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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
PACIFICHEALTH LABORATORIES, INC.
(Name of Small Business Issuer in Its Charter)
Delaware 22-3367588
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(State or jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1480 Route 9 North - Suite 204
Woodbridge, NJ 07095
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(Address of principal executive offices)
732/636-6141
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(Issuer's telephone number)
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act: Common Stock, par
value $.001 per share.
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
Yes |X| No | |
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this form 10-KSB. | |
The issuer's revenues for its most recent fiscal year were $1,000,019.
The aggregate market value of the common equity held by non-affiliates based on
the closing sale price of Common stock as of March 22, 1999, was
$6,053,711.
The number of shares outstanding of each class of the issuer's common equity,
as of March 22, 1999, was as follows: Common Stock -- 4,554,367 shares.
Transitional Small Business Disclosure Format (check one): Yes | | No |X|
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PACIFICHEALTH LABORATORIES, INC.
FORM 10-KSB
Fiscal Year Ended December 31, 1998
TABLE OF CONTENTS
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PART I
ITEM 1. BUSINESS ..................................................... 1
ITEM 2. DESCRIPTION OF PROPERTY ...................................... 11
ITEM 3. LEGAL PROCEEDINGS ............................................ 11
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS .......... 11
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ..... 12
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS .......................... 15
ITEM 7. FINANCIAL STATEMENTS ......................................... 20
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE .......................... 20
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT ... 21
ITEM 10. EXECUTIVE COMPENSATION ....................................... 24
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 27
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ............... 29
ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS
ON FORM 8-K .................................................. 29
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PART I
ITEM 1. BUSINESS.
1(a) Business Development:
PacificHealth Laboratories, Inc. (hereinafter referred to as the "Company") was
incorporated in the State of Delaware in April 1995 to develop and market
products based upon natural ingredients which have demonstrable health and other
benefits and which can be marketed without prior Food and Drug Administration
approval under current regulatory guidelines.
1(b) Business of the Issuer
From its organization in April 1995 until it introduced its first commercial
product in March 1996, the Company engaged primarily in organizational and
financing activities, product research, and preliminary marketing and
distribution activities, including developing a master broker network for its
products and obtaining distribution for its products in mass channels (mass
merchandisers, chain drug and supermarkets) and through health food chains and
individual stores.
In connection with its organization, the Company also entered into agreements
with the Institute of Nutrition & Food Hygiene of the Chinese Academy of
Preventive Medicine (the "INFH") in Beijing, People's Republic of China. Under
these agreements, in exchange for a royalty on sales of products utilizing
natural constituents exported from China or developed in China, the INFH granted
to the Company the right to commercialize within and outside of China all
products identified and developed by the Company and the INFH based upon natural
TCM herbs and other natural agents in certain areas.
Nothing in the Company's agreements with the INFH prevents any other person or
company from buying herbs and other natural agents in China for use or resale
inside or outside of China. The Company's royalty obligations to the INFH are
conditioned upon the Company first achieving a specified level of profits. To
date, the Company has not incurred any obligation for royalties to the INFH, and
the Company does not anticipate incurring any obligation to pay royalties in the
current fiscal year.
Ciwujia, an herb that is the active ingredient in the Company's ENDUROX(R) line
of products, was identified and tested with the cooperation of the INFH. Apart
from the ENDUROX line, none of the Company's present or proposed products is
based on herbs or other natural ingredients of Chinese origin.
The Company has identified and developed products utilizing botanicals of
non-Chinese origin, none of which is presently being marketed. In addition, the
Company seeks, where possible, to
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license products conceived or developed by others, or which contain proprietary
ingredients developed by others, which have some level of market protection
(e.g., through a patent, patent claim, manufacturing technology, etc.). Prosol
Plus(TM), which the Company introduced in December 1997, and the Company's PO-2
product, presently in development, are in this latter category.
The Company's business activities have been financed primarily with proceeds
from private placements in 1995 and 1996, and an initial public offering of
Common Stock, which was completed in December 1997. In its first year of
operations (1996), the Company had revenues of $3,085,726. In 1997 and 1998,
revenues were $3,356,725 and $1,000,019, respectively.
All of the Company's existing products, and its proposed products, are expected
to be manufactured in the United States by third parties. See Item 1(b)(i)
below.
1(b)(i) Principal Products and Markets
(a) ENDUROX(R) Product Line
The Company's initial product, ENDUROX(R), is a dietary supplement the principal
ingredient of which is the herb ciwujia. Laboratory tests and trials have
demonstrated that ENDUROX changes the way the body fuels a workout by shifting
the fuel source from carbohydrate to fat, thereby increasing fat metabolism;
builds endurance by slowing the lactic acid buildup that causes muscle soreness
and fatigue; raises the anaerobic threshold during workout; and speeds recovery
following workout, as measured by heart rate and lactic acid levels. The Company
introduced ENDUROX in March 1996 and commenced commercial sales of the product
in May 1996. In December 1996, the Company was issued patent #5,585,101 for its
ENDUROX product.
The first extensions to the ENDUROX line of products, ENDUROX EXCEL(R) and
ENDUROX ProHeart(R), were introduced in March 1997. ENDUROX EXCEL contains 50%
more ciwujia than regular ENDUROX, plus vitamin E. It is targeted to "serious"
athletes, i.e., individuals who engage in competitive athletics or whose
exercise regimen is comparable to that of a competitive athlete. ENDUROX
ProHeart, which contains vitamins E and C and folic acid, is targeted to the
heart conscious consumers who exercise regularly.
In February 1999, the Company introduced ENDUROX(R) R4(TM) Performance /
Recovery Drink at The Super Show in Atlanta, and launched the product nationally
at the Natural Products Expo West in Anaheim, CA in March 1999. Clinical trials
of this product, conducted at the University of North Texas Health Science
Center in Fort Worth, Texas, and the Human Performance Lab at St. Cloud
University in St. Cloud, Minnesota, were completed in the last quarter of 1998.
In these trials, the Company's product was tested against the nation's leading
sports drink and shown to deliver equal hydration effectiveness, while enhancing
performance and extending endurance by 55%, decreasing post-exercise muscle
stress by 36%, reducing free radical build-up by 69%, and increasing insulin
levels by 70%. The Company has begun a national print
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campaign for its new sports drink with ads appearing in such magazines as Muscle
& Fitness, Bicycling, Runner's World, Running Times, Fitness Swimmer, Inside
Triathlon, Triathlete, and numerous other publications. At the present time,
this product is being sold in General Nutrition Centers, other leading health
food stores, specialty sporting goods stores and on the Internet. The Company
has a patent pending on its ENDUROX(R) R4 (TM) Performance / Recovery Drink.
(b) Prosol Plus(TM)
Prosol Plus(TM), introduced in December 1997, is a unique product that combines
hypericum (St. John's Wort), ginkgo biloba and four essential vitamins. The
Company has an exclusive worldwide right to market this product granted by the
developer of the product. A patent application covering use of the Prosol Plus
formulation is pending.
Hypericum, the principal ingredient of Prosol Plus, has been shown to be
effective in treating the symptoms of mild to moderate depression in numerous
clinical studies. Under the Dietary Supplement Health and Supplement Act of
1994, Prosol Plus cannot be marketed for the treatment of depression, as such,
but can be marketed to improve emotional well being. During 1998, the Company
completed clinical trials to evaluate the product's effectiveness in treating
mild to moderate depression in patients undergoing a commercial weight loss
program. The tests were conducted by Dr. Harry Wexler, a well-known clinical
psychologist, at the Lindora Medical Clinic in California. This double blind
study, which included over 100 patients, showed that Prosol Plus significantly
reduced depression. The investigator who conducted this study intends to have it
published in a medical journal, after which time the Company could use the
results of the study as the basis for a new marketing and advertising program in
the current year. This new campaign, if successful, would enable the Company to
extend its present distribution from General Nutrition Centers and the Internet
to include other leading health food stores throughout the country.
(c) PO-2
PO-2 is the Company's working name for a new product based on a protein which,
when ingested, stimulates the action of cholecystokinin in the body.
Cholecystokinin is a protein that is involved in the human digestive process.
Research has shown that the release of cholecystokinin in humans increases
satiety resulting in decreased food intake and, thus, providing an approach to
weight loss and control using the body's natural appetite control mechanism.
The protein that stimulates cholecystokinin is found in potatoes. The
investigator who discovered the effect of this protein received a use patent on
the protein in 1985. However, purification of the protein was not commercially
feasible until recently, when researchers developed a proprietary method of
purification. The purified protein has been found effective to stimulate the
action of cholecystokinin in a number of studies, including studies published by
researchers at the University of Texas Health Science Center in San Antonio,
Texas, and unpublished studies by the same researchers.
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The Company has signed a license agreement with the licensor of the patent
covering the potato-derived protein and the developer of the proprietary
purification process. This agreement grants to the Company the exclusive
worldwide right to market and develop a number of weight loss products
incorporating the purified protein ingredient, which would be supplied to the
Company by the licensor.
In the latter part of 1998, the Company began clinical trials of PO-2 at the
Obesity Center at Columbia University in New York City and has recently
commissioned another study at Cooper Medical Center (a division of the Robert
Wood Johnson Medical School) located in Camden, NJ. The Company anticipates
obtaining the results of these studies by the end of the second quarter of 1999,
and estimates that the product will be launched by the end of the year as a
powder drink that would be taken fifteen minutes prior to meals. Initial
channels of distribution are planned to be through electronic media such as
infomercials or other television sales-type programs. Expanded distribution is
targeted to begin in January 2000. This schedule is intended to capitalize on
the fact that approximately 30%-35% of the annual sales of diet products and
services typically occur in January. Industry data indicates a national market
of approximately $3 billion for weight loss and weight control products,
including prescription drugs, OTC products, diet foods and nutritional
supplements.
(d) Other Products
The Company has identified and developed to varying degrees products for the
topical relief of arthritis pain (Arnicyn(TM)), wound healing and a sports
analgesic. During 1998, the Company decided to defer further development or
marketing of these products in order to concentrate its limited financial
resources on other products, which in the opinion of management, had greater
market potential and offered better opportunities to generate immediate
revenues.
1(b)(ii) Distribution Methods
The Company has pursued a "multi-channel" distribution strategy in marketing its
ENDUROX line of products. These products are sold nationally in retail outlets
including mass merchandisers, chain drug stores and grocery supermarkets. The
Company also distributes its products to the health food market through General
Nutrition Centers ("GNC"), independent health food retailers, sports specialty
stores, health clubs, military installations and on the Internet. The nature of
the product and its target market dictate the channels of distribution in which
a product is launched, and the level of effort directed to each channel of
distribution.
The Company uses two broker forces in its distribution network, one for mass
volume retailers and the other for the health food market. These brokers receive
commissions on sales under agreements that are terminable at will by either
party on thirty days notice. Most of the Company's customers are sold direct
through its broker networks, although GNC, which is the Company's largest
customer, is a "house account".
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The Company began distribution of ENDUROX in Canada in 1997 through an
independent distributor with the first retail sales made in April 1997. In 1998,
the Company began selling its ENDUROX product in South Africa with an
independent distributor on a non-exclusive basis. At the present time, these two
countries represent the Company's principal non-US direct marketing channels.
To support its marketing efforts, the Company advertises in trade and consumer
health food and sports magazines and in 1997 on television. In addition, the
Company attends trade shows and exhibitions, sponsors promotional programs and
events and in-store promotions, and engages in an extensive public relations
effort that has resulted in articles in numerous health, fitness, trade and
natural products publications, newspaper coverage and some television spots. In
September 1996, the Company entered into a three-year endorsement contract with
former professional football player Joe Montana. The Company has made extensive
use of television and other media advertising featuring Mr. Montana, and Mr.
Montana also has been featured in a number of the Company's promotional and
public relations activities. Other paid endorsers for the Company include Frank
Shorter (two-time Olympic medallist), Dave Scott (six-time winner of the
"Ironman" competition) and Grete Waitz (nine-time winner of the New York City
Marathon).
In the twelve-month periods ended December 31, 1998 and December 31, 1997, the
Company's expenditures for product advertising and promotion were approximately
$1,655,274 and $4,639,567, respectively.
1(b)(iii) Status of Publicly Announced New Products
The status of all products which have been the subject of or mentioned in public
announcements by the company in the past year are discussed above under the
caption "Principal Products and Markets".
1(b)(iv) Competition
Dietary supplements are distributed in variety of ways, including independent
health food suppliers who focus on vitamins and dietary supplements; mass volume
retail suppliers; gym and health club product suppliers; direct sale and mail
order vendors; and private label manufacturers. The Company estimates that there
are approximately 20 large national companies that manufacture or distribute
herbal products and medicinals. Generally, these companies are well funded and
sophisticated in their marketing approaches. Examples are Twinlab Corp., Rexall
Sundown, NBTY, Inc., Weider Nutrition International Inc., Nature's Sunshine, and
Herbalife International. In addition, there are a number of major pharmaceutical
companies such as Warner Lambert, American Home Products and Smithkline Beecham
that have launched proprietary brands of supplements or are expected to do so
within the next twelve months. Increased competitive activity from such
companies could have a material, adverse effect on the Company and other
participants in the industry since such companies have greater financial and
other resources available to them and possess far more extensive manufacturing,
distribution and marketing capabilities than the Company and many of its other
competitors.
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As the market for herbal products and medicinals has increased, major retailers
such as GNC have introduced house brands to take advantage of their retailing
strength, a trend that is likely to continue. Although major retailers generally
have not introduced innovative products in the past, the Company believes that
house brands represent a competitive threat once a product becomes established.
Since the Company's products are based upon natural ingredients, its competitors
have access to the same ingredients and will be able to develop and market
products the same as or similar to the Company's products. Except to the limited
extent that the Company may obtain patent protection for certain uses of
ingredients in its products, its competitors' products may make the same claims
of benefits from use of the products that the Company makes. For example, GNC,
the Company's largest customer, began offering a "generic" product based on
ciwujia, the natural ingredient on which the Company's ENDUROX line of products
is based, soon after the Company began commercial sales of its original ENDUROX
product.
The Company believes that long term success in the marketplace for any of the
Company's products is likely to be less dependent on the novelty of the product
than on such factors as distribution and marketing capabilities, and whether or
not the product enjoys some proprietary advantage, such as patent protection, an
established brand name, etc.
1(b)(v) Suppliers of Raw Materials
The Company obtains all of the raw materials necessary for the manufacture of
its products from independent sources. The Company generally does not have
contracts with any entities or persons committing such suppliers to provide the
materials required for the production of its products. The Company obtains
ciwujia for its ENDUROX line of products from suppliers in the Peoples Republic
of China. At the present time, the Company obtains all of its needs from one
supplier, but believes that adequate alternative suppliers are available if
needed. Prosol Plus is obtained from a single source, the licensor of the
product, which supplies the product in finished form. All other herbs, vitamins,
etc. used in the Company's existing products are available from multiple
sources. The Company has obtained proprietary ingredients for its proposed wound
healing and weight loss products from the licensors of those ingredients.
There is no assurance that suppliers will provide the raw materials needed by
the Company in the quantities requested or at a price the Company is willing to
pay. Because the Company does not control the source of these raw materials, it
is also subject to delays caused by interruption in production of materials
based on conditions outside of its control.
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1(b)(vi) Dependence on Major Customer
General Nutrition Centers accounted for approximately 19% of net sales in fiscal
1998. The loss of this customer, or a significant reduction in purchase volume
by or financial difficulty of such customer, for any reason, could have a
material adverse effect on the Company's results of operations or financial
condition. The Company has no agreement with or commitment from this customer
with respect to future purchases.
1(b)(vii) Patents and Trademarks
The Company received a United States patent in December 1996 covering the use of
ciwujia, the principal active herb in ENDUROX, to improve physical performance
and stamina during exercise, and for enhancing recovery after exercise is
completed. The Company has applied for foreign patents on ciwujia in Canada,
Mexico, all Western European countries and in 51 other principal European, South
American and Asian countries.
Prosol Plus, for which the Company is the exclusive distributor under license
from the developer of the product, is the subject of a pending patent
application. In addition, the use and purification of the active ingredient in
the Company's PO-2 product, which is currently undergoing two clinical studies,
is covered by an existing US patent. And, as previously noted, the Company's new
ENDUROX(R) R4(TM) PERFORMANCE/RECOVERY DRINK is also the subject of a pending
patent application for the "use" of that product.
To the extent the Company does not have patents on its products, there can be no
assurance that another company will not replicate one or more of the Company's
products, nor is there any assurance that patents which are obtained will
provide meaningful protection or significant competitive advantages over
competing products. For example, the Company's use patent on ciwujia would not
prevent sale of the herb with a claim or for a use that was not covered by the
Company's patent.
The Company has federal trademark registrations for ENDUROX(R), ENDUROX EXCEL(R)
and ENDUROX ProHeart(R) and has trademark applications pending to register
PROSOL PLUS(TM) and ARNICYN(TM) pending with the United States Patent and
Trademark Office. The Company also has filed its trademarks in most Western
European countries, Canada, Mexico and Japan. The Company's policy is to pursue
registrations for all of the trademarks associated with its key products, and to
protect its legal rights concerning the use of its trademarks. The Company
relies on common law trademark rights to protect its unregistered trademarks.
1(b)(viii) and (ix) Governmental Regulation
The Company believes that all of its existing and proposed products, as
described above, are dietary supplements that do not require governmental
approvals to market in the United States. The processing, formulation,
packaging, labeling and advertising of such products, however, are
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subject to regulation by one or more federal agencies including the Food and
Drug Administration ("FDA"), the Federal Trade Commission, the Consumer Products
Safety Commission, the Department of Agriculture and the Environmental
Protection Agency. See "RISK FACTORS -- Government Regulation". The Company's
activities also are subject to regulation by various agencies of the states and
localities in which its products are sold.
The FDA traditionally has been the main agency regulating the types of products
sold by nutritional supplement firms such as the Company, but much of that
authority stemmed from the FDA's treatment of dietary supplements as food
additives and drugs. The FDA's role in this area was reduced mainly to policing
the activities of makers of dietary supplements by the enactment of the Dietary
Supplement Health and Education Act of 1994 (the "DSHEA") in October 1994. The
DSHEA amended and modified the application of certain provisions of the Federal
Food, Drug and Cosmetics Act (the "FFDC Act") as they relate to dietary
supplements, established an Office of Dietary Supplements at the National
Institute of Health in order to coordinate and conduct scientific research into
the health benefits of dietary supplements, established a presidential
commission to study and make recommendations on the regulation of label claims
and statements for dietary supplements, and required the FDA to promulgate
regulations consistent with the DSHEA and the recommendations of the
presidential commission.
The DSHEA defines a dietary supplement to include (i) any product intended to
supplement the diet that bears or contains a vitamin, mineral, herb or other
botanical, an amino acid, a substance to supplement the diet by increasing the
total dietary intake, or any concentrate, constituent, extract, or combination
of any such ingredient, provided that such product is either intended for
ingestion in tablet, capsule, powder, softgel, gelcap, or liquid droplet form
or, if not intended to be ingested in such form, is not represented for use as a
conventional food or as a sole item of a meal or the diet, (ii) is not
represented for use as a conventional food or as a sole item of a meal or the
diet, and (iii) is labeled as a dietary supplement. The definition also includes
highly technical provisions dealing with a dietary supplement that contains an
ingredient that also has been approved by the FDA as a drug. The practical
effect of such an expansive definition is to ensure that the new protections and
requirements of the DSHEA will apply to a wide class of products.
DSHEA exempts the dietary ingredients in dietary supplements from being treated
as "food additives". Under the FFDC Act, a substance that is a food additive may
not be added to food products unless explicitly permitted by the FDA by issuance
of a regulation. Prior to enactment of the DSHEA, dietary supplement ingredients
were often alleged to have "food additive" status.
Although dietary supplements are now exempted from treatment as food additives
by the FDA, the DSHEA imposes significant safety standards regulating dietary
supplements to prevent the sale of dietary supplements that are unsafe, toxic,
unsanitary or adulterated. The DSHEA provides that a dietary supplement will be
deemed to be an adulterated food if it presents a significant or unreasonable
risk of illness or injury when used in accordance with its labeling or, if no
conditions of use are suggested or recommended in the labeling, under ordinary
conditions of use. Generally, the FFDC Act prohibits the introduction or
delivery of adulterated food into interstate commerce so a dietary supplement
that is deemed adulterated may not be sold or
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distributed through interstate commerce. The FDA has the burden of proof in
establishing that a dietary supplement is adulterated under such a standard,
thereby reducing the FDA's role from one of preapproval of dietary supplements
to that of policing those substances that present a significant or unreasonable
risk of illness or injury.
The DSHEA imposes additional requirements for dietary supplements which contain
a "new" dietary ingredient, i.e., one that was not marketed in the United States
before October 15, 1994. A dietary supplement that contains a new dietary
ingredient will be deemed to be adulterated unless either (a) all ingredients
contained in the dietary supplement have been present in the food supply as an
article used for food in a form in which the food has not been chemically
altered, or (b) there is a history of use or other evidence of safety
establishing that the new dietary ingredient, when used under the conditions
recommended or suggested in the labeling, will reasonably be expected to be
safe.
The DSHEA authorizes the Secretary of the Department of Health and Human
Services to declare that a dietary supplement poses an imminent hazard to public
health or safety. Following such declaration, it is immediately illegal to
market such a product, although the Secretary must thereafter promptly hold a
formal hearing in order to determine whether to affirm or withdraw the
declaration.
Under the DSHEA, a publication, including an article, a book or chapter in a
book, or an official abstract of a peer reviewed scientific publication that
appears in an article and was prepared by the authors or the editors of a
publication, is not considered "labeling", which is subject to FDA regulation,
and may be used in connection with the sale of a dietary supplement to consumers
if it (i) is not false or misleading; (ii) does not promote a particular
manufacture or brand of a dietary supplement; (iii) is displayed or presented
with other items on the same subject matter so as to present a balanced view of
the available scientific information; (iv) is physically separate from dietary
supplements if displayed in an establishment where such products are sold; and
(v) does not have appended to it any information by sticker or any other method.
The DSHEA specifically provides that it does not restrict a retailer or
wholesaler of dietary supplements in any way whatsoever from selling books or
other publications as a part of its business.
Under the DSHEA, companies that manufacture and distribute dietary supplements
are allowed to make any of the following four types of statements with regard to
nutritional support on labeling without FDA approval: (i) a statement that
claims a benefit related to a classical nutrient deficiency disease and
discloses the prevalence of such disease in the United States; (ii) a statement
that describes the role of a nutrient or dietary ingredient intended to affect
structure or function in humans; (iii) a statement that characterizes the
documented mechanism by which a nutrient or dietary ingredient acts to maintain
or function; or (iv) a statement that "describes general well-being" from
consumption of a nutrient or dietary ingredient. In addition to making sure that
a statement meets one of these four criteria, a manufacturer of the dietary
supplement must have substantiation that such statement is truthful and not
misleading, must not claim to diagnose, mitigate, treat, cure, or prevent a
specific disease or class of diseases, and must contain the following
disclaimer, prominently displayed in boldface type: "This statement has not been
evaluated by the Food and Drug Administration. This product is not intended to
diagnose, treat,
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cure, or prevent any disease." Additionally, the manufacturer must notify the
Secretary of Health and Human Services no later than 30 days after the first
marketing of the dietary supplement to which such statement relates. In
addition, a dietary supplement must list the name and quantity of each
ingredient and the total weight of a proprietary blend, be identified as a
"dietary supplement", and identify the part of a plant from which any herb or
botanical ingredient is derived. Special rules for branding apply if there is an
official FDA monograph covering the class of product in which the dietary
supplement is classified.
The DSHEA did not limit the FDA's ability to regulate manufacturing but
authorized the FDA to prescribe good manufacturing practice regulations for
dietary supplements which are to be modeled after current good manufacturing
practice regulations for food. Since the manufacturers that are involved in
manufacturing the Company's products are experienced in producing products
subject to FDA manufacturing standards, the Company does not believe that new
regulations regarding manufacture of dietary supplements will adversely affect
the Company or its suppliers.
The effect of new federal regulations and standards is that, although the
authority of the FDA to regulate dietary supplements has been limited, it and
other government agencies, particularly the Department of Health and Human
Services, have been granted substantial new policing authority to stop the
distribution of a dietary supplement if government personnel believe they can
show that the product is not safe. The Company is not able to predict with
certainty the long-term impact of this regulatory scheme on its activities.
On March 23, 1999, a new labeling format for dietary supplements went into
effect which necessitated the Company's abandonment of approximately $18,000
worth of packaging materials that were in the old format.
1(b)(x) Expenditures for Research and Development
The Company's research and development expenditures in the past two fiscal
years, exclusive of market research and marketing related expenditures, were as
follows: 1998 - $92,516; 1997 - $44,743.
1(b)(xi) Compliance with Environmental Laws
The Company is not aware of any "administrative" or other costs, which it incurs
which are directly related to compliance with environmental laws.
1(b)(xii) Employees
At the present time, the Company has ten full time employees at its Woodbridge,
NJ offices. Of these, two employees are executive, six are in sales and
marketing, and two are in accounting and
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operations. The Company employs a number of consultants who devote limited
portions of their time to the Company's business. None of the Company's
employees are represented by a union, and the Company believes that its employee
relations are good.
ITEM 2. DESCRIPTION OF PROPERTY
The Company entered into a new five year lease in February 1998 for
approximately 3,684 square feet at $14.50 per square foot, including utilities,
for an annual rent expense of $53,418 for the first three years. In the fourth
and fifth years of the lease, the rent increases to $16.50 per square foot,
including utilities. The Company believes that its new facilities will be
adequate for its present needs.
The Company does not intend to develop its own manufacturing capabilities, since
management believes that the availability of manufacturing services from third
parties on a contract basis is more than adequate to meet the Company's needs in
the foreseeable future.
The Company does not have any real estate investments.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to, or involved in, any legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
5(a) Market Information.
Since December 19, 1997, the Company's Common Stock has been quoted on the
SmallCap Market of the Nasdaq Stock Market, Inc. ("Nasdaq") under the symbol
"PHLI". The following sets forth certain information with respect to the high
and low sales prices reported by The Nasdaq Stock Market for the Common Stock
during the periods shown:
- --------------------------------------------------------------------------------
HIGH LOW
- --------------------------------------------------------------------------------
1997
(12/19/97 -- 12/31/97) $6.25 $6.00
- --------------------------------------------------------------------------------
1998
(1/1/98 -- 3/31/98) $6.25 $4.125
- --------------------------------------------------------------------------------
1998
(4/1/98 -- 6/30/98) $5.00 $3.125
- --------------------------------------------------------------------------------
1998
(7/1/98 -- 9/30/98) $4.75 $1.50
- --------------------------------------------------------------------------------
1998
(10/1/98 -- 12/31/98) $4.50 $2.125
- --------------------------------------------------------------------------------
1999
(1/1/99 -- 3/22/98) $3.50 $1.875
- --------------------------------------------------------------------------------
The closing price of the Company's Common Stock on March 22, 1999, as reported
by Nasdaq, was $1.875.
5(b) Holders.
As of March 22, 1999, there were approximately 84 record holders of the
Company's Common Stock.
5(c) Dividends.
The Company has never paid or declared dividends upon its Common Stock and does
not contemplate or anticipate paying any dividends on its Common Stock in the
foreseeable future.
12
<PAGE>
Prior to December 31, 1998, the Company had a class of Preferred Stock
outstanding on which it paid dividends in kind. All outstanding shares of
Preferred Stock were converted into Common Stock effective December 31, 1997.
5(d) Recent Sales of Unregistered Securities; Use of Proceeds from the Sale of
Registered Securities
5(d)(i) Recent Sales of Unregistered Securities.
There were no sales of unregistered securities by the Company in the year ended
December 31, 1998.
5(d)(ii) Use of Proceeds from the Sale of Registered Securities
5(d)(ii)(A) The Registration Statement to which the following disclosures
pertain is Registration Statement on Form SB-2 (Registration No. 333-36379)
effective December 18, 1997 (the "Registration Statement").
5(d)(ii)(B) The offering pursuant to the Registration Statement (the "Offering")
commenced on December 19, 1997. The classes of securities registered were Common
Stock and Underwriters Warrants. The Managing Underwriter of the Offering was
First Montauk Securities Corp. (the "Underwriter").
5(d)(ii)(C) The Offering has been terminated. All securities registered were
sold with the exception of (1) 180,000 shares of Common Stock registered for
issuance upon the exercise of the Underwriter's overallotment option, and (2)
120,000 shares of Common Stock reserved for issuance upon the exercise of
Underwriter's Warrants.
5(d)(ii)(D) The expenses incurred for the Company's account in connection with
the issuance and distribution of securities sold in the Offering were as
follows:
Underwriting discount and commissions - $720,000
Finder's Fees - 0
Expenses paid to or for the account of
Underwriter - 276,951
Other expenses (including legal, account-
ing, printing and transfer agent's expenses) - 224,623
---------
Total expenses $1,221,574
==========
13
<PAGE>
None of the foregoing expenses ("Offering Expenses") represent payments to
directors, officers or general partners of the Company, any associate of any
such persons, any person owning 10% or more of any class of equity securities of
the Company, or any affiliate of the Company (collectively, "Designated
Persons").
5(d)(ii)(E) The net proceeds to the Company from the Offering (i.e., gross
offering proceeds of $7,200,120 less Offering Expenses of $1,221,574) were
$5,978,546.
5(d)(ii)(F) From the effective date of the Registration Statement through
December 31, 1998, net Offering proceeds were applied as follows:
(1) Construction of plant, building
and facilities $ -0-
(2) Purchase and installation of
machinery and equipment 56,317
(3) Purchase of real estate -0-
(4) Acquisition of other businesses -0-
(5) Repayment of debt 74,658
(6) Research & Development 92,516
(7) Working capital 2,339,935
(8) Temporary investments* 3,415,120
(9) Any other purpose expected to
involve $100,000 or more -0-
----------
Total applied through 12/31/98 $5,978,546
==========
o Short term commercial paper.
5(d)(ii)(G) None of the expenditures described in sub-section 5(d)(ii)(F) were
made directly or indirectly to any Designated Person.
14
<PAGE>
5(d)(ii)(H) The application of net Offering proceeds described above does not
represent a material change in the use of proceeds described in the Prospectus
included in the Registration Statement.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
Company's financial statements, including the notes thereto, appearing elsewhere
in this Report.
FORWARD-LOOKING STATEMENTS
This annual report on Form 10-KSB contains statements relating to future results
of the Company (including certain projections and business trends) that are
"forward-looking statements" as defined in the Private Securities Litigation
Reform Act of 1995. Actual results may differ materially from those projected as
a result of certain risks and uncertainties, including but not limited to
changes in political and economic conditions; demand for and market acceptance
of new and existing products, as well as other risks and uncertainties detailed
from time to time in the filings of the Company with the Securities and Exchange
Commission.
(a) Introduction
The Company was incorporated in April 1995 to develop and market dietary
supplements that improve and promote health and well being and can be offered
for sale without prior approval by The Food and Drug Administration in
compliance with current regulatory guidelines. The Company's first product,
ENDUROX(R) was introduced in March 1996, and commercial sales began in May 1996.
Prior to that time, the Company was engaged in organizational and financing
activities, product research and development, and preliminary marketing and
distribution activities. In March 1997, the Company extended the ENDUROX line of
products with ENDUROX ProHeart(R) and ENDUROX EXCEL(R). Prosol Plus(TM), a
product marketed to sustain emotional balance and promote a positive frame of
mind, was introduced in December 1997. In February 1999, the Company introduced
ENDUROX(R)R4(TM) Performance/Recovery Drink, the latest in its ENDUROX line of
products, which was clinically proven in two separate university studies to:
enhance performance and extend endurance by 55%, decrease post-exercise muscle
stress by 36%, reduce free radical build-up by 69% and increase insulin levels
by 70%. In addition, the Company expects to introduce another new product by the
end of 1999 that will compete in the approximately $3 billion market for weight
loss and weight control products, which includes prescription drugs, OTC
products, diet foods and nutritional supplements.
15
<PAGE>
(b) Results of Operations - Years Ended December 31, 1998 and 1997
The Company incurred a net loss of $2,463,054 or $.54 per share for the year
ended December 31, 1998, compared to a net loss of $4,337,504 or $1.44 per share
for the year ended December 31, 1997. Revenues for the year ended December 31,
1998 were $1,000,019 compared to $3,356,725 for the year ended December 31,
1997.
Management attributes the decrease in revenues in the year ended December 31,
1998 compared to the similar 1997 period to a number of factors, beginning in
the fourth quarter of 1997 when the Company lacked sufficient funds to commit to
advance advertising and promotion dates in 1998. As a result of the Company's
significantly reduced advertising and promotional support, virtually no new
distribution channels were opened in 1998, and existing retailers' in-store
sales of the ENDUROX line of products sharply declined. As per store sales
declined, a substantial number of stores, including most significant mass market
customers, discontinued carrying the ENDUROX line which further contributed to
the Company's declining sales trend. Management decided at that time to maintain
a lower level of advertising for its ENDUROX line, in order to conserve its
financial resources to mount a substantial campaign for its new products, which
management believes to offer better long term prospects.
In addition, during the fourth quarter of 1998, the Company agreed to accept the
return of ENDUROX ProHeart product, previously sold to its largest customer
which was disappointed by the slow product movement and lack of advertising
support for the product. Although the Company was not obligated to accept the
return of this product, management felt that it was in the Company's best
interest to do so in order to maintain a positive relationship with its largest
customer. This return reduced sales in the fourth quarter of 1998 by $136,800
and will further reduce sales in the first quarter of 1999 by $84,474. In 1999,
this customer became the leading distributor for the Company's new product, the
ENDUROX(R)R4(TM) Performance/Recovery Drink on a nationwide basis.
The Company's net loss of $2,463,054 reported for the year ended December 31,
1998 was significantly lower than the comparable period in 1997 due to a
reduction in selling, general and administrative expenses. These expenses
decreased from $5,630,252 for the year ended December 31, 1997 to $2,927,734
(approximately 48%) for the year ended December 31, 1998. As previously
mentioned, a substantial part of this decrease was due to the elimination and/or
reduction in television and print advertising caused by a lack of funding in the
latter part of 1997 and management's subsequent decision to limit marketing
expenditures in support of Prosol Plus and the original products. The Company
believes this will assure that adequate funding will be available to support
promotion and advertising for ENDUROX(R) R4TM Performance/Recovery Drink and
PO-2. The decrease in mass market distribution during 1998, also resulted in
lower advertising and promotional expenditures associated with supporting that
channel of distribution. In addition, interest income increased from $44,095 for
the year ended December 31, 1997 to $241,253 for the year ended December 31,
1998. In December 1998, management decided to write-off a majority of its
ENDUROX ProHeart finished goods and work-in-process inventories due to
obsolescence. The Company determined that the product's lack of sales movement,
coupled with the timing of its product expiration dates, indicated a high
probability that the
16
<PAGE>
product would not be saleable into the near future. The obsolete inventory
write-off was charged to cost of goods sold in the amount of $350,706 and the
finished goods and work-in-process inventories were reduced by $139,628 and
$211,078, respectively.
The Company's net loss of $4,337,504 reported for the year ended December 31,
1997 included a non-recurring charge of $570,928, a $420,100 write-off of the
Endurox capsule inventory and a reduction in sales of $318,750 relative to
customer refunds for returned ENDUROX capsule inventory. The non-recurring
charge of $570,928 was incurred in connection with the replacement by the
Company of customers' inventories of ENDUROX in encapsulated form with a caplet
form of the product, and included a reserve of $610,491 at December 31, 1997,
which management believed was adequate to cover future exchanges or returns of
retailers' capsule inventory. At December 31, 1998, this reserve was $344,464.
This replacement of inventory was required because the active herbal ingredient
in ENDUROX is highly water absorbent, which resulted in the capsules changing
color and/or size in conditions of high heat and humidity, even though the
product was encapsulated in a gel capsule and sealed in a blister package. To
rectify this problem, the Company decided to switch to a caplet form of product,
in which the ingredients are compressed and coated, from the more porous gelatin
capsule filled with ingredients in powdered form. ENDUROX is now sold by the
Company only in caplet form, as are ENDUROX EXCEL and ENDUROX ProHeart which
were introduced in caplet form in the first quarter of 1997.
The Company's gross profit margin in 1998 (38.5%) was lower than the margin in
1997 (59.7%). In both years, the gross profit margins were lower than expected
due to two separate events. For the year ended December 31, 1998, the obsolete
inventory write-off was charged to cost of goods sold in the amount of $350,706,
which lowered the margin from 73.6% to 38.5%. For the year ended December 31,
1997, a write-off of Endurox capsule inventory in the amount of $420,100 was
charged to cost of goods sold, which lowered the margin from 72.3% to 59.7%.
Although the sales trend for the year ended December 31, 1998 was declining,
management believes that sales for the original ENDUROX products have stabilized
and, with the addition of the ENDUROX(R) R4(TM) Performance/Recovery Drink in
the first quarter of 1999, it is anticipated that sales will improve in future
periods based on the belief that advertising and promotional expenditures
associated with the launch and introduction of the new ENDUROX(R)R4(TM)
Performance/Recovery Drink will have a spillover effect on original ENDUROX
product sales. The Company cannot predict, however, what the sales of
ENDUROX(R)R4(TM) Performance/Recovery Drink will be, or the extent of any
spillover effect that advertising and other promotional expenditures for the
ENDUROX(R)R4(TM) Performance/Recovery Drink will have on the sales of the
existing ENDUROX product line.
Selling, general and administrative costs are expected to increase slightly
during 1999 with the launch of the new ENDUROX(R)R4(TM) Performance/Recovery
Drink. While the Company's current level of selling, general and administrative
expenses is high relative to present sales levels, management believes that its
investment in infrastructure, primarily sales and marketing personnel and in a
revamped advertising and promotional campaign, is necessary to build
17
<PAGE>
multiple product lines and to adequately support the sales that new products are
expected to generate.
(c) Liquidity and Capital Resources
At December 31, 1998, the Company's current assets exceeded its current
liabilities by $3,584,886 with a ratio of current assets to current liabilities
of approximately 7.52 to 1 versus a ratio of approximately 6.92 to 1 at December
31, 1997. The change in current ratio was attributable primarily to the
Company's receipt of proceeds from its public offering of Common Stock in
December 1997. Based on current activities, management expects the Company to be
able to satisfy its cash requirements in fiscal 1999 from its internal cash
reserves.
The Company projects an advertising and promotional budget of $1,200,000 for the
year ending December 31, 1999, including commitments of approximately $500,000
for consumer and trade print media. Management believes that once the
effectiveness of its advertising and promotional campaign can be determined,
appropriate measures can be taken to either reduce or increase its level of
expenditures in this area. The Company had no other material commitments apart
from existing personnel and occupancy costs.
(d) Year 2000 Discussion
As has been widely reported, many computer systems process dates based on two
digits for the year of a transaction and are unable to process dates in the year
2000 and beyond. Therefore, these computer programs do not properly recognize a
year that begins with "20" instead of the familiar "19". If not corrected, many
computer applications could fail or create erroneous results.
The Company primarily uses licensed software products in its operations with a
significant portion of processes and transactions centralized in one particular
software package. The manufacturer of this software has already provided the
Company with a Year 2000 Update for no charge, so that the Company's main
processing system is Year 2000 compliant. In addition, the server for the
Company's workstation environment and the word processing and spreadsheet
package that the Company utilizes has all been upgraded with "service releases"
or "patches" that have made these systems Year 2000 compliant. These upgrades
were provided to the Company at no cost.
The Company has initiated a formal communications program with a substantial
majority of its significant suppliers and customers to determine their plans to
address the Year 2000 issue. While the Company expects a successful resolution
of all issues, there can be no guarantee that the systems of other companies
which interact with the Company's systems will be converted in a timely manner.
Unsuccessful conversions by these third party companies should not have a
material adverse effect on the Company's business as contingent plans have been
formed to transact business through facsimile and telephone lines.
18
<PAGE>
(e) Impact of Inflation
The Company expects to be able to pass inflationary increases for raw materials
and other costs on to its customers through price increases, as required, and
does not expect inflation to be a significant factor in its business. However,
the Company's operating history is very limited, and this expectation is based
more on observations of its competitors' historic operations than its own
experience.
(f) Seasonality
Nutritional supplement sales tend to be somewhat seasonal, with lower sales
typically realized during the first and second fiscal quarters, and higher sales
typically realized during the third and fourth fiscal quarters. The Company
believes such fluctuations in sales are the result of greater marketing and
promotional activities toward the end of each fiscal year, customer buying
patterns, and consumer spending patterns related primarily to the consumers'
interest in achieving personal health and fitness goals after the beginning of
each new calendar year and before the summer fashion season. Some classes of
products, however, differ in seasonality. For example, January typically is the
best month for sales of products for weight loss and control. In any event, at
this stage and for the foreseeable future, the Company believes that the impact
of new product introductions and marketing expenses associated with the
introduction of new products will have a far greater impact on its operations
than industry and product seasonality.
(g) Impact of Recently Issued Financial Accounting Standards
In February 1997, the Financial Accountant Standards Board issued SFAS No. 128
(SFAS No. 128), "Earnings per Share", which supersedes Accounting Principles
Board Opinion No. 15 "Earnings per Share" and replaces the presentation of
primary EPS with a presentation of basic EPS. It also requires dual presentation
of basic and diluted EPS on the face of the income statement for all entities
with complex capital structures and provides guidance on other computational
changes. SFAS No. 128 is effective for financial statements for both interim and
annual periods ending after December 15, 1997. Earlier application is not
permitted. The 1997 earnings per share have been restated and are reported in
accordance with SFAS 128. The 1997 primary and fully diluted earnings per share
were previously reported as a net loss of $1.25. For the years ended December
31, 1998 and 1997, the computation of diluted loss per share was antidilutive;
therefore, the amounts reported for basic and dilutive loss per share were the
same. The Company does not expect the adoption of SFAS No. 128 to have a
material impact on the financial position and results of operations of the
Company.
19
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
Financial information required in response to this Item of Form 10-KSB is set
forth at pages F-1 through F-16 of this Report.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
20
<PAGE>
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT.
9(a) Directors and Executive Officers
The directors and executive officers of the Company as of the date of this
Report are as follows:
Name Position with the Company
---- -------------------------
Robert Portman, PhD. President and Chief Executive Officer,
Treasurer and Chairman of the Board of
Directors
Jonathan D. Rahn, CPA Executive Vice President, Chief Financial
Officer and Director
David I. Portman Secretary and Director
T. Colin Campbell, PhD Director
Irving I.A. Tabachnick, PhD. Director
DR. ROBERT PORTMAN, age 54, has served as President, Treasurer and Chairman of
the Board of Directors of the Company since its inception. Dr. Portman has a PhD
in Biochemistry and worked as a senior scientist at Schering Laboratories before
co-founding M.E.D. Communications in 1974 with his brother, David Portman. In
1987, Dr. Portman started a consumer agency and, in 1993, he merged both
agencies to form C&M Advertising. C&M Advertising, with billings in excess of
$100 million, handled national advertising for such diverse accounts as Berlex
Laboratories, Ortho-McNeil Laboratories, Tetley Tea, Radisson Hotels and HIP of
New Jersey. Effective June 1, 1995, Dr. Portman relinquished his
responsibilities as Chairman of C&M Advertising (which since has been renamed
"The Sawtooth Group") to assume his present positions with the Company on a full
time basis, and, in September 1996, Dr. Portman sold his interest in that
company.
In April 1988, Dr. Portman incorporated a company to develop and market a
patented dental device. A prototype of the device was developed in conjunction
with researchers at the University of Pennsylvania. In 1993, Dr. Portman
determined that the investment of additional funds for the purpose of marketing
and advertising the product was not warranted, and the company, HydroDent
Laboratories, Inc., of which Dr. Portman then was the President and principal
stockholder and creditor, was liquidated in the U.S. Bankruptcy Court for the
District of New Jersey.
21
<PAGE>
JONATHAN D. RAHN, age 55, is the Executive Vice President and Chief Financial
Officer, as well as a director, of the Company. From the inception of the
Company to his employment by the Company in July 1996, Mr. Rahn served as a
consultant to the Company in financial and certain operational matters. Mr.
Rahn, a certified public accountant, has over 30 years experience in accounting
and financial analysis, and has held various executive positions for a number of
diverse businesses, both public and private. For approximately three years
immediately preceding his employment by the Company, he was a self-employed
consultant involved in the evaluation, due diligence and structuring of
investments in and acquisitions of development-stage companies.
DAVID I. PORTMAN, age 58, has served as Secretary and a Director of the Company
from its inception. Mr. Portman has a BS in Pharmacy and an MBA. He worked as a
sales representative and marketing manager for Eli Lilly, Beecham-Massengill,
Winthrop Laboratories and Sandoz Pharmaceuticals before co-founding M.E.D.
Communications in 1974. In 1988, Mr. Portman sold his interest in M.E.D.
Communications to Robert Portman, and became President of TRIAD Development, a
real estate company that has numerous commercial and rental properties in New
Jersey, a position that he still holds. Mr. Portman also has served as a
director of First Montauk Securities Corp. since 1993.
Robert Portman and David Portman are brothers.
DR. T. COLIN CAMPBELL, age 65, has served as a Director of the Company since its
inception. Dr. Campbell also serves as Chairman of the Company's U.S. Scientific
Advisory Board. Dr. Campbell has been Jacob Gould Schurman Professor of
Nutritional Biochemistry of Cornell University since 1985. Over the past three
decades, Dr. Campbell has been directing research correlating diet, lifestyle
and disease. In 1979, Dr. Campbell, with the encouragement of the Chinese
government, initiated the largest epidemiological study ever undertaken focusing
on the relationship between nutrition and disease. The China-Cornell Research
Project is expected to continue well into the 21st Century. Dr. Campbell is an
honorary professor at the Chinese Academy of Preventive Medicine.
DR. IRVING I.A. TABACHNICK, age 74, was elected a director of the Company in
December 1997. Dr. Tabachnick has served as a consultant to Schering Plough
Corporation, a New York Stock Exchange listed company, since 1989. Prior to
1989, he was employed by Schering Plough Corporation in a number of positions,
including Vice President -- Drug Safety and Metabolism, Senior Director --
Biological Research and Development, and Director -- Biological Sciences and
Director -- Physiology and Biochemistry.
In connection with its initial public offering of Common Stock, completed in
December 1997, for which First Montauk Securities Corp. ("First Montauk") acted
as underwriter, the Company agreed for a period of five years from December 19,
1997 to cause a person designated by First Montauk to be elected to the
Company's Board of Directors. First Montauk has not advised the Company of any
designee to serve on the Board of Directors and, further, has advised the
Company that it does not intend to exercise its right to designate a nominee for
election as a director in the near future.
22
<PAGE>
Under corporate governance rules applicable to issuers with securities listed on
the Nasdaq SmallCap Market, the issuer must have a minimum of two independent
directors and an audit committee with a majority of independent directors. At
the present time, the Company considers T. Colin Campbell and Irving I.A.
Tabachnick to be "independent" directors, and has formed an Audit Committee
consisting of Dr. Campbell, Dr. Tabachnick and Jonathan D. Rahn.
9(b) Other Key Advisors and Consultants
In addition to its executive officers, the Company considers Dr. Junshi Chen to
be a key advisor. Dr. Chen, age 63, is Chairman of the Company's Chinese
Scientific Advisory Board, and is a Professor and Deputy Director of the INFH.
Besides directing the research activities of the INFH, Dr. Chen is a recognized
expert in China on nutritional status and cancer mortality and the antioxidant
properties of various dietary constituents. Dr. Chen also is a member of the
Political Consultative Group of China, a select group of individuals who serve
as advisors to the government and the People's Congress, and a member of the
government committee that reviews and approves new drug applications in China.
9(c) Scientific Advisory Boards
The Company has established U.S. and Chinese Scientific Advisory Boards to
provide it with on-going advice and counsel regarding research direction,
product development, analysis of data and general counseling. As a need rises,
the Company consults with individual members of these Boards on a non-scheduled
basis. A brief description of the backgrounds of the Advisory Boards' member are
set forth below.
U.S. Scientific Advisory Board:
T. Colin Campbell, a Director of the Company, is Chairman of the Company's U.S.
Advisory Board. Its other members are:
David Kritchevsky, PhD, Institute Professor, Wistar Institute, Professor of
Biochemistry in Surgery. Dr. Kritchevsky is an expert in lipid biochemistry,
atherosclerosis and the relationship between nutrition and aging and nutrition
and cancer. He has published on the effects of dietary fiber on colon cancer,
circulating cholesterol and the effects of dietary fat and energy on
experimental carcinogenesis. He was a member of the 1982 National Academy of
Sciences Committee on Diet, Nutrition and Cancer, is a member of numerous
professional societies, serves as editor of several professional annuals and was
Western Hemisphere Editor of the journal, Atherosclerosis.
William Pryor, PhD, Thomas and David Boyd Professor, Departments of Chemistry
and Biochemistry; Director, Biodynamics Institute, Louisiana State University.
Dr. Pryor is an authority in free radical chemistry and biology. He has
published on the role that various reactive
23
<PAGE>
oxygen species play in the production of degenerative tissue damage, such as
cancer and atherosclerotic diseases. His publications number over 500. Dr. Pryor
wrote the first textbook on free radicals (McGraw-Hill 1966) and was the founder
and first editor of the journal, Free Radical Biology & Medicine.
David J. Jenkins, PhD, Dsc, Professor of Medicine & Nutritional Sciences,
University of Toronto; Director, Clinical Nutrition & Risk Factor Modification
Center, St. Michael's Hospital. Dr. Jenkins has extensively researched the
effects of soluble and insoluble dietary fiber upon various biochemical factors
associated with, or predictive of, cardiovascular disease, diabetes and
colorectal and prostate cancers. Dr. Jenkins is a member of several professional
nutrition societies, in Canada, Great Britain and the United States. He has
served on a number of international committees involved in the treatment and
prevention of diabetes.
Chinese Scientific Advisory Board:
Professor Junshi Chen, MD, is Deputy Director of the Institute of Nutrition &
Food Hygiene at the Chinese Academy of Preventive Medicine and a Director of the
Company. Professor Chen is the Chair of the Chinese Scientific Advisory Board.
Professor Boping Wu, Former Director of Medicine Information, Research
Institute, Academy of Traditional Chinese Medicine; Member, Expert Committee,
Academy of Traditional Chinese Medicine ("TCM"); Advisory, Chinese
Administration of TCM. Dr. Wu is one of the leading experts on Traditional
Chinese Medicine. Although his professional expertise concerns treatment of
immune function disorders, he was responsible for creating a comprehensive
database on medicinal herbs. Dr. Wu is a member of Chinese AIDS prevention
committee and has developed TCM anti-AIDS formulas that are being tested in
Africa and England.
Professor Mingzhi Xie, Department of Phytopharmacology, Institute of Materia
Medica, Chinese Academy of Medical Sciences. Dr. Xie has worked in
phytopharmacology for more than 30 years. She is a member of the Review Board
for New Drugs. Her current research interests focus on the mechanism of TCM
compounds in treating obesity and diabetes.
ITEM 10. EXECUTIVE COMPENSATION
Robert Portman is the only executive officer of the Company with a fixed-term
employment agreement. Under this agreement, Dr. Portman is employed for a
three-year term commencing January 1, 1998, at an annual salary of $150,000 for
the first two years, and at a salary to be determined by the Compensation
Committee of the Company's Board of Directors during the third year. In addition
to salary, Dr. Portman is entitled to receive a bonus equal to five percent of
the amount, if any, by which the Company's net, pre-tax income exceeds
$1,000,000 in the fiscal year ending December 31, 1999.
Dr. Portman's employment agreement also provided for a grant of options under
the Company's Incentive Stock Option Plan, to purchase up to 475,000 shares of
Common Stock at a price of
24
<PAGE>
$6.00 per share, the initial public offering price of shares in the Company's
public offering in December 1997. This option vests as to one-third of the
shares issuable upon full exercise of the option as of the first, second and
third anniversaries of the effective date of the employment agreement, provided
that Dr. Portman is employed by the Company at such dates. To the extent not
previously vested, the option also will vest if Dr. Portman's employment is
terminated by the Company without cause. In addition, if Dr. Portman's
employment is terminated by the Company without cause, or by Dr. Portman with
cause, Dr. Portman will be entitled to receive payment of an amount equal to the
lesser of full salary for one year or for the remaining term of the agreement.
The table below sets forth information concerning compensation paid to Dr.
Portman in 1998, 1997 and 1996 and to Jonathan D. Rahn, Executive Vice President
of the Company, in 1998 and 1997. No executive officers of the Company other
than Dr. Portman and Mr. Rahn received compensation of $100,000 or more in
fiscal 1998, 1997 and only Dr. Portman received $100,000 or more in 1996.
<TABLE>
<CAPTION>
Summary Compensation Table
Annual Compensation Long-Term Compensation
Awards Payouts
Securities
Other Under-
Annual Restricted lying All Other
Name and Compen- Stock Options/ LTIP Compen-
Principal Salary Bonus Sation Award(s) SARs Payouts sation
Position Year ($) ($) ($) ($) (#) ($) ($)
(a) (b) (c) (d) (e) (f) (g) (h) (i)
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Robert Portman, 1998 150,000 -0- -0- -0- -0- -0- -0-
President -------------------------------------------------------------------------------------------------
1997 150,000 -0- (1) -0- 475,000 -0- -0-
-------------------------------------------------------------------------------------------------
1996 162,500 (2) -0- (1) -0- 225,000 -0- -0-
- --------------------
Jonathan Rahn,
Executive Vice 1998 125,000 -0- (1) -0- -0- -0- -0-
President 1997 100,000 -0- (1) -0- -0- -0- -0-
</TABLE>
(1) Less than 10% of annual salary and bonus.
(2) Includes $37,500 accrued in respect of 1995 salary which was paid in 1996.
25
<PAGE>
The follow ng table sets forth certain information regarding options granted in
fiscal 1998:
Option/SAR Grants in Fiscal Year 1998
(Individual Grants)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
Number of Percent Of Total
Securities Options/SARs
Underlying Granted to Exercise Or Base
Options/SARs Employees In Fiscal Price
Name Granted (#) Year ($/Sh) Expiration Date
(a) (b) (c) (d) (e)
<S> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------
Robert Portman -0- N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------------
Jonathan Rahn -0- N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
The following table sets forth information with respect to the number of
unexercised options and the value of unexercised "in-the-money" options held by
Robert Portman and Jonathan Rahn at December 31, 1998.
Aggregated Option/SAR Exercises in Fiscal Year 1998 and
Option/SAR Values at 12/31/98
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
Number of Securities $ Value of Unexercised
Underlying Unexercised In-the-Money Options/SARs
Shares Options/SARs At 12/31/98 At 12/31/98
Acquired On Value Exercisable/ Exercisable/
Exercise Realized Unexercisable Unexercisable
Name (#) ($) (#) ($)
(a) (b) (c) (d) (e)
- ------------------------------------------------------------------------------------------------------------------------
Exercisable Unexercisable Exercisable Unexercisable
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Robert Portman -0- -0- 525,000 475,000 412,500 -0-
- ------------------------------------------------------------------------------------------------------------------------
Jonathan Rahn -0- -0- 200,000 -0- -0- -0-
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
For the purpose of computing the value of "in-the-money" options at December 31,
1998, in the above table, the fair market value of the Common Stock at such date
is deemed to be $3.375 per share, the closing sale price of the Common Stock on
such date as reported by Nasdaq.
Directors' Compensation in Fiscal Year 1998
For the year ended December 31, 1998, the Company compensated its two
independent Directors, T. Colin Campbell and Irving I.A. Tabachnick in the
amount of $2,500 per Director. Their duties included attendance at all board
meetings, the annual shareholders meeting, and two meetings of the Audit
Committee.
26
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
As of March 22, 1999, the Company had outstanding 4,554,367 shares of Common
Stock. The following table sets forth information concerning the present
ownership of the Company's Common Stock by the Company's directors, executive
officers and each person known to the Company to be the beneficial owner of more
than five percent of either of such classes of the capital stock, the beneficial
ownership of these securities by such persons following the offering, and the
total voting power represented by the securities owned by such persons.
<TABLE>
<CAPTION>
Common Stock (1) Common Stock (1)
---------------- ----------------
Name and Address Amount Beneficially Owned Percentage of Class
---------------- ------------------------- -------------------
<S> <C> <C>
Robert Portman (2) 1,413,101 26.9%
President, Chief Executive Officer
and a Director
188 Igoe Road
Morganville, NJ 07751
Jonathan D. Rahn (3) 443,000 9.3%
Executive Vice President, Chief
Financial Officer and a Director
413 Gatewood Road
Cherry Hill, NJ 07751
David I. Portman 185,000 4.1%
Secretary and a Director
19 Pal Drive
Wayside, NJ 07712
T. Colin Campbell (4) 172,954 3.8%
Director
26 Beckett way
Ithaca, NY 14850
Irving Tabachnick (5) 10,000 *
Director
9 Woodland Avenue
North Caldwell, NJ 07006
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
Common Stock (1) Common Stock (1)
---------------- ----------------
Name and Address Amount Beneficially Owned Percentage of Class
---------------- ------------------------- -------------------
<S> <C> <C>
2,224,055 40.8%
Executive Officers and Directors as a
group (5 persons)
</TABLE>
- ----------
* Less than one percent
(1) Common Stock which is issuable upon the exercise of a stock option which is
presently exercisable or which becomes exercisable within sixty days is
considered outstanding for the purpose of computing the percentage
ownership (x) of persons holding such options, and (y) of officers and
directors as a group with respect to all options held by officers and
directors.
(2) Includes (i) a presently-exercisable option issued pursuant to the
Company's 1995 Incentive Stock Option Plan (a "1995 Plan Option") to
acquire 300,000 shares at a price of $2.00 per share, (ii) a
presently-exercisable 1995 Plan Option to acquire an additional 225,000
shares at a price of $3.75 per share, (iii) a 1998 Employment Contract
Option to acquire an additional 158,334 shares at a price of $6.00 per
share. Does not include (x) 200,000 shares of Common Stock owned by
Jennifer Portman, Dr. Portman's wife, individually and as Trustee for his
and her minor children, as to which Dr. Portman disclaims beneficial
ownership, and (y) 1998 Employment Contract Options to purchase an
additional 316,666 shares which are not vested and do not vest within sixty
days.
(3) Includes a 1995 Plan Option to acquire 200,000 shares at a price of $3.75
per share.
(4) Includes a 1995 Plan Option to acquire 5,000 shares at a price of $3.75 per
share. Does not include 38,900 shares of Common Stock owned by Dr.
Campbell's wife or 160,521 shares of Common Stock owned by Dr. Campbell's
adult children, as to which he disclaims beneficial ownership.
(5) Represents an option to purchase 10,000 shares at a price of $4.75 under
the Company's 1995 Option Plan.
28
<PAGE>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Through December 1997, the Company leased approximately 2,645 square feet of
office space, utilized for executive and administrative offices, from CSC
Associates, a company owned by Robert Portman, Chairman of the Board and Chief
Executive Officer of the Company, and David Portman, Secretary and a Director of
the Company, at a monthly rental of $2,645, plus utilities. The Company believes
that the terms of such lease were at least as favorable to it as could have been
obtained from an unrelated party through arms-length negotiations. At year-end
1997, CSC Associates sold the building in which such offices are located to an
unaffiliated person, subject to the Company's lease. The Company subsequently
modified its lease with the new lessor in connection with a planned move to
slightly larger space in an adjoining building.
Except as described above, during the last two fiscal years, the Company has not
entered into any material transactions or series of transactions which, in the
aggregate, would be considered material in which any officer, director or
beneficial owner of 5% or more of any class of capital stock of the Company had
a direct or indirect material interest, nor are any such transactions presently
proposed.
ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) A list of the financial statements and financial statement schedule filed as
a part of this report is set forth on page F-1 hereof. A list of the exhibits
filed as a part of this report is set forth in the Exhibit Index starting after
page F-16 hereof.
(b) Reports on Form 8-K
During the last quarter of the period covered by this report, the Company did
not file any Current Reports on Form 8-K.
29
<PAGE>
PACIFICHEALTH LABORATORIES, INC.
CONTENTS
Page
----
Independent Auditor's Report............................................. F-3
Financial Statements:
Balance Sheets.................................................... F-4
Statements of Operations.......................................... F-5
Statements of Stockholders' Equity................................ F-6
Statements of Cash Flows.......................................... F-7
Notes to Financial Statements..................................... F-8 - F-19
<PAGE>
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Stockholders
of PacificHealth Laboratories, Inc.
We have audited the accompanying balance sheets of PacificHealth Laboratories,
Inc. as of December 31, 1998 and 1997, and the related statements of operations,
stockholders' equity and cash flows for the years ended December 31, 1998 and
1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of PacificHealth Laboratories,
Inc. as of December 31, 1998 and 1997, and the results of its operations and its
cash flows for the years ended December 31, 1998 and 1997, in conformity with
generally accepted accounting principles.
Schiffman Hughes Brown
Blue Bell, Pennsylvania
February 12, 1999
F-3
<PAGE>
PACIFICHEALTH LABORATORIES, INC.
BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
ASSETS
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Current assets:
Cash and cash equivalents (Note 2) $ 3,415,120 $ 5,865,881
Accounts receivable, net (Note 3) 270,673 408,110
Inventories (Note 4) 375,074 553,098
Prepaid expenses 208,538 244,581
Other 2,906
----------- -----------
Total current assets 4,269,405 7,074,576
----------- -----------
Property and equipment (Note 5) 104,533 101,750
----------- -----------
Other asset:
Deposits 3,991
Organization cost, net of accumulated
amortization (Note 6) 4,107 7,288
----------- -----------
8,098 7,288
----------- -----------
$ 4,382,036 $ 7,183,614
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt (Note 7) $ 82,264 $ 74,658
Accounts payable and accrued expenses 252,262 255,630
Reserve for product replacement (Note 4) 344,464 610,491
Customer deposits 5,529
----------- -----------
Total current liabilities 684,519 940,779
----------- -----------
Long-term debt (Note 7) 82,264
----------- -----------
Commitments (Notes 9)
Stockholders' equity:
Common stock, $.0025 par value; authorized
10,000,000 shares; issued and outstanding
4,554,367 shares in 1998 and 1997 11,386 11,386
Additional paid-in capital 10,803,085 10,803,085
Accumulated deficit (7,116,954) (4,653,900)
----------- -----------
3,697,517 6,160,571
----------- -----------
$ 4,382,036 $ 7,183,614
=========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements
F-4
<PAGE>
PACIFICHEALTH LABORATORIES, INC.
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Revenues $ 1,000,019 $ 3,356,725
----------- -----------
Cost of goods sold:
Inventories, beginning 553,098 905,950
Purchases 437,071 999,288
----------- -----------
990,169 1,905,238
Less: inventories, ending 375,074 553,098
----------- -----------
615,095 1,352,140
----------- -----------
Gross profit 384,924 2,004,585
----------- -----------
Selling, general and administrative expenses 2,927,734 5,630,252
Research and development (Note 13) 92,516 44,743
Amortization expense 3,180 3,180
Depreciation expense 53,533 70,609
Provision for replacement of product (Note 4) 570,928
----------- -----------
3,076,963 6,319,712
----------- -----------
Net operating loss (2,692,039) (4,315,127)
----------- -----------
Other income (expense):
Interest income 241,253 44,095
Bad debt expense (12,268) (28,204)
----------- -----------
228,985 15,891
----------- -----------
Loss before income taxes (2,463,054) (4,299,236)
Provision (benefit) for income taxes (Note 12) 38,268
----------- -----------
Net loss $(2,463,054) $(4,337,504)
=========== ===========
Basic net income (loss) per share of common stock $ (.54) $ (1.44)
=========== ===========
Diluted net income (loss)
per share of common stock $ (.54) $ (1.44)
=========== ===========
Basic weighted average shares outstanding 4,554,367 3,102,621
=========== ===========
Diluted weighted average shares outstanding 4,718,618 3,972,332
=========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements
F-5
<PAGE>
PACIFICHEALTH LABORATORIES, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
Paid in
Preferred Common Stockholders' Accumulated Total
Stock Stock Capital Deficit Equity
--------- ------- ------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Balance, January 1, 1997 $ 1,337 $ 7,384 $3,694,990 $(177,657) $3,526,054
Issuance of 232,222 shares of common stock 580 993,474 994,054
Issuance of 13,816 shares of 10% convertible
preferred stock as a dividend 138 138,022 (138,160) -0-
Cancellation of 200,000 shares of common stock (500) 500 -0-
Public issuance of 1,200,000 shares of common stock 3,000 5,975,426 5,978,426
Conversion of 147,482 shares of 10% convertible
preferred stock for 368,695 shares of common stock (1,475) 922 553 -0-
Issuance of 120,000 shares of common stock
purchase warrants 120 120
Cash dividend (579) (579)
Net loss for the year ended December 31, 1997 (4,337,504) (4,337,504)
-------- ------- ----------- ----------- -----------
Balance, December 31, 1997 -0- 11,386 10,803,085 (4,653,900) 6,160,571
Net loss for the year ended December 31, 1998 (2,463,054) (2,463,054)
-------- ------- ----------- ----------- -----------
Balance, December 31, 1998 $ -0- $11,386 $10,803,085 $(7,116,954) $ 3,697,517
======== ======= =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements
F-6
<PAGE>
PACIFICHEALTH LABORATORIES, INC.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
----------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(2,463,054) $(4,337,504)
Adjustments to reconcile net loss to net
cash used in operating activities:
Loss on retirement of fixed assets -- 58,061
Depreciation 53,533 70,609
Amortization 3,180 3,180
Deferred taxes -- 38,012
Bad debts 12,268 28,204
Changes in assets and liabilities:
Decrease in accounts receivable 125,171 1,584,232
Decrease in prepaid expenses 36,043 24,219
Decrease in inventory 178,024 352,852
Decrease in other current assets 2,906 26,948
Increase in deposits (3,991) --
Decrease in accounts payable and accrued expenses (3,368) (413,597)
(Decrease) increase in reserve for product replacement (266,027) 610,491
Increase in customer deposits 5,529 --
----------- ------------
Net cash used in operating activities (2,319,786) (1,954,293)
----------- ------------
Cash flows for investing activities:
Purchase of fixed assets (34,124) (52,082)
Purchase of furniture and fixtures (22,193) --
----------- ------------
Net cash used in investing activities (56,317) (52,082)
----------- ------------
Cash flows from financing activities:
Repayment of note payable (74,658) --
Issuance of common stock -- 6,972,480
Issuance of common stock purchase warrants -- 120
Proceeds from insurance financing -- 156,922
Dividends paid -- (579)
----------- -----------
Net cash (used in) provided by financing activities (74,658) 7,128,943
----------- -----------
Net (decrease) increase in cash (2,450,761) 5,122,568
Cash, beginning balance 5,865,881 743,313
----------- ------------
Cash, ending balance $ 3,415,120 $ 5,865,881
=========== ============
Supplemental disclosure of cash flow information:
Taxes paid $ 200 $ 256
=========== ============
Non-cash financing activity:
Preferred stock dividend $ -0- $ 138,160
=========== ============
</TABLE>
The accompanying notes are an integral part of the financial statements
F-7
<PAGE>
PACIFICHEALTH LABORATORIES, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
1. Business:
PacificHealth Laboratories, Inc. (the Company) (PHL) was organized on
April 13, 1995 to develop and market innovative natural products that
have been clinically shown to improve health and well being. At present
time, the Company's ENDUROX line of products represents approximately
91% of revenues.
2. Summary of significant accounting policies:
Cash and cash equivalents:
For purposes of reporting cash flows, the Company considers all cash
accounts which are not subject to withdrawal restrictions or penalties,
and certificates of deposit with original maturities of 90 days or less
to be cash or cash equivalents.
Accounts receivable:
The Company provides an allowance for doubtful accounts, as needed, for
accounts deemed uncollectible.
Inventory:
Inventory is recorded at the lower of cost or market using the
first-in, first-out (FIFO) method.
Equipment and depreciation:
Property and equipment are carried at cost. Depreciation is calculated
using the straight-line method over their estimated useful lives
ranging from 2 to 5 years. Depreciation expense for the years ended
December 31, 1998 and 1997 was $53,533 and $70,609, respectively.
Organization cost:
Organization costs are capitalized and amortized over 5 years.
F-8
<PAGE>
PACIFICHEALTH LABORATORIES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
2. Summary of significant accounting policies (continued):
Use of estimates:
The preparation of the accompanying financial statements in conformity
with generally accepted accounting principles requires management to
make certain estimates and assumptions that directly affect the results
of reported assets, liabilities, revenue, and expenses. Actual results
may differ from these estimates.
Year 2000 compliance:
As has been widely reported, many computer systems process dates based
on two digits for the year of a transaction and are unable to process
dates in the year 2000 and beyond. Therefore, these computer programs
do not properly recognize a year that begins with "20" instead of the
familiar "19." If not corrected, many computer applications could fail
or create erroneous results.
The Company primarily uses licensed software products in its operations
with a significant portion of processes and transactions centralized in
one particular software package. The manufacturer of this software has
already provided the Company with a Year 2000 Update for no charge, so
that the Company's main processing system is Year 2000 compliant. In
addition, the server for the Company's workstation environment and the
word processing and spreadsheet package that the Company utilizes have
all been upgraded with "service releases" or "patches" that have made
these systems Year 2000 compliant. These upgrades were provided to the
Company at no cost.
The Company has initiated a formal communications program with a
substantial majority of its significant suppliers and customers to
determine their plans to address the Year 2000 issue. While the Company
expects a successful resolution of all issues, there can be no
guarantee that the systems of other companies which interact with the
Company's systems will be converted in a timely manner. Unsuccessful
conversions by these third party companies should not have a material
adverse effect on the Company's business as contingent plans have been
formed to transact business through facsimile and telephone lines.
F-9
<PAGE>
PACIFICHEALTH LABORATORIES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
2. Summary of significant accounting policies (continued):
Earnings (loss) per share:
In 1997, the Financial Accounting Standards Board issued SFAS No. 128,
Earnings per Share. SFAS No. 128 replaced the previously reported
primary and fully diluted earnings per share with basic and diluted
earnings per share, respectively. Unlike the previously reported
primary earnings per share, basic earnings per share excludes the
dilutive effects of stock options. Diluted earnings per share is
similar to the previously reported fully diluted earnings per share.
Earnings per share amounts for all periods presented have been
calculated in accordance with requirements of SFAS No. 128. The 1997
earnings per share have been restated and are reported in accordance
with SFAS No. 128. The 1997 primary and fully diluted earnings per
share were previously reported as a net loss of $1.25. For the year
ended December 31, 1998 and 1997, the computation of diluted loss per
share was antidilutive; therefore, the amounts reported for basic and
dilutive loss per share were the same.
Research and development:
Research and development costs consist of expenditures incurred by the
Company during the course of planned search and investigation aimed at
the discovery of new knowledge which will be used to develop and market
natural products which improve health and well being. The Company
expenses all such research and development costs as they are incurred.
Advertising costs:
Advertising costs are generally charged to operations in the year
incurred and totaled $1,655,274 and $4,639,567 in 1998 and 1997,
respectively.
Income taxes:
Income taxes are provided for the tax effects of transactions reported
in the financial statements and consist of taxes currently due plus
deferred taxes related primarily to differences between the basis of
balance sheet items for financial and income tax reporting. There is no
difference between the basis for financial and income tax reporting,
thus no deferred tax asset or liability was recorded.
F-10
<PAGE>
PACIFICHEALTH LABORATORIES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
3. Accounts receivable:
1998 1997
---- ----
<S> <C> <C>
Accounts receivable $277,825 $432,024
Less: allowance for doubtful accounts 7,152 23,914
-------- --------
$270,673 $408,110
======== ========
</TABLE>
<TABLE>
<CAPTION>
4. Inventories:
Inventories at December 31, 1998 and 1997 consisted of the following:
1998 1997
---- ----
<S> <C> <C>
Raw materials $ 15,065
Work-in-process $141,210 297,831
Finished goods 233,864 240,202
-------- --------
$375,074 $553,098
======== ========
</TABLE>
At the beginning of 1997, the Company decided to reformulate its
ENDUROX product into a caplet rather than a capsule, because the
capsule form was very hygroscopic and became altered in size and color
in conditions of high heat and humidity. As a result, the Company
abandoned its inventory of capsules and, whenever necessary, either
exchanged its retailers' inventory of capsules with caplets or issued a
credit for returned capsules. The exchange of caplets for capsules was
recorded as a charge to the provision for product replacement.
Refunds were recorded as a reduction of revenue.
At September 30, 1997, the Company's management estimated that
approximately 170,000 packages of capsule product were in retailers'
inventory and recorded a reserve totaling $752,250. The estimate
assumed that seventy-five percent of the packages would be returned for
replacement and twenty-five percent would be returned for refunds. The
cost of the replacement inventory, $433,500, was charged to the
provision, and the estimated refunds, $318,750, were recorded as a
reduction of revenue.
Both ENDUROX EXCEL and ENDUROX ProHeart, which were line extensions of
the original ENDUROX product, were introduced in a caplet form in 1997.
At December 31, 1998 and 1997, the balance in the reserve for product
replacement was $344,464 and $610,491, respectively.
In December 1998, management decided to write-off a majority of its
Endurox ProHeart finished goods and work-in-process inventories due to
obsolescence. The Company determined that the product's lack of sales
movement, coupled with the timing of its product expiration dates,
indicated a high probability that the product would not be saleable
into the near future. The obsolete inventory write-off was charged to
cost of goods sold in the amount of $350,706 and the finished goods and
work-in-process inventories were reduced by $139,628 and $211,078,
respectively.
F-11
<PAGE>
PACIFICHEALTH LABORATORIES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
5. Property and equipment:
1998 1997
---- ----
Furniture and equipment $169,170 $119,554
Molds and dies 55,117 48,417
-------- --------
224,287 167,971
Less: accumulated depreciation 119,754 66,221
-------- --------
$104,533 $101,750
======== ========
6. Organization costs:
1998 1997
---- ----
Cost $15,900 $15,900
Less: Accumulated amortization 11,793 8,612
------- -------
$ 4,107 $ 7,288
======= =======
7. Long-term debt:
1998 1997
---- ----
Installment note payable to insurance
finance company due in monthly installments
of $7,222, including interest at 9.74%
through December, 1999 $ 82,264 $156,922
Less: current portion 82,264 74,658
-------- --------
Long-term debt $ -0- $ 82,264
======== ========
Maturities of debt is as follows:
December 31, 1998 $ 74,658
December 31, 1999 $ 82,264 82,264
-------- --------
$ 82,264 $156,922
======== ========
F-12
<PAGE>
PACIFICHEALTH LABORATORIES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
8. Stock:
Capital stock:
The total number of shares of all classes of stock which the Company
has authority to issue is 11,000,000 shares, consisting of (a) ten
million (10,000,000) shares of Common Stock, par value $.0025 per
share, and (b) one million (1,000,000) shares of Preferred stock, par
value $.01 per share. The preferred stock may be issued in one or more
series, and may have such voting powers, full or limited, or no voting
powers, and such designations, preferences and relative, participating,
optional, or other special rights and qualifications, limitations, or
restrictions as shall be stated in the resolution or resolutions
providing for the issue thereof adopted by the Board of Directors of
the Company, from time to time.
Common stock:
In 1995, 3,945,000 shares were issued and subsequently reduced to
1,578,000 shares after a 2.5 for 1 reverse split. In 1996, the Company
issued 680,000 shares of common stock for $2,453,750 and 450 shares for
$1,800 in services. Also in 1996, under the terms of the Placement
Agency Agreement relating to the sale of 10% convertible preferred
stock described below, the Company sold 75,000 shares of common stock
to the placement agent for $18,000. During the first nine months of
1997, the Company issued 232,222 shares of common stock for $1,044,999
in private placements. In December, 1997, the Company issued 1,200,000
shares of common stock for $7,200,000 in its initial public offering.
As part of this initial public offering, the founders of PHL donated
back 200,000 shares of common stock to the Company. These shares have
been canceled. The Company also converted its outstanding 10%
convertible preferred stock into 368,695 shares of common stock.
10% convertible preferred stock:
In 1996 and 1995, the Company sold a total of 120,000 shares of its 10%
convertible preferred stock for $1,200,000.
Holders of shares of the 10% convertible preferred stock were entitled
to receive an annual dividend of $1.00 per share, payable in quarterly
installments of $.25 per share. Dividends were paid in cash or in
additional shares at the discretion of the Board of Directors of the
Company. On December 31, 1997, the Company converted the 147,482 shares
of 10% convertible preferred stock outstanding into 368,695 shares of
common stock.
F-13
<PAGE>
PACIFICHEALTH LABORATORIES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
8. Stock (continued):
10% convertible preferred stock (continued):
Activity for the periods ended is summarized as follows:
1998 1997
---- ----
Stock dividends (shown as shares) -0- 13,816
Cash dividends $ -0- $ 579
====== ======
9. Commitments:
Strategic Alliance Agreement:
The Company entered into an exclusive relationship with the Institute
of Nutrition & Food Hygiene (INFH), an institution located in The
People's Republic of China, for the purpose of commercializing various
products, know how and/or intellectual property outside of China. Per
the Agreement, the INFH will attempt to locate and enter into exclusive
licensing agreements with other institutions located in China to supply
the Company with an array of herbs, non-prescription drugs, nutritional
supplements, intellectual property, and technology for developing
products derived from natural sources which can be used in the
maintenance of health and well being. Any future products licensed by
the INFH will be assigned to the Company subject to terms and
conditions of the Agreement.
When the Company has achieved profitability on a cumulative basis, it
shall pay royalties to the INFH applicable to the net revenues of any
products exported from China, developed in China, or products which are
based on extracts from China. The royalties to be paid are as follows:
Net sales Royalty
--------- -------
$0 - 25 million 2%
$25 - 100 million 1 1/2%
$100 - 200 million 1%
Over $200 million 1/2%
F-14
<PAGE>
PACIFICHEALTH LABORATORIES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
9. Commitments (continued):
Strategic Alliance Agreement (continued):
For all royalties which are earned by INFH in excess of $25 million but
less than $100 million, PHL shall receive a 30% credit. This credit
shall be escrowed by PHL and be applied to "Special Services" performed
by the INFH, institutions, or individuals with whom the INFH has
entered into a licensing agreement. Unused credits shall carry over
beyond the year in which it was earned. For purposes of the Agreement,
Special Services shall be defined as:
(1) Clinical studies/research
(2) Laboratory studies/research
(3) Toxicology studies/research
(4) Formulation and/or product development
(5) Quality control studies/services
(6) Payment to Chinese consultants for work including,
but not limited to, clinical and/or research
design, product development, quality control,
manufacturing and/or sourcing.
Line of credit:
In May, 1997, the Company entered into a line of credit agreement with
its bank which enables the Company to borrow up to 80% of their current
accounts receivable (defined as less than 90 days old), up to a maximum
of $1,000,000. This line of credit expired on March 31, 1998 and the
Company has elected not to renew the line of credit. At December 31,
1997, the Company had not borrowed any monies from this line of credit.
Employment agreement:
The Company entered into a three year employment contract on January 1,
1998, with the Chairman and CEO that provides for minimum annual
compensation of $150,000. The Company is the beneficiary of a keyman
life insurance policy (on the Chairman's life) for $2,000,000.
Rent:
On February 3, 1998, the Company signed a new lease agreement with the
new owners of its office building. The new lease provides for the
rental of 3,684 square feet at $14.50 per square foot including
utilities, which equals a minimum annual rent expense of $53,418 for
the first three years. In the fourth and fifth years of the lease, the
cost per square foot increases to $16.50 per square foot including
utilities.
F-15
<PAGE>
PACIFICHEALTH LABORATORIES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
10. Incentive stock option plan:
In 1995, the Company established an incentive stock option plan (the
Plan) and presently has reserved 1,500,000 shares of the Company's
common stock for issuance under the plan. Options granted pursuant to
the Plan at December 31, 1996 were 879,500, and those options were
granted to certain officers, key employees and/or consultants to the
Company. Exercise prices range from $2 to $4 per common share, and vest
over varying periods of time. In 1998 and 1997, 21,500 and 490,700
options, respectively, were granted to certain officers, spokespersons
and/or consultants to the Company. Exercise prices on the options
granted in 1997 range from $4.25 to $6.00 per common share, and vest
over varying periods of time. Exercise prices on the options granted in
1998 range from $4.75 - $5.00 per common share and vested immediately.
All issuances were granted at the fair market value of the Company's
common stock at time of grant. As of December 31, 1998, no options have
been exercised.
Transactions in the Plan since inception are as follows:
<TABLE>
<CAPTION>
Exercise Price Weighted Average
Granted Vested Per Vested Exercise Price Per
Shares Shares Common Share Vested Common Share
------ ------ ------------ -------------------
<S> <C> <C> <C> <C>
Balance, December 31, 1995 $ 300,000 $ -0-
Activity during the year
ended December 31, 1996 579,500 144,500 $2.00 - $4.00 $ 2.57
---------- ----------
Balance, December 31, 1996 879,500 144,500
---------- ----------
Activity during the year
ended December 31, 1997 490,700 388,200 $2.00 - $6.00 $ 3.49
---------- ----------
Balance, December 31, 1997 1,370,200 532,700
--------- ----------
Activity during the year
ended December 31, 1998 21,500 359,000 $2.00 - $6.00 $ 3.35
---------- ----------
Balance, December 31, 1998 $1,391,700 $ 891,700 $ 3.28
========== ==========
</TABLE>
The Company accounts for stock-based compensation in accordance with
SFAS No. 123, Accounting for Stock-Based Compensation which permits the
use of the intrinsic value method described in APB Opinion No. 25,
Accounting for Stock Issued to Employees, and requires the Company to
disclose the pro forma effects of accounting for stock-based
compensation using the fair value method as described in the optional
accounting requirements of SFAS No. 123. As permitted by SFAS No. 123,
the Company will continue to account for stock-based compensation under
APB Opinion No. 25, under which the Company has recognized no
compensation expense.
F-16
<PAGE>
PACIFICHEALTH LABORATORIES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
10. Incentive stock option plan (continued):
Had compensation cost for the Company's stock option plan been
determined based on the fair value of the Company's common stock at the
dates of awards under the fair value method of SFAS No. 123, the
Company's net income and net income per common share would have been
reduced to the pro forma amounts indicated below.
1998 1997
---- ----
Net income:
As reported $ (2,463,054) $ (4,337,504)
Pro forma (2,838,557) (4,671,693)
Net loss per common share:
As reported (.54) (1.44)
Pro forma (.62) (1.51)
Significant assumptions used to calculate the above fair value of the
awards are as follows:
Risk free interest rates of return 5.00%
Expected option life 60 months
Expected dividends $ -0-
11. Warrants:
At December 31, 1998, the Company has warrants outstanding for the
purchase of 255,500 shares of the Company's common stock at exercise
prices ranging between $3.75 to $6.25 per common share. The warrants
expire at the close of business on July 31, 2000 (227,500 warrants
exercisable at $3.75 per share) and August 8, 2000 (28,000 warrants
exercisable at $6.25 per share). As of December 31, 1998, no warrants
have been exercised.
On December 24, 1997, the Underwriter for the Company's initial public
offering was issued warrants to buy 120,000 shares of the Company's
common stock at an exercise price of $8.70 per share. These warrants
will be exercisable for a period of four years, commencing December 19,
1998. As of December 31, 1998, no warrants have been exercised.
F-17
<PAGE>
PACIFICHEALTH LABORATORIES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
12. Income taxes:
Income tax provision (benefit) consists of the following:
1998 1997
---- ----
Current:
Federal $ -0- $ -0-
State -0- 256
-------- ---------
-0- 256
-------- ---------
Deferred:
Federal 30,067
State 7,945
------- ---------
-0- 38,012
------- ---------
$ -0- $ 38,268
======= =========
The Company has $6,848,247 in Federal and state net operating loss
carryovers which can be used to offset future taxable income. The net
operating loss carryforwards expire in the year 2010. In 1996,
management of the Company assessed its then current earnings along with
the then existing sales backlog and budgeted sales for 1997 and had
determined that it was more likely than not that the net operating loss
carryforwards would be utilized in 1997 thus a deferred tax asset of
$38,012 was recorded on the books. This deferred tax asset was
calculated using effective tax rates for federal and state. However, as
a result of reassessment by the Company at September 30, 1997, it
appears that net operating loss carryforwards would not be recognized
in 1997 and has thus reversed the deferred tax asset recorded at
December 31, 1996.
13. Research and development costs:
For the year ended December 31, 1998 and 1997, research and development
costs were $92,516 and $44,743, respectively.
14. Financial instruments:
Cash accounts are secured by the Federal Deposit Insurance Corporation
up to $100,000. At December 31, 1998 and 1997, cash deposits exceeded
federally insured limits by approximately $7,911 and $265,681,
respectively.
F-18
<PAGE>
PACIFICHEALTH LABORATORIES, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998 AND 1997
15. Significant customers:
During the year ended December 31, 1997, the Company had two customers
with billings in excess of 10% of total revenues. These two customers
accounted for approximately 38% of total revenues.
For the year ended December 31, 1998, the Company had revenues from one
customer which accounted for approximately 19% of total revenue.
F-19
<PAGE>
SUPPLEMENTAL INFORMATION
The Issuer has not sent an annual report or proxy statement to security holders
in respect of the fiscal year ending December 31, 1998, or otherwise in 1998.
Such report and proxy statement will be furnished to security holders in
connection with the Company's Annual Meeting, now scheduled to be held in the
second quarter of 1999. Copies of such material will be furnished to the
Commission when it is sent to security holders.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
PacificHealth Laboratories, Inc.
By: /s/ Robert Portman
------------------------------------------------------
Robert Portman, President, Chief Executive Officer
Date: March 26, 1999
In accordance with the Securities Exchange Act of 1934 and the requirements of
Form 10-KSB, this Report has been signed below by the following persons on
behalf of the registrant and in the capacities and on the dated indicated.
/s/ Robert Portman Director and Chief March 26, 1999
- ----------------------- Executive Officer
Robert Portman
/s/ Jonathan D. Rahn Director and Principal March 26, 1999
- ----------------------- Financial and Accounting
Jonathan D. Rahn Officer
/s/ David I. Portman Director March 26, 1999
- -----------------------
David I. Portman
30
<PAGE>
EXHIBIT INDEX
Incorporated
Exhibit No. Description by Reference
- ----------- ----------- ------------
3.1 -- Certificate of Incorporation of the Company and
all amendments thereto A
3.2 -- Amended and Restated Bylaws of the Company C
4.1 -- Specimen Common Stock Certificate C
4.2 -- Underwriter's Warrant Agreement and Form of
Warrant C
10.1 -- Incentive Stock Option Plan of 1995 A
10.2 -- Employment Agreement between the Company C
and Robert Portman effective January 1, 1998
10.3 -- Strategic Alliance Agreement between the Company A
and the Institute of Nutrition and Food Hygiene
10.4 -- Exclusive Licensing Agreement between the
Company and the INFH A
10.5 -- Shareholders Agreement A
23.1 -- Consent of Schiffman Hughes Brown *
27 -- Financial Data Schedule *
- ----------
* Filed herewith
A Filed with Registration Statement on Form SB-2 (Registration No. 333-36379)
(the "1997 SB-2") on September 25, 1997
B Filed with Amendment No.1 to the 1997 SB-2 on October 23, 1997
C Filed with Amendment No.3 to the 1997 SB-2 on December 17, 1997
31
ACCOUNTANT'S CONSENT
To the Stockholders and Board of Directors
PacificHealth Laboratories, Inc.
We consent to the use of our Independent Auditor's Report dated February 12,
1999, and accompanying financial statements of PacificHealth Laboratories, Inc.
(the "Company") for the years ended December 31, 1998 and 1997, in the Company's
Annual Report on Form 10K-SB for the year ended December 31, 1998, filed with
the Securities and Exchange Commission.
SCHIFFMAN HUGHES BROWN
Certified Public Accountants
Blue Bell, Pennsylvania
March 26, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 3,415,120
<SECURITIES> 0
<RECEIVABLES> 277,825
<ALLOWANCES> 7,152
<INVENTORY> 375,074
<CURRENT-ASSETS> 4,269,405
<PP&E> 105,533
<DEPRECIATION> 53,533
<TOTAL-ASSETS> 4,382,036
<CURRENT-LIABILITIES> 684,519
<BONDS> 0
0
0
<COMMON> 11,386
<OTHER-SE> 3,686,131
<TOTAL-LIABILITY-AND-EQUITY> 4,382,036
<SALES> 1,000,019
<TOTAL-REVENUES> 1,241,272
<CGS> 615,095
<TOTAL-COSTS> 3,692,058
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (2,463,054)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,463,054)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,463,054)
<EPS-PRIMARY> (0.54)
<EPS-DILUTED> (0.54)
</TABLE>
