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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-KSB/A
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For fiscal year ended December 31, 1997
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)
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
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 20, 1998, was $12,782,269
based on the closing bid price on that date as reported by the National Daily
Quotation Bureau, Inc. As of March 20, 1998, 4,249,383 shares of the
registrant's common stock, $.0001 par value, were outstanding.
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ADVANTAGE MARKETING SYSTEMS, INC.
FORM 10-KSB/A
For the Fiscal Year Ended December 31, 1997
TABLE OF CONTENTS
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Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Item 3. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Item 4. Submission of Matters to a Vote of Security Holders. . . . . . . . . . . . . . . . . . . . . 15
Item 5. Market for the Company's Common Equity and Related Stockholder Matters . . . . . . . . . . . 16
Item 6. Management's Discussion and Analysis of Financial Condition and Results of Operations. . . . 17
Item 7. Financial Statements and Supplementary Data. . . . . . . . . . . . . . . . . . . . . . . . . 25
Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure . . . . 25
Item 9. Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . . . . 26
Item 10. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Item 11. Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . . . . . 29
Item 12. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . . 30
Item 13. Exhibits, Financial Statement Schedules and Reports on Form 8-K. . . . . . . . . . . . . . . 32
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Certain statements under the captions "Management's Discussion and
Analysis of Financial Condition and Results of Operations," "Business" and
elsewhere in this document constitute "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. Certain, but not
necessarily all, of such forward-looking statements can be identified by the use
of forward-looking terminology such as "anticipates," "believes," "expects,"
"may," "will," or "should" or other variations thereon, or by discussions of
strategies that involve risks and uncertainties. The actual results of the
Company or industry results may be materially different from any future results
expressed or implied by such forward-looking statements. Factors that could
cause actual results to differ materially include general economic and business
conditions; the ability of the Company to implement its business and acquisition
strategies; changes in the network marketing industry and changes in consumer
preferences; competition; availability of key personnel; increasing operating
costs; unsuccessful advertising and promotional efforts; changes in brand
awareness; acceptance of new product offerings; and changes in, or the failure
to comply with, government regulations (especially food and drug laws and
regulations); the ability of the Company to obtain financing for future
acquisitions; and other factors.
Chambre-R-, Spark of Life-R-, Young at Heart-R-, Co-Clenz-R-, Stay 'N
Shape-R- and Sine-eze-R- 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. BUSINESS
The Company markets a product line consisting of approximately 101 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 8,100 at December 31, 1995, and 10,600 at December
31, 1996 to approximately 23,400 at December 31, 1997. 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.
On an ongoing basis management reviews the Company's product line for
duplication and sales movement and makes adjustments accordingly. As of March
20, 1998, the Company's product line consists of (i) seven weight management
products, (ii) 28 dietary supplement products and (iii) 66 personal care
products consisting primarily of cosmetic and skin care products. 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.
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;
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- a continual expansion and improvement of the Company's product line
and marketing plan; and
- 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 1997, the Company introduced Choc-Quilizer, and plans to introduce
several additional products. 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 "Management's Discussion and Analysis of Financial Condition
and Results of Operations".
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.
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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 March 20, 1998. The Company believes there are numerous
additional international markets in which its network marketing organization and
products could prove successful.
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. According to the Direct Selling Association, the
United States retail market for personal care and wellness products exceeded
$8.8 billion in 1996. 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.
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PRODUCTS
The Company's product line consists of products in the categories of weight
management, dietary supplements and personal care. The Company currently markets
101 products, exclusive of variations in product size, colors or similar
variations of the Company's basic product line.
WEIGHT MANAGEMENT CATEGORY. In 1997 and 1996, 36.7 and 41.7 percent,
respectively, of the Company's net sales were derived from the seven 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.
DIETARY SUPPLEMENT CATEGORY. In 1997 and 1996, 37.7 and 24.7 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 1997, 3.1 percent of the Company's net sales were derived
from 66 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,
reconstructor, hair hold, and style and set.
Chambre Cosmetics--Include foundations, mascara, lipliners, eyeliners,
powder and cream blushes, lip colors and eyeshadows.
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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 and two percent of
the Company's net sales for the years ended December 31, 1997 and 1996,
respectively.
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.
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 29.5 percent, 39.1
percent, and 31.5 percent of net sales for the years ended 1997, 1996 and 1995,
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.
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
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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 it appears that the Company will
have difficulty meeting 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 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.
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, 1997 and 1996, the cost of products returned to the Company was three
percent and four percent of gross sales, respectively.
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 more than 25,000 "active"
distributors as of March 20, 1998. At December 31, 1997 the Company had
23,400 "active" distributors compared to 10,600 and 8,100 "active"
distributors at December 31, 1996 and 1995, respectively. 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
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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 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, 1997 1996, and 1995, the
Company had 7,000, 3,800 and 2,300 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
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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 March 20, 1998,
the Company has 87 Silver Directors, 34 Gold Directors and eight 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 March 20, 1998, the Company has 42 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, 1997, 1996 and
1995, the Company paid bonuses to 4,600, 3,300 and 1,900 distributors,
respectively, in the aggregate amount of $4,557,355, $2,727,240 and $1,861,264,
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
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invested more than $500,000 to enhance its computer and telecommunications
systems.
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 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 not been clearly established. In December 1995, the FDA issued
proposed regulations which govern the labeling of dietary supplements, including
how to declare nutritional information, how to make permissible "statements of
nutritional support" and when additional defined terminology may be used on
dietary supplements. The period for comments on the proposed regulations
expired on December 2, 1997; however, final regulations have not been issued.
The proposed regulations, if adopted as proposed, would require the Company to
revise a substantial number of its labels at an undetermined, but likely
immaterial, expense to the Company. The FDA has not announced an exact date
that the final regulations will become effective. However, the FDA has stated
that the proposed regulations will not become effective until 180 days following
their publication in the Federal Register. 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.
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 herb 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.
Many companies manufacture products containing various amounts of ephedra
or ephedrine, and the FDA has on record 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
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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 ephedra or ephedrine, including the Company's
AM-300 product, which for the year ended December 31, 1997, represented 29.5
percent of the Company's net sales. Currently, the Company offers AM-300 only
where permitted in the United States. The proposed regulation was subject to
comment during the period ended August 18, 1997, which period was extended until
December 2, 1997. The FDA has indicated that the proposed regulations will
become effective 180 days following issuance of the final regulation. The
Company has been informed that several trade organizations in the dietary
supplement industry intend to comment on the proposed regulation, requesting
substantial modifications. As of March 20, 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 Science Toxicology
Technology Consultants, Inc., a consulting firm, to conduct a clinical study
concerning the safety of ephedrine when ingested in combination with caffeine as
a dietary supplement. This study is being carried out by researchers at two
nationally recognized hospitals associated with two major universities. The
results of the study are expected by April 30, 1998.
There can be no assurance that the FDA will not impose additional
regulations, including regulations prohibiting, limiting potencies or placing
other restrictions on the sale of products containing ephedra or ephedrine. 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, which contains ephedra concentrate, 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.
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 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
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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.
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.
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.
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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 purchase 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 1997, 8,024 of the Company's distributors placed a
total of 9,251 orders averaging $81 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 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, 1997 was $81. However, there can be no assurance
that claims similar to the claims brought
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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 tradenames in connection with its
products and operations. As of March 20, 1998, the Company had six 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.
EMPLOYEES
As of December 31, 1997, the Company had 43 full-time employees, of whom
three were executive officers or directors, 19 were in administrative
activities, five were in marketing activities, six were in customer service
activities, and 10 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. 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
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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 $5,814 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. In September
1995, the Oklahoma Department of Securities commenced an investigation of the
Company and the AMS Distributor Stock Pool (the "Pool") related to the
availability of exemptions under the Oklahoma Business Opportunity Act with
respect to the Company's network marketing activities and employees of the
Company without registration as broker-dealers, the purchase and resale of
the Company's Common Stock by officers and directors of the Company in the
public market. As the investigation progressed, the investigation narrowed to
focus on the activities associated and related to the Pool. The Pool, under
which the Company's independent distributors were permitted to participant on
a voluntary basis, was formed in 1990. Participants made contributions to the
Pool and, from such contributions, the administrator of the Pool purchased
on a monthly basis the Company's Common Stock in the over-the-counter market
for the participants. All purchase transactions were executed and effected
through a registered broker-dealer. All records of ownership of the Common
Stock held by the Pool were maintained at the offices of the Company. The
Pool only purchased shares of Common Stock and did not sell shares on behalf
of the participants. As of December 31, 1997, the Pool held approximately
245,000 shares of Common Stock for and on behalf of the participants. Each
participant has sole voting rights with respect to those shares of Common
Stock held for such participant's benefit. In the event a participant
desires to sell the Common Stock held for his benefit by the Pool,
certificates representing such shares are delivered to such participant for
the purpose of effecting such sale. The Oklahoma Department of Securities
took the position that the offer and sale of participation rights in the Pool
violated the registration provisions of the Oklahoma Securities Act. During
October 1997, the Company ceased accepting additional contributions to the
Pool and effecting purchase transactions in the Common Stock. On November 4,
1997, the Company, John W. Hail, Curtis H. Wilson, Sr. and Roger P. Baresel,
directors and executive officers of the Company, entered into an agreement
with the Administrator of the Oklahoma Department of Securities in settlement
of the investigation without any action having been taken against the Company
and its officers and directors. Pursuant to such agreement, John W. Hail
reimbursed the Department its costs of the investigation without entitlement
to reimbursement by the Company or any of its other officers and directors.
Under the terms of such agreement, the Company and Messrs. Hail, Wilson and
Baresel agreed to notify the Department of any proposed offer or sale of
additional securities by the Company or each of Messrs. Hail, Wilson and
Baresel pursuant to any registration exemption under the Oklahoma Securities
Act, for a period of three years ending on November 6, 2000.
COMPANY HISTORY
EXCHANGE. Pursuant to an Agreement and Plan of Reorganization, dated
May 1, 1989, the shareholders of the Company exchanged their common stock for
800,807 shares of the common stock of Pacific Coast International, Inc., a
Delaware corporation (the "Exchange"). Prior to the Exchange, the trade or
business activities of Pacific Coast International, Inc. had been limited to
those activities associated with a public offering of its securities and
investigation of corporate acquisition alternatives as a "blank check"
company. Upon consummation of the Exchange, (i) the officers and directors of
the Company assumed management of Pacific Coast International, Inc., (ii) the
Company became a wholly owned subsidiary of Pacific Coast International,
Inc., (iii) the Company changed its name from AMS, Inc. to Advantage
Marketing Systems, Inc., (an Oklahoma Corporation) and (iv) Pacific Coast
International, Inc. changed its name to Advantage Marketing Systems, Inc.
("AMS Delaware"). Prior to the Exchange, Pacific Coast International, Inc.
and certain individuals sold, in a public offering, 225,860 shares of Common
Stock and 525,860 Class A Common Stock Purchase Warrants ("Class A Warrants")
and Class B Common Stock Purchase Warrants ("Class B Warrants"). The Class A
Warrants and Class B Warrants were redeemed on March 17, 1997.
REINCORPORATION MERGER. Effective December 11, 1995, AMS Delaware, the
former parent of the Company (formerly Pacific Coast International, Inc.),
merged with the Company pursuant to an Agreement and Plan of Merger (the
"Merger"), with the Company as the surviving corporation. As a result of the
Merger, AMS Delaware ceased to exist, and the Company succeeded to all of its
assets and liabilities. Prior to the Merger, AMS Delaware did not conduct any
business, and all operations were conducted by the Company.
-16-
<PAGE>
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, 1997.
-17-
<PAGE>
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTER'S
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 closing bid quotations 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
CLOSING BID PRICES
------------------
HIGH LOW
------ -----
<S> <C> <C>
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
1995:
First Quarter Ended March 31. . . . . . . . . . . . . . . . $ 2.00 $1.76
Second Quarter Ended June 30. . . . . . . . . . . . . . . . 3.76 2.00
Third Quarter Ended September 30. . . . . . . . . . . . . . 10.00 3.60
Fourth Quarter Ended December 31. . . . . . . . . . . . . . 7.52 4.48
</TABLE>
On March 20, 1998, the closing sale price on the Nasdaq SmallCap Market of
the Common Stock was $3.38. As of March 20, 1998, there were approximately
1,891 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.
-18-
<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 broker-dealer for at
least one year or the broker-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.
RECENT SALES OF UNREGISTERED SECURITIES
During the year ended December 31, 1997, the Company sold the following
unregistered shares of Common Stock pursuant to exercise of stock options
held by employees or former employees of the Company:
<TABLE>
<CAPTION>
NUMBER
OF SHARES
DATE OF PURCHASE OF COMMON
PURCHASE OR PRICE PER STOCK NET
NAME ISSUANCE SHARE PURCHASED PROCEEDS(1) CONSIDERATION
- --------------------- ----------- --------- --------- ----------- ------------
<S> <C> <C> <C> <C> <C>
R. & R. Nance . . . . 2-28-97 2.16 6,945 15,001 Cash
D. Melakayil . . . . 3-18-97 2.00 1,250 2,500 Cash
T. Melakayil. . . . . 3-18-97 2.00 1,250 2,500 Cash
M. Walke. . . . . . . 5-29-97 1.60 6,250 10,000 Cash
W. Hargrove . . . . . 5-29-97 1.60 25,000 40,000 Cash
M. Steers . . . . . . 5-29-97 1.60 6,250 10,000 Cash
R. Baresel. . . . . . 12-28-97 1.60 7,862 12,579 Stock(2)
J. Duncan . . . . . . 12-28-97 1.60 15,000 24,000 Cash
L. Hooter . . . . . . 12-28-97 1.60 11,007 17,611 Stock(2)
D. Huff . . . . . . . 12-28-97 1.60 7,862 12,579 Stock(2)
D. Loney. . . . . . . 12-28-97 1.60 6,250 10,000 Cash
D. Morgan . . . . . . 12-28-97 1.60 25,000 40,000 Cash
</TABLE>
- --------------------
(1) No underwriting discounts or commissions were paid with respect to such
sales.
(2) The exercise price or considerationn for purchase of the shares of Common
Stock was paid in shares of the Company's Common Stock pursuant to
cashless exercise provisions of the respective stock option agreements.
Each of the foregoing named individuals was or is an officer, director,
employee and/or greater than five percent shareholder of the Company. The
Common Stock purchase by each was sold pursuant to Rule 506 of Regulation D
in connection with the exercise of stock options.
Pursuant to a Stock Purchase Agreement having an effective date of
January 31, 1997, (the "CII Purchase Agreement"), the Company acquired the
issued and outstanding capital stock of Chambre International, Inc., a Texas
corporation. The Company issued and delivered 6,842 shares of Common Stock
on January 31, 1997, and issued and delivered an additional 7,518 shares of
Common Stock to the shareholders of Chambre International, Inc. on March 31,
1997, pending determination of certain liabilities. The shares of Common
Stock were issued pursuant to Rule 506 of Regulation D.
Pursuant to an Asset Purchase Agreement dated April 16, 1997, the
Company issued and delivered 125,984 shares of Common Stock to Solution
Products International, Inc. for its own account and as agent for and on
behalf of Stay 'N Shape International, Inc., Nation of Winners, Inc., and Now
International, Inc. The shares of Common Stock were issued pursuant to Rule
506 of Regulation D.
With respect to each of the foregoing Common Stock sale transactions,
the Company relied on 4(2) of the Securities Act of 1933 and Regulation D for
exemption from the registration requirements of the Act. Prior to purchase
of the Common Stock, each purchaser was furnished copies of the Company's
most recent Form 10-KSB Annual Report, Form 10-QSB Quarterly report and other
reports filed with the Commissino during the year of purchase, and each had
the opportunity to verify the information supplied. Additionally, the
Company obtained a signed representation from each of the foregoing persons
in connection with the purchase of the Common Stock of his or her intent to
acquire such Common Stock for the purpose of investment only, and not with a
view toward the subsequent distribution thereof; each of the certificates
representing the Common Stock of the Company has been stamped with a legend
restricting transfer of the securities represented thereby, and the Company
has issued stop transfer instructions to U.S. Stock Transfer Inc., the
Transfer Agent for the Common Stock of the Company, concerning all
certificates representing the Common Stock issued in the above-described
transactions.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE
CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO OF THE COMPANY.
GENERAL
Effective December 11, 1995, Advantage Marketing Systems, Inc., a Delaware
corporation ("AMS Delaware") and the former parent of the Company, merged with
and into the Company, with the Company being the surviving corporation (the
"Reincorporation Merger"). Prior to the Reincorporation Merger, all operations
of AMS (Delaware) were conducted solely by the Company.
-19-
<PAGE>
The Company's business has been significantly affected by the recently
completed MMI Acquisition, the CII Acquisition and the SNSI Asset Purchase. As
a result of these acquisitions, the Company acquired 6,790 distributors and
added 114 products to its product line.
MMI ACQUISITION. Effective May 31, 1996, the Company acquired all of the
outstanding capital stock of MMI, and MMI became a wholly-owned subsidiary of
the Company. MMI was a network marketer of various third-party manufactured
nutritional supplement products. In connection with the MMI Acquisition, the
Company issued to the shareholders of MMI 20,000 shares of Common Stock. The
Company added one product to its line and 1,690 additional distributors as a
result of the MMI Acquisition.
CII ACQUISITION. Effective January 31, 1997, the Company acquired all of
the issued and outstanding capital stock of CII, and CII became a wholly-owned
subsidiary of the Company. CII was a network marketer of various third-party
manufactured cosmetics, skin care and hair care products. In connection with
the CII Acquisition, the Company issued 6,482 shares of Common Stock to the
shareholders of CII at closing and issued an additional 7,518 shares of Common
Stock to the shareholders of CII on March 31, 1997, after determination of
certain liabilities. The Company added 74 products to its line, 68 in the
personal care category and six in the dietary supplement category, and 2,100
additional distributors as a result of the CII Acquisition.
SNSI ASSET PURCHASE. The Company purchased all of the assets, including
the network marketing organizations, of Stay 'N Shape International, Inc.,
Solution Products International, Inc., Nation of Winners, Inc., and Now
International, Inc. pursuant to an Asset Purchase Agreement dated April 16,
1997. In connection with the SNSI Asset Purchase, the Company paid cash of
$1,174,441 and issued 125,984 shares of Common Stock at closing and agreed to
either issue additional shares of the Company's Common Stock having an
aggregate market value equal to, or make a cash payment of, or combination
thereof, $750,000 and $1,050,000 on or before June 29, 1998, and May 30,
1999, respectively, subject to reduction for variance from specified sales
targets, which will be accounted for as purchase price adjustments under the
purchase method of accounting. As 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.
The following discussion and analysis of financial condition and results
of operations of the Company are the consolidated results of operations of
AMS Delaware, the predecessor of the Company, and the Company prior to and
following the Reincorporation Merger. In addition, 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, since its consummation on April
16, 1997.
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
-20-
<PAGE>
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 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.
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 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 6, 1998, and on or
before November 6, 2002.
REPURCHASE OF COMMON STOCK BY THE COMPANY. On March 4, 1998, the
Company announced that it intends 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 March 24,
1998, the Company had repurchased 20,000 shares of the Common Stock. The
additional number of shares of the Common Stock that may be purchased by the
Company is not determinable as of March 24, 1998 and will depend upon a
number of factors, including the market price of the Common Stock and the
amount of funds utilized for repurchase on each date of repurchase.
RESULTS OF OPERATIONS
The following table sets forth, as a percentage of net sales, selected
results of operations for the fiscal years ended December 31, 1997, 1996 and
1995, 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,
---------------------------------------------------------------------------------
1997 1996 1995
-------------------------- ------------------------ -------------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
----------- -------- ---------- ------- ---------- -------
<S> <C> <C> <C> <C> <C> <C>
Net sales. . . . . . . . . . . . . . $10,192,227 100.0% $6,155,073 100.0% $4,492,604 100.0%
Cost of sales. . . . . . . . . . . . 7,271,660 71.3 4,265,905 69.3 3,045,636 67.8
----------- ----- ---------- ----- ---------- -----
Gross profit . . . . . . . . . . . 2,920,567 28.7 1,889,168 30.7 1,446,968 32.2
Marketing, distribution and
administrative expenses. . . . . . 2,792,879 27.4 1,561,753 25.4 1,199,797 26.7
----------- ----- ---------- ----- ---------- -----
Income from operations . . . . . . 127,688 1.3 327,415 5.3 247,171 5.5
Other income (expense):
Interest, net. . . . . . . . . . . . 34,017 .3 (10,538) (.2) (22,998) (.5)
Other income . . . . . . . . . . . . 28,017 .3 8,667 .2 25,535 .6
----------- ----- ---------- ----- ---------- -----
Total other income (expense) . . . 62,034 .6 (1,871) -- 2,537 .1
----------- ----- ---------- ----- ---------- -----
Income before income taxes . . . . . 189,722 1.9 325,544 5.3 249,708 5.6
Tax (expense) benefit . . . . . . . (59,696) (.6) 499,613 8.1 -- --
----------- ----- ---------- ----- ---------- -----
Net income . . . . . . . . . . . . . $ 130,026 1.3% $ 825,157 13.4% $ 249,708 5.6%
----------- ----- ---------- ----- ---------- -----
----------- ----- ---------- ----- ---------- -----
</TABLE>
The following table sets forth, as a percentage of net sales, selected cost of
sales detail for the fiscal years ended December 31, 1997, 1996 and 1995, which
are derived from the audited consolidated financial statements of the
-21-
<PAGE>
Company.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------------------
1997 1996 1995
-------------------------- ------------------------ -------------------------
AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
----------- -------- ---------- ------- ---------- -------
<S> <C> <C> <C> <C> <C> <C>
Commissions and bonuses. . . . . . . $4,557,355 44.7% $2,727,240 44.3% $1,861,264 41.4%
Cost of products . . . . . . . . . . 2,260,715 22.2 1,356,367 22.0 1,081,139 24.1
Cost of shipping . . . . . . . . . . 453,590 4.5 182,298 3.0 103,233 2.3
----------- ----- ---------- ----- ---------- -----
Cost of sales. . . . . . . . . . . $7,271,660 71.3% $4,265,905 69.3% $3,045,636 67.8%
----------- ----- ---------- ----- ---------- -----
</TABLE>
During 1997, 1996 and 1995, 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 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 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 23,400 "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
-22-
<PAGE>
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.
COMPARISON OF 1996 AND 1995
During the year ended December 31, 1996, net sales increased $1,662,469, or
37.0 percent, to $6,155,073 from $4,492,604 during the year ended December 31,
1995. 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 supplement and personal care
categories. Additional net sales by the acquired MMI distributors of $273,646
also contributed to the increase. During 1996, the Company made aggregate net
sales of $6,000,395 to 9,500 distributors, compared to aggregate net sales in
1995 of $4,219,394 to 5,800 distributors. Sales per distributor decreased from
$60 for 1995 to $53 for 1996.
During 1996, cost of sales increased $1,220,269, or 40.1 percent, to
$4,265,905 in 1996 from $3,045,636 during 1995. This increase was attributable
to an increase of (i) $865,976 in distributor bonuses due to special promotions
designed to expand the Company's distributor network, (ii) $275,228 in cost of
products sold, and (iii) $79,065 in shipping costs. Cost of sales, as a
percentage of net sales, increased to 69.3 percent during 1996 from 67.8 percent
during 1995 due to an increase in distributor bonuses as a percentage of net
sales to 44.3 percent from 41.4 percent as a result of various promotions, a
decrease in cost of products sold to 22.0 percent of net sales from 24.1 percent
and an increase in cost of shipping to 3.0 percent of net sales from 2.3
percent.
The Company's gross profit increased $442,200 or 30.6 percent to $1,889,168
in 1996 from $1,446,968 in 1995 as a result of the increased sales. Gross
profit decreased as a percentage of net sales to 30.7 percent in 1996 from 32.2
percent in 1995. The decrease in the Company's gross profit margin resulted
primarily from the increase in distributor bonuses during the more recent period
which increased at a faster rate than net sales.
Marketing, distribution and administrative expenses increased $361,956, or
30.2 percent, to $1,561,753 during 1996 from $1,199,797 during 1995. This
increase was attributable to expansion of the Company's administrative
infrastructure necessary to support increased levels of sales. Payroll and
employee costs increased by $258,541 during 1996 due to the increase in
full-time employees from 16 in the first quarter to 24 in the last quarter
-23-
<PAGE>
of 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 increased $75,836, or 30.4 percent, to $325,544 during
1996 from $249,708 during 1995. Income before taxes as a percentage of net
sales decreased to 5.3 percent during 1996 from 5.6 percent during 1995,
primarily as a result of the decline in the Company's gross profit margin due to
special promotions. 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. Total net income increased $575,449, or 230.5 percent, to
$825,157 in 1996 from $249,708 in 1995.
PRO FORMA EFFECT OF STOCK-BASED COMPENSATION
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 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. During the twelve months ended December 31, 1995 the
Company granted 1,189,819 stock options (as restated for the one-for-eight
reverse split of the Company's Common Stock in October 1996). In accordance
with Accounting Principles Board Opinion No. 25 of the American Institute of
Certified Public Accountants and related interpretations, the compensation cost
of such stock options was not recognized in the consolidated financial
statements of the Company. The weighted average exercise price and calculated
fair value at the date of grant of the options granted in 1997 were $3.68 and
$2.32, 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 loss of $297,644 ($.11 per
common share) for the year ended December 31, 1997. The Company did not grant
any such options during 1996 and therefore no pro forma effect on 1996. The
weighted average exercise price and calculated fair value at the date of grant
of the options granted in 1995 were $2.77 and $1.73, respectively. After giving
effect to the weighted average fair value of such options, the Company would
have had a pro forma loss of $1,830,000 ($.86 per common share) for the year
ended December 31, 1995.
RECENTLY ADOPTED ACCOUNTING STANDARDS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 128, EARNINGS PER SHARE. This statement established standards for
computing and presenting earnings per share. The adoption of SFAS No. 128 by
the Company for the year ended December 31, 1997 resulted in restated earnings
per share for all periods presented in accordance with this statement.
Also in February 1997, the FASB issued SFAS No. 129, DISCLOSURE OF
INFORMATION ABOUT CAPITAL STRUCTURE. SFAS No. 129 establishes standards for
disclosure of information regarding an entity's capital structure. The adoption
of SFAS No. 129 did not affect the Company's capital structure disclosures.
ACCOUNTING STANDARDS ISSUED BUT NOT YET ADOPTED
In June 1997, FASB 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 will adopt SFAS No. 130 on January 1, 1998 as required.
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<PAGE>
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 will adopt SFAS No.
131 on January 1, 1998 as required and believes the Company has only one
segment, as that term is defined in SFAS No. 131.
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 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 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 29.5
percent, 39.1 percent, and 31.5 percent of net sales for the years ended
1997, 1996, and 1995, 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 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 product 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 "Business -- Products --
Product Procurement and Distribution; Insurance."
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, 1997, the unamortized portions of the
goodwill was $1,700,909 (which represented 16.5 percent of total assets and
18.5 percent of stockholders' equity) and covenants not to compete was
$581,791 (which represented 5.6 percent of total assets and 6.3 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 reveiwed 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
assuarance 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 "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 below, the Company's
primary source of liquidity was net cash provided by operating activities and
stockholder loans. The Company does not have any significant outside
debt-based liquidity sources.
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 proceeds of $6,050,000. Accumulated offering
costs of approximately $720,000 were charged against the proceeds of the
offering.
At December 31, 1997, the Company had working capital of $6,143,046,
compared to $16,353 at December 31, 1996. The increase was primarily related to
the net proceeds from the Warrant Modification Offering and the Rights Offering,
and the Units Offering. 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
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<PAGE>
ended December 31, 1997, net cash used by operating activities was $118,587, net
cash used by investing activities was $1,692,055 (consisting primarily of the
SNSI Asset Purchase), and net cash provided by financing activities was
$7,416,349 (consisting primarily of proceeds from the Warrant Modification
Offering and the Rights Offering, and the Units Offering less payment of
deferred offering costs). This represented an average monthly negative cash
flow from operating activities of $9,882. The Company had a net increase in
cash during this period of $5,605,707. The Company's working capital needs over
the next 12 months consist primarily of marketing, distribution and
administrative expenses.
The Company made non-interest bearing advances to the John Hail Agency,
Inc. ("JHA"), a company controlled by John W. Hail, the Chief Executive Officer
and a major shareholder of the Company, 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. The
remaining principal balance of the note at December 31, 1997 is $54,780.
In connection with the SNSI Asset Purchase, the Company agreed to make
installment purchase price payments of $750,000 and $1,050,000 by June 29, 1998
and May 30, 1999, respectively, either by deliveries of additional shares of the
Company's Common Stock or by cash payments or any combination thereof which
will be accounted for as purchase price adjustments under the purchase method
of accounting. The $750,000 installment payment will 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. Based
upon current sales levels the Company believes that the $750,000 installment
payment will be reduced to zero and no payment will be 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. 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.
On March 4, 1998, the Company announced that it intends 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 March 24, 1998, the
Company had repurchased 20,000 shares of the Common Stock. The additional
number of shares of the Common Stock that may be purchased by the Company is not
determinable as of March 24, 1998 and will depend upon a number of factors,
including the market price of the Common Stock and the amount of funds utilized
for repurchase on each date of repurchase.
During the first quarter of 1998, the Company agreed to loan its chief
executive officer up to $250,000. The loan is secured, bears interest at eight
percent per annum and is due on March 31, 1999. As of March 20, 1998, the
balance due on this loan was approximately $66,000 plus interest. The Company
believes that the terms of the loan are comparable with those that could have
been obtained from an unaffiliated lender and the loan was unanimously approved
by the Company's board of directors.
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company prepared in accordance
with Regulation S-B are set forth beginning on page F-1 hereof.
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<PAGE>
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 AND EXECUTIVE OFFICERS OF THE REGISTRANT
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) 67 Chairman of the Board, Chief Executive Officer and Director
Curtis H. Wilson, Sr.(3) 71 Vice-Chairman of the Board and Director
Roger P. Baresel(1)(2) 42 President, Chief Financial Officer, Secretary and Director
R. Terren Dunlap(3)(5) 52 Director
Harland C. Stonecipher(4)(5) 58 Director
</TABLE>
- ------------------------
(1) Member of the Stock Option Committee.
(2) Term as a Director expires in 1998.
(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 initially for a term expiring
at the annual meeting of shareholders to be held in 1999, Class II Directors
hold office initially for a term expiring at the annual meeting of shareholders
to be held in 2000, and Class III Directors hold office initially for a term
expiring at the annual meeting of shareholders to be held in 1998. 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 is a 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
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<PAGE>
been Chairman of the Board and Chief Executive Officer of Pre-Paid Legal
Services, Inc. since its inception in 1972.
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth certain information relating to compensation
paid to or accrued for the named executive for services rendered during the
years ended December 31, 1997, 1996 and 1995. No executive officer of the
Company received total annual salary and bonus pursuant to a recurring
arrangement in excess of $100,000 during 1997, 1996 or 1995.
<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION COMPENSATION AWARDS
---------------------------------------------- SECURITIES UNDERLYING EXERCISE OR
NAME AND PRINCIPAL POSITION YEAR SALARY(1) BONUS OTHER(2) OPTIONS BASE PRICE
- --------------------------- ---- --------- ----- -------- ------- -----------
<S> <C> <C> <C> <C> <C> <C>
John W. Hail . . . . . . . . . 1997 $56,539 $ -- $ -- 100,000(3) $6.00
Chief Executive Officer 100,000(3) $2.70
1996 -- -- 22,000 -- --
1995 -- -- 87,684 375,000(4) $2.00
</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 and 1995, the
Company made non-interest bearing advances to the John Hail Agency, Inc.,
an affiliate of Mr. Hail, of $22,000 and $87,684, respectively.
(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).
(4) Adjusted to give effect to the one-for-eight reverse stock split on October
29, 1996. Of the 375,000 stock options received, Mr. Hail transferred by
gift 225,000 stock options during 1995.
AGGREGATE OPTION GRANTS AND EXERCISES IN 1997 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. The following table sets forth information
related to options granted to the named executive officer during 1997.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
------------------------------------------------------------------------
PERCENT OF
TOTAL OPTIONS
NUMBER GRANTED TO EXERCISE
OF OPTIONS EMPLOYEES PRICE PER EXPIRATION
GRANTED IN 1997 SHARE DATE
---------- ----------- --------- ----------
<S> <C> <C> <C> <C>
John W. Hail, Chief Executive Officer. . . . . . . 100,000(1) 20.3% $2.70 5/20/07
</TABLE>
- ------------------------
(1) Only includes those stock options that were granted and not surrendered
during 1997.
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, 1997. During 1997,
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, 1997 DECEMBER 31, 1997(1)
---------------------------- ------------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
John W. Hail, Chief Executive Officer. . . . . 150,000 100,000 $112,500 $ 5,000
- ------------------------
</TABLE>
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<PAGE>
(1) The closing sale price of the Common Stock as reported on the Nasdaq
SmallCap Market on December 31, 1997 was $2.75. 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 20, 1998, options to purchase a total of 315,600 shares
of Common Stock have been granted under the Plan at exercise prices of $2.70 to
$6.00 per share expiring March 2002 through May 2007, of which 141,750 options
were surrendered and canceled during 1997. As of March 20, 1998, there are
outstanding stock options granted under the Plan exercisable for the purchase of
173,850 shares of Common Stock and options and warrants for the purchase of
1,265,733 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 ending November 6, 1998, the Company has undertaken
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 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.
-30-
<PAGE>
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 20, 1998, 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 20, 1998, 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.
<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) . . . . . . . . . . . . . . . . . . . . . . . . . . 435,141 9.88%
Curtis H. Wilson(1)(3) . . . . . . . . . . . . . . . . . . . . . . . . 280,945 6.24%
Roger P. Baresel(1)(4) . . . . . . . . . . . . . . . . . . . . . . . . 176,707 4.03%
Harland C. Stonecipher(5). . . . . . . . . . . . . . . . . . . . . . . 120,768 2.84%
R. Terren Dunlap(1)(6) . . . . . . . . . . . . . . . . . . . . . . . . 37,500 .87%
Executive Officers and Directors as a group
(five persons)(7) . . . . . . . . . . . . . . . . . . . . . . . . . 1,051,061 21.79%
</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.
-31-
<PAGE>
(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 do not
include 100,000 shares of Common Stock that are subject to currently
unexercisable stock options held by Mr. Hail.
(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) 22,500 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.
(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 120,768 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 and 560,000 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.
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. JHA has made repayments of
these advances of $13,042, $6,141 and $67,401 during
-32-
<PAGE>
the fiscal years ended December 31, 1997, 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. The principal balance of this note is $54,780
at December 31, 1997.
At December 31, 1995, the balance due on a short-term loan to the Company
from Mr. Hail was $81,929. During 1995, the Company combined interest payable of
approximately $52,000 with the principal due under the loan and began making
weekly interest and principal payments of $1,500. The loan was unsecured, due on
demand and bore interest at 12 percent per annum. As of December 31, 1996, the
loan had 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, 1997, 1996 and 1995, the Company made
aggregate monthly payments pursuant to such lease agreements of $19,427, $19,427
and $14,314, respectively.
During the years ended December 31, 1997, 1996 and 1995, the Company paid
Curtis H. Wilson, Sr., a Director of the Company, sales commissions of $32,886,
$38,337 and $51,669, 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
"Business--Network Marketing."
During the first quarter of 1998, the Company agreed to loan John Hail up
to $250,000. The loan is secured, bears interest at eight percent per annum and
is due on March 31, 1999. As of March 20, 1998, the balance due on this loan
was approximately $66,000 plus interest. The Company believes that the terms of
the loan are comparable with those that could have been obtained from an
unaffiliated lender and the loan was unanimously approved by the Company's board
of directors.
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.
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 vale 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.
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 March 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.
-33-
<PAGE>
PART IV
ITEM 13. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, 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-18:
Independent Auditors' Report.
Consolidated Balance Sheets as of December 31, 1997 and 1996.
Consolidated Statements of Income for Years Ended December 31,
1997, 1996 and 1995.
Consolidated Statements of Stockholders' Equity (Deficiency) for
Years Ended December 31, 1997, 1996 and 1995.
Consolidated Statements of Cash Flows for Years Ended December
31, 1997, 1996 and 1995.
Notes to Consolidated Financial Statements for Years Ended
December 31, 1997, 1996 and 1995.
2. The following exhibits are filed with or incorporated by reference into this
Form 10-KSB.
EXHIBIT
NO.
-------
1.1 Form of Underwriting Agreement between Paulson Investment
Company, Inc. and Registrant. (6)
2.1 Agreement and Plan of Merger between Registrant and AMS, Inc. (1)
2.2 Certificate of Merger of Advantage Marketing Systems, Inc. (A
Delaware Corporation) with and into Advantage Marketing Systems,
Inc. (An Oklahoma Corporation). (1)
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)
-34-
<PAGE>
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)
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)
27 Financial Data Schedule
- ------------
(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, 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 (333-47801), filed with the Commission
on October 7, 1998.
-35-
<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.
(FORMERLY AMS, INC.)
Date: FEBRUARY 10, 1999 By: /s/ JOHN W. HAIL
-------------------------------------
John W. Hail, Chief Executive Officer
Date: FEBRUARY 10, 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: FEBRUARY 10, 1999 By: /s/ JOHN W. HAIL
-------------------------------------
John W. Hail, Chief Executive Officer,
Chairman of the Board and Director
Date: FEBRUARY 10, 1999 By: /s/ CURTIS H. WILSON, SR.
-------------------------------------
Curtis H. Wilson, Sr., Vice-Chairman
of the Board and Director
Date: FEBRUARY 10, 1999 By: /s/ ROGER P. BARESEL
-------------------------------------
Roger P. Baresel, President, Chief
Financial Officer and Director
Date: FEBRUARY 10, 1999 By: /s/ R. TERREN DUNLAP
-------------------------------------
R. Terren Dunlap, Director
Date: FEBRUARY 10, 1999 By: /s/ HARLAND C. STONECIPHER
-------------------------------------
Harland C. Stonecipher, Director
-36-
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
PAGE
----
ADVANTAGE MARKETING SYSTEMS, INC. AND SUBSIDIARIES
AUDITED CONSOLIDATED FINANCIAL STATEMENTS:
<S> <C>
Independent Auditors' Report . . . . . . . . . . . . . . . . . . . . . . . . . F-2
Consolidated Balance Sheets as of December 31, 1997 and 1996 . . . . . . . . . F-3
Consolidated Statements of Income for Years Ended December 31, 1997,
1996 and 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-4
Consolidated Statements of Stockholders' Equity (Deficiency) for
Years Ended December 31, 1997, 1996 and 1995. . . . . . . . . . . . . . . . F-5
Consolidated Statements of Cash Flows for Years Ended
December 31, 1997, 1996 and 1995. . . . . . . . . . . . . . . . . . . . . . F-6
Notes to Consolidated Financial Statements for Years Ended
December 31, 1997, 1996 and 1995. . . . . . . . . . . . . . . . . . . . . . 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,
1997, and 1996, and the related consolidated statements of income, stockholders'
equity (deficiency), and cash flows for each of the three years in the period
ended December 31, 1997. 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,
1997, and 1996, and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Oklahoma City, Oklahoma
March 26, 1998
F-2
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
ASSETS 1997 1996
------ --------- ---------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,775,276 $ 169,569
Receivables - net of allowance of $25,800 at each period end . . . . . . . . 184,915 52,013
Receivable from affiliate. . . . . . . . . . . . . . . . . . . . . . . . . . 14,124 13,042
Commission advances. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59,268 44,821
Inventory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 812,125 217,945
Deferred income taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . 85,224 157,853
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68,432 --
----------- ------------
Total current assets . . . . . . . . . . . . . . . . . . . . . . 6,999,364 655,243
RECEIVABLES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,079 18,000
RECEIVABLE FROM AFFILIATE. . . . . . . . . . . . . . . . . . . . . . . . . . . 40,656 54,780
PROPERTY AND EQUIPMENT, Net. . . . . . . . . . . . . . . . . . . . . . . . . . 695,896 377,190
GOODWILL, Net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,700,909 109,232
COVENANTS NOT TO COMPETE, Net. . . . . . . . . . . . . . . . . . . . . . . . . 518,791 52,222
DEFERRED INCOME TAXES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 354,693 341,760
OTHER ASSETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,918 181,914
----------- ------------
TOTAL. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,336,306 $ 1,790,341
----------- ------------
----------- ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
CURRENT LIABILITIES:
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 202,220 $ 268,433
Accrued promotion expense. . . . . . . . . . . . . . . . . . . . . . . . . . -- 46,370
Accrued commissions and bonuses. . . . . . . . . . . . . . . . . . . . . . . 325,077 172,502
Accrued other expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . 183,921 75,381
Notes payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26,304 9,446
Capital lease obligations. . . . . . . . . . . . . . . . . . . . . . . . . . 118,801 66,758
----------- ------------
Total current liabilities. . . . . . . . . . . . . . . . . . . . 856,323 638,890
LONG-TERM LIABILITIES:
Notes payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82,440 19,049
Capital lease obligations. . . . . . . . . . . . . . . . . . . . . . . . . . 221,148 210,973
----------- ------------
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . 1,159,911 868,912
----------- ------------
COMMITMENTS AND CONTINGENCIES (Notes 9 and 12)
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 and outstanding 4,249,383 and 2,157,262 shares,
respectively (See Note 4) . . . . . . . . . . . . . . . . . . . . . . . . . 425 214
Paid-in capital. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,180,109 1,981,380
Notes receivable for exercise of options . . . . . . . . . . . . . . . . . . (74,000) --
Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . (930,139) (1,060,165)
----------- ------------
Total stockholders' equity . . . . . . . . . . . . . . . . . 9,176,395 921,429
----------- ------------
TOTAL. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,336,306 $ 1,790,341
----------- ------------
----------- ------------
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-3
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
----------- ---------- ----------
<S> <C> <C> <C>
Net sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,192,227 $6,155,073 $4,492,604
Cost of sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,271,660 4,265,905 3,045,636
----------- ---------- ----------
Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,920,567 1,889,168 1,446,968
Marketing, distribution and administrative expenses. . . . . . . . . . 2,792,879 1,561,753 1,199,797
----------- ---------- ----------
Income from operations . . . . . . . . . . . . . . . . . . . . . . 127,688 327,415 247,171
Other income (expense):
Interest, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34,017 (10,538) (22,998)
Other income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,017 8,667 25,535
----------- ---------- ----------
Total other income (expense) . . . . . . . . . . . . . . . . . . . 62,034 (1,871) 2,537
----------- ---------- ----------
INCOME BEFORE TAXES. . . . . . . . . . . . . . . . . . . . . . . . . . 189,722 325,544 249,708
TAX (EXPENSE) BENEFIT. . . . . . . . . . . . . . . . . . . . . . . . . (59,696) 499,613 --
----------- ---------- ----------
NET INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 130,026 $ 825,157 $ 249,708
----------- ---------- ----------
----------- ---------- ----------
Net income per common share. . . . . . . . . . . . . . . . . . . . . . $ .05 $ .39 $ .12
----------- ---------- ----------
----------- ---------- ----------
Net income per common share - assuming dilution. . . . . . . . . . . . $ .04 $ .26 $ .09
----------- ---------- ----------
----------- ---------- ----------
Weighted average common shares outstanding . . . . . . . . . . . . . . 2,751,771 2,135,097 2,121,944
----------- ---------- ----------
----------- ---------- ----------
Weighted average common shares outstanding - assuming
dilution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,762,642 3,203,485 2,838,726
----------- ---------- ----------
----------- ---------- ----------
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-4
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIENCY)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
TOTAL
NOTES RECEIVABLE STOCKHOLDERS'
SHARES COMMON PAID-IN FOR EXERCISE OF ACCUMULATED EQUITY
(SEE NOTE 4) STOCK CAPITAL OPTIONS DEFICIT (DEFICIENCY)
----------- ------- ------- ---------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE,
JANUARY 1, 1995. . . . . . . . . . . 2,134,512 $212 $ 1,847,382 $ -- $(2,135,030) $(287,436)
Warrants exercised . . . . . . . . . . 1,250 -- 7,500 -- 7,500
Issuance of stock for cash . . . . . . 1,250 -- 5,000 -- -- 5,000
Net income . . . . . . . . . . . . . . -- -- -- -- 249,708 249,708
--------- ---- ----------- --------- ------------ ----------
BALANCE,
DECEMBER 31, 1995. . . . . . . . . . 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. . . . . . . . . . . . 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
--------- ---- ----------- --------- ------------ ----------
--------- ---- ----------- --------- ------------ ----------
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-5
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>
1997 1996 1995
----------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 130,026 $825,157 $249,708
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation and amortization . . . . . . . . . . . . . . . . . . . 251,443 65,993 43,310
Deferred taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . 59,696 (499,613) --
Provision for bad debts . . . . . . . . . . . . . . . . . . . . . . -- 4,319 2,000
Write-off of deferred offering costs. . . . . . . . . . . . . . . . -- 15,000 --
Gain on sale of property and equipment. . . . . . . . . . . . . . . (18,671) (1,572) --
Changes in assets and liabilities which (used) provided cash:
Receivables and commission advances. . . . . . . . . . . . . . . . (167,192) (80,139) 7,280
Inventory. . . . . . . . . . . . . . . . . . . . . . . . . . . . . (722,806) (119,324) (50,750)
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . 269,946 -- (40,852)
Accounts payable and accrued expense . . . . . . . . . . . . . . . 78,971 216,600 150,149
------------ ---------- ----------
Net cash (used in) provided by operating activities. . . . . . . (118,587) 426,421 360,845
------------ ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment. . . . . . . . . . . . . . . . . . (312,709) (66,675) (50,105)
Receivable from affiliate. . . . . . . . . . . . . . . . . . . . . . . -- (22,000) (87,684)
Proceeds from sale of property and equipment . . . . . . . . . . . . . 40,196 1,700 --
Repayment of receivable from affiliate . . . . . . . . . . . . . . . . 13,042 6,141 67,401
Purchase of Miracle Mountain International, Inc. . . . . . . . . . . . -- (56,103) --
Purchase of Chambre International, Inc.. . . . . . . . . . . . . . . . (51,340) -- --
Purchase of SNSI assets. . . . . . . . . . . . . . . . . . . . . . . . (1,274,441) -- --
Purchase of other assets . . . . . . . . . . . . . . . . . . . . . . . (106,803) -- --
------------ ---------- ----------
Net cash used in investing activities . . . . . . . . . . . . . (1,692,055) (136,937) (70,388)
------------ ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock . . . . . . . . . . . . . . . . 8,284,357 1,500 12,500
Loans from stockholders. . . . . . . . . . . . . . . . . . . . . . . . -- -- 31,963
Proceeds from notes payable. . . . . . . . . . . . . . . . . . . . . . 114,259 -- 39,098
Bank overdraft . . . . . . . . . . . . . . . . . . . . . . . . . . . . -- -- (46,663)
Payment of deferred offering costs . . . . . . . . . . . . . . . . . . (862,967) (125,400) (52,777)
Payment on notes payable - stockholders. . . . . . . . . . . . . . . . -- (81,929) (142,615)
Payment on notes payable . . . . . . . . . . . . . . . . . . . . . . . (34,010) (8,445) (7,985)
Principal payment on capital lease obligations . . . . . . . . . . . . (85,290) (17,728) (11,891)
------------ ---------- ----------
Net cash provided by (used in) financing activities. . . . . . . 7,416,349 (232,002) (178,370)
------------ ---------- ----------
NET INCREASE IN CASH . . . . . . . . . . . . . . . . . . . . . . . . . . 5,605,707 57,482 112,087
CASH AND CASH EQUIVALENTS, BEGINNING . . . . . . . . . . . . . . . . . . 169,569 112,087 --
----------- -------- --------
CASH AND CASH EQUIVALENTS, ENDING. . . . . . . . . . . . . . . . . . . . $ 5,775,276 $ 169,569 $ 112,087
------------ ---------- ----------
------------ ---------- ----------
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-6
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
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 resigns from the Company and
returns the product within 12 months of original purchase in marketable
condition. For the years ended December 31, 1997 and 1996, the cost of
products returned to the Company are included in net sales and was three
and four percent of gross sales, respectively.
ADVERTISING - The Company expenses advertising related to the Company as
incurred. Total advertising expense for 1997, 1996 and 1995 was
$28,416, $26,410 and $16,044, respectively.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents consist of cash in
banks and all short term investments with initial maturities of three
months or less.
INVENTORY - Inventory consists of consumer product inventory, and training
and promotional material such as video tapes, cassette tapes and paper
supplies held for sale to customers and independent distributors.
Inventory is stated at the lower of cost or market. Cost is determined on
a first-in, first-out method.
INTANGIBLES - Intangible assets consist of goodwill and covenants not to
compete. Goodwill represents the excess of cost over the fair value of the
net assets acquired pursuant to the Miracle Mountain International, Inc.
("MMI"), Chambre' International, Inc. ("CII") and Stay 'N Shape
International, Inc. ("SNSI") acquisitions (See Note 9). The Company
amortizes goodwill from the acquisition of MMI over seven years and from
the acquisitions of CII and SNSI over twenty years. Covenants not to
compete are being amortized over the life of the contracts. Goodwill
amortization for the years ended December 31, 1997 and 1996 was $78,026 and
$9,930, respectively. The net amount of goodwill arising from the MMI,
CCI and SNSI acquisitions at December 31, 1997 was $92,209, $171,107 and
$1,437,594, respectively. The net amount of goodwill arising from the
MMI acquisition at December 31, 1996 was $109,232. Covenant amortization
for the years ended December31, 1997 and 1996, was $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
F-7
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
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.
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 approxiamate 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, 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
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
-------- ---------- ----
For the year ended December 31, 1995:
Earnings per common share:
Income available to common stockholders. . . . . . . . . $249,708 2,121,944 $.12
Earnings per common share - assuming dilution:
Options. . . . . . . . . . . . . . . . . . . . . . . . . -- 716,782
-------- ----------
Income available to common stockholders plus assumed
conversions . . . . . . . . . . . . . . . . . . . . $249,708 2,838,726 $.09
-------- ---------- ----
</TABLE>
Options to purchase 5,000 shares of common stock at $6.00 per share were
outstanding at December 31, 1997 but were not included in the computation
of earnings per common share - assuming dilution because the
F-8
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
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 and 1995, respectively.
Warrants to purchase 525,860 shares at $8.00 and 1,050,470 shares ranging
from $6.00 to $8.00 of common stock were outstanding at December 31, 1996
and 1995, 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 ADOPTED ACCOUNTING STANDARDS - In February, 1997, the FASB issued
SFAS No. 129, DISCLOSURE OF INFORMATION ABOUT CAPITAL STRUCTURE. SFAS No.
129 establishes standards for disclosure of information regarding an
entity's capital structure. The adoption of SFAS No. 129 in 1997 did not
affect the Company's capital structure disclosures.
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.
ACCOUNTING STANDARDS ISSUED BUT NOT YET ADOPTED - In June 1997, the FASB
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
stockholders' equity section of the consolidated balance sheet. The
Company will adopt SFAS No. 130 on January 1, 1998 as required.
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 will adopt SFAS No. 131 on January 1, 1998 as
required and believes the Company has only one segment, as that term is
defined in SFAS No. 131.
RECLASSIFICATIONS - Certain reclassifications have been made to prior year
balances to conform with the presentation for the current period.
F-9
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
2. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31:
<TABLE>
<CAPTION>
1997 1996
---------- ---------
<S> <C> <C>
Office furniture, fixtures and equipment. . . . . . . . $ 954,293 $ 633,086
Automobiles . . . . . . . . . . . . . . . . . . . . . . 142,055 44,872
Leasehold improvements. . . . . . . . . . . . . . . . . 34,388 26,576
---------- ---------
1,130,736 704,534
Accumulated depreciation and amortization . . . . . . . (434,840) (327,344)
---------- ---------
Total property and equipment, net . . . . . . . . . . . $ 695,896 $ 377,190
---------- ---------
</TABLE>
Depreciation expense for the years ended December 31, 1997, 1996 and 1995
was $119,986, $48,285 and $43,310, respectively.
3. LEASE AGREEMENTS
During 1997 and 1996, the Company entered into various capital leases for
office related furniture and equipment. The lease terms range from 24 to
60 months. Additionally, annual lease rental payments for each lease range
from $900 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 $449,540 and $306,595 for
leases that have been capitalized at December 31, 1997 and 1996,
respectively. Related accumulated amortization amounted to $109,591 and
$28,864 at December 31, 1997 and 1996, respectively.
The Company leases office space, warehouse space and certain equipment
under noncancelable operating leases.
Future annual minimum lease payments under capital leases and noncancelable
operating leases with initial or remaining terms of one year or more at
December 31, 1997 are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES TOTAL
-------- --------- --------
<S> <C> <C> <C>
Year ending:
1998 . . . . . . . . . . . . . . . . . . . . . . $147,129 $136,640 $283,769
1999 . . . . . . . . . . . . . . . . . . . . . . 121,819 144,467 266,286
2000 . . . . . . . . . . . . . . . . . . . . . . 72,394 150,886 223,280
2001 . . . . . . . . . . . . . . . . . . . . . . 41,244 156,658 197,902
2002 . . . . . . . . . . . . . . . . . . . . . . 6,955 160,492 167,447
Minimum lease payments thereafter. . . . . . . . -- 91,897 91,897
-------- -------- ----------
Total minimum lease payments 389,541 $841,040 $1,230,581
-------- ----------
-------- ----------
Less amount representing interest 49,592
--------
Present value of net minimum lease payments 339,949
Less current portion 118,801
--------
Long-term capital lease obligations $221,148
--------
--------
</TABLE>
Rental expense under operating leases for the years ended December 31,
1997, 1996 and 1995 was $88,632, $63,425 and $55,476, respectively.
F-10
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
4. STOCKHOLDERS' EQUITY
COMMON STOCK - 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 net proceeds of $6,050,000. Accumulated
offering costs of approximately $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 470,790 shares of the
Company's common stock and stock options and warrants to purchase
728,983 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 1997, the Company granted
493,100 options at exercise prices ranging from $2.70 per share to $6.00
per share (173,850 shares under the 1995 Option Plan). 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 the 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.
During 1995, the Company granted various options at exercise prices ranging
from $2.00 per share to $6.48 per share. Options were granted primarily
for services rendered and to ensure the future availability of those
services to the Company. All of the options granted during 1995 and
currently outstanding are currently exercisable. In addition, during
1995 the Company granted other warrants exercisable through June 8, 2000
for the purchase of 125,000 shares for $3.60 per share which are still
outstanding and 125,000 shares for $4.96 per share which were canceled
in 1997. See Note 5 for the pro forma effects of SFAS 123.
F-11
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
The following table summarizes the Company's stock option and other
warrants activity for the years ended December 31, 1997, 1996 and 1995
(as restated for the one-for-eight reverse split in October 1996):
<TABLE>
<CAPTION>
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
1997 PRICE 1996 PRICE 1995 PRICE
--------- -------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Options and other warrants
outstanding, beginning of year . 1,528,927 $2.49 1,540,177 $2.52 350,358 $1.66
Options and other warrants
granted during the year. . . . . 493,100 3.68 -- -- 1,189,819 2.77
Options exercised
during the year. . . . . . . . . (135,695) 1.64 -- -- -- --
Options and other warrants
canceled during the year . . . . (444,250) 4.75 -- -- -- --
Options expired
during the year. . . . . . . . . (2,499) 1.60 (11,250) 6.48 -- --
--------- --------- ----------
Options and other warrants
outstanding, end of year . . . . 1,439,583 $2.28 1,528,927 $2.49 1,540,177 $2.52
--------- --------- ----------
--------- --------- ----------
Fair value of options and
other warrants granted
during the year. . . . . . . . . $ 467,554 -- $2,079,708
--------- --------- ----------
</TABLE>
The weighted average grant-date fair value of options and other warrants
granted during 1997 and 1995 was $1.20 and $.84 per share, respectively.
There were no options granted during 1996.
<TABLE>
<CAPTION>
OPTIONS AND OTHER WARRANTS OUTSTANDING OPTIONS AND OTHER WARRANTS EXERCISABLE
------------------------------------------ --------------------------------------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED-
NUMBER REMAINING AVERAGE NUMBER AVERAGE
RANGE OF OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
EXERCISE PRICES AT 12/31/97 LIFE PRICE AT 12/31/97 PRICE
----------------- ----------- ----------- -------- ----------- ---------
<S> <C> <C> <C> <C> <C>
$1.60 - 2.70 1,309,583 4.9 years $2.14 963,233 $1.94
$3.60 - 6.00 130,000 2.5 years $3.69 130,000 $3.69
--------- ---------
$1.60 - 6.00 1,439,583 1,093,233
--------- ---------
--------- ---------
</TABLE>
COMMON STOCK WARRANTS - The following table summarizes the Company's common
stock warrants and their activity for the years ended December 31, 1997,
1996 and 1995 (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, 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
---------
F-12
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997-A Warrants, end of year. . . . . . . . . . . . . . . . . 337,211
---------
---------
Redeemable Common Stock Purchase Warrants,
beginning of year . . . . . . . . . . . . . . . . . . . . . --
Redeemable Common Stock Purchase Warrants,
issued during the year. . . . . . . . . . . . . . . . . . . 1,495,000 $5.40 11/06/97 - 11/06/02
---------
---------
Redeemable Common Stock Purchase Warrants,
end of year . . . . . . . . . . . . . . . . . . . . . . . . 1,495,000
---------
---------
Underwriter's Warrants, beginning of year . . . . . . . . . . . --
Underwriter's Warrants issued during the year . . . . . . . . . 130,000 $5.40 11/12/98 - 11/12/02
Underwriter's 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
---------
---------
DECEMBER 31, 1995:
Class A Warrants, beginning of year . . . . . . . . . . . . . 525,860 $6.00 4/26/89 - 7/26/97
Class A Warrants exercised during the year. . . . . . . . . . (1,250) $6.00
---------
Class A Warrants, end of year . . . . . . . . . . . . . . . . 524,610
---------
---------
Class B Warrant . . . . . . . . . . . . . . . . . . . . . . . 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 Comon 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 at a price not less than 85% of the market value of the stock on
the date of grant. No stock options shall be exercisable within six months
from the date of grant, unless under a Plan exception, nor more than ten
years after the date of grant. The Plan provides for the grant of stock
appreciation rights, which allow the holder to receive in cash, stock or
combination thereof, the difference between the exercise price and the fair
value of the stock at date of exercise. The fair value of stock
appreciation rights is charged to compensation expense. The stock
appreciation right is not separable from the underlying stock option or
incentive stock option originally granted and can only be exercised in
tandem with the stock option. During the year ended December 31, 1997, the
Company granted 173,850 net options under the Plan. No stock appreciation
rights are attached to any options outstanding. At December 31, 1997, the
Company had 1,439,583 stock options outstanding of which only 173,850 had
been issued pursuant to this plan.
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
F-13
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
based upon the fair value at the grant date consistent with the methodology
prescribed under SFAS No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION:
<TABLE>
YEARS ENDED DECEMBER 31,
-----------------------------------------
1997 1996 1995
---------- --------- ------------
<S> <C> <C> <C>
Net income as reported . . . . . . . . . . . . . . . . . . . . . $ 130,026 $ 825,157 $ 249,708
Adjustment, net of tax . . . . . . . . . . . . . . . . . . . . (467,554) -- (2,079,708)
----------- --------- ------------
Pro forma net income (loss). . . . . . . . . . . . . . . . . . . $ (337,528) $ 825,157 $(1,830,000)
Net income per common share as reported. . . . . . . . . . . . . $ .05 $ 0.39 $ 0.12
Adjustment, net of tax . . . . . . . . . . . . . . . . . . . . (0.17) -- (0.98)
----------- --------- ------------
Pro forma net income (loss) per common share . . . . . . . . . . $ (0.12) $ 0.39 $ ( 0.86)
Pro forma net income (loss) per common share - assuming
dilution . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (0.12) $ 0.26 $ (0.86)
Weighted average common shares outstanding . . . . . . . . . . . 2,751,771 2,135,097 2,121,944
Weighted average common shares outstanding - assuming dilution . 3,762,642 3,203,485 2,838,726
</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 1997 and 1995, respectively (no option
grants during 1996): risk-free interest rates of 5.93 and 5.94 percent; no
dividend yield or assumed forfeitures; expected lives of 6.7 and 7.3 years;
and volatility of 60 and 59 percent. The pro forma amounts above are not
likely to be representative of future years because there is no assurance
that additional awards will be made each year.
6. RELATED PARTIES
During 1997, 1996 and 1995, the Company received approximately $7,157,
$9,116 and $16,415, 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.
The Company made non-interest bearing cash advances to the John Hail
Agency, Inc., ("JHA"), a company of which the Company's Chief Executive
Officer and major shareholder is the sole director and shareholder, of
$22,000 and $87,684 during the years ended December 31, 1996 and 1995,
respectively. JHA made repayments of these advances of $13,042, $6,141 and
$67,401 during the years ended December 31, 1997, 1996 and 1995,
respectively. The Company also provided administrative services for JHA
and recognized revenue from JHA of $6,000 and $12,000 for the years ended
December 31, 1996 and 1995, respectively, and are included in the advances.
The Company ceased providing administrative services for JHA during 1996
and adopted a policy to not make any further advances to JHA. In 1996 JHA
executed a promissory note payable to the Company which had a principal
balance of $54,780 and $67,822 at December 31, 1997 and 1996, respectively,
bearing interest at 8.00% per annum and payable in installments of $1,499
per month.
During 1995, the Company combined interest payable of approximately $52,000
to the Company's Chief Executive Officer with principal due and began
making weekly interest and principal payments of $1,500. The loan was
unsecured, due on demand and bore interest at 12%. The loan had been
repaid as of December 31, 1996.
Certain stockholders receive commissions on revenue of the Company. Such
commissions are recognized as compensation to the stockholders and are
included in selling expense.
During 1995, the Company's Chief Executive Officer individually entered
into lease agreements covering telephone equipment and related software.
Such equipment and software are utilized by the Company. During the
years ended December 31, 1997, 1996 and 1995 the Company made aggregate
monthly payments pursuant to such lease agreements of $19,427, $19,427
and $14,314, respectively.
During the years ended December 31, 1997, 1996 and 1995, the Company
paid a Director of the Company, sales commissions of $32,886, $38,337
and $51,669, respectively.
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
F-14
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
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, 1997,
totaling $1,193,428, which will begin to expire in 2003. The Company has
a net deferred tax asset at December 31, 1997 and 1996, of $439,917 and
$499,613, respectively.
A reconciliation of the statutory Federal income tax rate to the effective
income tax rate for the years ended December 31, 1997, 1996, and 1995 is as
follows:
<TABLE>
<CAPTION>
1997 1996 1995
----- ------ -----
<S> <C> <C> <C>
Statutory federal income tax rate. . . . . . . . . . . . . . 34.0 % 34.0 % 34.0%
State tax effective rate . . . . . . . . . . . . . . . . . . 4.6 4.3 4.5
Permanent differences. . . . . . . . . . . . . . . . . . . . 6.4 0.0 0.0
Benefit of graduated tax rates . . . . . . . . . . . . . . . (4.8) (0.4) (2.1)
Benefit of operating loss carryforwards. . . . . . . . . . . (0.0) (37.9) (36.4)
Change in effective rate . . . . . . . . . . . . . . . . . . (8.7) 0.0 0.0
Reduction in valuation allowance . . . . . . . . . . . . . . 0.0 (153.5) 0.0
----- ------ -----
Effective income tax rate. . . . . . . . . . . . . . . . . . 31.5 % (153.5)% 0.0 %
----- ------ -----
----- ------ -----
</TABLE>
Deferred tax liabilities and assets at December 31, 1997 and 1996 are
comprised of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1997 1996
---------- ---------
<S> <C> <C>
Deferred tax liabilities:
Depreciation and amortization. . . . . . . . . . . . $(20,682) $ (850)
---------- ---------
Total deferred tax liabilities. . . . . . (20,682) (850)
---------- ---------
Deferred tax assets:
Net operating loss carryforwards . . . . . . . . . . 458,796 500,463
Reserves . . . . . . . . . . . . . . . . . . . . . . 1,803 --
---------- ---------
Total deferred tax assets. . . . . . . . 460,599 500,463
---------- ---------
Net deferred taxes . . . . . . . . . . . . . . . . . . 439,917 499,613
Less current portion of net deferred tax assets. . . . 85,224 157,853
---------- ---------
Noncurrent portion . . . . . . . . . . . . . . . . . . $354,693 $341,760
---------- ---------
---------- ---------
</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
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
F-15
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(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.
In connection with the SNSI Asset Purchase, the Company paid cash of
$1,174,441 and issued 125,984 shares of the Company's common stock at
closing and agreed to either issue additional shares of the Company's
common stock having an aggregate fair value equal to, or make cash payments
of, or at the Company's sole option any combination thereof, $750,000 and
$1,050,000 on or before June 29, 1998, and May 30, 1999, respectively
which will be accounted for as purchase price adjustments under the
purchase method of accounting. The $750,000 aggregate fair value of the
additional shares of the Company's common stock or cash payment shall 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 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. Furthermore, the $1,050,000
aggregate fair value of the additional shares of the Company's common
stock or cash payment shall be reduced by the aggregate amount that
gross revenues, net or returns and allowances, during the 12-month
period ended March 31, 1999, from (i) sales (other than Choc-Quilizer)
of the purchased network marketing organization, sales to Market
America, Inc. and sales to retail outlet stores, are less than
$5,000,000 and (ii) the Company's sales of Choc-Quilizer are less than
$8,000,000 during such 12-month period. The fair value of the Company's
common stock on the last three trading days of the month preceding the
month in which the applicable 12-month period ends.
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
F-16
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
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. 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 1997 and 1996, 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>
YEAR ENDED DECEMBER 31,
--------------------------
1997 1996
----------- ----------
<S> <C> <C>
Net revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $10,776,000 $8,737,000
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 142,000 $ 669,000
Net income per common share. . . . . . . . . . . . . . . . . . . . . . $ 0.05 $ 0.29
Net income per common share - assuming dilution. . . . . . . . . . . . $ 0.04 $ 0.20
</TABLE>
10. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
<TABLE>
YEAR ENDED DECEMBER 31,
----------------------------------------
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Cash paid during the year for:
Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 33,012 $ 23,021 $ 27,335
Income taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,195 -- --
Noncash financing and investing activities:
Property and equipment acquired by capital lease. . . . . . . . . . . . 147,508 199,131 108,219
Deferred offering costs not yet paid. . . . . . . . . . . . . . . . . . 180,450 -- --
Reclassify interest payable to
notes payable - stockholders. . . . . . . . . . . . . . . . . . . . . -- -- 51,806
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) -- --
Purchase price in excess of tangible assets acquired and
covenant not to compete. . . . . . . . . . . . . . . . . . . . . . . (179,325) -- --
Fair value of common stock issued.. . . . . . . . . . . . . . . . . . 84,000 -- --
Liabilities assumed.. . . . . . . . . . . . . . . . . . . . . . . . . 148,787 -- --
----------- --------- ---------
F-17
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
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 issued.. . . . . . . . . . . . . . . . . 800,000 -- --
----------- --------- ---------
Cash paid to purchase SNSI assets.. . . . . . . . . . . . . . . . . $(1,274,441) $ -- $ --
----------- --------- ---------
----------- --------- ---------
</TABLE>
11. NOTES PAYABLE
The Company has notes payable of $108,744 and $28,495 for the years ended
December 31, 1997 and 1996, respectively. The current balance of the notes
at December 31, 1997 and 1996 is $26,304 and $9,446, respectively. The
notes were issued to acquire vehicles and equipment to be used by the
Company and are collateralized by such vehicles and equipment for which
the notes were issued to finance. These notes mature ranging from June
1998 to September 2002 with interest rates on the notes ranging from 9.5
percent to 12.1 percent. Payments of principal and interest are made on
the notes monthly ranging from $300 to $928. Scheduled maturities for 1998
through 2002 are $26,304, $23,202, $25,727, $23,917 and $9,594,
respectively.
12. 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
29.5 percent, 39.1 percent, and 31.5 percent of net sales for the years
ended 1997, 1996 and 1995, 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 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 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. The Company generally does not obtain contractual indemnification
from parties manufacturing its products. However, 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 products manufactured by Chemins and marketed by the Company.
The Company has not maintained any product liability insurance coverage.
Although the Company has never had a product liability claim, such claims
against the Company could result in material losses to the Company.
F-18
<PAGE>
ADVANTAGE MARKETING SYSTEMS, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
13. SUBSEQUENT EVENTS
On March 4, 1998, the Company announced that it intends 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
March 24, 1998, the Company has repurchased $62,000 of the Common Stock.
The additional number of shares of the Common Stock that may be purchased
by the Company is not determinable as of March 24, 1998 and will depend
upon a number of factors, including the market price of the Common Stock
and the amount of funds utilized for repurchase on each date of repurchase.
On March 11, 1998, the Company filed a Registration Statement, file number
333-47801, with the Securities and Exchange Commission pursuant to which
the Company is seeking to register 5,000,000 stock purchase plan
participation interests ("Participation Interests") in the Advantage
Marketing Systems, Inc. Distributor Stock Purchase Plan (the "Plan").
The Participation Interests are also being registered in accordance with
the Oklahoma Securities Act. The Participation Interests will be
offered to the distributors of the Company's products and services
("Eligible Persons"). An Eligible Person electing to participate in the
Plan (a "Participant") will be entitled through purchase of the
Participation Interests to purchase in the open market through the Plan,
shares of common stock, $.0001 par value per share (the "Common Stock"),
previously issued by the Company. The Participation Interests are
non-transferable; therefore, a market for the Participation Interests
will not develop. The proceeds from sale of the Participation Interests
will become the Participants' contributions to the Plan which will be
used to purchase the Common Stock and will not be placed into escrow
pending purchase of the Common Stock. Other than an annual service fee
of $5.00 per Participant and a transaction fee of $1.25 per month, the
Company will not receive any proceeds from the purchase of the Common
Stock by the Plan. The offering price of each Participation Interest
will be $1.00, and each Eligible Person will be required initially to
purchase a minimum of twenty-five Participation Interests upon electing
to participate in the Plan. There is no minimum amount of sales of
Participation Interests required.
* * * * * *
F-19
