business, resulting in a company-wide cost reduction program achieved through a downsizing of our employee workforce, a significant reduction in our use of contractors and outside service firms, and company-wide salary reductions. Restructuring charges include severance arrangements, early termination fees and legal costs associated with this effort. The Company expects an annual expense savings of approximately $6 million. The liability remaining at June 30, 2003 is reflected in accrued liabilities on the accompanying balance sheet. The liability will be relieved through the Company’s normal bi-monthly payrolls and will extinguish in April 2004.

8

Table of Contents

(3) Property and Equipment

Property and equipment consist of the following:

(4) Line of Credit

In May 2003, the Company entered into a $4.0 million receivable-based bank line of credit. Cash advances under the line are available pursuant to a borrowing-base formula and subject to the maintenance of certain financial covenants and other terms and conditions. Advances bear interest at prime rate, 4% at June 30, 2003. Amounts outstanding under the line are due May 5, 2004. There were no amounts outstanding under the line at June 30, 2003. The amount of available credit approximates $0.2 million at June 30, 2003.

(5) Warrants and Non-Qualified Stock Options

In April 2003, the Company issued a fully vested warrant to a consultant to purchase an aggregate of 85,000 shares of common stock at an exercise price of $7.50 per share. In addition, this consultant was issued fully vested non-qualified stock options to purchase an aggregate of 40,000 shares of common stock at an exercise price of $7.50 per share. The fair value of the warrant and stock options approximated $44,000, as determined using the Black-Scholes option pricing model assuming no dividends, 94% volatility, risk free interest rates ranging from 1.66% to 2.54% and expected lives of two to four years and has been included in selling, general and administrative stock-based charges on the accompanying statement of operations.

(6) Stockholders’ Equity

(a) Employee Stock Purchase Plan

The Company has an employee stock purchase plan for all eligible employees. Under the plan, shares of the Company’s common stock may be purchased at six-month intervals at 85% of the lower of the fair market value on the first or the last day of each six-month period. Employees may purchase shares having a value not exceeding 15% of their gross compensation during an offering period.

(b) Stock Options

The following table summarizes stock option activity and balances for the periods ended June 30, 2003 and 2002:

9

Table of Contents

The following table summarizes information about stock options outstanding at June 30, 2003:

The following table includes grants of options for common stock whose exercise price was less than the fair market value, for financial reporting purposes, of the underlying common stock at the date of grant, equal to the fair market value at the date of grant or greater than the fair market value at the date of grant:

10

Table of Contents

(7) Significant Customers

Revenue earned from significant customers is as follows:

At June 30, 2003 and 2002, receivables from these customers represented 78% and 81% of total receivables, respectively.

(8) Related Party Transactions

The Company receives professional services from a firm in which a director is a partner. Fees paid were $41,000 and $260,000 for the three months ended June 30, 2003 and 2002, respectively, and $220,000 and $400,000 for the six months ended June 30, 2003 and 2002, respectively.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of HealtheTech, Inc.’s (referred to herein as the Company, we, us or our) financial condition and results of operations should be read in conjunction with the financial statements and notes thereto included in Item 1 of Part 1 of this quarterly report and the audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2002 included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission. The following Management’s Discussion and Analysis of Financial Condition and Results of Operations, as well as information contained elsewhere in this report, contain statements that 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 (the “Exchange Act”). You can identify these statements by forward-looking words such as “may,” “will,” expect,” “intend,” “anticipate,” “believe,” “estimate,” “plan,” “could,” “should,” and “continue,” or similar words. Actual results could differ materially from those anticipated in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those mentioned in the discussion below, the summary “Risk Factors” contained herein and those described in the “Risk Factors” discussion of our Annual Report on Form 10-K for the year ended December 31, 2002. As a result, you should not place undue reliance on these forward-looking statements. We do not intend to update or revise these forward-looking statements to reflect future events or developments.

11

Table of Contents

Overview

We were incorporated in Delaware in February 1998. We design, develop and market technologically advanced and proprietary handheld medical devices and software for the measurement of resting metabolic rate and monitoring of nutrition.

We have incurred losses since commencing operations and, as of June 30, 2003, we had an accumulated deficit of $81.2 million. Our net loss was $7.0 million and $4.0 million for the three ended June 30, 2003 and 2002, respectively and $17.0 million and $7.9 million for the six months ended June 30, 2003 and 2002, respectively. We have not achieved profitability on a quarterly or annual basis. We intend to continue to develop our proprietary products and services and increase our sales efforts.

Early in the quarter ended June 30, 2003, we decided to refocus our business on the medical markets and commercial weight loss markets and the products that support those markets. As a result of this refocus, we in turn evaluated our operating expense levels and determined to restructure the business, resulting in headcount and salary reductions. We do expect to continue to incur losses at least through 2003. Despite the progress we made in reducing expenses, we will need to generate substantially higher revenue than that generated in the current quarter and past quarters in order to achieve and sustain profitability.

We are in the process of seeking additional capital and it may not be available when needed or, if available, we may not be able to obtain such capital on terms favorable to us or to our stockholders. If we raise additional capital by issuing equity securities, substantial dilution to existing stockholders may result. Insufficient capital may require us to delay, scale back or eliminate some or all of our current programs, or cause us to further contract the scope of our operations.

Since our inception, our principal activities have involved developing our products, forming distributor and strategic partner relationships, and more recently, marketing our initial products. We received FDA 510(k) clearance in January 2002 to market MedGem for the measurement of oxygen uptake in clinical and research applications. BodyGem, which we promote for non-medical weight management applications, was commercially launched in November 2001. Our BalanceLog software application, which can be used as a stand-alone weight and nutrition management program or in conjunction with measurements from our devices, was also commercially launched in November 2001.

We derive revenue from the sale of our health monitoring devices, single-use disposables, software products and license fees. We anticipate that our revenue will be generated primarily through strategic partnerships and distribution agreements. Our sales strategy is to focus on two key markets; medical and weight-loss. In the medical and clinical markets, we currently have agreements with HealthSouth Corporation and Mead Johnson & Company (a subsidiary of Bristol-Myers Squibb Company) for use or distribution of MedGem. In 2002, HealthSouth Corporation was our largest customer and contributed approximately 56% of our revenue. HealthSouth Corporation is currently the subject of various governmental investigations into its business. Because of the uncertainty around the outcome of these investigations and HealthSouth’s business prospects, we currently anticipate that we will receive no revenue from HealthSouth in 2003.

Our strategic partnership agreement with Mead Johnson & Company provides that Mead Johnson is obligated to fulfill certain take-or-pay commitments in exchange for exclusivity in certain medical markets. As of June 30, 2003, Mead Johnson had not fulfilled its commitment in its entirety due to a longer than expected sales and implementation cycle for our products. As a result, both parties are currently working to restructure the strategic partnership agreement and have expanded Mead Johnson’s product offerings to include weight management starter kits, which combine our devices, disposables and software, and are focused in the medically supervised weight management market segment.

In the non-medical markets, we currently have relationships with Nature’s Sunshine Products, Inc. for distribution of BodyGem through its independent distributors who provide measurement services to consumers; Bally Total Fitness for purchase of BodyGem devices to provide measurement services in its fitness clubs; and a subsidiary of Microlife Corporation for distribution of BodyGem to retail pharmacies in Europe to provide in-store metabolic rate measurement services and the weight management and

12

Table of Contents

fitness/exercise markets in Taiwan. In addition, we have entered into agreements with several regional distributors for the sale of MedGem and BodyGem into certain medical and non-medical markets.

We recognize revenue from the sale of our products, other than mass market retail software, when ownership transfers to our customer or distributor. Other than software, we offer products with warranty periods of 12 to 15 months from the date of purchase. With certain limited exceptions, we provide limited warranties on our software products for 90 days from the date of purchase. In the future, we expect that revenue from the sale of disposables will increase as a percentage of total revenue as the installed base of our monitoring devices increases.

We have decided to exit the mass-market retail distribution channel due to lower than expected sell-through rates experienced during the first quarter of 2003. Revenue was recognized as software was sold through to end users. We recognized total revenue in the first two quarters of 2003 approximating $228,000. In conjunction with our decision to exit the mass-market retail distribution channel, approximately 82,000 units of our software product were returned to us as of June 30, 2003. Due to the quantity of software returned and our expected sales of these products, we recorded a charge of approximately $254,000 representing the estimated excess inventory on hand of this product.

We pay royalties to third-parties to license various sensor technologies that are used in our health monitoring devices. These royalty expenses are included in our cost of revenue. In general, we pay the greater of minimum royalty amounts or a percentage of product revenue to these third-parties in order to maintain exclusivity in specified fields of use through the terms of the agreements covering the licensed technologies.

We currently outsource the manufacturing, testing and packaging of our health monitoring devices, disposable products and software. We pay our contract manufacturers a negotiated price, inclusive of labor, material, overhead and profit, for the products that they manufacture. Generally, we pay for products as they are completed and move into finished goods inventory. In some circumstances, if we reschedule purchase orders placed with our manufacturers, we may be liable for restocking fees or may be required to purchase surplus inventory at the manufacturer. Cost of revenue consists primarily of purchases of products from our contract manufacturing partners, royalties, obsolescence reserves, tooling depreciation and costs of our manufacturing liaison group. We anticipate that we will recognize higher margins on our disposables and software products as compared to our health monitoring devices. We anticipate that our gross margins will improve over time as product volume increases to cover fixed manufacturing costs and potentially enable the company to negotiate lower contract manufacturing rates

Research and development expenses have principally consisted of compensation and other personnel costs, contractor fees, fees paid to outside service providers, project material, and clinical expenses. Research and development costs are expensed as incurred.

Selling, general and administrative expenses consist of compensation and other personnel fees, professional fees, travel, tradeshows, public and investor relations, advertising, marketing, insurance, outsourced customer support and, to a lesser extent, account management and customer training. Our sales and marketing strategy is to establish strategic distribution relationships, generate awareness of our products and penetrate and expand in the medical nutrition therapy, weight management and fitness markets. We initiated an awareness campaign emphasizing the importance of metabolism in weight management and began running advertisements in magazines, cable and broadcast, television, and radio in late 2002. Largely because of the conclusion of our advertising campaigns in the first quarter of 2003 and the cost reduction efforts we have undertaken in the second quarter of 2003, we believe our selling, general and administrative expenditures will decline in future periods.

13

Table of Contents

Results of Operations

Three Months and Six Months Ended June 30, 2003 and 2002

Revenue. Revenue decreased $2.1 million to $1.2 million in the quarter ended June 30, 2003 from $3.3 million in the comparable quarter in 2002. Product revenue decreased $2.0 million for the three months ended June 30, 2003 from $2.7 million in the comparable period in 2002. In the second quarter of 2002, HealthSouth made a contractually required product purchase from us to maintain exclusivity in certain markets. In addition, we fulfilled a large re-stocking order of BodyGem and single-use disposables to a distributor in that same time period. We sold approximately 280 BodyGem and MedGem devices and approximately 60,000 single-use disposables in the second quarter of 2003 compared to approximately 1,400 devices and 120,000 disposables in the second quarter of 2002. Software and other revenue decreased nominally to $0.5 million in the second quarter of 2003 from $0.6 million in the comparable quarter of 2002. Sales of software in the second quarter of 2003 were primarily generated from our website.

Revenue decreased 50% to $2.8 million for the six months ended June 30, 2003 from $5.6 million in the comparable period in 2002. Product revenue decreased $3.1 million for the six months ended June 30, 2003 from $4.7 million in the comparable period in 2002. We sold 480 Gems and approximately 180,000 single-use disposables in the six months ended June 30, 2003 compared to 2,958 Gems and approximately 212,000 single-use disposables in the comparable period of 2002. In the six months ended June 30, 2003, we shipped a large re-stocking order of single-use disposables to a key customer and have sold kits comprised of the MedGem, single-use disposables and software to our new medical distributor. We also shipped a re-stocking order to our international distributor. Sales for the six months ended June 30, 2002 were primarily to our domestic and international distributors for initial stocking orders of Gems and single-use disposables, in addition to a large sale made to HealthSouth, as discussed above, and sales to a key customer in the home measurement market. Software and other revenue increased $0.3 million, with the addition of the mass-market retail channel for distribution of our BalanceLog software in early 2003. As discussed above, we have decided to exit this channel.

In late 2002 and early 2003, we received purchase orders from SAM’s Club and Wal-Mart and shipped a total of $3.8 million of BalanceLog software based on our retail selling prices. Through June 30, 2003, we recognized revenue of only $228,000 based on the sell-through of our software to customers from these retail stores. Because of the low sell-through rates, we have decided to exit the mass-market retail channel and therefore SAM’s and Wal-Mart have returned the majority of the unsold product to us during the second quarter of 2003. Based on our current sales forecasting, we do not anticipate selling this quantity of software in the next twelve months. Accordingly, we reserved approximately $254,000 as excess inventory in the quarter ended June 30, 2003. This charge is included in software cost of revenue.

Revenue from customers outside the United States accounted for 48% and 9% of total revenue for the three months ended June 30, 2003 and 2002, respectively and 27% and 15% for the six months ended June 30, 2003 and 2002, respectively.

Cost of Revenue. Total cost of revenue increased to 94% of sales in the second quarter of 2003 from 51% of sales in the second quarter of 2002. Total cost of revenue for the six months ended June 30, 2003 increased to 81% of sales from 63% of sales in the prior year period. The increase in cost of revenue as a percent of sales reflects lower sales volumes and discounted product pricing combined with increased minimum royalty costs on our single-use disposables and fixed internal costs supporting our production efforts. In addition, we reserved $254,000, approximately 21% of total revenues for excess software inventory returned to us from Wal-Mart and SAM’s Clubs.

Research and Development. Research and development expenses increased $0.1 million to $1.7 million in the quarter ended June 30, 2003 from $1.6 million in the comparable quarter in 2002. The variance is primarily due to increased license fees, expenditures for product prototypes for a new flow tube design and expenditures for other improvements to support our existing products. In addition, we have increased the scope of our

14

Table of Contents

clinical and validation activities relating to our BodyGem and MedGem measurement devices. We believe that a continued commitment to research and development is essential in order to provide enhancements to existing products and new product offerings.

Research and development expense increased $1.1 million to $4.1 million for the six months ended June 30, 2003 from $3.0 million in the comparable period of the prior year. The primary reason for the increase includes contracting hardware and software developers and outside service firms early in 2003 to assist in enhancing our current products and designing and developing next generation product. Many of these outside services firms and contractors have now been eliminated as a result of our cost reduction program in the second quarter and most projects will be now be conducted using internal resources.

Selling, General and Administrative. Selling, general and administrative expenses decreased $0.3 million to $2.8 million in the quarter ended June 30, 2003 from $3.1 million in the comparable quarter of the prior year. The primary reasons for the decrease include reduced contractors, outside service firms, legal services and travel expenditures. In the quarter ended June 30, 2002, we utilized more contractors and consultants to assist us with infrastructure, recruiting, and computer system projects. As stated above, many of the contractors and outside service firms have now been eliminated due to our cost reduction program. We are now using internal resources for most formerly sub-contracted functions, such as web hosting, customer service, marketing agency services, investor relations and public relations.

Selling, general and administrative expense increased $4.8 million to $10.3 million for the six months ended June 30, 2003 from $5.5 million in the comparable period of the prior year. This was primarily due to the first quarter 2003 metabolism awareness campaign and BalanceLog software radio and print advertising which totaled $3.3 million. In the first quarter of 2003, we also incurred approximately $0.7 million of merchandising costs launching into the mass-market retail channel. As of June 30, 2003, we have exited this channel.

Stock-based charges. Stock-based charges decreased $0.6 million for the second quarter of 2003 to $0.5 million from $1.1 million in the comparable quarter of the prior year. We recorded deferred stock-based charges of $4.9 million with respect to stock options that we granted through June 30, 2003. We recognized $1.8 million of the deferred stock-based charges through June 30, 2003, reduced deferred stock-based charges by $1.4 million for unvested options that have been forfeited and will ratably recognize the remaining $1.7 million of deferred stock-based charges over the remaining vesting period of the options, which is generally four years from the date of grant. We expect to record expense for deferred compensation as follows: $0.6 million for the remainder of 2003, $0.7 million during 2004 and $0.4 million during 2005. The amount of deferred compensation expense to be recorded in future periods may again decrease if unvested options for which deferred compensation has been recorded subsequently lapse or are cancelled.

Restructuring charges and asset impairment. During the second quarter of 2003, we implemented a company-wide cost reduction program, which we expect will reduce our quarterly operating expenses by approximately 25%. This was achieved through a downsizing of our employee workforce, a significant reduction in our use of contractors and outside service firms, and company-wide salary reductions. We incurred approximately $0.5 million of severance charges and termination fees associated with this effort.

We revised our business plan during the second quarter of 2003 to focus on a few core markets and the products that support these markets. The change in our business plan caused us to reevaluate the fair value of our intellectual property portfolio. This evaluation identified a number of patents and applications directed at products we have decided not to pursue, and others that may not result in meaningful cash flow within the next several years. Using probability-adjusted cash flow projections and other methods, we wrote down the value of these intangible assets to management’s best estimate of fair value, and we recognized an impairment charge of approximately $1.6 million for the three months ended June 30, 2003. We continue to have a very strong patent portfolio addressing methods of indirect calorimetry, integrated calorie management and other technologies that are related to or extensions of our current products.

15

Table of Contents

Liquidity and Capital Resources

Unrestricted cash, cash equivalents and short-term investments totaled $12.1 million at June 30, 2003. Cash used in operating activities was $9.6 million in the six months ended June 30, 2003, compared to $0.6 million in the comparable period of the prior year. The increase in usage reflects expenditures for supporting an advertising launch for BalanceLog software earlier in the year, severance payments to employees whose jobs were eliminated as part of our company-wide cost reduction program, an $0.8 million payment to our contract manufacturer for excess raw materials reserved in previous years and in general, supporting the operations of a now public organization. The increase is offset primarily by a reduction in our accounts receivable and prepaid expenses and a $0.9 million customer deposit that will be refunded in the near future.

Cash provided by investing activities was $3.4 million in the six months ended June 30, 2003, an increase of $3.1 million from the comparable period of the prior year, due to the redemption of marketable equity securities offset by purchases of capital equipment and laboratory equipment.

Cash flows from financing activities were $0.1 million in the six months ended June 30, 2003, a decrease of $0.8 million from the comparable period of the prior year. Net cash from financing activities for the six months ended June 30, 2003 primarily reflects proceeds from the sales of equity securities from the Company’s employee stock purchase plan and exercise of stock options. Net cash from financing activities for the six months ended June 30, 2002 primarily reflects proceeds from the sale of Series C preferred stock offset by stock offering costs.

We have no long-term debt. Stockholders’ equity at June 30, 2003 was $16.1 million. We expect to continue to modestly invest in sales and marketing programs and research and development. We do not expect significant additions to property and equipment in the near term. In May 2003, we entered into a $4.0 million receivable-based line of credit with a large bank. Advances under the line of credit are available to us pursuant to a borrowing-base formula and subject to the maintenance of certain financial covenants and other terms and conditions. Amounts outstanding under the line of credit are due one year from the execution of the agreement. As of June 30, 2003, there are no amounts outstanding under the line of credit. The amount of available credit under the line approximates $0.2 million at June 30, 2003.

We believe our current cash, investments and cash generated from operations is sufficient to fund our operations and working capital needs for the next twelve months. However, given our current financial projections, we anticipate we will require additional debt or equity financing and plan to seek this financing in 2003. We believe that such financing may be available from strategic or financial investors. However, to the extent that such financing is available, it may cause substantial dilution to existing stockholders or contain terms and conditions not favorable to us or our stockholders. Insufficient capital may require us to delay, scale back or eliminate some or all of our current programs, or cause us to further contract the scope of our operations.

The following table sets forth information concerning our material contractual obligations as of June 30, 2003:

We have contractual rights to third party intellectual property underlying certain of our sensor technologies under which there are obligations to pay transaction-based royalties. To maintain exclusive rights to these intellectual property rights, we may be obligated to make additional minimum payments.

16

Table of Contents

We have commitments to pay a total of $1.3 million secured by standby letters of credit as follows: $56,000 in one year and $1.2 million in five years. Cash securing the letters of credit becomes available when certain defined net worth and cash flow requirements are met.

Critical Accounting Policies and Estimates

We have disclosed in Note 2 to our financial statements those accounting policies that we consider to be significant in determining our results of operations and our financial position.

The preparation of financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses. We evaluate our estimates, including those related to bad debts, inventories and warranty obligations, on an ongoing basis. We base our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the periods presented. The actual results may differ from these estimates under different assumptions or conditions.

The significant accounting policies which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:

Revenue recognition

We derive our revenue primarily from the sale of our health monitoring devices, the recurring sale of our single-use disposables and our companion software. Our software revenue is recognized in accordance with Statement of Position 97-2, as amended by Statement of Position 98-9. We license our software products on a perpetual basis. We recognize revenue from the sale of our health monitoring devices and single-use disposables upon ownership transfer to the customer and when it is determined that a continuing service obligation no longer exists. We recognize revenue from the sale of our software when persuasive evidence of an arrangement exists, the product is delivered, the price is fixed or determinable and collectibility is probable. For sales of our software over the Internet, we use a credit card authorization as evidence of an arrangement. Sales through our distributors are evidenced by a master agreement governing the relationship together with binding purchase orders on a transaction-by-transaction basis. Delivery generally occurs when the product is delivered to a common carrier. Service revenue, including training, is recognized as services are performed. We offer customers a limited right to return software products within 30 days if they do not accept the terms and conditions of our software license agreement. We provide limited warranties on our health monitoring devices for a period of 12 to 15 months from the date of purchase and on our software products for 90 days from date of purchase, with certain limited exceptions.

Receivables are recorded net of allowance for doubtful accounts. We regularly review the adequacy of our accounts receivable allowance after considering the accounts receivable aging, the ages of each invoice, each customer’s expected ability to pay and our collection history with each customer. We review any invoice greater than 90 days past due to determine if an allowance is appropriate based on the risk category using the factors discussed above. The allowance for doubtful accounts represents our best estimate, but changes in circumstances relating to accounts receivable may result in additional allowances or recoveries in the near future.

Valuation allowances, specifically sales returns and warranty reserve

Management makes estimates of potential future product returns and product warranties related to current period product revenue, based on historical returns, current economic trends and changes in customer demand and acceptance of our products when evaluating the adequacy of the sales returns and other allowances. Significant management judgments and estimates must be made and used in connection with establishing the sales returns and other allowances in any accounting period. Significant differences may result

17

Table of Contents

in the amount and timing of our revenue for any period if management made different judgments or used different estimates.

Asset impairment

We revised our business plan during the second quarter of 2003. The change in our business plan necessitated an evaluation of our intellectual property portfolio for realizability. This evaluation identified a number of patents directed at products we have decided not to pursue, and others that may not result in meaningful cash flow within the next several years. Due to the modification to our strategic business plan, we determined that certain intangible assets were impaired and we recognized an impairment charge of approximately $1.6 million for the three months ended June 30, 2003.

Related party transactions

We periodically enter into transactions with individuals or entities that are considered to be related parties. Our policy is to enter into these transactions on terms consistent with those that have been, or would be, granted to unrelated parties.

Risk Factors

In addition to the other information contained in this report, we caution stockholders and potential investors that the following summary risk factors and those additional factors described in the “Risk Factors” discussion of our Annual Report on Form 10-K for the year ended December 31, 2002, in some cases have affected, and in the future could affect, our actual results of operations and could cause our actual operating results to differ materially from those expressed in any forward-looking statements made by or on our behalf. The following information is not intended to limit in any way the characterization of other statements or information under other captions or in the “Risk Factors” section of our Annual Report on Form 10-K for such purpose.

Failure to raise additional capital or to generate the significant capital necessary to expand our operations and invest in new products and technologies could reduce our ability to compete and to take advantage of market opportunities and could result in lower revenue and threaten our ability to remain a going concern.

We expect to expend significant capital to develop and market our products and technologies and expand our operations. These initiatives will require us to raise additional capital from public and private stock offerings, borrowings under lease lines, lines of credit or other sources. Although we currently believe that our current cash reserves should be sufficient to fund our operations, working capital and capital expenditure needs for the next twelve months, we may consume available resources more rapidly than anticipated. Our limiting operating history makes it difficult to predict whether these funds will be sufficient to finance our anticipated requirements.

We intend to raise additional funds in 2003 although we may not be able to raise additional funds when needed, or on acceptable terms, or at all. If adequate funds are not available on a timely basis, we may not be able to, among other things:

18

Table of Contents

Our failure to do any of these things could result in lower revenue and could seriously harm our business. Our inability to raise additional capital within the next 18 months could threaten our ability to remain a going concern. Moreover, if additional funds are raised through the issuance of equity securities, the percentage ownership of our then current stockholders would be reduced and the value of their investments might decline. In addition, any new securities issued might have rights, preferences or privileges senior to those of the securities held by stockholders. If we raise additional funds through the issuance of debt, we might become subject to restrictive covenants or we may subject our assets to security interests.

Our brief operating history makes it difficult to evaluate our prospects.

We were incorporated in February 1998. Through November 2001, we were primarily engaged in the research and development of our initial products. We commenced shipment of our health monitoring devices in 2001 and executed our first significant distribution agreement in August 2001. As a result of our limited operating history, we have a limited amount of financial data that you can use to evaluate our business. Moreover, the revenue and profitability potential of our markets are unproven. You must consider our prospects in light of the risks, expenses and challenges we might encounter because we are at an early stage of development in new and developing markets. We may not successfully address these risks, and our business strategy may not prove successful.

We recorded only $19.8 million in revenue since our inception, we have a large accumulated deficit, we expect future losses and we may not achieve or maintain profitability.

Since our inception through June 30, 2003, we recorded only $19.8 million in revenue. As a result, we will need to significantly increase the revenue we receive from sales of our products, while controlling our expenses, in order to achieve profitability. We have incurred substantial losses each year since our inception in funding the research and development of our products and technologies, the Food and Drug Administration (FDA) marketing clearance process for MedGem, the growth of our organizational resources and other activities. As of June 30, 2003, we had an accumulated deficit of $81.2 million. We may not generate a sufficient level of revenue to offset our planned expenditures, and we may be unable to adjust spending in a timely manner to respond to any failure to increase our revenue. Even if we do achieve profitability, we may not be able to sustain or increase profitability.

We expect our future financial results to fluctuate significantly, and failure to increase our revenue or achieve profitability may disappoint securities analysts or investors and result in a decline in our stock price.

We believe that period-to-period comparisons of our historical results of operations are not meaningful and are not a good predictor of our future performance. We expect our future quarterly and annual operating results to fluctuate significantly as we attempt to expand our product offerings and increase sales into different markets. Our revenue, gross margins and operating results are difficult to forecast and may vary significantly from period to period due to a number of factors, many of which are not in our control. These factors include:

19

Table of Contents

We forecast the volume and timing of orders for our products for operational and production planning and in some cases we become liable for procurement costs based on these forecasts. These forecasts, however, are based on many factors and subjective judgments, and they may be inaccurate. In particular, because of our limited operating history, we do not have meaningful historical information to predict demand for our products, and trends that may emerge, in the various markets into which we sell and plan to sell our products. Moreover, because most of our expenses, such as employee compensation and lease payment obligations, are relatively fixed in the short term, we may be unable to adjust spending quickly enough to offset any unexpected shortfall in revenue growth or any decrease in revenue levels in any particular period. As a result of the foregoing, our operating results may fall below the expectations of securities analysts or investors in future quarters or years, causing our stock price to decline.

We may be unable to maintain our listing on the Nasdaq National Market, which could cause our stock price to fall and decrease the liquidity of our common stock.

Our common stock is currently listed on the Nasdaq National Market, which has requirements for the continued listing of our stock. One of the continued listing requirements is that our common stock maintain a minimum bid price of $1.00 per share. Since May 2003, the bid price for our common stock has dropped below $1.00 during extended periods. If our common stock trades below $1.00 for 30 consecutive trading days, or if we fail to meet any of the other listing requirements, following a 180 calendar day grace period from Nasdaq, our common stock may be de-listed from the Nasdaq National Market and the trading market for our common stock could decline, which could depress our stock price and adversely affect the liquidity of our common stock.

Our strategic partners may experience financial difficulties or undergo organizational changes, which may harm our ability to distribute our products, and could result in a substantial decline in our revenue and overall operating results.

We expect that a majority of our sales will be made to a limited number of customers, including our strategic partners and distributors. One or more of our strategic partners may experience financial difficulties or undergo organizational changes that could affect their ability or need to purchase our products. Organizational restructurings and financial concerns may cause our strategic partners to substantially reduce the volume of

20

Table of Contents

their purchases of our products, or to no longer continue as our distributors. As a result, our ability to effectively distribute our products may be harmed, and we may experience a significant decline in our revenue and overall operating results.

We have very limited product offerings from which we expect to derive substantially all of our future revenue. If demand for our limited number of products fails to develop as we expect or otherwise declines, we could fail to generate sufficient revenue to achieve profitability.

We derive substantially all of our revenue from the sale of MedGem, BodyGem, disposables and software. In January 2002, we obtained FDA clearance to market MedGem and accordingly did not derive any of our revenue from the sale of MedGem prior to that time. We expect that revenue from the sale of MedGem, BodyGem, disposables and our BalanceLog and BalanceLog Pro software will account for substantially all of our revenue for the foreseeable future. In particular, we expect disposable sales to comprise a larger portion of revenue over time. The limited development and sales of our product line makes our future prospects difficult to predict. If the anticipated demand for our products fails to develop, our ability to generate revenue and achieve profitability would be significantly harmed. In particular, the failure to sell sufficient quantities of MedGem and BodyGem would not only directly affect revenue but would also significantly harm our ability to generate recurring revenue from the sale of our disposables and may limit sales of software products.

We currently rely on a limited number of distributors for the sale of MedGem and BodyGem into the medical markets and, to a lesser extent, other target markets. If these distributors are not successful selling our products, or if we are unable to establish additional distributor arrangements as planned, we will not be able to achieve our sales goals and our business will be harmed.

We expect to rely primarily upon distributors and their sales forces to sell MedGem into the medical market and to increasingly rely upon distributors and their sales forces to sell BodyGem into the retail pharmacy, weight management, fitness and other target markets. We currently have a limited number of distributors, such as HealthSouth Corporation, Mead Johnson & Company, Microlife Corporation and Nature’s Sunshine Products, Inc. for the distribution of our products into global markets. Our reliance on distributors subjects us to many risks, including risks related to their inventory levels and support for our products. If any of our distributors attempt to reduce their inventory levels or if they do not maintain sufficient levels to meet customer demand, our sales could be negatively affected. As is generally the case with our current distribution agreements, we anticipate that our future distribution agreements will allow our distributors to reduce or discontinue purchases of our products with short notice. Further, distributors may not recommend, or continue to recommend, our products. We will rely heavily upon our distributors for the sales and marketing activities that we believe are critical to the successful sale of our products. However, our distributors may not market or sell our products effectively or continue to develop and devote the resources necessary to provide us with effective sales, marketing and technical support. In addition, we intend to attract additional distributors of MedGem and BodyGem in order to increase penetration in the medical and other markets. It may be difficult to increase our distributor base due to current exclusivity arrangements and prospective requests for exclusivity from distributors and other customers. If we are unable to maintain successful relationships with our distributors or obtain additional distributors, we will have to devote substantially more resources to the distribution, sales, marketing, implementation and support of our products than we would otherwise and our efforts may not be as effective. The loss of any one or more of our distributors, a reduction in purchases of our products by or through our distributors, the decline of our distributors’ business or the inability to increase our third-party distributor base may limit our revenue growth and harm our operating results.

In particular, HealthSouth, which contributed 56% of our revenue in 2002, is currently the subject of various governmental investigations into its business. Because of the uncertainty of the outcome of these investigations and HealthSouth’s business prospects, we currently anticipate that we will receive no revenue from HealthSouth in 2003. If we are unable to offset the anticipated loss or decrease of this revenue stream, our operating results and financial condition will be materially and adversely affected.

21

Table of Contents

Our strategic partnership agreement with Mead Johnson & Company provides that Mead Johnson is obligated to fulfill certain take-or-pay commitments in exchange for exclusivity in certain medical markets. As of June 30, 2003, Mead Johnson had not fulfilled its commitment in its entirety due to a longer than expected sales and implementation cycle for our products. As a result, both parties are currently working to restructure the strategic partnership agreement and have expanded Mead Johnson’s product offerings to include weight management starter kits, which combine our devices, disposables and software, and are focused in the medically supervised weight management market segment.

Because a small number of customers are likely to account for a substantial portion of our revenue, the loss of any of these customers or the cancellation or deferment of a customer’s order could cause our revenue to decline substantially and may result in a decline in our share price.

We expect that the majority of our revenue will depend on sales of our products to a limited number of customers, which include our strategic partners and our distributors. We intend to establish strategic relationships with large, prominent companies that possess significant sales, marketing and distribution capabilities in each of our targeted medical and non-medical channels. We have only recently entered into contracts with customers that provide for the potential purchase of significant quantities of our products. As a result, we have not had significant working experience with these new customers and it is difficult to predict their purchasing patterns. Many of our contracts with our customers do not contain minimum purchase requirements and any customer may reduce or discontinue purchases of our products at any time. The loss of one or more of our customers, a reduction in purchases of our products by our customers or the decline of our customers’ business may cause our revenue to decline substantially or fall short of our expectations. In addition, because we expect our accounts receivable to be concentrated on a small group of customers, the failure of any of them to pay on a timely basis would reduce our cash flow and negatively affect our operating results.

We have granted, and may in the future grant, certain of our customers’ exclusive rights to particular markets. These exclusive agreements may limit our ability to add additional customers. If one of these current or future customers fails to adequately promote and sell our products, our sales and penetration into their markets will be adversely affected. Moreover, if any customer that has an exclusive right in a particular market proves to be ineffective, we may not be able to replace that customer for a significant period of time, if at all.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our interest income is sensitive to changes in the general level of interest rates in the United States, particularly since the majority of our investments are short-term in nature. Due to the nature of our short-term investments, we have concluded that we do not have material market risk exposure.

Our investment policy requires us to invest funds in excess of current operating requirements. At June 30, 2003, our cash and cash equivalents consisted primarily of money market and mutual funds with average maturities of less than 90 days. The recorded carrying amounts of cash and cash equivalents approximate fair value due to their short maturities. At June 30, 2003, we also invested funds in a short-duration government mutual fund with an average maturity of greater than 90 days, which is classified as a short-term investment. The recorded carrying amount of this investment approximates fair value.

Item 4. Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures within 90 days of filing of this quarterly report, and, based on their evaluation, our principal executive officer and principal financial officer have concluded that these controls

22

Table of Contents

and procedures are effective. There were no significant changes in our internal controls or other factors that could significantly affect these controls subsequent to the date of their evaluation.

Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

On March 19, 2003, Piranha Plastics, LLC, a supplier of plastic components and disposables for our MedGem and BodyGem devices, filed suit against us in Santa Clara County, California alleging breach of contract in conjunction with our Purchase Agreement dated March 6, 2002. On June 30, 2003, we entered into a Termination Agreement and Mutual General Release with Piranha Plastics pursuant to which Piranha Plastics agreed to dismiss with prejudice the suit in exchange for payment of $6,500 from us.

Item 2. Changes in Securities and Use of Proceeds

Changes in Securities. During the period covered by this report, we issued a warrant to Mine O Mine, Inc. to purchase an aggregate of 85,000 shares of our common stock at an exercise price of $7.50 per share pursuant to an endorsement agreement. We relied upon Rule 506 under the Securities Act of 1933, as amended (the “Securities Act”) and Section 4(2) of the Securities Act, as an exemption from the registration requirements of the Securities Act for these issuances of these securities.

Use of Proceeds. On July 12, 2002, the initial public offering of our common stock, $0.001 par value, commenced trading on the Nasdaq National Stock Market. The managing underwriters were UBS Warburg LLC, Credit Suisse First Boston Corporation, William Blair & Company, L.L.C. and Stifel, Nicolaus & Company, Inc. The shares of common stock sold in the offering were registered under the Securities Act on a registration statement on Form S-1 (File No. 333-86076) that was declared effective by the SEC on July 12, 2002. All of the 4,000,000 shares of common stock registered under the registration statement were sold at a price to the public of $7.50 per share. All of the shares of common stock sold in the offering were sold by us. The offering did not terminate until after the sale of all of the securities registered on the registration statement, which closing occurred on July 17, 2002. The aggregate gross proceeds were approximately $25.7 million after deducting $2.1 million in underwriting discounts and commissions and an estimated $2.2 million in other expenses incurred in connection with the offering.

Upon closing of the initial public offering, we paid $1.75 million out of the proceeds of the offering to Dr. James R. Mault, our former Chief Executive Officer, as partial consideration for the sale and assignment of patent rights by Dr. Mault to us.

We spent $3.5 million of the proceeds from the offering to implement and support a marketing campaign that was launched in the fourth quarter of 2002 and concluded in the first quarter of 2003 and an additional $1.0 million for radio and print advertising for our BalanceLog software product.

23

Table of Contents

No other proceeds of the offering were paid, directly or indirectly, to any other of our officers or directors or any of their associates, or to any persons owning 10% or more of our outstanding common stock or to any of our affiliates. We invested the remaining proceeds in short-term, investment-grade, interest bearing instruments, pending their use to fund working capital and capital expenditures.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Submission of Matters to a Vote of Security Holders

Based on these reporting results, each director nominated was elected and the appointment of KPMG LLP as the independent auditors of the Company for its fiscal year ending December 31, 2003 was ratified.

24

Table of Contents

Item 5. Other Information

None.

Item 6. Exhibits and Reports on Form 8-K

The Company filed a report on Form 8-K on May 6, 2003, during the second quarter ended June 30, 2003, regarding the issuance of a first quarter 2003 earnings press release dated May 6, 2003.

25

Table of Contents

SIGNATURES

Pursuant to the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

26

Table of Contents

EXHIBIT INDEX