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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
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FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For fiscal year ended December 31, 1998
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Commission File Number: 000-22279
ADVANTAGE MARKETING SYSTEMS, INC.
(Exact Name of Registrant as Specified in its Charter)
OKLAHOMA 73-1323256
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2601 NORTHWEST EXPRESSWAY, SUITE 1210W
OKLAHOMA CITY, OKLAHOMA 73112-7293
(Address of principal executive offices)
(405) 842-0131
(Registrant's telephone number)
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Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
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Common Stock, $0.0001 Par Value Boston Stock Exchange
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $0.0001 Par Value
Redeemable Common Stock Purchase Warrants
1997-A Warrants
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
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The aggregate market value of the registrant's common stock, $.0001 par value,
held by non-affiliates of the registrant as of March 26, 1999, was $8,906,160
based on the closing bid price on that date as reported by the National Daily
Quotation Bureau, Inc. As of March 26 1999, 4,141,014 shares of the registrant's
common stock, $.0001 par value, were outstanding.
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ADVANTAGE MARKETING SYSTEMS, INC.
FORM 10-KSB
For the Fiscal Year Ended December 31, 1998
TABLE OF CONTENTS
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Part I.
Item 1. Description of Business............................................ 3
Item 2. Description of Property............................................ 15
Item 3. Legal Proceedings.................................................. 15
Item 4. Submission or Matters to a Vote of Security Holders................ 15
Part II.
Item 5. Market for Common Equity and Related Stockholder Matters........... 16
Item 6. Management's Discussion and Analysis or Plan of Operation.......... 17
Item 7. Financial Statements............................................... 27
Item 8. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure............................................. 27
Part III.
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance With Section 16(a) of the Exchange Act................ 28
Item 10. Executive Compensation............................................. 29
Item 11. Security Ownership of Certain Beneficial Owners and Management..... 31
Item 12. Certain Relationships and Related Transactions..................... 33
Item 13. Exhibits and Reports on Form 8-K................................... 35
SIGNATURES................................................................... 38
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Certain statements under the captions "Item 6. Management's Discussion
and Analysis or Plan of Operation," "Item 1. Description of Business" and
elsewhere in this report 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 and its third party providers to
adequately address year 2000 issues; the ability of the Company and it's third
party providers to adequately address year 2000 issues: 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.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
The Company markets a product line consisting of approximately 100
products in three categories; weight management, dietary supplement and personal
care products through a network marketing organization in which independent
distributors purchase products for resale to retail customers as well as for
their own personal use. The number of the Company's active distributors has
increased from approximately 10,600 at December 31, 1996, and approximately
20,400 at December 31, 1997 to approximately 33,000 at December 31, 1998. An
"active" distributor is one who purchased $50 or more of the Company's products
within the preceding 12 months.
The distributors in the Company's network are encouraged to recruit
interested people to become new distributors of the Company's products. New
distributors are placed beneath the recruiting distributor in the "network" and
are referred to by the Company as being in that distributor's "downline"
organization. The Company's marketing plan is designed to provide incentives for
distributors to build, maintain and motivate an organization of recruited
distributors in their downline organization to maximize their earning potential.
Distributors generate income by purchasing the Company's products at wholesale
prices and reselling them at retail prices. Distributors also earn bonuses on
product purchases generated by the distributors in their downline organization.
See "--Network Marketing."
On an ongoing basis management reviews the Company's product line for
duplication and sales movement and makes adjustments accordingly. As of December
31, 1998, the Company's product line consists of (i) eight weight management
products, (ii) 28 dietary supplement products, (iii) 63 personal care products
consisting primarily of cosmetic and skin care products and (iv) Dial A Doc. The
Company's products are manufactured by various manufacturers pursuant to
formulations developed for the Company and are sold to the Company's independent
distributors located in all 50 states and the District of Columbia. The Company
also sells its personal care products to distributors in Greece who do not use
the Company's network marketing system. See "--Products."
The Company believes that its network marketing system is ideally
suited to marketing weight management, dietary supplement and personal care
products because sales of such products are strengthened by ongoing personal
contact between distributors and their customers. The Company's network
marketing system appeals to a broad cross-section of people, particularly those
looking to supplement family income or who are seeking part-time work.
Distributors are given the opportunity through Company-sponsored events and
training sessions to network with other distributors, develop selling skills and
establish personal goals. The Company supplements monetary incentives with other
forms of recognition in order to motivate distributors further and to foster an
atmosphere of excitement throughout its distributor network.
KEY OPERATING STRENGTHS
The Company believes the source of its success is its support of and
compensation program for its distributors. The Company provides its distributors
with high-quality products and a highly attractive bonus program along with
extensive Company-sponsored training and motivational events and services. The
Company believes that it has established a strong operating platform to support
distributors and facilitate future growth. The key components of this platform
include the following
- quality products, many of which emphasize herbs and other natural
ingredients to appeal to consumer demand for products that
contribute to a healthy lifestyle;
- a compensation program that permits distributors to earn income
from profits on the resale of products and residual income from
reorder bonuses on product purchases within a distributor's
downline organization, as well as to participate in various
non-cash awards, such as vacations offered through promotional
programs;
- a superior communications program that seeks to effectively and
efficiently communicate with distributors by utilizing new
technologies and marketing techniques, as well as motivational
events and training seminars;
- a continual expansion and improvement of the Company's product
line and marketing plan; and
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- employment of computer technology to provide timely and accurate
product order processing, weekly bonus payment processing,
detailed distributor earnings statements and inventory
management.
GROWTH STRATEGY
The Company's growth strategy is to expand its product line and
network of independent distributors to increase sales. An increase in the number
of distributors generally results in increased sales volume, and new products
create enthusiasm among distributors, serve as a promotional tool in selling
other products, and attract new distributors. Since 1995, the Company has
introduced nine new products to its product line in the weight management and
dietary supplement categories. Through the Chambre' International, Inc. ("CII")
Acquisition, in 1997, the Company added 68 products to its product line in the
personal care category and six products to its product line in the dietary
supplement category. Through the Stay 'N Shape International, Inc. ("SNSI")
Asset Purchase which was consummated on April 16, 1997, the Company added 38
products to its product line in the weight management and dietary supplement
categories and one product to its product line in the personal care category.
During 1998, the Company introduced ToppFast and Dial A Doc. In connection with
the 1996 Miracle Mountain, Inc. ("MMI") Acquisition, the CII Acquisition and the
SNSI Asset Purchase, the Company acquired approximately 1,690, 2,100 and 3,000
additional distributors, respectively. See "--Products," "Risk
Factors--Dependence on AM-300," and "Item 6. Management's Discussion and
Analysis or Plan of Operation--General".
The Company will also seek to increase sales through initiatives
designed to enhance sales in its existing markets. Such initiatives will include
increasing the number of Company-sponsored training and motivational events and
teleconferences, hiring additional distributor support personnel and
establishing more convenient Regional Success Centers in targeted geographic
markets.
In addition, the Company will seek to grow through acquisition. The
network marketing industry, which has relatively low barriers to entry, is
fragmented and includes a number of small marketing companies, many of which are
being acquired by larger companies. The Company's strategy is to capitalize on
these market characteristics to achieve additional growth, both in terms of
distributors and product line enhancement, through the acquisition of additional
network marketing companies or the assets of such companies.
The principal objective of the Company's acquisition strategy is to
acquire other network marketing organizations that can be combined with the
Company's network marketing organization, resulting in increased sales volume
with minimal additional administrative cost. The Company will not consummate an
acquisition unless, at the time, it is anticipated that such acquisition will
contribute to profitability and provide positive cash flows from operations.
There can be no assurance, however, that the Company will in the future be able
to acquire other network marketing organizations, or that such acquisitions will
result in increased profitability and cash flows.
The Company's growth strategy will require expanded distributor
services and support, increased personnel, expanded operational and financial
systems and implementation of additional control procedures. There can be no
assurance that the Company will be able to manage expanded operations
effectively. Furthermore, failure to implement financial, information
management, and other systems and to add control procedures could have a
material adverse effect on the Company's results of operations and financial
condition. The Company's acquisitions could involve a number of risks including
the diversion of management's attention to the assimilation of the acquired
companies or assets, adverse short-term effects on the Company's results of
operations, the amortization of acquired intangible assets, and the possibility
that the acquired network marketing organization will not contribute to the
Company's sales, profitability and cash flows, either in the near or long term,
as anticipated.
Although the Company's business plan includes expansion and
enhancement of the Company's network marketing organization and product line
through the acquisition of businesses engaged in network marketing, there are
currently no specific plans, negotiations, agreements or understandings with
respect to any material acquisition.
Although the Company intends to focus principally on the expansion of
sales within the United States, the Company also intends to expand its sales
activities in Greece. In addition, the Company is considering expansion into
markets in other countries, although the Company has not formalized any such
planned expansion as of December 31, 1998. The Company believes there are
numerous additional international markets in which its network marketing
organization and products could prove successful.
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INDUSTRY OVERVIEW
NETWORK MARKETING. The Company believes that network marketing is one
of the fastest growing channels of distribution for certain types of goods and
services.
WEIGHT MANAGEMENT AND DIETARY SUPPLEMENT PRODUCTS. The Company
believes that the weight management and dietary supplement category is expanding
because of heightened public awareness of reports about the positive effects of
weight management and dietary supplements on health. Many individuals also use
dietary supplements as a means of preventative health care. The Company believes
several factors account for the steady growth of the dietary supplement
category, including increased public awareness of the reported health benefits
of dietary supplements and favorable demographic trends toward older Americans
who are more likely to consume dietary supplements.
Over the past several years, widely publicized reports and medical
research findings have suggested a correlation between the consumption of
dietary supplements and the reduced incidence of certain diseases. The United
States government and universities generally have increased sponsorship of
research relating to dietary supplements. In addition, Congress has established
the Office of Alternative Medicine within the National Institutes of Health to
foster research into alternative medical treatments, which may include natural
remedies. Congress also recently established the Office of Dietary Supplements
in the National Institutes of Health to conduct and coordinate research into the
role of dietary supplements in maintaining health and preventing disease.
In addition, the Company believes that the aging of the United States
population, together with a corresponding increased focus on preventative health
care measures, will continue to result in increased demand for dietary
supplement products. The Company believes these trends have helped fuel the
growth of the dietary supplement category. To meet the increased demand for
dietary supplements, a number of successful dietary supplement products have
been introduced over the past several years by the Company and others, including
function specific products for weight loss, sports nutrition, menopause, energy
and mental alertness. In addition, the use of a number of ingredients, such as
chromium picolinate, shark cartilage, proanthocyanidins, citrin and colloidal
minerals, have created opportunities for the Company and others to offer new
products.
PERSONAL CARE PRODUCTS. The Company believes that the personal care
products market is a mature category that has been historically immune to swings
in the economy. Manufacturers and distributors of personal care products must
continually improve existing products, introduce new products and communicate
product advantages to consumers. With the aging population, there appears to be
a growing demand for a wide spectrum of new products in the area of skin care.
PRODUCTS
The Company's product line consists of products in the categories of
weight management, dietary supplements and personal care. The Company currently
markets 100 products, exclusive of variations in product size, colors or similar
variations of the Company's basic product line. Management believes that the
Company has only one operating segment as defined by accounting standards and,
therefore, no segment disclosures are provided.
WEIGHT MANAGEMENT CATEGORY. During the years ended December 31, 1998
and 1997, 55.5 and 36.7 percent, respectively, of the Company's net sales were
derived from the eight products in the weight management category that the
Company markets under its Advantage Marketing Systems label. The following
products represent the majority of the Company's product sales in the weight
management category:
- AM-300--A specialized blend of herbs, including an ephedra herb
concentrate and chromium picolinate.
- AS-200--A specialized blend of herbs and nutrients
in addition to citrin and chromium picolinate.
As a result of the SNSI Asset Purchase, the Company added several
additional products to its product line in the weight management category that
are marketed under its Advantage Marketing Systems or Stay 'N Shape labels,
including Choc-Quilizer. Choc-Quilizer is an appetite suppression product made
from a compound which occurs naturally in chocolate. It was originally developed
by Dr. George Kargas to control chocolate cravings, and is believed by Dr.
Kargas to decrease the appetite for other foods as well.
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DIETARY SUPPLEMENT CATEGORY. During the years ended December 31, 1998
and 1997, 33.9 and 37.7 percent, respectively, of the Company's net sales were
derived from the 28 products in the dietary supplement category which contain
herbs, vitamins, minerals and other natural ingredients. They are sold under the
Advantage Marketing Systems, Stay 'N Shape and Chambre' labels. The following
products represent the majority of the Company's product sales in the dietary
supplement category:
- Shark Cartilage Complex--Manufactured from shark fin
cartilage and a blend of curcumin, boswellin and vanadium.
- Super Anti-Oxidant--A blend of enzyme-active and
phyto-nutrient rich whole food and herbal antioxidant
concentrates including proanthocyanidins.
- Colloidal Plus--A natural assortment of 77
plant-derived colloidal minerals in a time release capsule.
- Chlorella--Fresh water green algae containing amino
acids of protein, nucleic acids, fibers, vitamins and
minerals.
As a result of the SNSI Asset Purchase, the Company has recently added
several additional products to its line in the dietary supplement category that
are being marketed under its Advantage Marketing Systems or Stay 'N Shape
labels, including Formula of Life Colloidal Minerals, Stress-Eze and Spark of
Life.
PERSONAL CARE CATEGORY. In January 1997, the Company dramatically
expanded and improved its product line by acquiring CII and its line of skin
care, hair care, family care and cosmetic products. CII had been marketing its
products for over 24 years. During the years ended December 31, 1998 and 1997,
2.1 and 3.1 percent, respectively, of the Company's net sales were derived from
63 personal care products marketed primarily under the Chambre label in the
personal care category. The following products represent the majority of the
Company's product sales in the personal care category:
- NH2 Lift System--A three-part skin-care system
combining enzymatic exfoliation and isometric action to firm
the skin, build muscle tone and lift the face.
- Skin Care Collections--Include cleansing lotion,
skin freshener, oatmeal scrub, night treatment, moisturizer
and protein or moisture masque.
- Hair Care Systems--Include keratin shampoo,
conditioning rinse, reconstruction, hair hold, and style and
set.
- Chambre Cosmetics--Include foundations, mascara,
lipliners, eyeliners, powder and cream blushes, lip colors and
eyeshadows.
DIAL A DOC. Effective May 1, 1998, the Company began offering the Dial
A Doc service to members of its monthly auto-ship program. Dial A Doc is a 24
hour a day service which allows participants to speak with and ask questions of
board certified, private practice physicians anytime, seven days a week. Members
access the service through a toll-free telephone number and a personal
identification number. During the year ended December 31, 1998, less than one
percent of the Company's net sales were derived from the Dial A Doc service.
PROMOTIONAL MATERIALS. The Company also derives revenues from the sale
of various educational and promotional materials designed to aid its
distributors in maintaining and building their businesses. Such materials
include various sales aids, informational videotapes and cassette recordings,
and product and marketing brochures.
OTHER PRODUCTS AND SERVICES. Prior to focusing on weight management,
dietary supplement and personal care products in October 1993, the Company
marketed various packages of consumer benefit services provided by third-party
providers. The consumer benefit services consist of a discount shopping service,
a grocery coupon service, a discount travel service, pre-paid legal services,
and a variety of other consumer benefits. The services under these consumer
benefit programs, except for the pre-paid legal services, are provided by
Consumer Benefit Services, Inc. The pre-paid legal services are provided by
Pre-Paid Legal Services, Inc. The Company no longer actively markets these
programs, although it continues to maintain the existing memberships. These
program membership sales represented less than one percent of the Company's net
sales for the years ended December 31, 1998 and 1997.
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NEW PRODUCT IDENTIFICATION. The Company expands its product line
through the development and acquisition of new products. New product ideas are
derived from a number of sources, including trade publications, scientific and
health journals, the Company's management, consultants, distributors and other
outside parties. Potential product acquisitions are identified in a similar
manner. Prior to introducing new products, the Company investigates product
formulation as it relates to regulatory compliance and other issues. See
"-Regulation".
The Company does not maintain its own product development staff, but
relies upon Chemins and other manufacturers, independent researchers, vendor
research departments, and others for such services. When a new product concept
is identified or when an existing product must be reformulated, the new product
concept or reformulation project is generally submitted to Chemins for technical
development and implementation. The Company is continually reviewing its
existing products for potential enhancements to improve their effectiveness and
marketability. While the Company considers its product formulations to be
proprietary trade secrets, such formulations are not patented and there can be
no assurance that another company will not replicate one or more of the
Company's products.
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 49.7
percent, 29.5 percent, and 39.1 percent of net sales for the years ended 1998,
1997 and 1996 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. Although the
Company has never had a product liability claim, such claims against the Company
could result in material losses to the Company. See "Risk Factors--Regulation"
and "--Regulation".
PRODUCT PROCUREMENT AND DISTRIBUTION; INSURANCE. Essentially all of
the Company's product line in the weight management and dietary supplement
categories is manufactured by Chemins utilizing the Company's product
formulations. Essentially all of the Company's product line in the personal care
category is manufactured by GDMI, Inc., Custom Cosmetics, Inc. and Columbia
Cosmetics, Inc.
In connection with the SNSI Asset Purchase, the Company succeeded to
the rights and obligations of Nation of Winners International, Inc. under the
Marketing and Distribution Agreement with Tinos, L.L.C. (the "Marketing
Agreement"), pursuant to which the Company acquired the exclusive worldwide
right to market Choc-Quilizer for the purpose of appetite suppression and weight
control through December 6, 2006. The Marketing Agreement is subject to
termination by Tinos, L.L.C. upon 60 days' written notice in the event the
Company does not obtain a sales volume of 300,000 units of 90 count capsules or
caplets of Choc-Quilizer during the period from the date of the license through
December 5, 1998, or reasonable sales volumes during each 12-month period
thereafter. Based upon current sales levels the Company has not met the required
sales volume, however, the Company is in the process of evaluating several
alternatives that should increase the likelihood of the Company meeting the
required sales volume.
The Company has not generally entered into long-term supply agreements
with the manufacturers of its product line or the third-party providers of its
consumer benefit services. However, the Company customarily enters into
contracts with its manufacturers and suppliers to establish the terms and
conditions of purchases. The Company's arrangements with Chemins may be
terminated by either party upon the completion of any outstanding purchase
orders. Therefore, there can be no assurance that Chemins will continue to
manufacture products for the Company or provide research, development and
formulation services. In the event the Company's relationship with any of its
manufacturers becomes impaired, the Company would be required to obtain
alternative sources for its products. In such event, there can be no assurance
that the manufacturing processes of the Company's current manufacturers could be
replicated by another manufacturer. Although the Company has not previously
experienced product unavailability or supply interruptions, the Company believes
that it would be able to obtain alternative sources of its weight management,
dietary supplement and personal care products. A significant delay or reduction
in availability of products, however, could have a material adverse effect on
the Company's business, operating results and financial condition.
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
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manufacturer's product liability insurance for coverage. The Company obtained
product liability insurance coverage in its own name in 1997. The limits on
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.
See "Item 1. Description of Business--Products--Product Procurement and
Distribution."
All of the items in the Company's product line include a customer
satisfaction guarantee. Within 30 days of purchase, any retail customer or
distributor who is not satisfied with a Company product for any reason may
return it or any unused portion to the distributor from whom it was purchased or
to the Company for a full refund or credit toward the purchase of another
Company product. Distributors may obtain replacements from the Company for
products returned to them by retail customers if they return such products to
the Company on a timely basis. Furthermore, in most jurisdictions, the Company
maintains a buy-back program pursuant to which it will repurchase products sold
to a distributor (subject to a 10 percent restocking charge), provided that the
distributor resigns from the Company and returns the product in marketable
condition within 12 months of original purchase, or longer where required by
applicable state law or regulations. The Company believes this buy-back policy
addresses a number of the regulatory compliance issues pertaining to network
marketing systems. For the years ended December 31, 1998 and 1997, the cost of
products returned to the Company was two percent of gross sales.
The Company's product line is distributed principally from the
Company's facilities in Oklahoma City or from its Regional Success Centers.
Products are warehoused in Oklahoma City and at selected Regional Success
Centers.
NETWORK MARKETING
The Company markets its product line through independent distributors
in a network marketing organization, which consists of approximately 33,000
"active" distributors as of December 31, 1998. At December 31, 1997 the Company
had approximately 20,400 "active" distributors compared to approximately 10,600
"active" distributors at December 31, 1996. A distributor is considered "active"
if the distributor purchased $50 or more of the Company's products within the
preceding 12 months. Distributors are independent contractors who purchase
products directly from the Company for resale to retail consumers. Distributors
may elect to work on a full-time or part-time basis. The Company believes that
its network marketing system appeals to a broad cross-section of people,
particularly those seeking to supplement family income, start a home business or
pursue employment opportunities other than conventional, full-time employment,
and that a majority of its distributors therefore work on a part-time basis.
Management believes that its network marketing system is ideally
suited to marketing its product line because sales of such products are
strengthened by ongoing personal contact between retail consumers and
distributors, many of whom use the Company's products themselves. Sales are made
through direct personal sales presentations as well as presentations made to
groups in a format known as "opportunity meetings" which are designed to
encourage individuals to purchase the Company's products by informing potential
customers and distributors of the Company's product line and results of personal
use, and the potential financial benefits of becoming a distributor. The
objective of the marketing program is to develop a broad based network marketing
organization of distributors within a relatively short period. The Company's
marketing efforts are typically focused on middle-income families and
individuals.
The Company's network marketing program encourages individuals to
develop their own downline network marketing organizations. Each new distributor
is linked to an existing distributor that personally enrolled the new
distributor into the Company's network marketing organization or is linked to an
existing distributor in the enrolling distributor's downline as specified by the
enrolling distributor at the time of enrollment. Growth of a distributor's
downline organization is dependent on the recruiting and enrollment of
additional distributors by the distributor or the distributors within such
distributor's downline organization.
Distributors are encouraged to assume responsibility for training and
motivation of other distributors within their downline organization and to
conduct opportunity meetings as soon as they are appropriately trained. The
Company strives to maintain a high level of motivation, morale, enthusiasm and
integrity among the members of its network marketing organization. The Company
believes this result is achieved through a combination of products, sales
incentives, personal recognition of outstanding achievement, and quality
promotional materials. Under the Company's network marketing program,
distributors purchase sales
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aids and brochures from the Company and assume the costs of advertising and
marketing the Company's product line to their customers as well as the direct
cost of recruiting new distributors. The Company believes that this form of
sales organization is cost efficient for the Company because direct sales
expenses are primarily limited to the payment of bonuses, which are only
incurred when products are sold.
The Company continually strives to improve its marketing strategies,
including the compensation structure within its network marketing organization
and the variety and mix of products in its line, to attract and motivate
distributors. These efforts are designed to increase distributors' monthly
product sales and the recruiting of new distributors.
To aid distributors in easily meeting the monthly personal product
purchase requirement to qualify for bonuses, the Company developed the "Q-Club"
in 1994. Under the Q-Club purchasing arrangement, distributors establish a
standing product order for an amount in excess of $50 which is automatically
charged to their credit cards or deducted from their bank accounts each month
prior to shipment of the ordered products. At December 31, 1998, 1997 and 1996,
the Company had 13,000, 7,000 and 3,800 distributors participating in the
Q-Club, respectively.
Growth of the network marketing organization is in part attributable
to the Company's bonus structure which provides for payment of bonuses on
product purchases made by other distributors in a distributor's downline
organization. Distributors derive income from several sources. First,
distributors earn profits by purchasing from the Company's product line at
wholesale prices (which are discounted up to 40 percent from suggested retail
prices) and selling the Company's product line to customers at retail. Second,
distributors who establish their own downline distributor organizations may earn
bonuses of up to 15 percent on product purchases by distributors within the
first four levels of their downline organization. Third, distributors who have
personally enrolled three active distributors and have (i) $300 per month of
Q-Club product purchases by personally enrolled distributors on their first
level and (ii) $300 per month of Q-Club product purchases on their second level,
become Directors and have the opportunity to build an additional Director
downline organization and receive additional bonuses of four percent on product
purchases by such downline organization. Fourth, distributors who have
personally enrolled six active distributors and have (i) $600 per month of
Q-Club product purchases by personally enrolled distributors on their first
level and (ii) $600 per month of Q-Club product purchases on their second level,
become Silver Directors and have the opportunity to build an additional Silver
Director downline organization and receive additional bonuses of five percent on
product purchases by such downline organization. Fifth, Silver Directors who
have personally enrolled twelve active distributors and have (i) $1,200 per
month of Q-Club product purchases by personally enrolled distributors on their
first level and (ii) $1,200 per month of Q-Club product purchases on their
second level, become Gold Directors and have the opportunity to receive an
additional bonus of three percent on product purchases by their Silver Director
downline organization. In addition, Gold Directors have the opportunity to
receive generation bonuses of up to three percent on the product purchases by
distributors of Silver Director downline organizations that originate from their
Silver Director downline organization through four generations. Sixth, Gold
Directors who maintain the Gold Director requirements and develop four Gold
Directors, each one from a separate leg of their downline organization, become
Platinum Directors and have the opportunity to build an additional Platinum
Director downline organization and receive additional bonuses of five percent on
product purchases by such downline organization. Combining these levels of
bonuses, the Company's total "pay-out" on products subject to bonuses is
approximately 67 percent of the bonus value of product sales. However, in the
case of a distributor who is not qualified to receive bonuses (I.E., a
distributor who has not purchased $50 or more of the Company's products during
the preceding month), the bonuses otherwise payable on the first two levels of
those distributors' downline organizations are retained by the Company. Each
distributor in the Company's network marketing organization has a Director, a
Silver Director, a Gold Director and a Platinum Director, and each Director has
a Silver Director, a Gold Director and a Platinum Director, and each Silver
Director has a Gold Director and a Platinum Director, and each Gold Director has
a Platinum Director. As of December 31, 1998, the Company has 98 Silver
Directors, 78 Gold Directors and 11 Platinum Directors.
Under the Company's Regional Success Center Program, the Company, in
its sole discretion, designates distributors to serve as Regional Success Center
Directors, and provides them special training and support. Each Regional Success
Center Director functions as a product distribution center for the Company. As
of December 31, 1998, the Company has 40 Regional Success Center Directors.
The Company maintains a computerized system for processing distributor
orders and calculating bonus payments which enables it to remit such payments
promptly to distributors. The Company believes that prompt and accurate
remittance of bonuses is vital to recruiting and maintaining distributors, as
well as increasing their motivation and loyalty to the Company. The Company
makes bonus payments to its distributors weekly, based upon the previous week's
product purchases, compared to most network marketing companies that only make
monthly bonus payments. During the years ended December 31, 1998, 1997 and 1996,
the
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Company paid bonuses to 5,400, 4,600 and 3,300 distributors, respectively, in
the aggregate amount of $5,487,418, $4,557,355 and $2,727,240, respectively.
The Company is committed to providing the best possible support to its
distributors. Distributors in the Company's network marketing organization are
provided training guides and are given the opportunity to participate in Company
training programs. The Company sponsors regularly scheduled conference calls for
its distributors which include testimonials from successful distributors and
satisfied customers as well as current product and promotional information. The
Company produces a monthly newsletter which provides information on the Company,
its products and network marketing system. The newsletter is designed to help
recruit new distributors by answering commonly asked questions and includes
product information and business building information. The newsletter also
provides a forum for the Company to give additional recognition to its
distributors for outstanding performance. In addition, the Company regularly
sponsors training sessions for its distributors across the United States, at
which distributors are provided the opportunity to learn more about the
Company's product line and selling techniques so that they can build their
businesses more rapidly. The Company produces comprehensive and attractive four
color catalogues and brochures that display and describe the Company's product
line.
Furthermore, in order to facilitate its continued growth and support
distributor activities, the Company continually upgrades its management
information and telecommunications systems. These systems are designed to
provide, among other things, financial and operating data for management, timely
and accurate product ordering, bonus payment processing, inventory management
and detailed distributor records. Since 1994, the Company has invested more than
$900,000 to enhance its computer and telecommunications systems. See
"Management's Discussion and Analysis or Plan of Operation--Year 2000 Computer
System Compliance".
REGULATION
In the United States as well as in any foreign markets in which the
Company may sell its products, the Company will be subject to laws, regulations,
administrative determinations, court decisions and similar constraints (as
applicable, at the federal, state and local levels) (hereinafter "regulations")
including, among others, regulations pertaining to (i) the formulation,
manufacture, packaging, labeling, distribution, importation, sale and storage of
the Company's products, (ii) product claims and advertising (including direct
claims and advertising by the Company as well as claims and advertising by
distributors, for which the Company may be held responsible), and (iii) the
Company's network marketing organization.
PRODUCTS. The formulation, manufacture, packaging, storing, labeling,
advertising, distribution and sale of the Company's products are subject to
regulation by federal agencies, including the Food and Drug Administration (the
"FDA"), the Federal Trade Commission (the "FTC"), the Consumer Product Safety
Commission (the "CPSC"), the United States Department of Agriculture (the
"USDA"), the Environmental Protection Agency (the "EPA") and the United States
Postal Service. The Company's activities are also regulated by various agencies
of the states, localities and foreign countries in which the Company's products
are or may be manufactured, distributed and sold. The FDA, in particular,
regulates the formulation, manufacture and labeling of weight management
products, dietary supplements, cosmetics and skin care products, such as those
distributed by the Company. FDA regulations require the Company and its
suppliers to meet relevant regulatory good manufacturing practices for the
preparation, packaging and storage of these products. Good manufacturing
practices for dietary supplements have yet to be promulgated but are expected to
be proposed. The Dietary Supplement Health and Education Act of 1994 (the
"DSHEA") revised the provisions of the Federal Food, Drug and Cosmetic Act ( the
"FDCA") concerning the composition and labeling of dietary supplements and, the
Company believes, is generally favorable to the dietary supplement industry. The
DSHEA created a new statutory class of "dietary supplements." This new class
includes vitamins, minerals, herbs, amino acids and other dietary substances for
human use to supplement the diet, and the DSHEA grandfathered, with certain
limitations, dietary ingredients that were on the market before October 15,
1994. A dietary supplement which contains a new dietary ingredient (I.E., one
not on the market before October 15, 1994) will require evidence of a history of
use or other evidence of safety establishing that it is reasonably expected to
be safe. Manufacturers of dietary supplements which make a "statement of
nutritional support" must have substantiation that the statement is truthful and
not misleading.
The majority of the Company's sales come from products that are
classified as dietary supplements under the FDCA. The labeling requirements for
dietary supplements have been set forth, in a final rule issued by the FDA on
September 23, 1997, and effective with respect to labels affixed to containers
beginning after March 23, 1999. These final regulations include how to declare
nutrient content information, and the proper detail and format required for the
"Supplemental Facts" box. The new labeling regulations will require the Company
to revise a substantial number of its labels at an undetermined expense to the
Company. Some of the Company's product labels have been revised to be in
compliance with the new regulations in advance of March 23, 1999.
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Many states have also recently become active in the regulation of dietary
supplement products, and may require the Company to modify the labeling or
formulation of certain products sold in those states.
In addition, on April 29, 1998 the FDA published a proposed rule
offering guidance and providing limitations on permissible structure/function
statements (claims as to the benefit or effect of a product or an ingredient
on the body's structure or function) to be placed on labels and in brochures.
Comments on this proposed rule were due by August 27, 1998. The Company
anticipates that at least 80 percent of the rule as proposed will become
final, but this new regulation will not significantly change the way that the
FDA currently interprets structure/function statements. Thus, the Company
does not expect to make any substantial label revisions based on any new
regulation as to structure/function statements.
As a marketer of products that are ingested by consumers, the Company
is subject to the risk that one or more of the ingredients in its products may
become the subject of adverse regulatory action. For example, one of the
ingredients in AM-300 is ephedra, an herb which contains naturally-occurring
ephedrine. The Company's manufacturer uses a powdered extract of that herb when
manufacturing AM-300. The extract is an eight percent extract which means that
every 100 milligrams of the powdered extract contains approximately eight
milligrams of naturally occurring ephedrine alkaloids. Ephedrine containing
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.
Many companies distribute products containing various amounts of
ephedrine. The FDA has received approximately 900 reports of adverse reactions
to these products; on April 10, 1996, the FDA issued a statement warning
consumers not to purchase or ingest dietary supplements containing ephedrine
that are claimed to produce such effects as euphoria, heightened awareness,
increased sexual sensations or increased energy, because these products pose
significant adverse health risks, including dizziness, headache,
gastrointestinal distress, irregular heartbeat, heart palpitations, heart
attack, strokes, seizures, psychosis and death. The Company markets AM-300
principally as an aid in weight management.
On June 4, 1997, the FDA proposed a regulation that will, if it
becomes effective as proposed, significantly limit the ability of the Company to
sell dietary supplements that contain ephedrine, including the Company's AM-300
product. For the years ended December 31, 1998 and 1997, it represented 49.7
percent and 29.5 percent of the Company's net sales, respectively. The proposed
regulation was subject to comment until December 2, 1997. The proposed
regulations will become effective 180 days following its issuance as a final
regulation. Several trade organizations in the dietary supplement industry have
commented on the proposed regulation, requesting substantial modifications. As
of December 31, 1998, it is not possible to predict whether the FDA will make
any material changes to the proposed regulation.
The Company is a member of a non-profit corporation, The Ephedra
Research Foundation (the "Foundation"), which has contracted with a consulting
firm to carry out a clinical study concerning the safety of ephedrine when
ingested in combination with caffeine as a dietary supplement. This study is
currently being conducted at two sites, Beth Israel-Deaconess Medical Center in
Boston, affiliated with Harvard Medical School, and St. Luke's-Roosevelt
Hospital in New York City, affiliated with Columbia University.
In addition, several states either regulate or are considering
regulating ephedrine-containing products as controlled substances or are
prohibiting the sale of such products by persons other than licensed
pharmacists. There is a risk that the Company's AM-300 product may become
subject to further federal, state, local or foreign laws or regulations. These
regulations could require the Company to (i) withdraw or reformulate its AM-300
product with reduced ephedrine levels or with a substitute for ephedra or
ephedrine, (ii) relabel its product with different warnings or revised
directions for use, or (iii) not make certain statements, possibly including
weight loss claims, with respect to any product containing ephedra or ephedrine.
Even in the absence of further laws or regulation, the Company may elect to
reformulate or relabel its AM-300 product containing ephedra or ephedrine. While
the Company believes that its AM-300 product could be reformulated and
relabeled, there can be no assurance that reformulation and relabeling would not
have an adverse effect on sales even though such products or related products
would not contain ephedra or ephedrine. See "--Products--Recent Regulatory
Developments".
In foreign markets, prior to commencing operations and prior to making
or permitting sales of its products, the Company may be required to obtain an
approval, license or certification from the country's ministry of health or
comparable agency. Prior to entering a new market in which a formal approval,
license or certificate is required, the Company will be required to work
extensively with local authorities to obtain the requisite approvals. The
approval process generally requires the Company to present each product and
product ingredient to appropriate regulators and, in some instances, arrange for
testing of products by local
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technicians for ingredient analysis. Such approvals may be conditioned on
reformulation of the Company's products or may be unavailable with respect to
certain products or ingredients.
PRODUCT CLAIMS AND ADVERTISING. The FTC and certain states regulate
advertising, product claims, and other consumer matters, including advertising
of the Company's products. All advertising, promotional and solicitation
materials used by distributors must be approved by the Company prior to use. The
FTC has in the past several years instituted enforcement actions against several
dietary supplement companies for false and misleading advertising of certain
products. In addition, the FTC has increased its scrutiny of the use of
testimonials, such as those utilized by the Company. While the Company has not
been the target of FTC enforcement action, there can be no assurance that the
FTC will not question the Company's advertising or other operations in the
future. In addition, there can be no assurance that a state will not interpret
product claims presumptively valid under federal law as illegal under that
state's regulations, or that future FTC regulations or decisions will not
restrict the permissible scope of such claims. The Company also is subject to
the risk of claims by distributors and customers who may file actions on their
own behalf, as a class or otherwise, and may file complaints with the FTC or
state or local consumer affairs offices. These agencies may take action on their
own initiative against the Company for alleged advertising or product claim
violations or on a referral from distributors, consumers or others. Remedies
sought in such actions may include consent decrees and the refund of amounts
paid by the complaining distributor or consumer, refunds to an entire class of
distributors or customers, or other damages, as well as changes in the Company's
method of doing business. A complaint based on a practice of one distributor,
whether or not that practice was authorized by the Company, could result in an
order affecting some or all distributors in a particular state, and an order in
one state could influence courts or government agencies in other states
considering similar matters. Proceedings resulting from these complaints may
result in significant defense costs, settlement payments or judgements and could
have a material adverse effect on the Company.
COMPLIANCE EFFORTS. The Company retains special legal counsel for
advice on both FDA and FTC legal issues. In particular, the Company works
closely with special legal counsel who specializes in DSHEA regulations, for
label revisions, content of structure/function statements, advertising copy, and
also the FDA's position on ephedra-containing products. This relationship
reflects the Company's good faith effort to stay in full compliance with all
applicable laws governing the manufacture, labeling, sale, distribution, and
advertising of its dietary supplements.
NETWORK MARKETING SYSTEM. The Company's network marketing system is
subject to a number of federal and state regulations administered by the FTC and
various state agencies. Regulations applicable to network marketing
organizations are generally directed at ensuring that product sales are
ultimately made to consumers (as opposed to other distributors) and that
advancement within such organization be based on sales of the organization's
products, rather than investment in the organization or other non-retail sales
related criteria. For instance, in certain markets there are limits on the
extent to which distributors may earn royalties on sales generated by
distributors that were not directly sponsored by the distributor.
The Company's network marketing organization and activities are
subject to scrutiny by various state and federal governmental regulatory
agencies to ensure compliance with various types of laws and regulations,
including but not limited to securities, franchise investment, business
opportunity and criminal laws prohibiting the use of "pyramid" or "endless
chain" types of selling organizations. The compensation structure of such
selling organizations is very complex, and compliance with all of the applicable
laws is uncertain in light of evolving interpretation of existing laws and the
enactment of new laws and regulations pertaining to this type of product
distribution. The Company has an ongoing compliance program with assistance from
counsel experienced in the laws and regulations pertaining to network sales
organizations. The Company is not aware of any legal actions pending or
threatened by any governmental authority against the Company regarding the
legality of the Company's network marketing operations.
The Company currently has independent distributors in all 50 states
and the District of Columbia. The Company reviews the requirements of various
states as well as seeks legal advice regarding the structure and operation of
its selling organization to ensure that it complies with all of the applicable
laws pertaining to network sales organizations. On the basis of these efforts
and the experience of its management, the Company believes that it is in
compliance with all applicable federal and state regulatory requirements.
Although the Company believes that the structure and operation of its network
marketing organization complies with all of the applicable laws pertaining to
network sales organizations, the Company has not obtained any no-action letters
or advance rulings from any federal or state security regulator or other
governmental agency concerning the legality of the Company's operations, nor is
the Company relying on an opinion of counsel to such effect. The Company
accordingly remains subject to the risk that, in one or more of its markets, its
marketing system could be found to not be in compliance with applicable
regulations. Failure by the Company to comply with these regulations could have
a material adverse effect on the Company in a particular market or in general.
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The Company is subject to the risk of challenges to the legality of
its network marketing organization, including claims by the Company's
distributors, both individually and as a class, that the Company's network
marketing program is operated as an illegal "pyramid scheme" in violation of
federal securities laws, state unfair practice and fraud laws and the Racketeer
Influenced and Corrupt Organizations Act ("RICO"). Two important FTC cases have
established legal precedent for determining whether a network marketing program
constitutes an illegal pyramid scheme. The first, IN RE KOSCOT INTERPLANETARY,
INC., 86 F.T.C. 1106 (1975), set forth a standard for determining whether a
marketing system constituted a pyramid scheme. Under the KOSCOT standard, a
pyramid scheme is characterized by the participants' payment of money to a
company in return for (i) the right to sell a product and (ii) the right to
receive, in return for recruiting other participants into the program, rewards
that are unrelated to sales of the product to ultimate users. Applying the
KOSCOT standard in IN RE AMWAY CORP., 93 F.T.C. 618 (1979), the FTC determined
that a company will not be classified as operating a pyramid scheme if the
company adopts and enforces policies that in fact encourage retail sales to
consumers and prevent "inventory loading" (I.E., distributors' purchases of
large quantities of non-returnable inventory to obtain the full amount of
compensation available under the system). In AMWAY, the FTC found that the
marketing system of Amway Corporation ("Amway") did not constitute a pyramid
scheme, noting the following Amway policies: (i) participants were required to
buy back, from any person they recruited, any saleable, unsold inventory upon
the recruit's leaving Amway; (ii) every participant was required to sell at
wholesale or retail at least 70 percent of the products bought in a given month
in order to receive a bonus for that month; and (iii) in order to receive a
bonus in a month, each participant was required to submit proof of retail sales
made to 10 different consumers.
The Company believes that its network marketing system would not be
classified as a pyramid scheme under the standards set forth in KOSCOT, AMWAY,
and other applicable law. In particular, in most jurisdictions, the Company
maintains an inventory buy-back program to address the problem of "inventory
loading." Pursuant to this program, the Company will repurchase products sold to
a distributor (subject to a 10 percent restocking charge) provided that the
distributor resigns from the Company and returns the product in marketable
condition within 12 months of original purchase, or longer where required by
applicable state law or regulations. The Company's literature provided to
distributors describes the Company's buy-back program. In addition, pursuant to
the Company's agreements with its distributors, each distributor represents that
at least 70 percent of the products he or she buys will be sold to
non-distributors. However, as is the case with other network marketing
companies, the bonuses paid by the Company to its distributors are based on
product purchases including purchases of products that are personally consumed
by the downline distributors and such products may be considered an inventory
loading purchase. Furthermore, distributors' bonuses are based on the wholesale
prices received by the Company on product purchases or, in some cases based upon
the particular product purchased, on prices less than the wholesale prices. In
the event of challenges to the legality of its network marketing organization by
distributors, the Company would be required to demonstrate that the Company's
network marketing policies are enforced, and that the network marketing program
and distributors' compensation thereunder serve as safeguards to deter inventory
loading and encourage retail sales to the ultimate consumers.
In a recent case, WEBSTER V. OMNITRITION INTERNATIONAL, INC., 79 F.3d
776 (9th Cir. 1996), the United States Court of Appeals held that a class action
brought against Omnitrition International, Inc. ("Omnitrition"), a multilevel
marketing seller of nutritional supplements and skin care products, should be
allowed to proceed to trial. The plaintiffs, former distributors of
Omnitrition's products, alleged that Omnitrition's selling program was an
illegal pyramid scheme and claimed violations of RICO and several federal and
state fraud and securities laws. Despite evidence that Omnitrition complied with
the AMWAY standards, the court ruled that a jury would have to decide whether
Omnitrition's policies, many of which apparently were similar to compliance
policies adopted by the Company, were adequate to ensure that Omnitrition's
marketing efforts resulted in a legitimate product marketing and distribution
structure and not an illegal pyramid scheme. The Company believes that its
marketing and sales programs differ in significant respects from those of
Omnitrition, and that the Company's marketing program complies with applicable
law. The two most significant differences are (i) the Omnitrition marketing plan
required distributors to purchase $2,000 in merchandise in order to qualify for
bonuses as compared to $50 under the Company's marketing program and (ii) the
Omnitrition inventory repurchase policy was limited to products that were less
than three months old as compared to one year under the Company's inventory
repurchase policy. A lesson from the OMNITRITION case is that a selling program
which operates to only generate the minimum purchases necessary to qualify for
bonuses is suspect and that a selling program must operate to generate purchases
independently of the payment of bonuses, i.e. "for intrinsic value", in order to
have a legitimate product marketing and distribution structure. The Company
believes that its selling program operates to generate significant purchases
"for intrinsic value" as demonstrated by its sales figures. During the month of
December, 1998, 16,725 of the Company's distributors placed a total of 20,474
orders averaging $61 in size while only a single $50 order per month is
necessary to qualify for bonuses. In view of the holding of the court of appeals
in the OMNITRITION case, however, there can be no assurance that, if challenged,
the Company would prevail against private plaintiffs alleging violations of
anti-pyramid and securities laws. A final ruling against the Company in such a
suit could result in the imposition of a material liability against the Company.
Moreover, even if the Company were successful
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in defending against such suit, the costs of such defense, both in dollars
spent and in management time, could be material and adversely affect the
Company's operating results. In addition, the negative publicity of such a
suit could adversely affect the Company's sales and ability to attract and
retain distributors.
Nutrition for Life International, Inc. ("NFLI"), a competitor of the
Company and a multi-level seller of personal care and nutritional supplements,
recently announced that it had settled class action litigation brought by
distributors alleging fraud in connection with the operation of a pyramid
scheme. NFLI agreed to pay in excess of $3 million to settle claims brought on
behalf of its distributors, and related securities fraud claims brought on
behalf of certain purchasers of its stock. The Company believes that its
marketing program is significantly different from the program allegedly promoted
by NFLI and that the Company's marketing program is not in violation of
anti-pyramid laws or regulations. Two issues in the NFLI matter were a $1,000
buy-in urged on new recruits, and the paying of commissions on product vouchers
prior to the actual delivery of product. By design, the Company's marketing
program offers no incentive to anyone to make a large personal purchase nor does
the Company use product vouchers. Actual average order size in December, 1998
was $61. However, there can be no assurance that claims similar to the claims
brought against NFLI and other multi-level marketing organizations will not be
made against the Company, or that the Company would prevail in the event any
such claims were made. Furthermore, even if the Company were successful in
defending against any such claims, the costs of conducting such a defense, both
in dollars spent and in management time, could be material and adversely affect
the Company's operating results and financial condition. In addition, the
negative publicity of such a suit could adversely affect the Company's sales and
ability to attract and retain distributors.
INTELLECTUAL PROPERTY
The Company uses several trademarks and trade names in connection with
its products and operations. As of December 31, 1998, the Company had seven
federal trademark registrations with the United States Patent and Trademark
Office. The Company relies on common law trademark rights to protect its
unregistered trademarks. Common law trademark rights do not provide the Company
with the same level of protection as afforded by a United States federal
registration of a trademark. Moreover, common law trademark rights are limited
to the geographic area in which the trademark is actually used. In addition, the
Company's product formulations are not protected by patents and are not
patentable. Therefore, there can be no assurance that another company will not
replicate one or more of the Company's products.
COMPETITION
The Company is subject to significant competition in recruiting
distributors from other network marketing organizations, including those that
market products in the weight management, dietary supplement and personal care
categories, as well as other types of products. There are over 300 companies
worldwide that utilize network marketing techniques, many of which are
substantially larger, offer a greater variety of products, and have available
considerably greater financial resources than the Company. The Company's ability
to remain competitive depends, in significant part, on the Company's success in
recruiting and retaining distributors through an attractive bonus plan and other
incentives. The Company believes that its bonus plan and incentive programs
provide its distributors with significant income potential. However, there can
be no assurance that the Company's programs for recruitment and retention of
distributors will continue to be successful.
In addition, the business of marketing products in the weight
management, dietary supplement and personal care categories is highly
competitive. This market segment includes numerous manufacturers, other network
marketing companies, catalog companies, distributors, marketers, retailers and
physicians that actively compete in the sale of such products. The Company also
competes with other providers of such products, especially retail outlets, based
upon convenience of purchase and immediate availability of the purchased
product. The market is highly sensitive to the introduction of new products or
weight management plans (including various prescription drugs) that may rapidly
capture a significant share of the market. As a result, the Company's ability to
remain competitive depends in part upon the successful introduction and addition
of new products to its line.
The Company's network marketing competitors that market products in
the weight management, dietary supplement and personal care categories include
small, privately held companies, as well as larger, publicly held companies with
greater financial resources and greater product and market diversification and
distribution. The Company's competitors include Shaklee Corporation, The A.L.
Williams Corporation, Mary Kay Cosmetics, Inc., Amway Corporation, Nutrition for
Life International, Inc., and Herbalife International, Inc. See "Risk
Factors--Competition".
EMPLOYEES
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As of December, 1998, the Company had 46 full-time employees, of whom
two were executive officers or directors, 19 were in administrative activities,
eight were in marketing activities, nine were in customer service activities,
and eight were in shipping activities. The Company's employees are not
represented by a labor organization. The Company considers its employee
relations to be good.
ITEM 2. DESCRIPTION OF PROPERTIES
The Company maintains its executive office in 7,667 square feet at
2601 Northwest Expressway, Suite 1210W, Oklahoma City, Oklahoma 73112-7293 and
its warehouse and distribution center in 10,340 square feet at 4000 North
Lindsay, Oklahoma City, Oklahoma. The premises are occupied pursuant to
long-term leases which expire on May 31, 2003, and which require monthly rental
payments of $6,709 and $5,170, respectively. The Company believes that the
present space will be adequate for the next twelve months.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any pending litigation.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of the Company's fiscal year ended December 31, 1998.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Common Stock was traded only in the over-the-counter market and
was quoted by the National Quotation Bureau, Incorporated under the symbol
"AMSO" until September 10, 1997, when the Common Stock became listed on the
Boston Stock Exchange under the symbol "AMG," which was subsequently changed to
"AMM." On November 6, 1997, the Common Stock was first included on the Nasdaq
SmallCap Market under the symbol "AMSO." The following table sets forth, for the
periods presented, the high and low sale prices in the over-the-counter market
as quoted by the National Quotation Bureau, Incorporated, adjusted to give
effect to the one-for-eight reverse split of the outstanding Common Stock on
October 29, 1996. The bid quotations reflect inter-dealer prices without
adjustment for retail markups, markdowns or commissions and may not reflect
actual transactions.
<TABLE>
<CAPTION>
COMMON STOCK
SALE PRICES
--------------
HIGH LOW
------ -----
<S> <C> <C>
1998:
First Quarter Ended March 31 ................. $ 3.38 $2.13
Second Quarter Ended June 30.................. 4.00 3.00
Third Quarter Ended September 30.............. 4.00 1.88
Fourth Quarter Ended December 31 2.41 1.50
------ -----
1997:
First Quarter Ended March 31.................. $ 6.25 $5.50
Second Quarter Ended June 30.................. 8.38 5.69
Third Quarter Ended September 30.............. 9.00 5.00
Fourth Quarter Ended December 31.............. 6.88 2.56
------ -----
1996:
First Quarter Ended March 31.................. $ 6.48 $5.04
Second Quarter Ended June 30.................. 8.00 5.04
Third Quarter Ended September 30.............. 7.84 5.52
Fourth Quarter Ended December 31.............. 6.50 5.00
</TABLE>
On March 26, 1999, the closing sale price on the Nasdaq SmallCap
Market of the Common Stock was $2.50. As of March 26, 1999, there were
approximately 1,874 holders of the Common Stock.
DIVIDEND POLICY
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.
PENNY STOCK TRADING RULES
The Common Stock is included on the Nasdaq SmallCap Market, and is
listed on the Boston Stock Exchange. The continued inclusion or listing of the
Common Stock on the Nasdaq SmallCap Market and the Boston Stock Exchange is
subject to certain conditions, generally including the Common Stock having a
certain minimum sale price per share, the Company having certain minimum levels
of assets, stockholders' equity, number of shareholders, and number of
outstanding publicly held shares of Common Stock. In the event requirements for
continued inclusion or listing are not met, the Common Stock will be delisted
and no longer included on the Nasdaq SmallCap Market and the Boston Stock
Exchange, will then be traded in the over-the-counter market and may become
subject to the "penny stock" trading rules.
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<PAGE>
The penny stock trading rules impose additional duties and
responsibilities upon broker-dealers recommending the purchase of a penny stock
(by a purchaser that is not an accredited investor as defined by Rule 501(a)
promulgated under the Securities Act of 1933, as amended) or the sale of a penny
stock. Among such duties and responsibilities, with respect to a purchaser who
has not previously had an established account with the broker-dealer, the
broker-dealer is required to (i) obtain information concerning the purchaser's
financial situation, investment experience, and investment objectives, (ii) make
a reasonable determination that transactions in the penny stock are suitable for
the purchaser and the purchaser (or his independent adviser in such
transactions) has sufficient knowledge and experience in financial matters and
may be reasonably capable of evaluating the risks of such transactions, followed
by receipt of a manually signed written statement which sets forth the basis for
such determination and which informs the purchaser that it is unlawful to
effectuate a transaction in the penny stock without first obtaining a written
agreement to the transaction. Furthermore, until the purchaser becomes an
established customer (I.E., having had an account with the dealer for at least
one year or the dealer having effected for the purchaser three sales of penny
stocks on three different days involving three different issuers), the
broker-dealer must obtain from the purchaser a written agreement to purchase the
penny stock which sets forth the identity and number of shares or units of the
security to be purchased prior to confirmation of the purchase. A dealer is
obligated to provide certain information disclosures to the purchaser of a penny
stock, including (i) a generic risk disclosure document which is required to be
delivered to the purchaser before the initial transaction in a penny stock, (ii)
a transaction-related disclosure prior to effecting a transaction in the penny
stock (I.E., confirmation of the transaction) containing bid and asked
information related to the penny stock and the dealer's and salesperson's
compensation (I.E., commissions, commission equivalents, markups and markdowns)
in connection with the transaction, and (iii) the purchaser-customer must be
furnished account statements, generally on a monthly basis, which include
prescribed information relating to market and price information concerning the
penny stocks held in the account. The penny stock trading rules do not apply to
those transactions in which a broker-dealer or salesperson does not make any
purchase or sale recommendation to the purchaser or seller of the penny stock.
Compliance with the penny stock trading rules may affect the ability
to resell the Common Stock by a holder principally because of the additional
duties and responsibilities imposed upon the broker-dealers and salespersons
recommending and effecting sale and purchase transactions in such securities. In
addition, many broker-dealers will not effect transactions in penny stocks,
except on an unsolicited basis, in order to avoid compliance with the penny
stock trading rules. The penny stock trading rules consequently may materially
limit or restrict the liquidity typically associated with other publicly traded
equity securities. Therefore, the holder of penny stocks may be unable to obtain
on resale the quoted bid price because a dealer or group of dealers may control
the market in such securities and may set prices that are not based totally on
competitive forces. Furthermore, at times there may be a lack of bid quotes
which may mean that the market among dealers is not active, in which case a
holder of penny stocks may be unable to sell such securities. In addition,
because market quotations in the over-the-counter market are often subject to
negotiation among dealers and often differ from the price at which transactions
in securities are effected, the bid and asked quotations of securities traded in
the over-the-counter market may not be reliable.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED
FINANCIAL STATEMENTS AND NOTES THERETO OF THE COMPANY.
GENERAL
The Company's business over the last three years has been
significantly affected by the MMI Acquisition, the CII Acquisition, the SNSI
Asset Purchase and the ToppMed Asset Purchase. As a result of these
acquisitions, the Company acquired 6,790 distributors and added 115 products to
its product line. The Company currently markets approximately 100 products.
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
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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. 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.
REPURCHASE OF COMMON STOCK BY THE COMPANY. On March 4, 1998, the
Company announced it's intent to repurchase up to $1 million of the 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 December 31, 1998, the Company had repurchased
134,500 shares of the Common Stock for approximately $378,000. The Company has
ceased making repurchases and the last repurchase was made December 1998.
UNITS OFFERING. On November 12, 1997, the Company completed the
offering of 1,495,000 units, each consisting of one share of Common Stock and
one Redeemable Common Stock Purchase Warrant (the "Units"), and the Company
received gross proceeds of $6,050,000 (the "Units 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 12, 1998, and on or before November 12,
2002.
WARRANT MODIFICATION OFFERING AND RIGHTS OFFERING. On January 31,
1997, the Company distributed, at no cost, non-transferable rights ("Rights") to
the holders of record of shares of its common stock, par value $.0001 per share.
The Rights entitled the holders (the "Rights Holders") to subscribe for and
purchase up to 2,148,191 units (each unit consisting of one share of common
stock and one 1997-A warrant) for the price of $6.80 per unit (the "Rights
Offering"). The record date holders of the Company's common stock received one
Right for each share of common stock held by them as of the record date. The
Rights expired on March 17, 1997. Pursuant to the Rights, Rights Holders could
purchase one unit for each Right held.
Concurrent with the Rights Offering, the Company elected to redeem all
of its outstanding Class A and Class B common stock Purchase Warrants (the
"Public Warrants") for $.0008 per warrant (the "Warrant Redemption") on March
17, 1997. However, in connection with the Warrant Redemption, the Company,
pursuant to modification of the terms of the Public Warrants, offered to the
Public Warrant holders (the "Warrant Holders") the right to exercise the Public
Warrants to purchase units, each comprised of one share of common stock and one
1997-A warrant, at an exercise price of $6.00 per unit (the "Warrant
Modification Offering").
The share of common stock and 1997-A warrant comprising each unit were
separately transferable immediately after the sale of the units to the Rights
Holders and Warrant Holders. Each 1997-A warrant was exercisable at any time 90
days after January 16, 1997, and on or before January 31, 1999, to purchase one
share of common stock for $12.00, subject to adjustment in certain events, and
may be redeemed by the Company at any time upon 30 days' notice, at a price of
$.0001 per 1997-A warrant. 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
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<PAGE>
exercise period from January 31, 1999 to November 6, 2002, to make the terms of
the 1997-A Warrants correspond more closely to the terms of the Redeemable
Common Stock Purchase Warrants.
The units in the offering described above were offered on a best
efforts basis by the Company and its officers and directors, without
commissions, selling fees or direct or indirect remuneration. The Rights Holders
and Warrant Holders were not required to pay any brokerage commissions or fees
with respect to the exercise of their Rights or Public Warrants. The Company
paid all charges and expenses of the subscription and warrant agents.
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 net proceeds from these offerings. Pursuant to
the Offering the Company issued 337,211 shares of common stock and a
corresponding number of 1997-A warrants.
DISTRIBUTOR STOCK PURCHASE PLAN. 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 registered 5,000,000 stock
purchase plan participation interests ("Participation Interests") in the
Advantage Marketing Systems, Inc. 1998 Distributor Stock Purchase Plan (the
"Plan"). The Participation Interests will be offered to the distributors of the
Company's products and services ("Eligible Persons") in lots of five
Participation Interests. 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 is $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. The Registration Statement became
effective February 19, 1999 under the Securities Act of 1933, as amended.
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
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<PAGE>
The following table sets forth, as a percentage of net sales, selected
results of operations for the fiscal years ended December 31, 1998, 1997 and
1996, which are derived from the audited consolidated financial statements of
the Company. The results of operations for the periods presented are not
necessarily indicative of the Company's future operations.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------------
1998 1997 1996
---------------------- ---------------------- ----------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
----------- ------- ----------- ------- ---------- -------
<S> <C> <C> <C> <C> <C> <C>
Net sales................................ $13,287,824 100.0% $10,192,227 100.0% $6,155,073 100.0%
Cost of sales............................ 8,999,229 67.7 7,271,660 71.3 4,265,905 69.3
----------- ----- ----------- ----- ---------- -----
Gross profit......................... 4,288,595 32.3 2,920,567 28.7 1,889,168 30.7
Marketing, distribution and
administrative expenses............... 3,548,772 26.7 2,792,879 27.4 1,561,753 25.4
----------- ----- ----------- ----- ---------- -----
Income from operations................ 739,823 5.6 127,688 1.3 327,415 5.3
Other income (expense):
Interest, net............................ 309,908 2.3 34,017 .3 (10,538) (.2)
Other income............................. 39,280 .3 28,017 .3 8,667 .2
Settlement of additional tax liability... (421,623) (3.2) -- -- -- --
----------- ----- ----------- ----- ---------- -----
Total other income (expense).......... (72,435) (.6) 62,034 .6 (1,871) --
----------- ----- ----------- ----- ---------- -----
Income before income taxes............... 667,388 5.0 189,722 1.9 325,544 5.3
Tax expense (benefit).................... 253,340 1.9 59,696 .6 (499,613) (8.1)
----------- ----- ----------- ----- ---------- -----
Net income............................... $ 414,048 3.1% $ 130,026 1.3% $ 825,157 13.4%
----------- ----- ----------- ----- ---------- -----
----------- ----- ----------- ----- ---------- -----
</TABLE>
The following table sets forth, as a percentage of net sales, selected cost of
sales detail for the fiscal years ended December 31, 1998, 1997 and 1996, which
are derived from the audited consolidated financial statements of the Company.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------------
1998 1997 1996
---------------------- ---------------------- ----------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
----------- ------- ----------- ------- ---------- -------
<S> <C> <C> <C> <C> <C> <C>
Commissions and bonuses.................. $5,487,418 41.3% $4,557,355 44.7% $2,727,240 44.3%
Cost of products......................... 3,146,765 23.7 2,260,715 22.2 1,356,367 22.0
Cost of shipping......................... 365,046 2.7 453,590 4.5 182,298 3.0
----------- ----- ----------- ----- ---------- -----
Cost of sales.......................... $8,999,229 67.7% $7,271,660 71.3% $4,265,905 69.3%
----------- ----- ----------- ----- ---------- -----
</TABLE>
During the years 1998, 1997 and 1996, 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 1998 AND 1997
Net sales during the year ended December 31, 1998, increased by
$3,095,597, or 30.4 percent, to $13,287,824 from $10,192,227 during the year
ended December 31, 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 $1,121,173 to the increase between the two periods. During
the year ended December 31, 1998, the Company made aggregate net sales of
$13,159,821 to 33,700 distributors, compared to aggregate net sales during the
same period in 1997 of $10,030,327 to 20,300 distributors. At December 31, 1998,
the Company had approximately 33,000 "active" distributors compared to
approximately 20,400 at December 31, 1997. A distributor is considered to be
"active" if he or she has made a product purchase of $50 or more from the
Company within the previous 12 months. Sales per distributor per month decreased
from $41 to $33 for the year ended December 31, 1998, compared to the same
period in 1997.
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<PAGE>
Cost of sales during the year ended December 31, 1998, increased by
$1,727,569 or 23.8 percent, to $8,999,229 from $7,271,660 during the same period
in 1997. This increase was attributable to (i) an increase of $930,063 in
distributor commissions and bonuses due to the increased level of sales, (ii) an
increase of $886,050 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 $88,544 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 67.7 percent during the year ended December 31, 1998, from 71.3 percent
during the same period in 1997 due to a decrease in distributor commissions and
bonuses as a percentage of net sales to 41.3 percent from 44.7 percent, an
increase in cost of products sold to 23.7 percent of net sales from 22.2 percent
and a decrease in cost of shipping to 2.7 percent of net sales from 4.5 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 $1,368,028 or 46.8 percent, to
$4,288,595 for the year ended December 31, 1998 from $2,920,567 for the same
period in 1997. The gross profit increased as a percentage of net sales to 32.3
percent of net sales from 28.7 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 $755,893,
or 27.1 percent, to $3,548,772 during the year ended December 31, 1998, from
$2,792,879 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
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, telephone, bank card service charges, and supplies.
Other income (expense) decreased by $134,469 or 216.8 percent to a net
expense of $(72,435) during the year ended December 31, 1998 from $62,034. The
decrease was attributable to the one time expense of the settlement of the
additional tax liability of $421,623 ($261,400 net of the related tax effect).
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 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 $477,666, or 251.8 percent, to $667,388
during the years ended December 31, 1998, from $189,722 during the same period
in 1997. Income before taxes as a percentage of net sales increased to 5.0
percent during the year ended December 31, 1998, from 1.9 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 ($261,400 net of
the related tax effect). Income taxes during the years ended December 31, 1998
and 1997 were $253,340 and $59,696 respectively.
Net income increased $284,022, or 218.4 percent, to $414,048 during the
year ended December 31, 1998, from $130,026 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
($261,400 net of the related tax effect). Net income as a percentage of net
sales increased to 3.1 percent during the year ended December 31, 1998, from 1.3
percent during the same period in 1997.
COMPARISON OF 1997 AND 1996
Net sales during the year ended December 31, 1997, increased by
$4,037,154, or 65.6 percent, to $10,192,227 from $6,155,073 during the year
ended December 31, 1996. The increase was principally attributable to expansion
of the Company's network of independent distributors and increased sales of the
Company's product line within the weight management, dietary
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<PAGE>
supplement and personal care categories. Through the MMI Acquisition (which
was consummated on May 31, 1996), CII Acquisition (which was consummated on
January 31, 1997) and the SNSI Asset Purchase (which was consummated on April
16, 1997), the Company added 114 products to its product line and acquired
6,790 distributors. The distributors acquired in connection with the MMI
Acquisition, the CII Acquisition and the SNSI Asset Purchase contributed
$105,290, $435,506 and $1,089,359, respectively, to the increase in net sales
between the two periods. During the year ended December 31, 1997, the Company
made aggregate net sales of $10,030,327 to 20,300 distributors, compared to
aggregate net sales during the same period in 1996 of $6,000,395 to 9,500
distributors. At December 31, 1997, the Company had approximately 20,400
"active" distributors compared to approximately 10,600 at December 31, 1996.
A distributor is considered to be "active" if he or she has made a product
purchase of $50 or more from the Company within the previous 12 months. Sales
per distributor decreased from $53 to $41 for the year ended December 31,
1997, compared to the same period in 1996. This decrease was due to the
increase in the number of active distributors as a result of the CII
Acquisition and SNSI Asset Purchase (which were consummated on January 31,
1997 and April 16, 1997, respectively), which new distributors did not
contribute sales during the full year ended December 31, 1997.
Cost of sales during the year ended December 31, 1997, increased by $3,005,755,
or 70.5 percent, to $7,271,660 from $4,265,905 during the same period in 1996,
reflecting the increase in sales. The increase was attributable to an increase
of (i) $1,830,115 in distributor bonuses due in part to special promotions
designed to expand the Company's distributor network, (ii) $904,348 in the cost
of products sold due in part to an improvement in the quality of products, and
(iii) $271,292 in shipping costs due in part to an increase in shipment costs
charged by the shipping companies. Total cost of sales, as a percentage of net
sales, increased to 71.3 percent during the year ended December 31, 1997, from
69.3 percent during the same period in 1996 due to an increase in distributor
bonuses as a percentage of net sales to 44.7 percent from 44.3 percent, an
increase in cost of products sold to 22.2 percent of net sales from 22.0
percent, and an increase in cost of shipping to 4.5 percent of net sales from
3.0 percent. During periods of growth, it is anticipated that the Company will
from time-to-time offer promotions to distributors to increase sales and their
income, which if successful will result in increases in distributor bonuses and
temporary increases in cost of sales.
The Company's gross profit increased $1,031,399, or 54.6 percent, to
$2,920,567 for the year ended December 31, 1997 from $1,889,168 for the same
period in 1996. The gross profit decreased as a percentage of net sales to 28.7
percent of net sales from 30.7 percent. The decrease in the Company's gross
profit margin resulted from the increase in cost of sales as a percent of net
sales.
Marketing, distribution and administrative expenses increased
$1,231,126, or 78.8 percent, to $2,792,879 during the year ended December 31,
1997, from $1,561,753 during the same period in 1996. This increase was
attributable to expansion of the Company's administrative infra-structure
necessary to support increased levels of sales and distributors. Payroll and
employee costs increased by $628,568 during the year ended December 31, 1997, as
compared to the same period in 1996, due to the increase in full-time employees
to 30 during the first quarter of 1997, 38 during the second quarter of 1997, 47
during the third quarter of 1997, and 43 during the fourth quarter of 1997, as
compared to 16, 17, 17 and 24, respectively, during the same periods in 1996.
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 and supplies.
Income before taxes decreased $135,822, or 41.7 percent, to $189,722
during the year ended December 31, 1997, from $325,544 during the same period in
1996. Income before taxes as a percentage of net sales decreased to 1.9 percent
during the year ended December 31, 1997, from 5.3 percent during the same period
in 1996, primarily as a result of the increase in the Company's marketing,
distribution and administrative expenses. Income taxes were $59,696 during the
year ended December 31, 1997, while during the same period of 1996 an income tax
benefit of $499,613 was recognized. The Company recognized a one-time tax
benefit of $499,613 in 1996 primarily related to the reversal of a deferred tax
valuation allowance related to the expected future tax benefits to be realized
from operating loss carryforwards. As a result, during 1997 the Company began
reporting income tax expense for financial reporting purposes.
Net income decreased $695,131, or 84.2 percent, to $130,026 during the
year ended December 31, 1997, from $825,157 during the same period in 1996. This
decrease in net income was primarily the result of a decrease in the Company's
gross profit margin combined with the increase in marketing, distribution and
administrative expenses in addition to the recording of income tax expense for
financial reporting purposes during the year ended December 31, 1997. Net income
as a percentage of net sales decreased to 1.3 percent during the year ended
December 31, 1997, from 13.4 percent during the same period in 1996.
PRO FORMA EFFECT OF STOCK-BASED COMPENSATION
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<PAGE>
As a portion of and in lieu of payments of salaries and consulting
fees, the Company has historically used options to attract, retain and
compensate its officers, directors, other employees and consultants. The Company
also believes that linking the compensation of its officers and directors to
increases in the value of the Common Stock achieves improved performance. During
1998, the Company granted 809,819 options at exercise prices ranging from $1.75
per share to $3.00 per share. Options were granted primarily for services
rendered and to ensure the future availability of those services to the Company.
A total of 418,819 of the options granted during 1998 are unexercisable at
December 31, 1998 due to a six month vesting period. During 1998, 57,306 options
were exercised in exchange for 31,025 mature shares. In addition, during 1998,
519,944 options with a weighted average exercise price of $2.32 per share were
voluntarily surrendered and canceled by the Company in exchange for an equal
number of options, with weighted average exercise price of $1.82 and 128,830
other options were canceled without exchange for new options. The exercise price
of the exchanged options was equal to the market value of the Company's stock on
the date of exchange. There was no expense recognized in the Company's financial
statements relating to the exchange. During 1997, the Company granted 493,100
options at exercise prices ranging from $2.70 per share to $6.00 per share.
Options were granted primarily for services rendered and to ensure the future
availability of those services to the Company. Options granted pursuant to the
Company's 1995 Stock Option Plan at December 26, 1997 have a six month vesting
period.
During 1997, 135,695 options were exercised of which 46,945, 42,500 and
46,250 were exercised for cash, 15,769 mature shares and notes receivable,
respectively. In addition, during this period 319,250 options were voluntarily
surrendered and canceled by the Company in exchange for an equal number of
options at a lower price, 125,000 options were canceled without exchange for new
options and 2,499 options expired. No options were granted during 1996. The
weighted average exercise price and calculated fair value at the date of grant
of the options granted in 1998 were $1.93 and $1.05, respectively, utilizing the
methodology prescribed under Statement of Financial Accounting Standards
("SFAS") No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION. After giving effect
to the weighted average fair value of such options, the Company would have had a
pro forma net income of $180,719 ($.04 per common share) for the year ended
December 31, 1998. The weighted average exercise price and calculated fair value
at the date of grant of the options granted in 1997 were $3.68 and $1.20,
respectively. After giving effect to the weighted average fair value of such
options, the Company would have had a pro forma loss of $337,528 ($.12 per
common share) for the year ended December 31, 1997. The Company did not grant
any such options during 1996 and as such there is no pro forma effect on 1996.
RECENTLY ADOPTED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FSAB") issued
SFAS No. 130, REPORTING COMPREHENSIVE INCOME, which establishes standards for
reporting and displaying comprehensive income and its components (revenues,
expenses, gains and losses) in financial statements. In addition, SFAS No. 130
requires the Company to classify items of other comprehensive income by their
nature in a financial statement and display the accumulated balance of other
comprehensive income separately in the shareholders' equity section of the
statement of financial condition. The Company adopted SFAS No. 130 on January 1,
1998 as required and has no items of other comprehensive income to disclose.
Also in June 1997, the FASB issued SFAS No. 131, DISCLOSURES ABOUT
SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. SFAS No. 131 establishes
reporting standards for public companies concerning annual and interim financial
statements of their operating segments and related information. Operating
segments are components of a company about which separate financial information
is available that is regularly evaluated by the chief operating decision
maker(s) in deciding how to allocate resources and assess performance. The
Standard sets criteria for reporting disclosures about a company's products and
services, geographic areas and major customers. The Company has only one
segment, as that term is defined in SFAS No. 131, therefore, the adoption of
SFAS No. 131 in 1998 did not affect the Company's disclosures.
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, as the Company does not offer postretirement benefits.
-23-
<PAGE>
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 impact on the Company's consolidated
financial statements from the adoption of SFAS No. 133 has not yet been
determined. This statement is effective for all fiscal quarters beginning after
June 15, 1999. The Company will adopt SFAS No. 133 on January 1, 2000 as
required.
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.
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., micro controllers). Management expects the
program to be complete 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 and ship 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 contacting 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.
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 49.7
percent and 29.5 percent of net sales for the years ended December 31, 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 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 could be a material reduction in
sales, cost of sales and marketing, distribution and administrative expenses and
could result in material losses to the Company, but would not have a significant
adverse effect on it's financial position.
-24-
<PAGE>
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 on 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. See "Item 1. Description of Business--Products--Product
Procurement and Distribution."
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.
FUTURE ASSESSMENT OF RECOVERABILITY AND IMPAIRMENT OF GOODWILL AND COVENANTS
In connection with its various acquisitions (see "--General"), the
Company recorded goodwill, which is being amortized on a straight-line basis
over periods of 7 to 20 years, and covenants not to compete which are being
amortized on a straight-line basis over the life of the contractual covenants
(the estimated periods that the Company will be benefitted by such goodwill and
covenants). At December 31, 1998, the unamortized portions of the goodwill was
$1,725,734 (which represented 16.1 percent of total assets and 18.7 percent of
stockholders' equity) and covenants not to compete was $511,685 (which
represented 4.8 percent of total assets and 5.5 percent of stockholders'
equity). Goodwill arises when an acquirer pays more for a business than the fair
value of the tangible and separately measurable intangible net assets (such as
covenants not to compete). For financial reporting purposes, goodwill and all
other intangible assets be amortized over the period benefitted. The Company has
determined the life for amortizing goodwill based upon several factors, the most
significant of which are (i) the size of the distributor network being acquired
and (ii) the length of the time the network has been in existence. Management
determined that the period to be no less than seven years for the MMI
Acquisition and no less than 20 years for the CII Acquisition, SNSI Asset
Purchase and the TI Asset Purchase.
The Company's carrying value and recoverability of unamortized goodwill
and covenants not to compete are periodically reviewed by management of the
Company. If the facts and circumstances suggest that the goodwill or covenant
may be impaired, the carrying value of goodwill or covenant will be adjusted
which will result in an immediate charge against income during the period of the
adjustment and/or the length of the remaining amortization period may be
shortened, which will result in an increase in the amount of goodwill or
covenant amortization during the period of adjustment and each period thereafter
until fully amortized. Once adjusted, there can be no assurance that there will
not be further adjustments for impairment and recoverability in future periods.
Of the various factors to be considered by management of the Company in
determining goodwill or covenant, the most significant will be (i) losses from
operations, (ii) loss of distributors and customers, and (iii) industry
developments, including the Company's inability to maintain its market share,
development of competitive products, and imposition of additional regulatory
requirements. See "Item 1. Description of Business--Network Marketing," and
"--Regulation." In the event management of the Company determines that goodwill
or the covenants not to compete have become impaired, the adjustment for
impairment and recoverability will most likely occur during a period of
operations in which the Company has sustained losses or has only marginal
profitability from operations, and the impairment or increased amortization
amount will either increase such losses from operations or further reduce
profitability.
LIQUIDITY AND CAPITAL RESOURCES
Prior to completion of the offerings described above, 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.
-25-
<PAGE>
At December 31, 1998, the Company had working capital of $5,823,182,
compared to $6,143,041 at December 31, 1997. Management believes that its cash
and cash equivalents and cash flows from operations will be sufficient to fund
its working capital needs over the next 12 months. During the year ended
December 31, 1998, net cash provided by operating activities was $1,242,254, net
cash used in investing activities was $996,283, and net cash used in financing
activities was $732,030. This represented an average monthly positive cash flow
from operating activities of $103,521. The Company had a net decrease in cash
during this period of $486,059. The Company's working capital needs over the
next 12 months consist primarily of marketing, distribution and administrative
expenses.
On March 4, 1998, the Company announced it's intent to repurchase up to
$1 million of the 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 December 31, 1998, the
Company had repurchased 134,500 shares of the Common Stock for approximately
$378,000. The Company has ceased making repurchases and the last repurchase was
made December 31, 1998.
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. The loan has been extended until March 31, 2000. As of December
31, 1998, the balance due on this loan was $293,936. 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 June 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 gross 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 12, 1998, and on or
before November 12, 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 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
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<PAGE>
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 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. 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.
ITEM 7. FINANCIAL STATEMENTS
The consolidated financial statements of the Company prepared in
accordance with Regulation S-B are set forth beginning on page F-1 hereof.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no disagreements concerning matters of accounting
principle or financial statement disclosure between the Company and its
independent accountants of the type requiring disclosure hereunder.
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<PAGE>
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
CURRENT DIRECTORS AND EXECUTIVE OFFICERS
The following table sets forth certain information with respect to each
executive officer and director of the Company.
<TABLE>
<CAPTION>
NAME AGE POSITION WITH THE COMPANY
---- --- -------------------------
<S> <C> <C>
John W. Hail(1)(2) ......... 69 Chairman of the Board, Chief Executive Officer and Director
Curtis H. Wilson, Sr.(3) ... 73 Vice-Chairman of the Board and Director
Roger P. Baresel(1)(2) ..... 44 President, Chief Financial Officer, Secretary and Director
R. Terren Dunlap(3)(5) ..... 54 Director
Harland C. Stonecipher(4)(5) 60 Director
</TABLE>
- --------------------
(1) Member of the Stock Option Committee.
(2) Term as a Director expires in 2001.
(3) Term as a Director expires in 2000.
(4) Term as a Director expires in 1999.
(5) Member of Audit Committee.
Pursuant to the terms of the Company's Bylaws, the directors are
divided into three classes. Class I Directors hold office for a term expiring at
the annual meeting of shareholders to be held in 1999, Class II Directors hold
office for a term expiring at the annual meeting of shareholders to be held in
2000, and Class III Directors hold office for a term expiring at the annual
meeting of shareholders to be held in 2001. Each director will hold office for
the term to which he is elected and until his successor is duly elected and
qualified. At each annual meeting of the shareholders of the Company, the
successor to a member of the class of directors whose term expires at such
meeting will be elected to hold office for a term expiring at the annual meeting
of shareholders held in the third year following the year of his election.
Executive officers are elected by the Board of Directors and serve at its
discretion.
JOHN W. HAIL is the founder of Advantage Marketing Systems, Inc. and
has served as its Chief Executive Officer and Chairman of the Board of Directors
of the Company since its inception in June 1988. During 1987 and through May
1988, Mr. Hail served as Executive Vice President, Director and Agency Director
of Pre-Paid Legal Services, Inc., a public company engaged in the sale of legal
services contracts, and also served as Chairman of the Board of Directors of TVC
Marketing, Inc., the exclusive marketing agent of Pre-Paid Legal Services, Inc.
CURTIS H. WILSON, SR. has served as Vice-Chairman of the Board of
Directors of the Company since June 1988. From January 1984 to June 1988, Mr.
Wilson was Executive Vice President of TVC Marketing, Inc.
ROGER P. BARESEL has served as Vice President, Chief Financial
Officer, Secretary and a Director of the Company since June 1995, and in July
1995, he became President. Mr. Baresel is a Certified Public Accountant and
holds a Master of Business Administration degree. From 1988 until joining the
Company full-time in 1995, he maintained an accounting practice, specializing in
providing consulting services to small and growing businesses and provided
consulting services to the Company.
R. TERREN DUNLAP has served as a Director of the Company since June
1995. He is Chief Executive Officer of DuraSwitch Industries, Inc., a company
formed in 1997 that developed and distributes electronic switches. He served
as Vice President-International Development of the Company from June 1995
through March 1996. Mr. Dunlap isa Director and the co-founder, and from 1984
and until March 1994 served as Chief Executive Officer and Chairman of the
Board, of Go-Video, Inc., a developer and distributor of consumer electronics
products.
HARLAND C. STONECIPHER has served as a Director of the Company since
August 1995. Mr. Stonecipher has been Chairman of the Board and Chief Executive
Officer of Pre-Paid Legal Services, Inc. since its inception in 1972.
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<PAGE>
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth certain information relating to
compensation for services rendered during the years ended December 31, 1998,
1997 and 1996, paid to or accrued for John W. Hail, the Chief Executive Officer.
No executive officer of the Company received total annual salary and bonus
pursuant to a recurring arrangement in excess of $100,000 during 1998, 1997 or
1996.
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION AWARDS
----------------------
ANNUAL COMPENSATION SECURITIES EXERCISE
------------------------------------- UNDERLYING OR BASE
NAME AND PRINCIPAL POSITION YEAR SALARY(1) BONUS OTHER(2) OPTIONS PRICE
- --------------------------- ---- --------- ----- -------- ------- ------
<S> <C> <C> <C> <C> <C> <C>
John W. Hail................. 1998 $60,000 $16,565 $ -- 100,000(3) $1.75
Chief Executive Officer 1997 $56,539 $ -- $ -- 100,000(3) $6.00
100,000(3) $2.70
1996 $ -- $ -- $22,000 -- $ --
</TABLE>
- --------------------
(1) Dollar value of base salary earned during the year.
(2) The Company furnishes the use of an automobile to Mr. Hail, the value
of which is not greater than $5,000 annually. During 1996, the
Company made non-interest bearing advances to the John Hail Agency,
Inc., an affiliate of Mr. Hail, of $22,000.
(3) During 1997 the Company granted 100,000 stock options to Mr. Hail pursuant
to the Company's Stock Option Plan, each exercisable for the purchase of
one share of Common Stock at an exercise price of $6.00 per share (the
market value of the Common Stock on the date of grant). These options
were surrendered by Mr. Hail during 1997 in exchange for 100,000 stock
options having the same terms other than an exercise price of $2.70 per
share of Common Stock (which was equal to the fair value of the Common
Stock on the date of exchange). These options were surrendered by Mr.
Hail on October 8, 1998 in exchange for 100,000 stock options 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.
AGGREGATE OPTION GRANTS AND EXERCISES IN 1998 AND YEAR-END OPTION VALUES
STOCK OPTIONS AND OPTION VALUES. During 1997 the Company granted
100,000 stock options to Mr. Hail pursuant to the Company's Stock Option Plan,
each exercisable for the purchase of one share of Common Stock at an exercise
price of $6.00 per share. These options were surrendered by Mr. Hail in exchange
for 100,000 stock options having the same terms other than an exercise price of
$2.70 per share of Common Stock. These options were surrendered by Mr. Hail on
October 8, 1998 in exchange for 100,000 stock options having the same terms
other than an exercise price of $1.75 per share of Common Stock. The following
table sets forth information related to options granted to the named executive
officer during 1998.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
---------------------------------------------------
PERCENT OF
TOTAL OPTIONS
NUMBER GRANTED TO EXERCISE
OF OPTIONS EMPLOYEES PRICE PER EXPIRATION
GRANTED IN 1998 SHARE DATE
------- ------- ----- ----
<S> <C> <C> <C> <C>
John W. Hail, Chief Executive Officer ...... 100,000(1) 13.3% $1.75 5/20/07
</TABLE>
- --------------------
(1) Only includes those stock options that were granted and not
surrendered during 1998.
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<PAGE>
AGGREGATE STOCK OPTION EXERCISE AND YEAR-END AND OPTION VALUES. The
following table sets forth information related to the number and value of
options held by the named executive officer at December 31, 1998. During 1998,
no options to purchase Common Stock were exercised by the named executive
officer.
<TABLE>
<CAPTION>
VALUE OF UNEXERCISED
NUMBER OF UNEXERCISED IN-THE-MONEY
OPTIONS AS OF OPTIONS AS OF
DECEMBER 31, 1998 DECEMBER 31, 1998(1)
--------------------------- ---------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
John W. Hail, Chief Executive Officer 150,000 100,000 $ -0- $25,000
</TABLE>
- --------------------
(1) The closing sale price of the Common Stock as reported on the Nasdaq
SmallCap Market on December 31, 1998 was $2.00. The per-share value is
calculated based on the applicable closing highest bid price per
share, minus the exercise price, multiplied by the number of shares of
Common Stock underlying the options.
COMPENSATION OF DIRECTORS
Directors who are not employees of the Company receive $250 for each
Board meeting attended. Directors who are also employees of the Company receive
no additional compensation for serving as Directors. The Company reimburses its
Directors for travel and out-of-pocket expenses in connection with their
attendance at meetings of the Board of Directors. The Company's Bylaws provide
for mandatory indemnification of directors and officers to the fullest extent
permitted by Oklahoma law.
STOCK OPTION PLAN
The Company established the Advantage Marketing Systems, Inc. 1995
Stock Option Plan (the "Stock Option Plan" or the "Plan") in June 1995. The Plan
provides for the issuance of incentive stock options ("ISO Options") with or
without stock appreciation rights ("SARs") and nonincentive stock options ("NSO
Options") with or without SARs to employees and consultants of the Company,
including employees who also serve as Directors of the Company. The total number
of shares of Common Stock authorized for issuance under the Plan is 1,125,000.
As of March 26, 1999, options to purchase a total of 831,669 shares of Common
Stock have been granted under the Plan at exercise prices of $1.75 to $6.00 per
share expiring March 2002 through May 2007, of which 380,524 options have been
surrendered and canceled. As of March 26, 1999, there are outstanding stock
options granted under the Plan exercisable for the purchase of 437,589 shares of
Common Stock and options and warrants for the purchase of 1,101,733 shares of
Common Stock outstanding that were granted outside of the Stock Option Plan.
The Stock Option Committee, which is currently comprised of Messrs.
Hail and Baresel, administers and interprets the Plan and has authority to grant
options to all eligible employees and determine the types of options granted and
the terms, restrictions and conditions of the options at the time of grant.
During the one-year period ended November 6, 1998, the Company undertook not to
grant (i) any additional options or warrants other than pursuant to the Plan
except in exchange for existing options, (ii) stock options under the Plan to
any officer, director or employee of the Company and its subsidiaries that have
an aggregate exercise price in excess of the annual salary during the year of
such grant of such officer, director or employee and (iii) John W. Hail, Curtis
H. Wilson, Sr. and Roger P. Baresel any stock options under the Plan without the
unanimous approval of the independent directors of the Company which at all such
times shall not be less than two independent directors.
The option price of the Common Stock is determined by the Stock Option
Committee, provided such price may not be less than 85 percent of the fair
market value of the shares on the date of grant of the option. The fair market
value of a share of the Common Stock is determined by either (i) averaging the
closing high bid and low asked quotations for such share on the date of grant of
the option as reported by the National Quotation Bureau, Incorporated, or (ii)
if not quoted by the National Quotation Bureau, Incorporated by the Stock Option
Committee. Upon the exercise of an option, the option price must be paid in
full, in cash or with an SAR. Subject to the Stock Option Committee's approval,
upon exercise of an option with an SAR attached, a participant may receive cash,
shares of Common Stock or a combination of both, in an amount or having a fair
market value equal to the excess of the fair market value, on the date of
exercise, of the shares for which the option and SAR are exercised, over the
option exercise price.
Options granted under the Plan may not be exercised until six months
after the date of the grant, except in the event of death or disability of the
participant. ISO Options and any SARs are exercisable only by participants while
actively employed as an
-30-
<PAGE>
employee or a consultant of the Company, except in the case of death,
retirement or disability. Options may be exercised at any time within three
months after the participant's retirement or within one year after the
participant's disability or death, but not beyond the expiration date of the
option. No option may be granted after April 30, 2005. Options are not
transferable except by will or by the laws of descent and distribution.
OFFICER AND DIRECTOR LIABILITY
As permitted by the provisions of the Oklahoma General Corporation
Act, the Certificate of Incorporation (the "Certificate") eliminates in certain
circumstances the monetary liability of directors of the Company for a breach of
their fiduciary duty as directors. These provisions do not eliminate the
liability of a director for (i) a breach of the director's duty of loyalty to
the Company or its shareholders, (ii) acts or omissions by a director not in
good faith or which involve intentional misconduct or a knowing violation of
law, (iii) liability arising under Section 1053 of the Oklahoma General
Corporation Act (relating to the declaration of dividends and purchase or
redemption of shares in violation of the Oklahoma General Corporation Act), or
(iv) any transaction from which the director derived an improper personal
benefit. In addition, these provisions do not eliminate liability of a director
for violations of federal securities laws, nor do they limit the rights of the
Company or its shareholders, in appropriate circumstances, to seek equitable
remedies such as injunctive or other forms of non-monetary relief. Such remedies
may not be effective in all cases.
The Certificate of Incorporation and Bylaws of the Company provide
that the Company shall indemnify all directors and officers of the Company to
the fullest extent permitted by the Oklahoma General Corporation Act. Under such
provisions, any director or officer, who in his capacity as such, is made or
threatened to be made, a party to any suit or proceeding, may be indemnified if
the Board of Directors determines such director or officer acted in good faith
and in a manner he reasonably believed to be in or not opposed to the best
interests of the Company. The Certificate and Bylaws and the Oklahoma General
Corporation Act further provide that such indemnification is not exclusive of
any other rights to which such individuals may be entitled under the
Certificate, the Bylaws, an agreement, vote of shareholders or disinterested
directors or otherwise. Insofar as indemnification for liabilities arising under
the Act may be permitted to directors and officers of the Company pursuant to
the foregoing provisions, or otherwise, the Company has been advised that in the
opinion of the Commission such indemnification is against public policy as
expressed in the Act and is, therefore, unenforceable.
The Company maintains insurance to protect its directors and officers
against liability asserted against them in their official capacities. Such
insurance protection covers claims and any related defense costs of up to $3
million based on alleged or actual securities law violations, other than
intentional dishonest or fraudulent acts or omissions, or any willful violation
of any statute, rule or law, or claims arising out of any improper profit,
remuneration or advantage derived by an insured director or officer.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table presents certain information as to the beneficial
ownership of the Common Stock as of March 26, 1999, of (i) each person who is
known to the Company to be the beneficial owner of more than five percent
thereof, (ii) each director and executive officer of the Company, and (iii) all
executive officers and directors as a group, together with their percentage
holdings of the outstanding shares. For purposes of the following table, the
number of shares and percent of ownership of outstanding Common Stock that the
named person beneficially owns includes shares of Common Stock that such person
has the right to acquire within 60 days of March 26, 1999, upon exercise of
options and warrants, but such shares are not included for the purposes of
computing the number of shares beneficially owned and percent of outstanding
Common Stock of any other named person.
-31-
<PAGE>
<TABLE>
<CAPTION>
COMMON STOCK
------------------------
SHARES PERCENT OF
BENEFICIALLY SHARE
NAME AND ADDRESS OF BENEFICIAL OWNER OWNED OUTSTANDING
- ------------------------------------ ------------ -----------
<S> <C> <C>
John W. Hail(1)(2) .................................... 577,630 13.15%
Curtis H. Wilson(1)(3) ................................ 280,945 6.39%
Roger P. Baresel(1)(4) ................................ 176,707 4.14%
Harland C. Stonecipher(5) ............................. 180,768 4.37%
R. Terren Dunlap(1)(6) ................................ 37,500 .90%
Executive Officers and Directors as a group
(five persons)(7) .................................. 1,253,550 26.03%
</TABLE>
- -----------
(1) A Director or an executive officer of the Company, with a business
address of 2601 Northwest Expressway, Suite 1210W, Oklahoma City,
Oklahoma 73112-7293.
(2) The number of shares and each percentage presented includes (i) 150,000
shares of Common Stock that are subject to currently exercisable stock
options and 1,000 shares of Common Stock that are subject to currently
exercisable Redeemable Common Stock Purchase Warrants held by Mr. Hail,
(ii) 16,500 shares of Common Stock and 1,000 shares of Common Stock that
are subject to currently exercisable Redeemable Common Stock Purchase
Warrants owned by corporations controlled by Mr. Hail, (iii) 1,000 shares
of Common Stock and 1,000 shares of Common Stock that are subject to
currently exercisable Redeemable Common Stock Purchase Warrants held by
Helen Hail, wife of Mr. Hail, with respect to which Mr. Hail disclaims
any beneficial interest (iv) the number of shares and each percentage
include 100,000 shares of Common Stock that are subject to currently
unexercisable stock options held by Mr. Hail, which become exercisable on
April 8, 1999.
(3) The number of shares and each percentage presented includes 250,000
shares of Common Stock that are subject to currently exercisable stock
options held by Mr. Wilson and 12,338 shares of outstanding Common Stock
and 3,000 shares of Common Stock that are subject to currently
exercisable Redeemable Common Stock Purchase Warrants held by Ruth
Wilson, wife of Mr. Wilson, with respect to which Mr. Wilson disclaims
any beneficial interest.
(4) The number of shares consist of and each percentage presented includes
(i) 7,500 shares of outstanding Common Stock jointly held by Mr. Baresel
and his wife, Judith A. Baresel, (ii) 2,000 shares of Common Stock
subject to currently exercisable 1997-A Warrants and 1,000 shares of
Common Stock that are subject to currently exercisable Redeemable Common
Stock Purchase Warrants held by Mr. Baresel, (iii) 12,500 shares of
Common Stock that are subject to currently exercisable stock options held
by Mr. Baresel, (iv) 24,845 shares of outstanding Common Stock held by
Mrs. Baresel, (v) 87,500 shares of Common Stock that are subject to
currently exercisable stock options and 6,000 shares of Common Stock that
are subject to currently exercisable Redeemable Common Stock Purchase
Warrants held by Mrs. Baresel, and (vii) 12,500 shares of Common Stock
that are subject to currently exercisable stock options held by Mrs.
Baresel as the custodian for the benefit of the children of Mr. and Mrs.
Baresel, with respect to which Mr. Baresel disclaims any beneficial
interest, (viii) the number of shares and each percentage include 10,000
shares of Common Stock that are subject to currently unexercisable stock
options held by Mr. Baresel, which become exercisable on May 18, 1999.
(5) Mr. Stonecipher is a Director of the Company with a business address of
321 East Main Street, Ada, Oklahoma 74820, and Chairman of the Board and
Chief Executive Officer of Pre-Paid Legal Services, Inc. The number of
shares consist of and each percentage presented is based upon 180,768
shares of outstanding Common Stock held by Pre-Paid Legal Services, Inc.,
which may be deemed to be beneficially owned by Mr. Stonecipher.
(6) The number of shares consist of and each percentage presented is based
upon 37,500 shares of Common Stock that are issuable upon exercise of
stock options.
(7) The number of shares and each percentage presented includes 2,000 shares
of Common Stock subject to currently exercisable 1997-A Warrants, 13,000
shares of Common Stock that are subject to currently exercisable
Redeemable Common Stock Purchase Warrants 100,000 and 10,000 shares of
Common Stock that are subject to currently unexercisable stock options
which will become exercisable on April 8, 1999 and May 18, 1999,
respectively, and 550,000 shares of Common Stock that are issuable upon
exercise of other currently exercisable stock options held by the
executive officers and directors as a group.
-32-
<PAGE>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Set forth below is a description of transactions entered into
between the Company and certain of its officers, directors and shareholders
during the last two years. Certain of these transactions may result in
conflicts of interest between the Company and such individuals. Although
these persons have fiduciary duties to the Company and its shareholders,
there can be no assurance that conflicts of interest will always be resolved
in favor of the Company.
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 per annum
and payable in 60 installments of $1,499 per month. JHA has made repayments
of these advances of $54,780, $13,042 during the fiscal years ended December
31, 1998 and 1997, respectively. As of December 31, 1998 the note has been
paid in full.
During 1995, John W. Hail individually entered into lease
agreements covering telephone equipment and related software and requiring
monthly rental payments. Such equipment and software are utilized exclusively
by the Company. During the years ended December 31, 1998 and 1997, the
Company made aggregate payments pursuant to such lease agreements of $17,939
and $19,427, respectively. As of December 31, 1998 these leases had been
terminated.
During the years ended December 31, 1998 and 1997, the Company paid
Curtis H. Wilson, Sr., a Director of the Company, sales commissions of
$62,555 and $32,886, respectively. These commissions were based upon
purchases by Mr. Wilson and his downline distributors in accordance with the
Company's network marketing program in effect at the time of the sales. See
"Description of Business--Network Marketing."
During the first quarter of 1998, the Company agreed to loan John
Hail 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. The loan has been extended until March
31, 2000. As of December 31, 1998, the balance due on this loan was $293,936.
The loan was unanimously approved by the Company's board of directors.
During 1997, pursuant to the Company's Stock Option Plan, the
Company granted Mr. Hail 10-year nontransferable stock options exercisable
for the purchase of 100,000 shares of Common Stock for $6.00 per share. On
the date of grant of these stock option, the exercise price was equal to the
fair value of the Common Stock. These options were surrendered by Mr. Hail in
exchange for 100,000 stock options having the same terms other than an
exercise price of $2.70 per share of Common Stock, which was equal to the
fair value of the Common Stock on the date of exchange. These options were
surrendered by Mr. Hail on October 8, 1998 in exchange for 100,000 stock
options 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 1995, the Company granted United Financial Advisors, Inc.
("UFAI") five-year warrants exercisable for the purchase of 125,000 shares of
Common Stock for $3.60 per share and 125,000 shares of Common Stock for $4.96
per share. All of the warrants were granted at or above the fair market value
of the Common Stock on the date of grant. As a result of the grant of these
warrants, UFAI became a greater than five percent beneficial owner of the
Common Stock of the Company. These warrants were not granted pursuant to the
Company's Stock Option Plan. Effective May 30, 1997, pursuant to written
agreement between UFAI and the Company, the warrants exercisable for the
purchase of 125,000 shares of Common Stock for $4.96 were released without
exercise and canceled by the Company, at which time UFAI ceased to be a
greater than five percent beneficial owner of the Common Stock. The remaining
warrants held by UFAI are currently exercisable. In addition, UFAI received
cash compensation of $10,000 and $20,000 from the Company during 1995 and
1997, respectively, for consulting and financial advisory.
-33-
<PAGE>
On December 17, 1996, the Company adopted policies that any loans
to officers, directors and five percent or more shareholders ("affiliates")
are subject to approval by a majority of not less than two of the
disinterested independent directors of the Company and that such loans and
other transactions with affiliates will be on terms no less favorable than
could be obtained from unaffiliated parties and approved by a majority of not
less than two of the disinterested independent directors. As of December 31,
1998, the Board of Directors is comprised of five members, of which R. Terren
Dunlap and Harland C. Stonecipher are the only independent directors.
-34-
<PAGE>
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
The following documents are filed as part of this report:
1. Financial Statements appearing at pages F-2 through F-22:
Independent Auditors' Report.
Consolidated Balance Sheets as of December 31, 1998 and 1997.
Consolidated Statements of Income for Years Ended December 31, 1998,
1997 and 1996.
Consolidated Statements of Stockholders' Equity for Years
Ended December 31, 1998, 1997 and 1996.
Consolidated Statements of Cash Flows for Years Ended December 31,
1998, 1997 and 1996.
Notes to Consolidated Financial Statements for Years Ended December
31, 1998, 1997 and 1996.
2. The following exhibits are filed with or incorporated by reference
into this Form 10-KSB.
<TABLE>
<CAPTION>
Exhibit
No.
- -------
<S> <C>
3.1 The Registrant's Certificate of Incorporation. (6)
3.2 The Registrant's Bylaws. (6)
4.1 Certificate of Common Stock of the Registrant. (1)
4.2 Form of Purchase Warrant issued to Paulson Investment Company, Inc.
pursuant to Underwriting Agreement included as Exhibit 1.1. (6)
4.3 1997-A Warrant Certificate. (2)
4.4 Warrant Agreement between Registrant and U.S. Stock Transfer Inc.,
dated January 20, 1997. (2)
4.5 Stock Purchase Agreement having an effective date of May 31, 1996,
between Registrant, Miracle Mountain International, Inc., Richard
Seaton, Gene Burson, Kaye Jennings, Daryl Burson and James Rogers. (3)
4.6 Stock Purchase Agreement having an effective date of January 31, 1997,
among Registrant, Chambre' International, Inc., Janet Britt, Jerry
Hampton, Teresa Hampton, James Baria, Florence Baria, Rose Cashin, Pat
Eason, Joseph Williams, Livia Williams, Don Black, Nadine Black, Lynda
Brown, Gary Galindo, Harold Griffin, Linda Griffin, Irene Van
Vlaenderen, Dean Van Vlaenderen, Rose Hilgedick, Julie Connary and
Royce Britt. (4)
4.7 Asset Purchase Agreement among Registrant, Stay 'N Shape
International, Inc., Solution Products International, Inc., Nation of
Winners, Inc., Now International, Inc., Carl S. Rainey and Danny
Gibson, dated April 16, 1997. (8)
-35-
<PAGE>
4.8 Form of Redeemable Common Stock Purchase Warrant Certificate. (6)
4.9 Form of Warrant Agreement between Registrant and U.S. Stock Transfer
Inc. (6)
10.1 Legal Services Agreement between Registrant and Pre-Paid Legal
Services, dated September 1, 1988. (5)
10.2 Lease Agreement between Registrant and International Business Machines
Corporation, dated May 22, 1989. (5)
10.3 Group Contract between Registrant and Consumer Benefit Services, Inc.,
dated April 2, 1989. (5)
10.4 Advantage Marketing Systems, Inc. 1995 Stock Option Plan. (7)
10.5 Agreement between Registrant and Consumer Benefit Services, Inc.,
dated October 20, 1995. (7)
10.6 Agreement between Registrant and Advanced Products, Inc., dated
November 28, 1994. (7)
10.7 Agreement between Registrant and J&K Pharmaceutical Laboratories,
dated April 22, 1996. (2)
10.8 Stock Purchase Agreement having an effective date of May 31, 1996,
between Registrant, Miracle Mountain International, Inc., Richard
Seaton, Gene Burson, Kaye Jennings, Daryl Burson and James Rogers. (3)
10.9 Stock Purchase Agreement having an effective date of January 31, 1997,
among Registrant, Chambre' International, Inc., Janet Britt, Jerry
Hampton, Teresa Hampton, James Baria, Florence Baria, Rose Cashin, Pat
Eason, Joseph Williams, Livia Williams, Don Black, Nadine Black, Lynda
Brown, Gary Galindo, Harold Griffin, Linda Griffin, Irene Van
Vlaenderen, Dean Van Vlaenderen, Rose Hilgedick, Julie Connary and
Royce Britt. (4)
10.10 Asset Purchase Agreement among Registrant, Stay 'N Shape
International, Inc., Solution Products International, Inc., Nation of
Winners, Inc., Now International, Inc., Carl S. Rainey and Danny
Gibson, dated April 16, 1997. (8)
10.11 The Registrant has two subsidiaries, (i) Miracle Mountain
International, Inc. which is incorporated in Colorado and (ii)
Chambre' International, Inc. which is incorporated in Texas. The
Registrant and both of these subsidiaries do business under the same
name.
10.12 The Promotional Shares Escrow Agreement, dated November 4, 1997, by
and between Advantage Marketing Systems, Inc., John W. Hail, Curtis H.
Wilson, Sr., Ruth Wilson, Roger P. Baresel, Judith A. Baresel, R.
Terren Dunlap, Pre-Paid Legal Services, Inc., TVC, Inc., and Liberty
Bank and Trust Company of Oklahoma City, N.A. (9)
10.13 The Promotional Shares Escrow Agreement, dated October 31, 1997, by
and between Advantage Marketing Systems, Inc., Robert and Retha H.
Nance, and Liberty Bank and Trust Company of Oklahoma City, N.A. (9)
10.14 The Promotional Shares Lock-In Agreement, dated November 5, 1997, by
and between Advantage Marketing Systems, Inc., Roger P. Baresel, and
Judith A. Baresel. (9)
</TABLE>
- ------------
(1) Incorporated by reference to Form 8-K, filed with the Commission on
December 11, 1995.
(2) Incorporated by reference to Amendment No. 3 to Form SB-2 Registration
Statement (No. 33-80629), filed with the Commission on January 14,
1997.
(3) Incorporated by reference to Form 8-K, filed with the Commission on
July 12, 1996.
(4) Incorporated by reference to Form 8-K, filed with the Commission on
February 18, 1997.
(5) Incorporated by reference to Form 10-K Annual Report for the year
ended December 31, 1989,
-36-
<PAGE>
filed with the Commission on September 18, 1990.
(6) Incorporated by reference to Amendment No. 1 to Form SB-2 Registration
Statement (No. 333-34885), filed with the Commission on October 20,
1997.
(7) Incorporated by reference to Form SB-2 Registration Statement (No.
33-80629), filed with the Commission on November 20, 1996.
(8) Incorporated by reference to Form 8-K, filed with the Commission on
May 1, 1997.
(9) Incorporated by reference to Amendment No. 1 to Form SB-2 Registration
Statement (No. 333-47801), filed with the Commission on October 7,
1998.
-37-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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: March 31, 1999 By: /s/ JOHN W. HAIL
-----------------------------------------
John W. Hail, Chief Executive Officer
Date: March 31, 1999 By: /s/ ROGER P. BARESEL
-----------------------------------------
Roger P. Baresel, President, Chief
Financial and Accounting Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the Registrant and in the capacities and on the dates indicated.
Date: March 31, 1999 By: /s/ JOHN W. HAIL
-----------------------------------------
John W. Hail, Chief Executive Officer,
Chairman of the Board and Director
Date: March 31, 1999 By: /s/ CURTIS H. WILSON, SR.
-----------------------------------------
Curtis H. Wilson, Sr., Vice-Chairman of
the Board and Director
Date: March 31, 1999 By: /s/ ROGER P. BARESEL
-----------------------------------------
Roger P. Baresel, President, Chief
Financial Officer and Director
Date: March 31, 1999 By: /s/ R. TERREN DUNLAP
-----------------------------------------
R. Terren Dunlap, Director
Date: March 31, 1999 By: /s/ HARLAND C. STONECIPHER
-----------------------------------------
Harland C. Stonecipher, Director
-38-
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
ADVANTAGE MARKETING SYSTEMS, INC. AND SUBSIDIARIES
AUDITED CONSOLIDATED FINANCIAL STATEMENTS:
Independent Auditors' Report........................................................F-2
Consolidated Balance Sheets as of December 31, 1998 and 1997........................F-3
Consolidated Statements of Income for Years Ended December 31, 1998,
1997 and 1996.....................................................................F-4
Consolidated Statements of Stockholders' Equity for Years Ended
December 31, 1998, 1997 and 1996..................................................F-5
Consolidated Statements of Cash Flows for Years Ended December 31,
1998, 1997 and 1996...............................................................F-6
Notes to Consolidated Financial Statements for Years Ended December 31,
1998, 1997 and 1996...............................................................F-7
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Advantage Marketing Systems, Inc. and Subsidiaries
Oklahoma City, Oklahoma
We have audited the accompanying consolidated balance sheets of Advantage
Marketing Systems, Inc. and subsidiaries (the "Company") as of December 31,
1998, and 1997, and the related consolidated statements of income,
stockholders' equity, and cash flows for each of the three years in the
period ended December 31, 1998. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits 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 audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of December 31,
1998, and 1997, and the results of its operations and its cash flows for each
of the three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Oklahoma City, Oklahoma
March 19, 1999
F-2
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
ASSETS 1998 1997
------------ ------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents ......................................................... $ 5,289,217 $ 5,775,276
Receivables - net of allowance of $36,604 and $25,800, respectively ............... 263,503 184,915
Receivable from affiliate ......................................................... 293,936 14,124
Commission advances ............................................................... -- 59,268
Inventory ......................................................................... 1,009,998 812,125
Deferred income taxes ............................................................. 93,496 85,224
Other assets ...................................................................... 100,345 68,432
------------ ------------
Total current assets .................................................. 7,050,495 6,999,364
RECEIVABLES ......................................................................... 129,440 15,079
RECEIVABLE FROM AFFILIATE ........................................................... -- 40,656
PROPERTY AND EQUIPMENT, Net ......................................................... 1,090,280 695,896
GOODWILL, Net ....................................................................... 1,725,734 1,700,909
COVENANTS NOT TO COMPETE, Net ....................................................... 511,685 518,791
DEFERRED INCOME TAXES ............................................................... 95,277 354,693
OTHER ASSETS ........................................................................ 114,572 10,918
------------ ------------
TOTAL ............................................................................... $ 10,717,483 $ 10,336,306
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable .................................................................. $ 60,172 $ 202,220
Accrued commissions and bonuses ................................................... 156,174 325,077
Accrued other expenses ............................................................ 277,651 183,921
Accrued sales tax liability ....................................................... 616,735 --
Notes payable ..................................................................... 29,476 26,304
Capital lease obligations ......................................................... 87,105 118,801
------------ ------------
Total current liabilities ............................................. 1,227,313 856,323
LONG-TERM LIABILITIES:
Notes payable ..................................................................... 94,311 82,440
Capital lease obligations ......................................................... 173,247 221,148
------------ ------------
Total liabilities .................................................... 1,494,871 1,159,911
------------ ------------
COMMITMENTS AND CONTINGENCIES (Note 13)
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 4,275,514 and 4,249,383 shares; outstanding 4,141,014 and 4,249,383
shares, respectively ............................................................. 428 425
Paid-in capital ................................................................... 10,180,106 10,180,109
Notes receivable for exercise of options .......................................... (63,960) (74,000)
Accumulated deficit ............................................................... (516,091) (930,139)
------------ ------------
Total capital and accumulated deficit .............................. 9,600,483 9,176,395
F-3
<PAGE>
Less cost of treasury stock (134,500 shares, common) .............................. (377,871) --
------------ ------------
Total stockholders' equity .......................................... 9,222,612 9,176,395
------------ ------------
TOTAL ............................................................................... $ 10,717,483 $ 10,336,306
------------ ------------
------------ ------------
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ -----------
<S> <C> <C> <C>
Net sales .................................................... $ 13,287,824 $ 10,192,227 $ 6,155,073
Cost of sales ................................................ 8,999,229 7,271,660 4,265,905
------------ ------------ -----------
Gross profit ............................................. 4,288,595 2,920,567 1,889,168
Marketing, distribution and administrative expenses .......... 3,548,772 2,792,879 1,561,753
------------ ------------ -----------
Income from operations ................................... 739,823 127,688 327,415
Other income (expense):
Interest, net ................................................ 309,908 34,017 (10,538)
Other income ................................................. 39,280 28,017 8,667
Settlement of additional tax liability (Note 12).............. (421,623) -- --
------------ ------------ -----------
Total other income (expense) ............................. (72,435) 62,034 (1,871)
------------ ------------ -----------
INCOME BEFORE TAXES .......................................... 667,388 189,722 325,544
TAX EXPENSE (BENEFIT) ........................................ 253,340 59,696 (499,613)
------------ ------------ -----------
NET INCOME ................................................... $ 414,048 $ 130,026 $ 825,157
------------ ------------ -----------
------------ ------------ -----------
Net income per common share .................................. $ .10 $ .05 $ .39
------------ ------------ -----------
------------ ------------ -----------
Net income per common share - assuming dilution .............. $ .09 $ .04 $ .26
------------ ------------ -----------
------------ ------------ -----------
Weighted average common shares outstanding ................... 4,191,760 2,751,771 2,135,097
------------ ------------ -----------
------------ ------------ -----------
Weighted average common shares outstanding - assuming dilution 4,503,411 3,762,642 3,203,485
------------ ------------ -----------
------------ ------------ -----------
</TABLE>
F-4
<PAGE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-5
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
NOTES
RECEIVABLE TOTAL
SHARES COMMON PAID-IN FOR EXERCISE ACCUMULATED TREASURY STOCKHOLDERS'
(SEE NOTE 4) STOCK CAPITAL OF OPTIONS DEFICIT STOCK EQUITY
------------ ------ ------- ------------ ----------- -------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE,
JANUARY 1, 1996................ 2,137,012 $212 $ 1,859,882 $ -- $(1,885,322) $ -- $(25,228)
Issuance of stock for Miracle
Mountain International, Inc.
acquisition................... 20,000 2 119,998 -- -- -- 120,000
Warrants exercised.............. 250 -- 1,500 -- -- -- 1,500
Net income...................... -- -- -- -- 825,157 -- 825,157
--------- ----- ----------- -------- ----------- --------- ----------
BALANCE,
DECEMBER 31, 1996............ 2,157,262 214 1,981,380 -- (1,060,165) -- 921,429
Issuance of stock for
Chambre' acquisition.......... 14,000 1 83,999 -- -- -- 84,000
Warrants and rights offering,
net........................... 337,211 34 1,831,247 -- -- -- 1,831,281
Issuance of stock for
SNSI acquisition.............. 125,984 13 799,987 -- -- -- 800,000
Options exercised for cash...... 46,945 4 79,996 -- -- -- 80,000
Options exercised by tendering
mature shares, net............ 26,731 4 (4) -- -- -- --
Options exercised by issuance
of note....................... 46,250 5 73,995 (74,000) -- -- --
Common stock offering, net...... 1,495,000 150 5,329,509 -- -- -- 5,329,659
Net income...................... -- -- -- -- 130,026 -- 130,026
--------- ----- ----------- -------- ----------- --------- ----------
BALANCE,
DECEMBER 31, 1997............. 4,249,383 425 10,180,109 (74,000) (930,139) -- 9,176,395
Payments on notes receivable.... -- -- -- 10,040 -- -- 10,040
Options exercised by tendering
mature shares, net............ 26,131 3 (3) -- -- -- --
Purchases of treasury stock,
at cost......................... (134,500) -- -- -- -- (377,871) (377,871)
Net income...................... -- -- -- -- 414,048 -- 414,048
--------- ----- ----------- -------- ----------- --------- ----------
F-6
<PAGE>
BALANCE,
DECEMBER 31, 1998............ 4,141,014 $ 428 $10,180,106 $(63,960) $ (516,091) $(377,871) $9,222,612
--------- ----- ----------- -------- ----------- --------- ----------
--------- ----- ----------- -------- ----------- --------- ----------
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-7
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
---------- ----------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................................ $ 414,048 $ 130,026 $ 825,157
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation and amortization.................................... 387,160 251,443 65,993
Deferred taxes................................................... 251,144 59,696 (499,613)
Provision for bad debts.......................................... 10,804 -- 4,319
Write-off of deferred offering costs............................. -- -- 15,000
Gain on sale of assets........................................... (35,329) (18,671) (1,572)
Changes in assets and liabilities which provided (used) cash:
Receivables and commission advances........................... (144,485) (167,192) (80,139)
Inventory..................................................... (197,873) (722,806) (119,324)
Other assets (23,179) 269,946 --
Accounts payable and accrued expenses......................... 579,964 78,971 216,600
---------- ----------- ---------
Net cash provided by (used in) operating activities...... 1,242,254 (118,587) 426,421
---------- ----------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment................................... (547,592) (312,709) (66,675)
Receivable from affiliate............................................. (293,936) -- (22,000)
Proceeds from sale of assets.......................................... 125,340 40,196 1,700
Repayment of receivable from affiliate................................ 54,780 13,042 6,141
Purchase of Miracle Mountain International, Inc. ..................... -- -- (56,103)
Purchase of Chambre International, Inc. .............................. -- (51,340) --
Purchase of assets pursuant to SNSI Asset Purchase.................... -- (1,274,441) --
Purchase of ToppMed, Inc. Assets...................................... (192,000) -- --
Purchase of other assets.............................................. (142,875) (106,803) --
---------- ----------- ---------
Net cash used in investing activities................... (996,283) (1,692,055) (136,937)
---------- ----------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock................................ -- 8,284,357 1,500
Proceeds from notes payable........................................... 62,727 114,259 --
Purchases of treasury stock........................................... (377,871) -- --
Payment of deferred offering costs.................................... (180,450) (862,967) (125,400)
Repayments of notes receivable for exercise of stock options.......... 10,040 -- --
Payment on notes payable - stockholders............................... -- -- (81,929)
Payment on notes payable.............................................. (47,684) (34,010) (8,445)
Principal payment on capital lease obligations........................ (198,792) (85,290) (17,728)
---------- ----------- ---------
Net cash (used in) provided by financing activities..... (732,030) 7,416,349 (232,002)
---------- ----------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS..................... (486,059) 5,605,707 57,482
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR............................. 5,775,276 169,569 112,087
---------- ----------- ---------
CASH AND CASH EQUIVALENTS, END OF YEAR................................... $5,289,217 $5,775,276 $169,569
---------- ----------- ---------
---------- ----------- ---------
</TABLE>
F-8
<PAGE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-9
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION- The 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 terminates his/her
distributorship agreement with the Company and returns the product within
12 months of original purchase in marketable condition. For the years
ended December 31, 1998, 1997 and 1996, the cost of products returned to
the Company are included in net sales and was two, three and four percent
of gross sales, respectively.
ADVERTISING - The Company expenses advertising as incurred. Total
advertising expense for 1998, 1997, and 1996 was $16,459, $28,416 and
$26,410, 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.
F-10
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
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 December 31, 1998 was $75,186, $162,140, $1,363,075
and $125,333, respectively. The net amount of goodwill arising from the
MMI, CII and SNSI acquisitions at December 31, 1997 was $92,208, $171,107
and $1,437,594, respectively. Goodwill amortization for the years ended
December 31, 1998, 1997 and 1996 was $103,175, $78,026 and $9,930,
respectively. Covenant amortization for the years ended December 31,
1998, 1997 and 1996, was $71,106, $53,431 and $7,778, 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 future cash flows generated by that asset.
Recoverability is assessed and measured on long-lived assets using an
estimate of the undiscounted future cash flows attributable to the asset.
Impairment is measured based on future cash flows discounted at an
appropriate rate.
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 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>
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ------
<S> <C> <C> <C>
Weighted average common shares outstanding:
For the year ended December 31, 1998:
Earnings per common share:
Income available to common stockholders................ $414,048 4,191,760 $.10
----
Earnings per common share - assuming dilution:
Options............................................... -- 311,651
-------- ---------
F-11
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Income available to common stockholders plus assumed
conversions..................................... $414,048 4,503,411 $.09
-------- --------- ----
For the year ended December 31, 1997:
Earnings per common share:
Income available to common stockholders.................. $130,026 2,751,771 $.05
----
Earnings per common share - assuming dilution:
Options.................................................. -- 825,061
<CAPTION>
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ------
Warrants -- 185,810
-------- ---------
Income available to common stockholders plus assumed
conversions..................................... $130,026 3,762,642 $.04
-------- --------- ----
For the year ended December 31, 1996:
Earnings per common share:
Income available to common stockholders.................. $825,157 2,135,097 $.39
----
Earnings per common share - assuming dilution:
Options.................................................. -- 990,379
Warrants................................................. -- 78,009
-------- ---------
Income available to common stockholders plus assumed
conversions..................................... $825,157 3,203,485 $.26
-------- --------- ----
</TABLE>
Options to purchase 130,358 shares of common stock ranging from $2.80 to
$3.60 per share and 5,000 shares of common stock at $6.00 per share were
outstanding at December 31, 1998 and 1997, respectively, but were not
included in the computation of earnings per common share - assuming
dilution because the options' exercise price was greater than the
average market price of the common shares. There were no antidilutive
options to purchase shares of common stock at December 31, 1996.
Warrants to purchase 1,962,211 shares of common stock ranging from $3.40
to $5.40 and 525,860 shares of common stock at $8.00 were outstanding at
December 31, 1998 and 1996, respectively, but were not included in the
computation of earnings per common share - assuming dilution because the
warrants' exercise price was greater than the average market price of
the common shares. There were no antidilutive warrants to purchase
shares of common stock at December 31, 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,
as the Company does not offer postretirement benefits.
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 impact on the
Company's consolidated financial statements from the adoption of SFAS
No. 133 has not yet been determined. This statement is effective for all
fiscal quarters beginning after June 15, 1999. The Company will adopt
SFAS No. 133 on January 1, 2000 as required.
F-12
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
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.
RECLASSIFICATIONS - Certain reclassifications have been made to prior
year balances to conform with the presentation for the current period.
2. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Office furniture, fixtures and equipment............ $1,466,273 $ 954,293
Vehicles............................................ 193,982 142,055
Leasehold improvements.............................. 38,936 34,388
---------- ----------
1,699,191 1,130,736
Accumulated depreciation and amortization........... (608,911) (434,840)
---------- ----------
Total property and equipment, net................... $1,090,280 $ 695,896
---------- ----------
</TABLE>
Depreciation expense for the years ended December 31, 1998, 1997 and 1996
was $203,972, $119,986 and $48,285, respectively.
3. LEASE AGREEMENTS
During 1998 and 1997, the Company entered into various capital leases for
office equipment. The lease terms range from 24 to 60 months.
Additionally, annual lease rental payments for each lease range from $700
to $40,000 per year. The schedule of future minimum lease payments below
reflects all payments under the leases.
The property and equipment accounts include $422,616 and $449,540 for
leases that have been capitalized at December 31, 1998 and 1997,
respectively. Related accumulated amortization amounted to $128,338 and
$109,591 at December 31, 1998 and 1997, respectively.
The Company leases office and warehouse space under noncancellable
operating leases.
F-13
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Future annual minimum lease payments under capital leases and
noncancellable operating leases with initial or remaining terms of one
year or more at December 31, 1998 are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES TOTAL
-------- --------- --------
<S> <C> <C> <C>
Year ending:
1999.............................................................. $101,013 $145,426 $246,439
2000.............................................................. 71,212 151,844 223,056
2001.............................................................. 61,576 157,617 219,193
2002.............................................................. 26,206 161,450 187,656
2003.............................................................. 30,763 67,937 98,700
-------- --------- --------
Total minimum lease payments...................................... 290,770 $684,274 $975,044
--------- --------
--------- --------
Less amount representing interest................................. 30,418
--------
Present value of net minimum lease payments....................... 260,352
Less current portion.............................................. 87,105
--------
Long-term capital lease obligations............................... $173,247
--------
--------
</TABLE>
Rental expense under operating leases for the years ended December 31,
1998, 1997 and 1996 was $147,166, $88,632 and $63,425, respectively.
4. STOCKHOLDERS' EQUITY
COMMON STOCK - On March 4, 1998, the Company announced it's intent 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 December 31, 1998, the Company
has repurchased 134,500 shares of the Common Stock at a total cost of
$377,871. The Company has ceased making repurchases and the last
repurchase was made December 31, 1998.
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 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.
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 gross proceeds of
$6,050,000. Accumulated offering costs of approximately
F-14
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
$720,000 were charged against the proceeds of the offering (the "Units
Offering").
During 1997 in connection with the registration of the Units Offering,
certain officers and shareholders agreed to certain escrow and lock-in
arrangements required by the Oklahoma Department of Securities until
November 6, 2000. The agreement encompasses 377,682 shares of the
Company's common stock and stock options and warrants to purchase 674,500
shares of such common stock and does not permit the sale or disposition
of such securities by these officers and shareholders. There are no
conditions under which these shares of common stock, stock options and
warrants would be required to be returned to the Company and they are
treated as outstanding securities for purposes of the Company's earnings
per share calculations.
On October 29, 1996, the Board of Directors of the Company effected a
one-for-eight reverse split of the Company's outstanding common stock,
options and warrants. In addition, the number of the Company's
outstanding options and warrants has been reduced by a factor of eight
and their exercise price has been increased by a factor of eight pursuant
to this action. This one-for-eight reverse split is reflected in the
accompanying consolidated financial statements and footnotes on a
retroactive basis.
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 - During 1998, the Company
granted 809,819 options at exercise prices ranging from $1.75 per share
to $3.00 per share. Options were granted primarily for services rendered
and to ensure the future availability of those services to the Company. A
total of 418,819 of the options granted during 1998 are unexercisable at
December 31, 1998 due to a six month vesting period. During 1998, 57,306
options were exercised for 31,025 mature shares. In addition, during this
period 519,944 options with a weighted average exercise price of $2.32
per share were voluntarily surrendered and canceled by the Company in
exchange for an equal number of options, with a weighted average exercise
price of $1.82 and 128,830 other options were canceled without exchange
for new options. The exercise price of the exchanged options was equal to
the market value of the Company's stock on the date of exchange. There
was no expense recognized in the Company's financial statements relating
to the exchange. See Note 5 for the pro forma effects of SFAS 123
ACCOUNTING FOR STOCK-BASED COMPENSATION ("SFAS 123").
During 1997, the Company granted 493,100 options at exercise prices
ranging from $2.70 per share to $6.00 per share. Options were granted
primarily for services rendered and to ensure the future availability of
those services to the Company. Options granted on December 26, 1997 have
a six month vesting period. During 1997, 135,695 options were exercised
of which 46,945, 42,500 and 46,250 were exercised for cash, 15,769 mature
shares and notes receivable, respectively. In addition, during this
period 319,250 options with a weighted average exercise price of $4.67
per share were voluntarily surrendered and canceled by the Company in
exchange for an equal number of options, with an exercise price of $2.70
per share, 125,000 other warrants were canceled without exchange for new
warrants or options and 2,499 options expired. The exercise price of the
exchanged option was equal to the market value of the Company's stock on
the date of exchange. There was no expense recognized in the Company's
financial statements relating to the exchange. See Note 5 for the pro
forma effects of SFAS 123.
F-15
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
The following table summarizes the Company's stock option and other
warrants activity for the years ended December 31, 1998, 1997 and 1996
(as restated for the one-for-eight reverse split in October 1996):
<TABLE>
<CAPTION>
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
1998 PRICE 1997 PRICE 1996 PRICE
--------- ----- --------- ----- --------- -----
<S> <C> <C> <C> <C> <C> <C>
Options and other
warrants outstanding,
beginning of year.......... 1,439,583 $2.28 1,528,927 $2.49 1,540,177 $2.52
Options and other
warrants granted
during the year............ 809,819 1.93 493,100 3.68 -- --
Options exercised
during the year............ (57,306) 2.17 (135,695) 1.64 -- --
Options and other
warrants canceled
during the year............ (617,524) 2.35 (444,250) 4.75 -- --
Options expired
during the year............ (31,250) 1.60 (2,499) 1.60 (11,250) 6.48
-------- --------- ---------
Options and other
warrants outstanding,
F-16
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
end of year................ 1,543,322 $2.09 1,439,583 $2.28 1,528,927 $2.49
--------- ----- --------- ----- --------- -----
--------- ----- --------- ----- --------- -----
</TABLE>
The weighted average grant-date fair value of options and other warrants
granted during 1998 and 1997 was $1.05 and $1.20 per share, respectively.
There were no options granted during 1996.
<TABLE>
<CAPTION>
OPTIONS AND OTHER WARRANTS OPTIONS AND OTHER WARRANTS
OUTSTANDING EXERCISABLE
----------------------------------------- -----------------------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED-
NUMBER REMAINING AVERAGE NUMBER AVERAGE
RANGE OF OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
EXERCISE PRICES AT 12/31/98 LIFE PRICE AT 12/31/98 PRICE
--------------- ----------- ----------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
$1.75 - 3.60 1,543,322 4.8 years $2.09 1,124,503 $2.15
</TABLE>
COMMON STOCK WARRANTS - The following table summarizes the Company's common
stock warrants and their activity for the years ended December 31, 1998,
1997 and 1996 (as restated for the one-for-eight reverse split in October
1996):
<TABLE>
<CAPTION>
WARRANTS
ISSUED AND EXERCISE
OUTSTANDING PRICE EXERCISE PERIOD
----------- -------- ---------------
<S> <C> <C> <C>
DECEMBER 31, 1998:
1997-A Warrants......................................... 337,211 $3.40 1/31/97 - 1/31/99
---------
---------
Redeemable Common Stock Purchase Warrants............... 1,495,000 $3.40 11/06/97 - 11/06/02
---------
---------
Underwriters' Warrants.................................. 130,000 $5.40 11/12/98 - 11/12/02
---------
---------
DECEMBER 31, 1997:
Class A Warrants, beginning of year..................... 524,360 $6.00 4/26/89 - 7/26/97
Class A Warrants redeemed during the year............... (524,360) $6.00
---------
Class A Warrants, end of year........................... --
---------
---------
Class B Warrants, beginning of year..................... 525,860 $8.00 4/26/89 - 7/26/97
Class B Warrants redeemed during the year............... (525,860) $8.00
---------
Class B Warrants, end of year........................... --
---------
---------
1997-A Warrants, beginning of year...................... --
1997-A Warrants issued during the year 337,211 $12.00 1/31/97 - 1/31/99
---------
1997-A Warrants, end of year............................ 337,211
---------
---------
F-17
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Redeemable Common Stock Purchase Warrants,
beginning of year.................................... --
Redeemable Common Stock Purchase Warrants,
issued during the year............................... 1,495,000 $5.40 11/6/97 - 11/6/02
---------
Redeemable Common Stock Purchase Warrants,
end of year.......................................... 1,495,000
---------
---------
Underwriters' Warrants, beginning of year............... --
Underwriters' Warrants issued during the year........... 130,000 $5.40 11/12/98 - 11/12/02
---------
Underwriters' Warrants, end of year..................... 130,000
---------
---------
DECEMBER 31, 1996:
Class A Warrants, beginning of year..................... 524,610 $6.00 4/26/89 - 7/26/97
Class A Warrants exercised during the year.............. (250) $6.00
---------
Class A Warrants, end of year........................... 524,360
---------
---------
Class B Warrants........................................ 525,860 $8.00 4/26/89 - 7/26/97
---------
---------
</TABLE>
Each warrant entitles the holder to purchase one share of common stock.
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 reduction as the change
only affects allocations of additional paid-in capital because the
Redeemable Common Stock Purchase Warrants were issued in conjunction with
an equity offering of the Company. The reduced exercise prices exceeded
the market value of the Company's Common Stock on the date of the
reduction.
The Redeemable Common Stock Purchase Warrants are subject to redemption
by the Company at a price of $0.25 per warrant. All of the outstanding
Redeemable Common Stock Purchase Warrants must be redeemed if any are
redeemed. The Company may redeem the 1997-A Warrants for $0.0001 per
warrant. Any redemption of unexercised 1997-A Warrants would be for all
such outstanding warrants. The Underwriters' Warrants were issued in
connection with the Company's sale of Common Stock and Redeemable
Warrants in November 1997 and were in addition to other fees paid to the
underwriters. The Underwriters' Warrants entitle the holder to buy one
unit consisting of one share of the Company's Common Stock and one
warrant for the purchase of one other share of the Company's Common Stock
for $3.40.
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 of stock subject to this Plan is set by the Stock Option Committee
of the Board of Directors
F-18
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
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 years ended December 31, 1998
and 1997 the Company granted 281,295 and 173,850 net options under the
Plan, respectively. No stock appreciation rights are attached to any
options outstanding. At December 31, 1998 and 1997, the Company had
1,543,322 and 1,439,583 stock options outstanding of which only 441,589
and 173,850 had been issued pursuant to this plan, respectively.
The Company applies Accounting Principles Board Opinion No. 25 and
related interpretations in accounting for its stock-based compensation
awards. Accordingly, no compensation cost has been recognized in the
accompanying consolidated financial statements. The following pro forma
data is calculated net of tax as if compensation cost for the Company's
stock-based compensation awards (see also Note 4) was determined based
upon the fair value at the grant date consistent with the methodology
prescribed under SFAS No. 123.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Net income as reported.......................................... $ 414,048 $ 130,026 $ 825,157
Adjustment, net of tax........................................ (233,329) (467,554) --
---------- --------- ---------
Pro forma net income (loss)..................................... $ 180,719 $(337,528) $ 825,157
Net income per common share as reported......................... $ .10 $ .05 $ 0.39
Adjustment, net of tax........................................ (.06) (0.17) --
---------- --------- ---------
Pro forma net income (loss) per common share.................... $ .04 $ (0.12) $ 0.39
Pro forma net income (loss) per common share - assuming
dilution...................................................... $ .04 $ (0.12) $ 0.26
Weighted average common shares outstanding...................... 4,191,760 2,751,771 2,135,097
Weighted average common shares outstanding - assuming
dilution...................................................... 4,503,411 2,751,771 3,203,485
</TABLE>
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following weighted
average assumptions used for grants in 1998 and 1997, respectively (no
option grants during 1996): risk-free interest rates of 4.50 and 5.93
percent; no dividend yield or assumed forfeitures; expected lives of 5.4
and 6.7 years; and volatility of 59 and 60 percent. The pro forma
amounts above are not likely to be representative of
F-19
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
future years because there is no assurance that additional awards will be
made each year.
6. RELATED PARTIES
During 1998, 1997 and 1996, the Company received approximately $6,822,
$7,157 and $9,116, respectively, from Pre-Paid Legal Services, Inc., a
stockholder, for commissions on sales of memberships for the services
provided by Pre-Paid Legal Services, Inc.
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 $73,963 bearing
interest at eight percent per annum and payable in 60 installments of
$1,499 per month. JHA has made repayments of these advances of $13,042,
$6,141 during the fiscal years ended December 31, 1997 and 1996,
respectively. During the year ended December 31, 1998, JHA made
repayments of $54,780. As of June 30, 1998 the note has been paid in full.
During 1995, John W. Hail individually entered into lease agreements
covering telephone equipment and related software and requiring monthly
rental payments. Such equipment and software are utilized exclusively by
the Company. During the years ended December 31, 1998, 1997 and 1996, the
Company made aggregate monthly payments pursuant to such lease agreements
of $17,939, $19,427 and $19,427, 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 years ended December 31, 1998, 1997 and 1996, the Company paid
Curtis H. Wilson, Sr., a Director of the Company, sales commissions of
$62,555, $32,886 and $38,337, respectively. These commissions were based
upon purchases by Mr. Wilson and his downline 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. The loan has been extended until
March 31, 2000. As of December 31, 1998, the balance due on this loan was
$293,936. The loan was unanimously approved by the Company's board of
directors.
F-20
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
7. INCOME TAXES
On a regular basis, management evaluates all available evidence, both
positive and negative, regarding the ultimate realization of the tax
benefits of its deferred tax assets. Management concluded in 1996 that it
is more likely than not that a tax benefit will be realized from its
deferred tax assets and therefore eliminated the previously recorded
valuation allowance. The Company's deferred tax assets relate primarily
to net operating loss carryforwards for income tax purposes at December
31, 1998, totaling $531,856 , which will begin to expire in 2003. The
Company has a net deferred tax asset at December 31, 1998 and 1997, of
$188,773 and $439,917, respectively.
Income taxes for 1998 were comprised of current taxes of $2,196 and
deferred taxes of $251,144. Income taxes for 1997 and 1996 were comprised
of deferred taxes. A reconciliation of the statutory Federal income tax
rate to the effective income tax rate for the years ended December 31,
1998, 1997, and 1996 is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----- ----- --------
<S> <C> <C> <C>
Statutory federal income tax rate............. 34.0% 34.0% 34.0%
State tax effective rate...................... 4.0 4.6 4.3
Permanent differences......................... 2.3 6.4 0.0
Benefit of graduated tax rates................ 0.0 (4.8) (0.4)
Benefit of operating loss carryforwards....... 0.0 (0.0) (37.9)
Change in effective rate...................... 0.0 (8.7) 0.0
Other......................................... (2.3) 0.0 0.0
Reduction in valuation allowance.............. 0.0 0.0 (153.5)
----- ----- --------
Effective income tax rate..................... 38.0% 31.5% (153.5)%
----- ----- --------
----- ----- --------
</TABLE>
Deferred tax liabilities and assets at December 31, 1998 and 1997 are
comprised of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1998 1997
-------- --------
<S> <C> <C>
Deferred tax liabilities:
Depreciation and amortization......................... $(38,037) $(20,682)
-------- --------
Total deferred tax liabilities............. (38,037) (20,682)
-------- --------
Deferred tax assets:
Net operating loss carryforwards...................... 160,889 458,796
Reserves.............................................. 49,404 1,803
Other................................................. 16,517 --
-------- --------
Total deferred tax assets................. 226,810 460,599
-------- --------
F-21
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Net deferred taxes...................................... 188,773 439,917
Less current portion of net deferred tax assets......... 93,496 85,224
-------- --------
Noncurrent portion...................................... $ 95,277 $354,693
-------- --------
-------- --------
</TABLE>
8. COMMISSION ADVANCES
Commission advances represent advances to certain associates and are
repayable from future commissions earned by the associates. These
advances do not bear interest and are classified in the accompanying
consolidated balance sheets according to the expected timing of
commissions to be earned by the associates.
9. ACQUISITIONS
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.
Pursuant to a Stock Purchase Agreement having an effective date of
January 31, 1997 (the "Purchase Agreement"), the Company acquired all of
the issued and outstanding capital stock of Chambre' International, Inc.,
a Texas corporation ("CII"), and CII became a wholly-owned subsidiary of
the Company (the "CII Acquisition"). The CII Acquisition was closed on
January 31, 1997, and was accounted for under the purchase method of
accounting. CII is a network marketer of various third-party manufactured
cosmetics, skin care and hair care products. In connection with the CII
Acquisitions, the Company issued 6,482 shares of its common stock to the
shareholders of CII at closing and issued an additional 7,518 shares of
its common stock to the shareholders of CII on March 31, 1997, after
determination of certain liabilities.
In connection with the CII Acquisition, the excess of the purchase price
of $135,340, which includes $3,549 of transaction costs, over the
negative $63,985 fair value of assets of CII acquired, net of liabilities
assumed, has been allocated $179,325 to goodwill and $20,000 to a
covenant not to complete. Goodwill and the covenant not to compete will
be amortized over 20 year and 47 month periods, respectively.
Pursuant to an Asset Purchase Agreement having an effective date of April
16, 1997 (the "Purchase Agreement"), the Company acquired all the assets
of Stay 'N Shape International, Inc. ("SNSI"), Solution Products
International, Inc. ("SPII"), Nation of Winners, Inc. ("NWI"), Now
International, Inc. ("NII"), all Georgia corporations, (collectively
SNSI, SPII, NWI and NII are referred to as the "Selling Group"), free and
clear of any lien, charge, claim, pledge, security interest or other
encumbrance of any type or kind whatsoever, known or unknown (the "SNSI"
Asset Purchase"). The SNSI Asset Purchase was closed on April 16, 1997,
and was accounted for under the purchase method of accounting. Each
company in the Selling Group is a network marketer of various third-party
manufactured nutritional supplements and was under common ownership.
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
F-22
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
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. 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.
In connection with the SNSI Asset Purchase, the excess of the purchase
price of $2,074,441, which included $100,000 of transaction costs, over
the $84,063 fair value of the assets acquired, has been allocated
$1,490,378 to goodwill and $500,000 to two covenants not to compete.
Goodwill and the covenants not to compete will be amortized over 20 and
10 year periods, respectively.
Pursuant to a Stock Purchase Agreement having an effective date of May
31, 1996 (the "Purchase Agreement"), the Company acquired all of the
issued and outstanding capital stock of Miracle Mountain International,
Inc., a Colorado corporation ("MMI"), and MMI became a wholly owned
subsidiary of the Company (the "MMI Acquisition"). The MMI Acquisition
was accounted for under the purchase method of accounting. MMI is a
network marketer of various third-party manufactured nutritional
supplement products. Pursuant to the Purchase Agreement and in connection
with the MMI Acquisition, the Company issued and delivered to the
shareholders of MMI 20,000 shares of the Company's common stock.
In connection with the MMI Acquisition, the excess of the purchase price
of $176,103, which includes $56,103 of transaction costs, over the
negative $3,059 fair value of the assets of MMI acquired, net of
liabilities assumed, has been allocated $119,162 to goodwill and $60,000
to the covenant not to compete.
F-23
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Goodwill and the covenant not to compete will be amortized over seven and
four and one-half year periods, respectively.
The following unaudited pro forma information presents a summary of
consolidated results of operations as if the acquisitions had occurred at
the beginning of 1998 and 1997, with pro forma adjustments to give effect
to amortization of goodwill together with the related income tax effect.
The unaudited pro forma information is not necessarily indicative of
either the results of operations that would have occurred had the
purchases been made during the periods presented or the future results of
the combined operations.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1998 1997
----------- -----------
<S> <C> <C>
Net revenues....................................... $13,228,000 $10,776,000
Net income......................................... $ 397,000 $ 142,000
Net income per common share........................ $ .09 $ .05
Net income per common share - assuming dilution.... $ .09 $ .04
</TABLE>
10. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
--------- ----------- --------
<S> <C> <C> <C>
Cash paid during the year for:
Interest........................................... $ 34,663 $ 33,012 $ 23,021
Income taxes....................................... -- 2,196 --
Noncash financing and investing activities:
Property and equipment acquired by capital lease... 99,007 147,508 199,131
Deferred offering costs not yet paid............... -- 180,450 --
Fair value of capital stock issued to purchase
Miracle Mountain International Inc...................... -- -- 120,000
Acquisition of Chambre' International, Inc.:
Fair value of assets acquired...................... $ -- $ (84,802) $ --
Fair value of covenant not to compete.............. -- (20,000) --
F-24
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
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) $ --
--------- ----------- --------
--------- ----------- --------
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
acquired 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) $ --
--------- ----------- --------
--------- ----------- --------
ToppMed, Inc. asset purchase:
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) $ -- $ --
--------- ----------- --------
--------- ----------- --------
</TABLE>
11. NOTES PAYABLE
The Company has notes payable of $123,787 and $108,744 for the years
ended December 31, 1998 and 1997, respectively. The current balance of
the notes at December 31, 1998 and 1997 is $29,476 and $26,304,
respectively. The notes were issued to acquire vehicles to be used by
the Company and are collateralized by such vehicles for which the notes
were issued to finance. These notes mature ranging from June 2001 to
September 2003 with interest rates on the notes ranging from 8.25 percent
to 10.98 percent. Payments of principal and interest are made on the
notes monthly ranging from $425 to $928. Scheduled maturities for 1999
through 2003 are $29,476, $32,371, $30,946, $22,035 and $8,957,
respectively.
12. 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 additional 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 $261,400 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 represents neither
additional income nor additional expense to the Company but instead is a
pass through item with no income statement effect.
F-25
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
13. 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
49.7 percent, 29.5 percent, and 39.1 percent of net sales for the years
ended 1998, 1997 and 1996, 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.
14. SUBSEQUENT EVENTS
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") in lots of five Participation Interests. 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
F-26
<PAGE>
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. The registration statement became effective February 19, 1999.
* * * * * *
F-27
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 5,289,217
<SECURITIES> 0
<RECEIVABLES> 594,043
<ALLOWANCES> 36,604
<INVENTORY> 1,009,998
<CURRENT-ASSETS> 7,050,495
<PP&E> 1,699,191
<DEPRECIATION> 608,911
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0
0
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<EPS-PRIMARY> .10
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</TABLE>
