<PAGE>
FORM 10-QSB/A
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(X) QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For Quarter Ended Commission File Number
September 30, 1998 000-22279
- ------------------ ----------------------
ADVANTAGE MARKETING SYSTEMS, INC
------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
Oklahoma 73-1323256
---------------------------------- ----------------------------
(State or Other Jurisdiction (IRS Employer Identification
of Incorporation or Organization) Number)
2601 N.W. Expressway, Suite 1210W, Oklahoma City, Oklahoma 73112
----------------------------------------------------------------
(Address of Principal Offices) (Zip Code)
(405) 842-0131
----------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the Registrant (i) has filed all reports
required to be filed by Section 13, or 15 (d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports)n and (ii) has been subject to
such filing requirements for the past 90 days. Yes X No
----- ------
Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date.
Common Stock, $.0001 par value 4,157,908
- ------------------------------- ----------------------------
Title of Class Number of Shares outstanding
at September 30, 1998
Exhibit Index appears on page 22.
Page 1 of 23
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
QUARTERLY REPORT ON FORM 10-QSB/A
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998
TABLE OF CONTENTS
<TABLE>
<CAPTION>
<S> <C>
Part I - Financial Information
Condensed Consolidated Balance Sheets.................... 3
Condensed Consolidated Statements of Income.............. 4
Condensed Consolidated Statements of Cash Flows.......... 5
Notes to Condensed Consolidated Financial Statements..... 7
Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 15
Part II - Other Information........................................ 22
</TABLE>
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Certain statements under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations" constitute "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933,
as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. Certain, but not necessarily all, of such forward-looking statements
can be identified by the use of forward-looking terminology such as
"anticipates," "believes, "expects," "may, "will," or "should" or other
variations thereon, or by discussions of strategies that involve risks and
uncertainties. The actual results of the Company or industry results may be
materially different from any future results expressed or implied by such
forward-looking statements. Factors that could cause actual results to differ
materially include general economic and business conditions; the ability of
the Company to implement its business and acquisition strategies; changes in
the network marketing industry and changes in consumer preferences;
competition; availability of key personnel; increasing operating costs;
unsuccessful advertising and promotional efforts; changes in brand awareness;
acceptance of new product offerings; and changes in, or the failure to comply
with, government regulations (especially food and drug laws and regulations);
the ability of the Company to obtain financing for future acquisitions; and
other factors.
Chambre-Registered Trademark-, Spark of Life-REGISTERED TRADEMARK-, Young at
Heart-Registered Trademark-, Co-Clenz-Registered Trademark-, Stay 'N
Shape--Registered Trademark-, Sine-eze-Registered Trademark- and
ToppFast-Registered Trademark- are registered trademarks of the Company, and
Choc-Quilizer-TM- is a trademark of Tinos, L.L.C.
Page 2
<PAGE>
PART 1. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 1998 AND DECEMBER 31, 1997
(UNAUDITED)
<TABLE>
<CAPTION>
September 30, December 31,
ASSETS 1998 1997
----------- -------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents............................... $ 5,580,422 $ 5,775,276
Receivables - net of allowance of $33,904
and $25,800, respectively........................... 269,050 184,915
Receivable from affiliate............................. 293,936 14,124
Commission advances................................... -- 59,268
Inventory............................................. 836,326 812,125
Deferred income taxes................................. 93,496 85,224
Other assets.......................................... 105,585 68,432
----------- -----------
Total current assets........................... 7,178,815 6,999,364
RECEIVABLES............................................. 56,740 15,079
RECEIVABLE FROM AFFILIATE .............................. -- 40,656
PROPERTY AND EQUIPMENT, Net............................. 926,761 695,896
GOODWILL, Net........................................... 1,752,461 1,700,909
COVENANTS NOT TO COMPETE, Net........................... 530,395 518,791
DEFERRED INCOME TAXES................................... 197,841 354,693
OTHER ASSETS............................................ 115,610 10,918
----------- -----------
TOTAL................................................... $10,758,623 $10,336,306
----------- -----------
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable...................................... $ 236,326 $ 202,220
Accrued commissions and bonuses....................... 168,173 325,077
Accrued other expenses................................ 910,250 183,921
Notes payable......................................... 28,709 26,304
Capital lease obligations............................. 84,646 118,801
----------- -----------
Total current liabilities...................... 1,428,104 856,323
LONG-TERM LIABILITIES:
Notes payable......................................... 101,942 82,440
Capital lease obligations............................. 112,754 221,148
----------- -----------
Total liabilities.............................. 1,642,800 1,159,911
----------- -----------
COMMITMENTS AND CONTINGENCIES (Note 6)
STOCKHOLDERS' EQUITY:
Preferred stock - $.0001 par value;
authorized 5,000,000 shares; none issued............ -- --
Common stock - $.0001 par value;
authorized 495,000,000 shares;
issued 4,259,908 and 4,249,383 shares,
respectively........................................ 426 425
Paid-in capital....................................... 10,180,108 10,180,109
Notes receivable for exercise of options.............. (74,000) (74,000)
Accumulated deficit................................... (683,718) (930,139)
----------- -----------
Total capital and accumulated deficit.......... 9,422,816 9,176,395
Less cost of treasury stock (102,000 shares, common).. (306,993) --
----------- -----------
Total stockholders' equity..................... 9,115,823 9,176,395
----------- -----------
TOTAL................................................... $10,758,623 $10,336,306
----------- -----------
----------- -----------
</TABLE>
See notes to condensed consolidated financial statements.
Page 3
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
FOR THE PERIODS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net sales...................................... $3,630,912 $2,889,906 $9,500,936 $7,635,321
Cost of sales.................................. 2,472,539 2,057,733 6,263,775 5,472,819
---------- ---------- ---------- ----------
Gross profit............................... 1,158,373 832,173 3,237,161 2,162,502
Marketing, distribution and
administrative expenses........................ 920,407 818,616 2,671,332 1,957,755
---------- ---------- ---------- ----------
Income from operations..................... 237,966 13,557 565,829 204,747
Other income (expense):
Interest, net.................................. 74,273 803 213,509 1,810
Other income (expense)......................... (1,238) 3,188 39,482 7,303
Settlement of additional tax
liability (Note 3)........................... (421,623) -- (421,623) --
---------- ---------- ---------- ----------
Total other income (expense)............... (348,588) 3,991 (168,632) 9,113
---------- ---------- ---------- ----------
INCOME (LOSS) BEFORE TAXES .................... (110,622) 17,548 397,197 213,860
TAX EXPENSE (BENEFIT).......................... (42,275) 6,857 150,776 81,377
---------- ---------- ---------- ----------
NET INCOME (LOSS).............................. $ (68,347) $ 10,691 $ 246,421 $ 132,483
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Net income (loss) per common share............. $ (.02) $ NIL $ .06 $ .05
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Net income (loss) per common share - assuming
dilution..................................... $ (.02) $ NIL $ .05 $ .04
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Weighted average common shares outstanding..... 4,168,619 2,680,081 4,201,954 2,489,450
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Weighted average common shares outstanding -
assuming dilution.............................. 4,168,619 3,753,566 4,538,783 3,443,266
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
</TABLE>
See notes to condensed consolidated financial statements.
Page 4
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
<TABLE>
<CAPTION>
September 30, September 30,
1998 1997
------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................... $ 246,421 $ 132,483
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation and amortization........................... 267,703 170,078
Deferred taxes.......................................... 148,580 79,182
Gain on sale of other assets............................ (35,920) --
Changes in assets and liabilities which provided
(used) cash:
Receivables and commission advances.................. (66,528) (58,489)
Inventory............................................ (24,201) (560,996)
Accounts payable and accrued expenses................ 693,781 20,465
---------- -----------
Net cash provided by (used in)
operating activities.......................... 1,229,836 (217,277)
---------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment.......................... (365,334) (130,568)
Purchase of Chambre International, Inc....................... -- (51,340)
Purchase of assets pursuant to SNSI Asset Purchase........... -- (1,274,441)
Purchase of ToppMed Assets................................... (192,000) --
Advances to affiliate........................................ (293,936) --
Repayment of receivable from affiliate....................... 54,780 9,683
Purchase of other assets..................................... (83,565) (106,803)
---------- -----------
Net cash used in investing activities ......... (880,055) (1,553,469)
---------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock....................... -- 2,234,357
Proceeds from notes payable.................................. 62,727 40,980
Purchase of treasury stock................................... (306,993) --
Payment of deferred offering costs........................... (112,610) (240,703)
Principal payment on notes payable........................... (40,821) (9,194)
Principal payment on capital lease obligations............... (146,938) (67,211)
---------- -----------
Net cash provided by (used in) financing
activities.................................... (544,635) 1,958,229
---------- -----------
NET INCREASE (DECREASE) IN CASH................................. (194,854) 187,483
CASH AND CASH EQUIVALENTS, BEGINNING............................ 5,775,276 169,569
---------- -----------
CASH AND CASH EQUIVALENTS, ENDING............................... $5,580,422 $ 357,052
---------- -----------
---------- -----------
(Continued)
</TABLE>
See notes to condensed consolidated financial statements.
Page 5
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
<TABLE>
<CAPTION>
September 30, September 30,
1998 1997
------------- -------------
<S> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid during the period for interest...................... $ 27,186 $ 21,104
Cash paid during the period for income taxes.................. -- 2,195
Noncash financing and investing activities:
Property and equipment acquired by capital lease........... 4,389 140,869
SNSI Asset Purchase:
Fair value of assets acquired.............................. $ -- $ (84,063)
Fair value of covenant not to compete...................... -- (500,000)
Purchase price in excess of tangible assets and covenant
not to compete........................................... -- (1,490,378)
Fair value of common stock issuance........................ -- 800,000
--------- -----------
Cash paid to purchase SNSI assets.......................... $ -- $(1,274,441)
--------- -----------
--------- -----------
Acquisition of Chambre' International, Inc.:
Fair value of assets acquired.............................. $ -- $ (84,802)
Fair value of covenant not to compete...................... -- (20,000)
Purchase price in excess of tangible assets acquired and
covenant not to compete.................................. -- (179,325)
Fair value of common stock issuance........................ -- 84,000
Liabilities assumed........................................ -- 148,787
--------- -----------
Cash paid to purchase Chambre' International, Inc.......... $ -- $ (51,340)
--------- -----------
--------- -----------
Acquisition of ToppMed, Inc.:
Fair value of assets acquired.............................. $ -- $ --
Fair value of covenant not to compete...................... (64,000) --
Purchase price in excess of tangible assets acquired and
covenant not to compete.................................. (128,000) --
--------- -----------
Cash paid to purchase ToppMed, Inc......................... $(192,000) $ --
--------- -----------
--------- -----------
(Concluded)
</TABLE>
See notes condensed consolidated financial statements
Page 6
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
1. UNAUDITED INTERIM FINANCIAL STATEMENTS
The unaudited condensed financial statements and related notes have been
prepared pursuant to the rules and regulations of the Securities and
Exchange Commission. Accordingly, certain information and footnote
disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been omitted
pursuant to such rules and regulations. The accompanying condensed
financial statements and related notes should be read in conjunction with
the audited consolidated financial statements of the Company, and notes
thereto, for the year ended December 31, 1997.
The information furnished reflects, in the opinion of management, all
adjustments, consisting of normal recurring accruals, necessary for a fair
presentation of the results of the interim periods presented. Operating
results of the interim period are not necessarily indicative of the amounts
that will be reported for the year ending December 31, 1998. Certain
reclassifications have been made to prior period balances to conform with
the presentation for the current period.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION- The condensed consolidated financial
statements include the accounts of Advantage Marketing Systems, Inc. and
its wholly owned subsidiaries, Miracle Mountain International, Inc. and
Chambre International, Inc. (the "Company"). All significant intercompany
accounts have been eliminated.
NATURE OF BUSINESS - The Company markets a product line of consumer
oriented products in the weight management, dietary supplement and personal
care categories that are produced by various manufacturers. The Company
sells its product line through a network of full and part-time independent
distributors developed by the Company.
The Company also sells supplies and materials to its independent
distributors.
USE OF ESTIMATES - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
REVENUE RECOGNITION - The Company recognizes revenue upon shipment of
products, training aids and promotional material to the independent
distributors.
SALES RETURNS - All of the Company's products include a customer
satisfaction guarantee. Company products may be returned within 30 days of
purchase for a full refund or credit toward the purchase of another Company
product. The Company also has a buy-back policy where by it will repurchase
products sold to an independent distributor (subject to a restocking fee)
provided that the distributor resigns from the Company and returns the
product within 12 months of original purchase in marketable condition. For
the
Page 7
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
three months ended September 30, 1998 and 1997 and the nine months ended
September 30, 1998 and 1997, the cost of products returned to the Company
is included in net sales and at each period was two percent, three percent,
two percent and three percent of gross sales, respectively.
ADVERTISING - The Company expenses advertising related to the Company as
incurred. Total advertising expense for the three months ended September
30, 1998 and 1997 and the nine months ended September 30, 1998 and 1997 was
$5,958, $52, $13,070 and $14,583, respectively.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents consist of cash in
banks and all short-term investments with initial maturities of three
months or less.
INVENTORY - Inventory consists of consumer product inventory, and training
and promotional material such as video tapes, cassette tapes and paper
supplies held for sale to customers and independent distributors. Inventory
is stated at the lower of cost or market. Cost is determined on a first-in,
first-out method.
INTANGIBLES - Intangible assets consist of goodwill and covenants not to
compete. Goodwill represents the excess of cost over the fair value of the
net assets acquired pursuant to the Miracle Mountain International, Inc.
("MMI"), Chambre International, Inc. ("CII"), Stay 'N Shape International,
Inc. ("SNSI") and ToppMed, Inc. ("TI") acquisitions. The Company amortizes
goodwill from the acquisition of MMI over seven years and from the
acquisitions of CII, SNSI, and TI over twenty years. Covenants not to
compete are being amortized over the life of the contracts. The net amount
of goodwill arising from the MMI, CII, SNSI and TI acquisitions at
September 30, 1998 was $79,441, $164,382, $1,381,705 and $126,933,
respectively. The net amount of goodwill arising from the MMI, CII and SNSI
acquisitions at September 30, 1997 was $97,127, $173,348 and $1,456,224,
respectively. Goodwill amortization for the three months ended
September 30, 1998 and 1997 was $25,660 and $25,127, respectively. Goodwill
amortization for the nine months ended September 30, 1998 and 1997 was
$76,448 and $52,899, respectively. Covenant amortization for the three
months ended September 30, 1998 and 1997, was $17,643 and $17,110,
respectively. Covenant amortization for the nine months ended September 30,
1998 and 1997, was $52,396 and $36,321, respectively.
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost or,
in the case of leased assets under capital leases, at the fair value of
the leased property and equipment, less accumulated depreciation and
amortization. Property and equipment are depreciated using the
straight-line method over the estimated useful lives of the assets of
three to seven years. Assets under capital leases and leasehold
improvements are amortized over the lesser of the term of the lease or
the life of the asset.
LONG-LIVED ASSETS - Management of the Company assesses recoverability of
its long-lived assets, including goodwill, whenever events or changes in
circumstances indicate that the carrying value of the asset may not be
recoverable through undiscounted future cash flows generated by that
asset.
FAIR VALUE DISCLOSURE - The Company's financial instruments include cash
and cash equivalents, receivables, short-term payables, notes payable
and capital lease obligations. The carrying amounts of cash and cash
equivalents, receivables and short-term payables approximate fair value
due to their short-term nature. The carrying amounts of notes payable
and capital lease obligations approximate fair value based on borrowing
rates currently available to the Company.
EARNINGS PER SHARE - In 1997, the Company adopted the Financial
Accounting Standards Board ("FASB") Statement of Financial Accounting
Standards ("SFAS") No. 128, EARNINGS PER SHARE, and has restated
earnings per share for all periods presented in accordance with that
Statement. Earnings per common share is computed based upon net income
divided by the weighted average number of common shares
Page 8
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
outstanding during each period. Earnings per common share - assuming
dilution is computed based upon net income divided by the weighted
average number of common shares outstanding during each period adjusted
for the effect of dilutive potential common shares calculated using the
treasury stock method. The following is a reconciliation of the common
shares used in the calculations of earnings per common share and
earnings per common share - assuming dilution:
<TABLE>
<CAPTION>
Per
Income Shares Share
(Numerator) (Denominator) Amount
----------- ------------- ------
<S> <C> <C>
Weighted average common shares outstanding:
For the three months ended September 30, 1998:
Earnings per common share:
Income available to common stockholders................... $(68,347) 4,168,619 $(.02)
-----
Earnings per common share - assuming dilution:
Income available to common stockholders plus assumed
conversions.............................................. $(68,347) 4,168,619 $(.02)
-------- --------- -----
For the three months ended September 30, 1997:
Earnings per common share:
Income available to common stockholders................... $ 10,691 2,680,081 $ NIL
-----
Earnings per common share - assuming dilution:
Options.................................................. -- 1,013,560
Warrants.................................................. -- 59,925
-------- ---------
Income available to common stockholders plus assumed
conversions............................................... $ 10,691 3,753,566 $ NIL
-------- --------- -----
Weighted average common shares outstanding:
For the nine months ended September 30, 1998:
Earnings per common share:
Income available to common stockholders.................... $246,421 4,201,954 $ .06
-----
Earnings per common share - assuming dilution:
Options................................................... -- 336,829
-------- ---------
Income available to common stockholders plus assumed
conversions............................................... $246,421 4,538,783 $ .05
-------- --------- -----
For the nine months ended September 30, 1997:
Earnings per common share:
Income available to common stockholders.................... $132,483 2,489,450 $ .05
-----
Earnings per common share - assuming dilution:
Options................................................... -- 929,597
Warrants.................................................. -- 24,219
-------- ---------
Income available to common stockholders plus assumed
conversions............................................... $132,483 3,443,266 $ .04
-------- --------- -----
</TABLE>
Due to the net loss for the 3 months ended September 30, 1998, all
options and warrants outstanding as of the end of the 3 month period are
antidilutive and are not included in the computation of earnings per
common share - assuming dilution.
Page 9
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
Options to purchase 154,750 shares of common stock ranging from $3.00 to
$6.00 per share were outstanding at September 30, 1998 but were not
included in the computation of earnings per common share - assuming
dilution for the nine months then ended, because the options' exercise
price was greater than the average market price of the common shares
during the period. There were no antidilutive options to purchase
shares of common stock at September 30, 1997.
Warrants to purchase 2,092,211 shares ranging from $3.40 to $5.40 were
outstanding at September 30, 1998, but were not included in the
computation of earnings per common share - assuming dilution for the
nine months then ended, because the warrants' exercise price was greater
than the average market price of the common shares during the period.
There were no antidilutive warrants to purchase shares of common stock
at September 30, 1997.
RECENTLY ISSUED ACCOUNTING STANDARDS - In February 1998, the FASB issued
SFAS No. 132, EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER
POSTRETIREMENT BENEFITS, which revises employers' disclosures about
pension and other postretirement benefit plans. The new statement will
not have any impact on the Company's consolidated financial statements.
In June 1998, the FASB issued SFAS No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES, which establishes accounting and
reporting standards for derivative instruments. The adoption of SFAS
133 would not have any present impact on the Company's consolidated
financial statements. This statement is effective for all fiscal
quarters beginning after June 15, 1999.
INCOME TAXES - The Company uses an asset and liability approach to
account for income taxes. Deferred income taxes are recognized for the
tax consequences of temporary differences and carryforwards by applying
enacted tax rates applicable to future years to differences between the
financial statement amounts and the tax bases of existing assets and
liabilities. A valuation allowance is established if, in management's
opinion, it is more likely than not that some portion of the deferred
tax asset will not be realized.
3. ADDITIONAL TAX LIABILITY
ADDITIONAL TAX LIABILITY - During 1998, in an effort to facilitate the
growth of its distributor network, the Company voluntarily began contacting
all of the state sales and use tax authorities to enter into agreements
with them whereby the Company would assume the responsibility for
collecting and remitting sales and use taxes on behalf of its independent
distributors. Certain states had requirements which resulted in an
addiitonal tax liability for the Company as a condition of entering into
the agreement. The liability has an adverse impact on the Company's
earnings, net of the related tax effect, of $256,300 or $.06 per share.
Management believes the liability is a one time nonrecurring charge
and will have no further adverse impact on the Company's future results
of operations because the ongoing collection and remittance of sales
and use tax presents neither additional income nor additional expense
to the Company but instead is a pass through item with no income
statement effect.
4. STOCKHOLDERS' EQUITY
COMMON STOCK - On March 4, 1998, the Company announced that it intends
to repurchase up to $1 million of the Company's Common Stock in the open
market for cash. In connection with such repurchase, the Company filed
with the Securities and Exchange Commission pursuant to Section 13(e)(1)
of the Securities Exchange Act of 1934, as amended, an Issuer Tender
Offer Statement on March 4, 1998. As of September 30, 1998, the Company
has repurchased 102,000 shares of the Common Stock at a total cost of
$306,993. The additional number of shares of the Common Stock that may
be purchased by the Company
Page 10
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
is not determinable as of September 30, 1998 and will depend upon a
number of factors, including the market price of the Common Stock and
the amount of funds utilized for repurchase on each date of repurchase.
The Company's policy is to retain earnings to support the expansion of
its operations. The Board of Directors of the Company does not intend
to pay cash dividends on the Common Stock in the foreseeable future.
Any future cash dividends will depend on future earnings, capital
requirements, the Company's financial condition and other factors deemed
relevant by the Board of Directors.
COMMON STOCK OPTIONS AND OTHER WARRANTS- The following table summarizes
the Company's stock option and other warrants activity for the three months
and nine months ended September 30, 1998:
<TABLE>
<CAPTION>
THREE WEIGHTED- NINE WEIGHTED-
MONTHS ENDED AVERAGE MONTHS ENDED AVERAGE
SEPTEMBER 30, EXERCISE SEPTEMBER 30, EXERCISE
1998 PRICE 1998 PRICE
------------- --------- ------------- ---------
<S> <C> <C> <C> <C>
Options and other warrants outstanding,
beginning of period................ 1,414,333 $2.30 1,439,583 $2.28
Options granted
during the period.................. 35,000 $2.00 59,750 $2.41
Options exercised
during the period.................. 13,556 $2.70 26,056 $2.36
Options canceled
during the period.................. -- -- 37,500 $2.00
--------- ---------
Options and other warrants outstanding,
end of period....................... 1,435,777 $2.29 1,435,777 $2.29
--------- ---------
--------- ---------
</TABLE>
COMMON STOCK WARRANTS - As of January 8, 1998, the Company reduced the
exercise price of the 1997-A Warrants from $12.00 to $3.40 and extended
the exercise period from January 31, 1999 to November 6, 2002 to make
them correspond more closely to the Redeemable Common Stock Purchase
Warrants. As of January 6, 1998, the exercise price of the Redeemable
Common Stock Purchase Warrants was adjusted from $5.40 to $3.40
representing 120 percent of the average daily closing price of the
Company's common stock for the preceding 20-day period as prescribed in
the prospectus of the Units Offering. There was no expense recognized
in the Company's financial statements relating to either of the warrant
exercise price reductions as the changes only affect allocations of
additional paid-in capital because the warrants were issued in
conjunction with certain of the Company's equity offerings.
5. STOCK OPTION PLAN
During 1995, the Company approved the 1995 Stock Option Plan (the
"Plan"). Under this Plan, options available for grant can consist of
(i) nonqualified stock options, (ii) nonqualified stock options with
stock appreciation rights attached, (iii) incentive stock options, and
(iv) incentive stock options with stock appreciation rights attached.
The Company has reserved 1,125,000 shares of the Company's common stock
$.0001 par value, for the Plan. The Plan limits participation to
employees, independent contractors, and consultants. Nonemployee
directors are excluded from Plan participation. The option price for
shares
Page 11
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
of stock subject to this Plan is set by the Stock Option Committee of
the Board of Directors at a price not less than 85% of the market value
of the stock on the date of grant. No stock options shall be
exercisable within six months from the date of grant, unless under a
Plan exception, nor more than ten years after the date of grant. The
Plan provides for the grant of stock appreciation rights, which allow
the holder to receive in cash, stock or combination thereof, the
difference between the exercise price and the fair value of the stock at
date of exercise. The fair value of stock appreciation rights is
charged to compensation expense. The stock appreciation right is not
separable from the underlying stock option or incentive stock option
originally granted and can only be exercised in tandem with the stock
option. During the year ended December 31, 1997, the Company granted
173,850 net options under the Plan. During the nine months ended
September 30, 1998, the Company granted 59,750 options and had 26,056
options exercised under the Plan. No stock appreciation rights are
attached to any options outstanding. At September 30, 1998, the Company
had 1,435,777 stock options outstanding of which only 220,044 had been
granted pursuant to this plan.
6. COMMITMENTS AND CONTINGENCIES
RECENT REGULATORY DEVELOPMENTS - A significant portion of the Company's
net sales has been, and is expected to continue to be, dependent upon
the Company's AM-300 product. The Company's net sales of AM-300
represented 45.3 percent and 28.9 percent of net sales for the nine
months ended September 30, 1998 and 1997, respectively. One of the
herbal ingredients in AM-300 is ephedra concentrate, which contains
naturally occurring ephedrine. Ephedrine products have been the subject
of adverse publicity in the United States and other countries relating
to alleged harmful effects, including the deaths of several individuals.
Currently, the Company offers AM-300 only in the United States (except
in certain states in which regulations may prohibit or restrict the sale
of such product). On April 10, 1996, the Food and Drug Administration
("FDA") issued a statement warning consumers not to purchase or ingest
natural sources of ephedrine within dietary supplements claiming to
produce certain effects (none of which are claimed for the Company's
product). On June 4, 1997, the FDA proposed a regulation which will, if
it becomes effective as proposed, significantly limit the ability of the
Company to sell AM-300 and any other weight management products which
contain ephedra or ephedrine. If the FDA's proposed regulations were to
become effective, management believes that the impact on the Company's
financial statements would be a significant reduction in sales, cost of
sales and marketing, distribution and administrative expenses and could
result in material losses to the Company, but would not result in a
significant increase in sales returns nor have a significant adverse
effect on financial position.
PRODUCT LIABILITY - The Company, like other marketers of products that
are intended to be ingested, faces an inherent risk of exposure to
product liability claims in the event that the use of its products
results in injury. Historically, the Company has relied upon its
manufacturer's product liability insurance for coverage. The Company
obtained product liability insurance coverage in its own name in 1997.
The limits of this coverage are $4,000,000 per occurrence and $5,000,000
aggregate. The Company generally does not obtain contractual
indemnification from parties manufacturing its products. However, all
of the manufacturers of the Company's products carry product liability
insurance which covers the Company's products. The Company has agreed
to indemnify Tinos, L.L.C., the licensor of Choc-Quilizer, against any
product liability claims arising from the Choc-Quilizer product marketed
by the Company, and the Company has agreed to indemnify Chemins against
claims arising from claims made by the Company's distributors for
products manufactured by Chemins and marketed by the Company. Although
the Company has never had a product liability claim, such claims against
the Company could result in material losses to the Company.
Page 12
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
7. RELATED PARTY TRANSACTION
John W. Hail, Chief Executive Officer and Chairman of the Board of
Directors of the Company, is the sole director and shareholder of the
John Hail Agency, Inc. ("JHA"). Pursuant to an unwritten agreement, the
Company provided office space, utilities and supplies, as well as an
occasional part-time administrative staff person, through June 30, 1996,
to JHA for a monthly payment of $1,000 as reimbursement of the Company's
costs. In addition, the Company made non-interest bearing advances to
JHA of $22,000 and $87,684 during the years ended December 31, 1996 and
1995, respectively. Effective June 30, 1996, the Company adopted a
policy to not make any further advances to JHA, and JHA executed a
promissory note payable to the Company in the principal amount of
$73,964 bearing interest at eight percent perannum and payable in 60
installments of $1,499 per month. During the three months ended
September 30, 1998 and 1997, JHA made repayments of $0 and $4,499,
respectively. During the nine months ended September 30, 1998 and 1997,
JHA made repayments of $54,780 and $13,497, respectively. As of
September 30, 1998 the note has been paid in full.
During 1995, John W. Hail individually entered into lease agreements
coveirng telephone equipment and related software and requiring monthly
rental payments. Such equipment and software are utilized exclusively by
the Company. During the three months ended September 30, 1998 and 1997,
the Company made aggregate monthly payments pursuant to such lease
agreements of $4,856 and $4,856, respectively. During the nine months
ended September 30, 1998 and 1997, the Company made aggregate monthly
payments pursuant to such lease agreements of $14,570 and $14,570,
respectively.
On October 8, 1998, John W. Hail voluntarily surrendered an option to
purchase 100,000 shares of the Company's common stock for $2.70 per
share with an expiration date of May 20, 2007 in exchange for an option
having the same terms other than an exercise price of $1.75 per share of
common stock, which was equal to the fair value of the common stock on
the date of exchange. These options will become exercisable on April 8,
1999.
During the three months ended September 30, 1998 and 1997, the Company
paid Curtis H. Wilson, Sr., a Director of the Company, sales commissions
of $19,292 and $7,815, respectively. During the nine months ended
September 30, 1998 and 1997, the Company paid Curtis H. Wilson, Sr.,
sales commissions of $38,537 and $25,583, respectively. These
commissions were based upon purchases by Mr. Wilson and his downtime
distributors in accordance with the Company's network marketing program
in effect at the time of the sales.
During the first quarter of 1998, the Company agreed to loan John W.
Hail, the Chief Executive Officer and a major shareholder of the
Company, up to $250,000. Subsequently the Company agreed to loan up to
an additional $75,000. The loan is secured, bears interest at eight
percent per annum and is due on March 31, 1999. As of September 30,
1998, the balance due on this loan was $293,936 plus any accrued
interest. The loan was unanimously approved by the Company's board of
directors.
8. PENDING REGISTRATION STATEMENT
On March 11, 1998, the Company filed a Registration Statement, file
number 333-47801, with the Securities and Exchange Commission pursuant
to which the Company is seeking to register 5,000,000 stock purchase
plan participation interests ("Participation Interests") in the
Advantage Marketing Systems, Inc. Distributor Stock Purchase Plan (the
"Plan"). The Participation Interests are also being registered in
accordance with the Oklahoma Securities Act. The Participation Interests
will be offered to the distributors of the Company's products and
services ("Eligible Persons"). An Eligible Person electing to
participate in the Plan (a "Participant") will be entitled through
purchase of the Participation Interests to purchase in the open market
through the Plan, shares of common stock, $.0001 par value per share
(the "Common Stock"), previously issued by the Company. The
Participation Interests are non-transferable; therefore, a market for
the Participation Interests will not develop. The proceeds from sale of
the Participation Interests will become the Participants' contributions
to the Plan which will be used to purchase the Common Stock and will not
be placed into escrow pending purchase of the Common Stock. Other than
an annual service fee of $5.00 per Participant and a transaction fee of
$1.25 per month, the Company will not receive any proceeds from the
purchase of the Common Stock by the Plan. The offering price of each
Participation Interest will be $1.00, and each Eligible Person will be
required initially to purchase a minimum of twenty-five Participation
Interests upon electing to participate in the Plan. There is no minimum
amount of sales of Participation Interests required. As of September 30,
1998, the registration statement has not yet been declared effective.
9. TOPPMED ASSET PURCHASE
On July 31, 1998, the Company acquired all rights, including
formulations and trademarks, for the ToppFast, ToppStamina and ToppFitt
products from ToppMed, Inc. of Los Angeles, California for a total
purchase price of $192,000 which was paid at closing.
* * * * * *
Page 13
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company's business over the last three years has been significantly
affected by the 1996 MMI Acquisition, the 1997 CII Acquisition and the 1997
SNSI Asset Purchase. As a result of these acquisitions, the Company acquired
6,790 distributors and added 114 products to its product line. In 1998, the
Company acquired the assets of ToppMed, Inc. and added one product to its
product line.
MMI ACQUISITION. Effective May 31, 1996, the Company acquired all of the
outstanding capital stock of MMI, and MMI became a wholly-owned subsidiary of
the Company. MMI was a network marketer of various third-party manufactured
nutritional supplement products. In connection with the MMI Acquisition, the
Company issued to the shareholders of MMI 20,000 shares of Common Stock. The
Company added one product to its line and 1,690 additional distributors as a
result of the MMI Acquisition.
CII ACQUISITION. Effective January 31, 1997, the Company acquired all of the
issued and outstanding capital stock of CII, and CII became a wholly-owned
subsidiary of the Company. CII was a network marketer of various third-party
manufactured cosmetics, skin care and hair care products. In connection with
the CII Acquisition, the Company issued 6,482 shares of Common Stock to the
shareholders of CII at closing and issued an additional 7,518 shares of
Common Stock to the shareholders of CII on March 31, 1997, after
determination of certain liabilities. The Company added 74 products to its
line, 68 in the personal care category and six in the dietary supplement
category, and 2,100 additional distributors as a result of the CII
Acquisition.
SNSI ASSET PURCHASE. The Company purchased all of the assets, including the
network marketing organizations, of Stay 'N Shape International, Inc.,
Solution Products International, Inc., Nation of Winners, Inc., and Now
International, Inc. pursuant to an Asset Purchase Agreement dated April 16,
1997. In connection with the SNSI Asset Purchase, the Company paid cash of
$1,174,441 and issued 125,984 shares of Common Stock at closing and agreed to
either issue additional shares of the Company's Common Stock having an
aggregate market value equal to, or make a cash payment of, or combination
thereof, $750,000 and $1,050,000 on or before June 29, 1998, and May 30,
1999, respectively, subject to reduction for variance from specified sales
targets, which will be accounted for as purchase price adjustments under the
purchase method of accounting. As of June 29, 1998 the specified sales
requirement had not been met, therefore the $750,000 installment payment was
reduced to zero and no payment was required. Based upon current sales levels
the Company believes that the $1,050,000 installment payment will be reduced
to zero and no payment will be required. As a result of the SNSI Asset
Purchase, the Company added 39 products to its line, 38 in the weight
management and dietary supplement categories and one in the personal care
category, and 3,000 additional distributors.
TOPPMED ASSET PURCHASE. On July 31, 1998, the Company acquired all rights,
including formulations and trademarks, for the ToppFast, ToppStamina and
ToppFitt products from ToppMed, Inc. ("TI") of Los Angeles, California for a
total purchase price of $192,000 which was paid at closing.
The following discussion and analysis presents the consolidated results of
operations of the Company and MMI since completion of the MMI Acquisition on
May 31, 1996, and of the Company and CII since completion of the CII
Acquisition on January 31, 1997, and gives effect to the SNSI Asset Purchase
and the ToppMed Asset Purchase, since their consummation on April 16, 1997
and July 31, 1998, respectively.
RESULTS OF OPERATIONS
The following table sets forth, as a percentage of net sales, selected
results of operations for the three months and the nine months ended
September 30, 1998 and 1997, which are derived from the unaudited
consolidated financial statements of the Company. The results of operations
for the periods presented are not necessarily indicative of the Company's
future operations.
Page 14
<PAGE>
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------------------- -----------------------------------------
1998 1997 1998 1997
------------------- ------------------- ------------------- -------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
---------- ------- ---------- ------- ---------- ------- ---------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net sales................... $3,630,912 100.0% $2,889,906 100.0% $9,500,936 100.0% $7,635,321 100.0%
Cost of sales............... 2,472,539 68.1 2,057,733 71.2 6,263,775 65.9 5,472,819 71.7
---------- ------- ---------- ------- ---------- ------- ---------- -------
Gross profit............ 1,158,373 31.9 832,173 28.8 3,237,161 34.1 2,162,502 28.3
Marketing, distribution
and administrative
expenses................. 920,407 25.3 818,616 28.3 2,671,332 28.1 1,957,755 25.6
---------- ------- ---------- ------- ---------- ------- ---------- -------
Income from operations.... 237,966 6.6 13,557 0.5 565,829 6.0 204,747 2.7
Other income (expense):
Interest, net............... 74,273 2.0 803 0.0 213,509 2.2 1,810 0.0
Other income (expense)...... (1,238) 0.0 3,188 0.1 39,482 0.4 7,303 0.1
Settlement of additional
tax liability ............ (421,623) (11.6) -- -- (421,623) (4.4) -- --
---------- ------- ---------- ------- ---------- ------- ---------- -------
Total other income
(expense)................. (348,588) (9.6) 3,991 0.1 (168,632) (1.8) 9,113 0.1
---------- ------- ---------- ------- ---------- ------- ---------- -------
Income (loss) before
income tax................ (110,622) (3.0) 17,548 .6 397,197 4.2 213,860 2.8
Tax expense (benefit) ...... (42,275) (1.2) 6,857 0.2 150,776 1.6 81,377 1.1
---------- ------- ---------- ------- ---------- ------- ---------- -------
Net income (loss)........... $ (68,347) (1.8%) $ 10,691 0.4% $ 246,421 2.6% $ 132,483 1.7%
---------- ------- ---------- ------- ---------- ------- ---------- -------
---------- ------- ---------- ------- ---------- ------- ---------- -------
</TABLE>
The following table sets forth, as a percentage of net sales, cost of sales
detail for the three months and the nine months ended September 30, 1998 and
1997, which are derived from the unaudited consolidated financial statements
of the Company.
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------------------- -----------------------------------------
1998 1997 1998 1997
------------------- ------------------- ------------------- -------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
---------- ------- ---------- ------- ---------- ------- ---------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Commissions and bonus....... $1,468,286 40.4% $1,255,679 43.4% $3,815,454 40.2% $3,456,360 45.3%
Cost of products............ 899,610 24.8 661,695 22.9 2,151,645 22.6 1,679,843 22.0
Cost of shipping............ 104,643 2.9 140,359 4.9 296,676 3.1 336,616 4.4
---------- ------- ---------- ------- ---------- ------- ---------- -------
Cost of sales........... $2,472,539 68.1% $2,057,733 71.2% $6,263,775 65.9% $5,472,819 71.7%
---------- ------- ---------- ------- ---------- ------- ---------- -------
---------- ------- ---------- ------- ---------- ------- ---------- -------
</TABLE>
During the three months and nine months ended 1998 and 1997, the Company
experienced increases in net sales compared to the preceding year. The
increases were principally the result of expansion of the Company's network
of independent distributors and additions to the Company's product line
within the weight management, dietary supplement and personal care
categories. The Company expects to continue to expand its network of
independent distributors, which may result in increased sales volume.
However, there is no assurance that increased sales volume will be achieved
through expansion of the Company's network of independent distributors, or
that, if sales volume increases, the Company will realize increased
profitability.
COMPARISON OF THE THREE MONTH PERIODS ENDED SEPTEMBER 30, 1998 AND 1997
Net sales during the three months ended September 30, 1998, increased by
$741,006, or 25.6 percent, to $3,630,912 from $2,889,906 during the three
months ended September 30, 1997. The increase was principally attributable to
expansion of the Company's network of independent distributors and increased
sales of the Company's weight management, dietary supplement and personal
care products. During the three months ended September 30, 1998, the Company
made aggregate net sales of $3,582,049 to 19,480 distributors, compared to
aggregate net sales during the same period in 1997 of $2,855,000 to 12,400
distributors. Sales per distributor per month decreased from $77 to $61 for
the three months ended September 30, 1998, compared to the same period in
1997.
Cost of sales during the three months ended September 30, 1998, increased by
$414,806 or 20.2 percent, to $2,472,539 from $2,057,733 during the same
period in 1997. This increase was attributable to (i) an increase of $212,607
in distributor commissions and bonuses due to the increased level of sales,
(ii) an increase of $237,915 in the cost of products sold due to the
increased level of sales and the increased quality of marketing tools made
available and (iii) a decrease of $35,716 in shipping costs due to the pass
through of shipping costs to the distributors beginning in February 1998.
Total cost of sales, as a percentage of net sales, decreased to 68.1 percent
during the three months ended September 30, 1998, from 71.2 percent during
the same period in 1997 due to a
Page 15
<PAGE>
decrease in distributor commissions and bonuses as a percentage of net sales
to 40.4 percent from 43.5 percent, an increase in cost of products sold to
24.8 percent of net sales from 22.9 percent and a decrease in cost of
shipping to 2.9 percent of net sales from 4.9 percent. During periods of
growth, the Company has and it is anticipated will continue to offer
promotions to distributors to increase sales and their income from time to
time, which if successful will result in increases in distributor commissions
and bonuses and temporary increases in cost of sales.
The Company's gross profit increased $326,200, or 39.2 percent, to $1,158,373
for the three months ended September 30, 1998 from $832,173 for the same
period in 1997. The gross profit increased as a percentage of net sales to
31.9 percent of net sales from 28.8 percent. The increase in the Company's
gross profit margin resulted from the decrease in cost of sales as a
percentage of net sales.
Marketing, distribution and administrative expenses increased $101,791, or
12.4 percent, to $920,407 during the three months ended September 30, 1998,
from $818,616 during the same period in 1997. This increase was attributable
to (i) an increase in expenses involved in expanding investor awareness of
the Company, (ii) increased utilization of contract labor resources due to
increased levels of activity, (iii) increased promotional expense designed to
increase sales and (iv) an increase in lease expense from the addition of
10,340 square feet of warehouse and distribution space in October 1997. The
balance of the increase in marketing, distribution and administrative
expenses resulted from the higher level of activity and corresponding
increases in variable costs, such as postage, bank card service charges and
supplies.
Other income (expense) decreased by $352,579 or 8,834.4 percent, to a net
expense of $(348,588) during the three months ended September 30, 1998 from
$3,991 during the same period in 1997. The decrease was attributable to the
one time expense of the settlement of additional tax liability of $421,623
($256,300 net of the related tax effect). During 1998, in an effort to
facilitate the growth of its disributor network the Company voluntarily began
contacting all of the state sales and use tax authorities to enter into
agreements with them whereby the Company would assume the responsibility for
collecting and remitting sales and use taxes on behalf of its independent
distributors. Certain states had requirements which resulted in an additional
tax liability for the Company as a condition of entering into the agreement.
Management believes the liability is a one-time nonrecurring charge and
will have no further adverse impact on the Company's future results of
operations because the ongoing collection and remittance of sales and use tax
represents neither additional income nor additional expense to the Company
but instead is a pass through item with no income statement effect.
Income (loss) before taxes decreased by $128,170, or 730.4 percent, to a loss
of $(110,622) during the three months ended September 30, 1998, from $17,548
during the same period in 1997. Income before taxes as a percentage of net
sales decreased to a loss of (3.0) percent during the three months ended
September 30, 1998, from .6 percent during the same period in 1997, primarily
as a result of an increase of other expenses due to the one time expense of
the settlement of additional tax liability of $421,623 ($256,000 net of the
related tax effect) for the three months ending September 30, 1998. The
Company recognized a tax benefit during the three months ended September 30,
1998 to adjust year to date income tax expense to the Company's annualized
estimate. Income tax expense (benefit) during the three months ended
September 30, 1998 and 1997 was $(42,275) and $6,857 respectively.
Net income (loss) decreased by $79,038 or 739.3 percent, to a loss of
$(68,347) during the three months ended September 30, 1998, from $10,691
during the same period in 1997. This decrease in net income was primarily
the result of the increase in other expenses due to the one time expense of
the settlement of additional tax liability of $421,623 ($256,000 net of the
related tax effect) offset by the increase in Company's gross profit margin
for the three months ending September 30, 1998. Net income (loss) as a
percentage of net sales decreased to a loss of (2.0) percent during the three
months ended September 30, 1998, from .4 percent during the same period in 1997.
COMPARISON OF THE NINE MONTH PERIODS ENDED SEPTEMBER 30, 1998 AND 1997
Net sales during the nine months ended September 30, 1998, increased by
$1,865,615, or 24.4 percent, to $9,500,936 from $7,635,321 during the nine
months ended September 30, 1997. The increase was principally attributable
to expansion of the Company's network of independent distributors and
increased sales of the Company's weight management, dietary supplement and
personal care products. Through the CII Acquisition (which was consummated
on January 31, 1997) and the SNSI Asset Purchase (which was consummated on
April 16, 1997), the Company added 113 products to its product line and
acquired 5,100 distributors. The distributors acquired in connection with
the CII Acquisition and the SNSI Asset Purchase contributed $568,287 to the
increase between the two periods. During the nine months ended September 30,
1998, the Company made aggregate net sales of $9,392,614 to 26,483
distributors, compared to aggregate net sales during the same period in 1997
of $7,529,749 to 17,309 distributors. Sales per distributor per month
decreased from $48 to $39 for the nine months ended September 30, 1998,
compared to the same period in 1997.
Page 16
<PAGE>
Cost of sales during the nine months ended September 30, 1998, increased by
$790,956, or 14.5 percent, to $6,263,775 from $5,472,819 during the same
period in 1997. This increase was attributable to (i) an increase of $359,094
in distributor commissions and bonuses due to the increased level of sales,
(ii) an increase of $471,802 in the cost of products sold due to the
increased level of sales and the increased quality of marketing tools made
available and (iii) a decrease of $39,940 in shipping costs due to the
increased level of sales combined with the pass through of shipping costs to
the distributors beginning in February 1998. Total cost of sales, as a
percentage of net sales, decreased to 65.9 percent during the nine months
ended September 30, 1998, from 71.7 percent during the same period in 1997
due to a decrease in distributor commissions and bonuses as a percentage of
net sales to 40.2 percent from 45.3 percent, an increase in cost of products
sold to 22.6 percent of net sales from 22.0 percent and a decrease in cost of
shipping to 3.1 percent of net sales from 4.4 percent. During periods of
growth, the Company has and it is anticipated will continue to offer
promotions to distributors to increase sales and their income from time to
time, which if successful will result in increases in distributor commissions
and bonuses and temporary increases in cost of sales.
The Company's gross profit increased $1,074,659 or 49.7 percent, to
$3,237,161 for the nine months ended September 30, 1998 from $2,162,502 for
the same period in 1997. The gross profit increased as a percentage of net
sales to 34.1 percent of net sales from 28.3 percent. The increase in the
Company's gross profit margin resulted from the decrease in cost of sales as
a percentage of net sales.
Marketing, distribution and administrative expenses increased $713,577, or
36.4 percent, to $2,671,332 during the nine months ended September 30, 1998,
from $1,957,755 during the same period in 1997. This increase was
attributable to (i) increased promotional expense designed to increase
sales, (ii) an increase in expenses involved in expanding investor awareness
of the Company, (iii) increased payroll and employee costs related to cost of
living and employee mix and99 (iv) an increase in lease expense from the
addition of 10,340 square feet of warehouse and distribution space in
October, 1997. The balance of the increase in marketing, distribution and
administrative expenses resulted from the higher level of activity and
corresponding increases in variable costs, such as postage, telephone, bank
card service charges, and supplies.
Other income (expense) decreased by $177,745 or 1,950.5 percent to a net
expense of $(168,632) during the nine months ended September 30, 1998 from
$9,113. The decrease was attributable to the one time expense of the
settlement of the additional tax liability of $421,623 ($256,300 net of the
related tax effect). During 1998, in an effort to facilitate the growth of
its disributor network the Company voluntarily began contacting all of the
state sales and use tax authorities to enter into agreements with them
whereby the Company would assume the responsibility for collecting and
remitting sales and use taxes on behalf of its independent distributors.
Certain states had requirements which resulted in an additional tax liability
for the Company as a condition of entering into the agreement. Management
believes the liability is a one-time nonrecurring charge and will have no
further adverse impact on the Company's future results of operations because
the ongoing collection and remittance of sales and use tax represents neither
additional income nor additional expense to the Company but instead is a pass
through item with no income statement effect.
Income before taxes increased $183,337, or 85.7 percent, to $397,197 during
the nine months ended September 30, 1998, from $213,860 during the same
period in 1997. Income before taxes as a percentage of net sales increased
to 4.2 percent during the nine months ended September 30, 1998, from 2.8
percent during the same period in 1997, primarily due to the increase in the
Company's gross profit margin and offset by the increase of other expenses
due to the one time expense of the settlement of the additional tax liability
of $421,623 ($256,000 net of the related tax effect). Income taxes during
the nine months ended September 30, 1998 and 1997 were $155,744 and $81,377
respectively.
Net income increased $113,938, or 86.0 percent, to $246,421 during the nine
months ended September 30, 1998, from $132,483 during the same period in
1997. This increase in net income was primarily the result of the increase
in the Company's gross profit margin and offset by the increase of other
expenses due to the one time expense of the settlement of the additional tax
liability of $421,623 ($256,000 net of the related tax effect). Net income as
a percentage of net sales increased to 2.6 percent during the nine months
ended September 30, 1998, from 1.7 percent during the same period in 1997.
SEASONALITY
No pattern of seasonal fluctuations exists due to the growth patterns that
the Company is currently experiencing. However, there can be no assurance
that the Company will not become subject to seasonal fluctuations in
operations.
COMMITMENTS AND CONTINGENCIES
RECENT REGULATORY DEVELOPMENTS - A significant portion of the Company's net
sales has been, and is expected to continue to be, dependent upon the
Company's AM-300 product. The Company's net sales of AM-300 represented
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45.3 percent and 28.9 percent of net sales for the nine months ended
September 30, 1998 and 1997, respectively. One of the herbal ingredients in
AM-300 is ephedra concentrate, which contains naturally occurring ephedrine.
Ephedrine products have been the subject of adverse publicity in the United
States and other countries relating to alleged harmful effects, including the
deaths of several individuals. Currently, the Company offers AM-300 only in
the United States (except in certain states in which regulations may prohibit
or restrict the sale of such product). On April 10, 1996, the Food and Drug
Administration ("FDA") issued a statement warning consumers not to purchase
or ingest natural sources of ephedrine within dietary supplements claiming to
produce certain effects (none of which are claimed for the Company's
product). On June 4, 1997, the FDA proposed a regulation which will, if it
becomes effective as proposed, significantly limit the ability of the Company
to sell AM-300 and any other weight management products which contain ephedra
or ephedrine. If the FDA's proposed regulations were to become effective,
management believes that the impact on the Company's financial statements
would be a significant reduction in sales, cost of sales and marketing,
distribution and administrative expenses and could result in material losses
to the Company, but would not result in a significant increase in sales
returns nor have a significant adverse effect on financial position.
PRODUCT LIABILITY - The Company, like other marketers of products that are
intended to be ingested, faces an inherent risk of exposure to product
liability claims in the event that the use of its products results in injury.
Historically, the Company has relied upon its manufacturer's product
liability insurance for coverage. The Company obtained product liability
insurance coverage in its own name in 1997. The limits of this coverage are
$4,000,000 per occurrence and $5,000,000 aggregate. The Company generally
does not obtain contractual indemnification from parties manufacturing its
products. However, all of the manufacturers of the Company's products carry
product liability insurance which covers the Company's products. The Company
has agreed to indemnify Tinos, L.L.C., the licensor of Choc-Quilizer, against
any product liability claims arising from the Choc-Quilizer product marketed
by the Company, and the Company has agreed to indemnify Chemins against
claims arising from claims made by the Company's distributors for products
manufactured by Chemins and marketed by the Company. Although the Company
has never had a product liability claim, such claims against the Company
could result in material losses to the Company.
CHOC-QUILIZER AGREEMENT - In the event that the Company fails to achieve the
required contractual sales volumes provided for in the marketing agreement
with Tinos, LLC, the Company will need to (i) renegotiate the marketing
agreement or (ii) give up its marketing rights to Choc-Quilizer. The Company
does not believe that loss of the marketing rights to Choc-Quilizer will have
a material adverse effect on the Company's results of operations, financial
condition or liquidity.
YEAR 2000 COMPUTER SYSTEM COMPLIANCE
The Company has two primary computer systems both of which were developed
employing six digit date structures. Where date logic requires the year 2000
or beyond, such structures may produce inaccurate results. Management has
substantially completed the implementation of a program to comply with year
2000 requirements on a system-by-system basis including information
technology ("IT") and non-IT systems (e.g., microcontrollers). Management
expects the program to be completed during 1999 at which time the Company's
computer systems are expected to be year 2000 compliant.
Management has evaluated its in-house supported IT systems and has identified
certain internally written IT System programs that have date dependent
calculations or operations that are affected by this six digit date
structure. The Company's vendor-supported IT system has been updated and
certified year 2000 compliant by the vendor. Non-IT systems including all
personal computers will be evaluated by a third party contractor, updated if
necessary, and certified as compliant during 1999. The Company's risks
associated with the year 2000 are mainly its ability to communicate with its
distributors, take orders for the shipment of products and pay its employees,
distributors and vendors. Although management's evaluation is complete and
vendor certifications are being obtained, a failure of the Company's computer
systems or other support systems to function adequately with respect to year
2000 issues could have a material adverse effect on the Company's operations.
Based on progress to date and the limited instances of date sensitive
calculations, the Company has concluded that there is no need for a
contingency plan; therefore such plan has not been developed. The Company
estimates that the total cost of its program to make the Company's computer
systems year 2000 compliant is less than $25,000, however, the Company has
not obtained independent verification or validation to assure the reliability
of its cost estimate.
The Company is in the early process of contracting its major suppliers to
determine if their systems will be year 2000 compliant on a timely basis. In
the event that the Company experiences product unavailability or supply
interruptions due to year 2000 non-compliance by its suppliers, management
believes that it would be able to obtain alternative sources of its products.
A significant delay or reduction in availability of products, however, could
also have a material adverse effect on the Company's operations.
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LIQUIDITY AND CAPITAL RESOURCES
Prior to completion of the offerings described below, the Company's primary
source of liquidity was net cash provided by operating activities and
stockholder loans. The Company does not have any significant outside
debt-based liquidity sources.
At September 30, 1998, the Company had working capital of $5,750,711,
compared to $6,143,041 at December 31, 1997. Management believes that its
cash and cash equivalents and cash flows from operating activities will be
sufficient to fund its working capital needs over the next 12 months. During
the nine months ended September 30, 1998, net cash provided by operating
activities was $1,229,836, net cash used in investing activities was
$880,055, and net cash used in financing activities was $544,635. This
represented an average monthly positive cash flow from operating activities
of $136,648. The Company had a net decrease in cash during this period of
$194,854. The Company's working capital needs over the next 12 months consist
primarily of marketing, distribution and administrative expenses and the
repurchase of common stock.
On March 4, 1998, the Company announced that it intends to repurchase up to
$1 million of its common stock in the open market for cash. In connection
with such repurchase, the Company filed with the Securities and Exchange
Commission pursuant to Section 13(e)(1) of the Securities Exchange Act of
1934, as amended, an Issuer Tender Offer Statement on March 4, 1998. As of
September 30, 1998, the Company had repurchased 102,000 shares of its common
stock. The additional number of shares of its common stock that may be
purchased by the Company is not determinable as of September 30, 1998 and
will depend upon a number of factors, including the market price of its
common stock and the amount of funds utilized for repurchase on each date of
repurchase.
During the first quarter of 1998, the Company agreed to loan John W. Hail,
the Chief Executive Officer and a major shareholder of the Company, up to
$250,000. Subsequently the Company agreed to loan up to an additional
$75,000. The loan is secured, bears interest at eight percent per annum and
is due on March 31, 1999. As of September 30, 1998, the balance due on this
loan was $293,936 plus interest. The Company believes that the terms of the
loan are comparable with those that could have been obtained from an
unaffiliated lender and the loan was unanimously approved by the Company's
board of directors.
The Company made non-interest bearing advances to the John Hail Agency, Inc.
("JHA"), a company controlled by the Chief Executive Officer of $22,000 and
$87,684 during the years ended December 31, 1996 and 1995, respectively.
During the years ended December 31, 1997 and 1996, JHA made repayments to the
Company of $13,042 and $6,141 respectively. Effective June 30, 1996, the
Company adopted a policy to not make any further advances to JHA, and JHA
executed a promissory note payable to the Company with a principal balance of
$73,964, bearing interest at eight percent per annum and payable in 60
installments of $1,499 per month. As of September 30, 1998 the note has been
paid in full.
On November 12, 1997, the Company sold 1,495,000 shares of Common Stock and
1,495,000 Redeemable Common Stock Purchase Warrants in units consisting of
one share of Common Stock and one Redeemable Common Stock Purchase Warrant
from which the Company received proceeds of $6,050,000. Accumulated offering
costs of approximately $720,000 were charged against the proceeds of the
offering. As of January 6, 1998, the exercise price of the Redeemable Common
Stock Purchase Warrants was adjusted from $5.40 to $3.40 representing 120
percent of the average daily closing price of the Company's Common Stock for
the preceding 20 day period as prescribed in the prospectus of the Units
Offering. The Redeemable Common Stock Purchase Warrants are exercisable to
purchase one share of common stock for $3.40 on or before November 6, 2002.
In connection with the Units Offering, the Company sold to Paulson Investment
Company, Inc. and Joseph Charles & Assoc., Inc., the representatives of
underwriters of the Units Offering, warrants exercisable for the purchase of
130,000 Units for $5.40 per Unit (the "Underwriters' Warrants") after November
6, 1998, and on or before November 6, 2002.
On January 31, 1997, the Company distributed, at no cost, 2,148,191
non-transferable rights ("Rights") to its shareholders of record on such
date. Each of the Rights entitled the holder to purchase one unit
(consisting of one share of Common Stock and one 1997-A Warrant) on or before
March 17, 1997 for $6.80 per unit (the "Rights Offering"). Concurrently with
the Rights Offering, the Company redeemed its outstanding Class A and Class B
Common Stock Purchase Warrants (the "Public Warrants") for $.0008 per warrant
(the "Warrant Redemption") effective on March 17, 1997. In connection with
the Warrant Redemption, the Company modified the terms of the
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Public Warrants and offered to holders of the Public Warrants (the "Warrant
Holders") the right to exercise each of the Public Warrants for the purchase
of one unit (consisting of one share of Common Stock and one 1997-A Warrant),
at an exercise price of $6.00 per unit (the "Warrant Modification Offering").
Proceeds to the Company from the Warrant Modification Offering and the
Rights Offering (the "Offerings") were $2,154,357. Accumulated offering
costs of $323,076 were charged against the proceeds of the Offerings.
Pursuant to the Offerings, the Company issued in units 337,211 shares of
Common Stock and 337,211 1997-A Warrants. As of January 8, 1998, the Company
reduced the exercise price of the 1997-A Warrants from $12.00 to $3.40 and
extended the exercise period from January 31, 1999 to November 6, 2002 to
make them correspond more closely to the Redeemable Common Stock Purchase
Warrants.
In connection with the SNSI Asset Purchase, the Company agreed to make
installment purchase price payments of $750,000 and $1,050,000 by June 29,
1998 and May 30, 1999, respectively, either by deliveries of additional
shares of the Company's Common Stock or by cash payments or any combination
thereof, which will be accounted for as purchase price adjustments under the
purchase method of accounting. The $750,000 installment payment was to be
reduced by the aggregate amount that gross revenues, net of returns and
allowances, during the 12-month period ended April 30, 1998, from (i) sales
(other than sales of Choc-Quilizer) of the purchased network marketing
organization, sales to Market America, Inc. (an unrelated network marketing
company) and sales to retail outlet stores, are less than $2,500,000 and (ii)
the Company's sales of Choc-Quilizer are less than $4,000,000 during such
12-month period. As of September 30, 1998 the specified sales requirement
had not been met, therefore the $750,000 installment payment was reduced to
zero and no payment was required. Furthermore, the $1,050,000 installment
payment shall also be reduced by the aggregate amount that gross revenues,
net of returns and allowances, during the 12-month period ended March 31,
1999, from such sales are less than $5,000,000 and less than $8,000,000,
respectively, during such 12-month period. Based upon current sales levels
the Company believes that the $1,050,000 installment payment will be reduced
to zero and no payment will be required. The value of the Common Stock to be
issued and delivered, if any, will be based upon the average of the closing
prices of the Common Stock on the last three trading days of the month
preceding the month in which the applicable 12-month period ends.
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PART II. OTHER INFORMATION
- -------------------------------------------------------------------------------
Item 1. LEGAL PROCEEDINGS
None
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
RECENT SALES OF UNREGISTERED SECURITIES
On July 21, 1998, the Company sold 13,556 unregistered shares of Common
Stock to P. Shirley and 31,250 unregistered shares to R. Sanders pursuant to
exercise of stock options. Both P. Shirley and R. Sanders are employees of
the Company. The exercise price of the stock options was paid by delivery of
Common Stock of the Company pursuant to cashless exercise provisions of the
stock options. The exercise price or consideration for purchase of the
shares of Common Stock was paid in shares of the Company's Common Stock
pursuant to cashless exercise provisions of the respective stock option
agreements. As a result of the cashless exercise, the Company did not
receive any proceeds from sale of the Common Stock.
The Common Stock purchased by P. Shirley and R. Sanders was sold
pursuant to Rule 506 of Regulation D in connection with the exercise of stock
options. With respect to the foregoing Common Stock sale transactions, the
Company relied on 4(2) of the Securities Act of 1933 and Regulation D for
exemption from the registration requirements of the Securities Act of 1933,
as amended. Prior to purchase of the Common Stock, P. Shirley and R. Sanders
were furnished copies of the Company's most recent Form 10-KSB Annual Report,
Form 10-QSB Quarterly Report and other reports filed with the Commission
during 1998 preceding exercise of the stock options, and P. Shirley and R.
Sanders had the opportunity to verify the information provided.
Additionally, the Company obtained a signed representation from P. Shirley
and R. Sanders in connection with the purchase of the Common Stock of the
intent to acquire such Common Stock for the purpose of investment only, and
not with a view toward the subsequent distribution thereof; the certificates
representing the Common Stock of the Company has been stamped with a legend
restricting transfer of the securities represented thereby, and the Company
has issued stop transfer instructions to U.S. Stock Transfer Inc., the
Transfer Agent for the Common Stock of the Company, concerning all
certificates representing the Common Stock issued in the above-described
transactions.
Item 3. DEFAULTS IN SECURITIES
None
Item 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS
None
Item 5. OTHER INFORMATION
None
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
None
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
REGISTRANT:
ADVANTAGE MARKETING SYSTEMS, INC.
Date: February 10, 1999 By: /s/ ROGER P. BARESEL
-----------------------------------
Roger P. Baresel,
President, Chief Financial
and Accounting Officer
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