UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[X]QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2006
or
[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _______ to _______
Commission File Number: 001-13343
AMS HEALTH SCIENCES, INC.
(Exact name of Small Business Issuer as specified in its charter)
Oklahoma
(State or other jurisdiction of incorporation or organization)
73-1323256
(I.R.S. Employer Identification No.)
711 NE 39th Street
Oklahoma City, Oklahoma 73105
(Address of principal executive offices)
(405) 842-0131
(Issuer's telephone number, including area code)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the issuer is a shell company (as defined in Rule
12b-2 of the Exchange Act).
Yes [ ] No [X]
On August 7, 2006, we had outstanding 7,775,824 shares of our common stock,
$0.0001 par value.
Transitional Small Business Disclosure Format (check one):
Yes [ ] No [X]
AMS HEALTH SCIENCES, INC.
QUARTERLY REPORT ON FORM 10-QSB
FOR THE SIX MONTHS ENDED JUNE 30, 2006
Table of Contents
Part I Financial Information 3
Item 1. Financial Statements 3
Consolidated Balance Sheets 3
Consolidated Statements of Operations 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
Report of Independent Registered Public Accounting Firm 20
Item 2. Management's Discussion and Analysis or Plan of Operation 21
Item 3. Controls and Procedures 28
Part II -Other Information 29
Item 1. Legal Proceedings 29
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 29
Item 3. Defaults Upon Senior Securities 30
Item 4. Submission of Matters to a Vote of Security Holders 30
Item 5. Other Information 30
Item 6. Exhibits 30
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Certain statements under the caption "Item 2 - Management's Discussion and
Analysis or Plan of Operation" 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. Our actual results 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; our ability
to implement our 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; changes in, or the failure to comply with, government
regulations (especially food and drug laws and regulations); product liability
matters; our ability to obtain financing for future acquisitions and other
factors. We do not undertake to update forward-looking statements to reflect the
impact of circumstances or events that arise after the date the forward-looking
statements were made.
PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
AMS HEALTH SCIENCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 2006 AND DECEMBER 31, 2005
June 30, December 31,
ASSETS 2006 2005
------------------- -------------------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $1,555,521 $118,805
Marketable securities, available for sale, at fair value 156,547 278,131
Receivables 96,413 59,846
Inventory 629,385 860,540
Other assets 65,017 24,542
Current assets of discontinued operation 301,529 507,831
---------- ----------
Total current assets 2,804,412 1,849,695
RESTRICTED SECURITIES 76,464 75,477
RECEIVABLES 34,054 44,016
PROPERTY AND EQUIPMENT, net 3,112,462 3,131,092
COVENANTS NOT TO COMPETE and other intangibles, net 363,462 402,370
OTHER ASSETS 547,714 26,793
NONCURRENT ASSETS OF DISCONTINUED OPERATIONS 1,307,192 1,375,792
---------- ----------
TOTAL $8,245,760 $6,905,235
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $118,978 $391,615
Bank overdraft 0 203,500
Accrued commissions and bonuses 264,484 254,828
Accrued other expenses
436,310 355,398
Accrued sales tax liability
93,000 40,980
Deferred compensation 126,470 0
Capital lease obligations 123,336 76,650
Current liabilities of discontinued operations 485,172 592,317
---------- ----------
Total current liabilities 1,647,750 1,915,288
LONG-TERM LIABILITIES:
Note Payable 823,096 0
Capital lease obligations 159,705 74,320
Deferred compensation 474,260 615,301
Lease abandonment liability 88,479 110,249
Liabilities of discontinued operations 1,548,241 1,670,688
---------- ----------
Total liabilities 4,741,531 4,385,846
---------- ----------
COMMITMENTS AND CONTINGENCIES (NOTE 10)
STOCKHOLDERS' EQUITY
Common stock - $.0001 par value; authorized 495,000,000
shares; issued 8,354,053 and 8,344,803 shares, outstanding
7,775,824 and 7,766,574 shares, respectively 860 835
Paid-in capital 23,310,815 21,870,872
Notes receivable for exercise of options (31,000) (31,000)
Accumulated deficit (17,143,667) (16,674,324)
Accumulated other comprehensive income, net of tax 0 (14,215)
---------- ----------
Total capital and accumulated deficit 6,137,008 5,152,168
Less cost of treasury stock (591,595 shares) (2,632,779) (2,632,779)
---------- ----------
Total stockholders' equity 3,504,229 2,519,389
---------- ----------
TOTAL $8,245,760 $6,905,235
========== ==========
See notes to consolidated financial statements.
AMS HEALTH SCIENCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE PERIODS ENDED JUNE 30, 2006 AND 2005
(UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- --------------------------
2006 2005 2006 2005
----------- ----------- ----------- -----------
Net sales $ 2,397,975 $ 3,528,319 $ 4,749,688 $ 7,549,077
Cost of sales 1,487,485 2,392,676 3,052,639 5,934,808
----------- ----------- ----------- -----------
Gross profit 910,490 1,135,643 1,697,049 1,614,269
Marketing and administrative expenses:
Marketing 101,851 322,357 242,995 634,478
Administrative 765,564 1,624,270 1,455,084 3,133,779
----------- ----------- ----------- -----------
Total marketing and administrative expenses 867,415 1,946,627 1,698,079 3,768,257
----------- ----------- ----------- -----------
Income (loss) from operations 43,075 (810,984) (1,030) (2,153,988)
Other income (expense):
Interest and dividends, net 5,246 14,988 9,088 22,557
Other, net (15,704) 4,094 43,959 24,925
----------- ----------- ----------- -----------
Total other income (10,458) 19,082 53,047 47,482
----------- ----------- ----------- -----------
Income (loss) from continuing operations before taxes 32,617 (791,902) 52,017 (2,106,506)
Income tax expense (benefit) - (22,456) - 1,363
----------- ----------- ----------- -----------
Income (loss) from continuing operations 32,617 (769,446) 52,017 (2,107,869)
Discontinued Operations (Note 13)
Loss from discontinued operations, net of tax (185,517) - (521,232) -
----------- ----------- ----------- -----------
Net loss $ (152,900) $ (769,446) $ (469,215) $(2,107,869)
=========== =========== =========== ===========
Net income (loss) per share:
Basic:
Income (loss) from continuing operations $ .01 $ (.11) $ .01 $ (.30)
Loss from discontinued operations, net of tax (.03) - (.07) -
----------- ----------- ----------- -----------
Net loss per share $ (.02) $ (.11) $ (.06) $ (.30)
=========== =========== =========== ===========
Diluted:
Income (loss) from continuing operations $ .01 $ (.11) $ .01 $ (.30)
Loss from discontinued operations, net of tax (.03) - (.07) -
----------- ----------- ----------- -----------
Net loss per share $ (.02) $ (.11) $ (.06) $ (.30)
=========== =========== =========== ===========
Shares used in computing net loss per share:
Basic 7,545,708 7,187,171 7,545,708 7,088,773
=========== =========== =========== ===========
Diluted 7,547,324 7,187,171 7,555,868 7,088,773
=========== =========== =========== ===========
See notes to consolidated financial statements.
AMS HEALTH SCIENCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2006 AND 2005
(UNAUDITED)
Six months ended
June 30,
---------------------------------------
2006 2005
---------------- -------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (469,215) $ (2,107,869)
Adjustments to reconcile net loss to net cash provided by (used in) operating
activities:
Net loss from discontinued operations 521,232 -
Depreciation and amortization 333,466 402,768
Bad debt expense (recovery) (15,590)
Employee compensation recognized upon exercise or grant of stock options 4,794 66,602
Gain on sale of assets (42,530) (7,073)
Loss on sale of marketable securities 14,126 (14,228)
Deferred taxes - 1,361
Changes in operating assets and liabilities:
Receivables (30,094) 180,939
Inventory 231,154 616,535
Other assets (34,059) (41,870)
Accounts payable and accrued expenses (115,236) (460,663)
Lease abandonment liability (36,585) 22,130
Deferred compensation (14,570) (27,009)
Net operating activities of discontinued operations (394,828) -
---------------- -------------------
Net cash used in operating activities (47,935) (1,368,377)
---------------- -------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (133,435) (177,301)
Sales of property and equipment 72,235 282,836
Receipts of notes receivable 19,078 15,160
Purchases of marketable securities, available for sale (283,766) (1,596,214)
Sales of marketable securities, available for sale 404,452 2,348,450
Net investing activities of discontinued operations 12,970 -
---------------- -------------------
Net cash provided by (used in) investing activities 91,534 872,931
---------------- -------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Bank overdraft (203,500) (395,936)
Net proceeds from issuance of notes 1,897,000 1,005,742
Deferred financing fees paid (160,000)
Principal payment on capital lease obligations (46,190) (134,064)
Net financing activities of discontinued operations (94,193) -
---------------- -------------------
Net cash provided by financing activities 1,393,117 475,742
---------------- -------------------
NET DEC/INC IN CASH AND CASH EQUIVALENTS 1,436,716 (19,704)
CASH AND CASH EQUIVALENTS, BEGINNING 118,805 588,909
---------------- -------------------
CASH AND CASH EQUIVALENTS, ENDING $ 1,555,521 $ 569,205
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Fixed assets acquired through capital lease financing 178,261 -
Value of warrants issued to lenders recorded as debt discount 588,452 -
Value of beneficial conversion feature of notes issued recorded as debt discount 588,452 -
Value of warrants issued to advisor recorded as deferred financing costs 130,770 -
Issuance of common stock recorded as deferred financing costs 127,500 -
See notes to consolidated financial statements.
AMS HEALTH SCIENCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED JUNE 30, 2006 AND 2005
(UNAUDITED)
1. UNAUDITED INTERIM FINANCIAL STATEMENTS
The unaudited consolidated financial statements and related notes have
been prepared pursuant to the rules and regulations of the Securities and
Exchange Commission (SEC). Accordingly, certain information and footnote
disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United
States of America have been omitted pursuant to such rules and regulations.
The accompanying consolidated financial statements and related notes should
be read in conjunction with the audited consolidated financial statements
of the Company, and notes thereto, for the year ended December 31, 2005.
The information furnished reflects, in the opinion of management, all
adjustments, consisting of normal recurring accruals, necessary for a fair
presentation of the results of the interim periods presented. Operating
results of the interim period are not necessarily indicative of the amounts
that will be reported for the year ending December 31, 2006.
2. SHARE-BASED COMPENSATION
On January 1, 2006, the Company adopted Statement of Financial
Accounting Standards No. 123 (revised 2004), "Share-Based Payment", ("SFAS
123R") which requires the measurement and recognition of compensation
expense based on estimated fair values for all share-based payment awards
made to employees and directors, including employee stock options. SFAS
123R supersedes the Company's previous accounting under Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25") for periods beginning in 2006. In March 2005, the Securities and
Exchange Commission issued Staff Accounting Bulletin No. 107 ("SAB 107")
relating to SFAS 123R. The Company has utilized the guidance of SAB 107 in
its adoption of SFAS 123R.
Equity Compensation Plans
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. Non-employee 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 may be exercised 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. No stock appreciation rights are attached to
any options outstanding. At June 30, 2006, no shares were available for
future grants under the 1995 Stock Option Plan. Options granted under the
Plan have an exercise price equal to the fair market value on the date of
grant, are fully vested at June 30, 2006, and generally expire ten years
after grant date.
During 2003, the Company approved the 2003 Stock Incentive Plan, or
2003 Plan. Under the 2003 Plan, options available for grant can consist of
(i) nonqualified stock options, (ii) incentive stock options and (iii)
restricted stock. The Company has reserved 2,000,000 shares of the
Company's common stock $.0001 par value for the 2003 Plan. The Plan limits
participation to employees, independent contractors, and consultants. The
option price for shares of stock subject to this Plan is set by the
Compensation Committee of the Board of Directors at a price not less than
market value of the common stock on the date of grant. No stock options may
be exercised within six months from the date of grant, unless under a Plan
exception, nor more than ten years after the date of grant. At June 30,
2006, no shares were available for future grants under the 2003 Stock
Incentive Plan. Options granted under the Plan have an exercise price equal
to the fair market value on the date of grant, are fully vested at June 30,
2006, and generally expire ten years after grant date.
Grant-Date Fair Value
The Company uses the Black-Scholes option pricing model to calculate
the grant-date fair value of an award. The fair value of options granted
during the second quarter of 2006 and 2005 were calculated using the
following estimated weighted average assumptions:
Three months ended June 30, Six months ended June 30,
2006 2005 2006 2005
------------- ------------- ----------- -------------
Expected volatility 76.10% 62.20% 76.10% 62.20%
Expected term (in years) 5 5 5 5
Risk-free interest rate 4.64% 3.95% 4.35% 3.90%
Expected dividend yield 0% 0% 0% 0%
Expected volatility is based on historical volatility. The expected
term of the options is based on management's best estimate. The risk-free
interest rate is based on the yield on zero-coupon U.S. Treasury securities
for a period that is commensurate with the expected term assumption. The
Company has not historically issued any dividends and does not expect to in
the future.
Share-Based Compensation Expense
The Company uses the straight-line attribution method to recognize
expense for unvested options. The amount of share-based compensation
recognized during a period is based on the value of the awards that are
ultimately expected to vest. SFAS 123R requires forfeitures to be estimated
at the time of grant and revised, if necessary, in subsequent periods if
actual forfeitures differ from those estimates. The Company will
re-evaluate the forfeiture rate annually and adjust as necessary.
Share-based compensation expense recognized under SFAS 123R for the
three months ended and six months ended June 30, 2006 was $1,857 and
$4,773, respectively, allocated as follows:
Three months ended Six months ended
June 30, June 30,
2006 2006
------------------ ----------------
Distribution and administrative
expenses $ 3,044 $ 7,825
Income tax effect 1,187 3,052
------------------ -----------------
Total share-based compensation $ 1,857 $ 4,773
================== =================
There was no share-based compensation expense related to employee
stock options recognized during the three months ended and six months ended
June 30, 2005. Prior to January 1, 2006, the Company accounted for its
share-based compensation under the recognition and measurement principles
of APB 25 and related interpretations, the disclosure-only provisions of
SFAS No. 123, "Accounting for Stock-Based Compensation" and the disclosures
required by SFAS No. 148, "Accounting for Stock-Based Compensation-
Transition and Disclosure". In accordance with APB 25, no
share-based compensation cost was reflected in the Company's net income for
grants of stock options to employees because the Company granted stock
options with an exercise price equal to the market value of the stock on
the date of grant. Had the Company used the fair value based accounting
method for share-based compensation expense prescribed by SFAS Nos. 123 and
148 for the periods ended June 30, 2005, the Company's consolidated net
loss and net loss per share would have been increased to the pro-forma
amounts illustrated as follows:
Three months ended Six months ended
June 30, 2005 June 30, 2005
------------------- --------------------
Basic and diluted:
Net loss as reported $ (769,446) $ (2,107,869)
Deduct: share-based employee
compensation, net of income tax (213,574) (232,637)
------------------- --------------------
Pro forma net loss $ (983,020) $ (2,340,506)
=================== ====================
Net loss per share:
Basic - as reported $ (0.11) $ (0.30)
Basic - proforma $ (0.14) $ (0.33)
Diluted - as reported $ (0.11) $ (0.30)
Diluted - proforma $ (0.13) $ (0.33)
Shares outstanding - basic 7,187,171 7,088,773
Shares outstanding - diluted 7,187,171 7,088,773
Option Activity
A summary of the activity under the Company's stock options plans for
the six-month period ended June 30, 2006 is presented below:
Weighted
Average
Weighted Remaining
Average Contractual Aggregate
Exercise Term Intrinsic
-------------- ------------- ----------------- --------------
Shares Price (Years) Value
-------------- ------------- ----------------- --------------
Options outstanding at December 31, 2005 1,950,009 $ 3.13
Granted 400,000 0.63 $ 8,000
Exercised - - $ -
Canceled - -
--------------
Options outstanding at June 30, 2006 2,350,009 $ 2.70 5.01 $ 8,000
==============
Options exercisable at June 30, 2006 1,950,009 $ 3.13 4.95 $ -
--------------
Options vested and options expected to
vest at June 30, 2006 1,950,009 $ 3.13 4.95 $ -
==============
The total grant-date fair value of stock options that became fully
vested during the six months ended June 30, 2006 was $4,794. As of June 30,
2006, there was $143,645 of total unrecognized compensation cost, net of
tax and estimated forfeitures, related to unvested share-based awards,
which is expected to be recognized over a period of 4.63 years.
3. MARKETABLE SECURITIES
Securities are classified as available for sale with the related
unrealized gains and losses excluded from earnings and reported net of
income tax as a separate component of stockholders' equity until realized.
Realized gains and losses on sales of securities are based on the specific
identification method. Declines in the fair value of investment securities
below their carrying value that are other than temporary are recognized in
earnings.
For the six months ended June 30, 2006, there were no unrealized gains
or losses, as all securities are in cash or cash equivalents. Net
unrealized losses, net of tax, of approximately $8,000 and $47,000,
including approximately $26,000 and $6,000 reclassified to earnings, were
included in accumulated other comprehensive loss for the three and six
months ended June 30, 2005. Total comprehensive loss for the three and six
months ended June 30, 2006 was $152,900 and $469,215, and total
comprehensive loss for the three and six months ended June 30, 2005 was
approximately $781,000 and $2,159,000.
4. RESTRICTED SECURITIES
In connection with the Heartland acquisition, the Company has pledged
marketable securities in the amount of $76,464 as restricted cash against
one of the notes payable.
5. ACQUISITION
On September 9, 2005, the Company entered into a definitive Stock
Purchase Agreement with Heartland Cup, Inc. ("Heartland Cup") and its
principal shareholder for the purchase of all of the principal
shareholder's stock in Heartland Cup. Upon closing of the Stock Purchase
Agreement, the Company acquired 2,000,000 shares, or approximately 83% of
the outstanding capital stock of Heartland Cup, for 200,000 shares of the
Company's common stock. In addition, the Company paid approximately
$200,000 to acquire the remaining shares of Heartland Cup. Additionally,
see Note 13, Discontinued Operations.
The Heartland Cup acquisition was accounted for as a purchase under
Statement of Financial Accounting Standards No. 141 ("SFAS No. 141"). In
accordance with SFAS No. 141, the Company allocated the purchase price of
the acquisition based on the fair value of the assets acquired and
liabilities assumed. Goodwill resulting from the Heartland Cup acquisition
was reserved for impairment.
6. DEBT
The secured financing consists of the following at June 30, 2006 and
December 31, 2005:
June 30, December 31,
2006 2005
----------------- -----------------
Laurus term note $ 2,000,000 $ -
Valuation discount (1,176,904) -
----------------- -----------------
Total Secured Financing $ 823,096 $ -
================= =================
On June 28, 2006, the Company entered into a series of agreements with
Laurus Master Fund, Ltd. ("Laurus") whereby the Company issued to Laurus
(i) a secured convertible term note ("Note") in the principal amount of
$2,000,000, and (ii) a warrant ("Warrant") to purchase up to 2,272,727
shares of the Company's common stock at a price of $0.53 per share. Out of
the loan proceeds, the Company agreed to pay the sum of $74,000 to Laurus
Capital Management, LLC, the investment advisor to Laurus, the sum of
$27,500 to Laurus Capital Management, LLC as reimbursement for its due
diligence and legal fees and expenses incurred in connection with the
transaction, and the sum of $1,500 to Loeb & Loeb LLP, the escrow agent for
Laurus. Total closing costs were $103,000.
The principal amount of the Note bears interest at a per annum rate
equal to the prime rate (as published in the Wall Street Journal from time
to time) plus three percent (3.0%); provided, however that the interest
rate may not be less than ten percent (10.0%). Interest payments are due
monthly beginning July 1, 2006. Principal payments in the amount of
$83,333.33 are due monthly beginning July 1, 2007. The final maturity date
of the Note is June 28, 2009 (the "Maturity Date"). The Company's
obligations under the Note are secured by all of the Company's assets,
including its shares of AMS Manufacturing, Inc. and by all of AMS
Manufacturing's assets including its shares of Heartland Cup, Inc.
Additionally, the Company's obligations under the Note are guaranteed by
AMS Manufacturing.
The principal amount of the Note and accrued interest thereon is
convertible into shares of the Company's common stock at a price of $0.51
per share, subject to anti-dilution adjustments. Under the terms of the
Note, the monthly payments of interest and/or principal (the "Monthly
Amount") due on the Note are payable in shares of the Company's common
stock if the following criteria are met: (i) the average closing price of
the Company's common stock for the five (5) days preceding the payment date
is greater than or equal to 115% of the Fixed Conversion Price (defined
below) and (ii) the amount of such conversion does not exceed twenty five
percent (25%) of the aggregate dollar trading volume of the Company's
common stock for the period of twenty-two trading days immediately
preceding such payment date. If subsection (i) above is met but subsection
(ii) above is not met as to the entire Monthly Amount, then Laurus is
required to convert only such part of the Monthly Amount that meets the
criteria of subsection (ii). The Company has agreed to register all of the
shares that are issuable upon conversion of the Note and exercise of the
2,272,727 Warrants. The Company has granted Laurus a right of first refusal
with respect to any debt or equity financings.
The Company calculated that the fair value of the Warrants issued to
Laurus was $588,452 based upon the relative value of the Black-Scholes
valuation of the warrants and the underlying debt amount. The Company
determined that the beneficial conversion feature ("BCF") of the note
was $588,452. The closing costs of $103,000, the value of the warrants
issued to Laurus of $588,452 and the $588,452 of calculated BCF have been
reflected by the Company as a valuation discount and offset to the face
amounts of the Notes.
In conjunction with the financing, the Company also incurred fees to
various investment advisors that facilitated the transaction. These fees
totaled $287,500, of which $127,500 was paid through the issuance of
250,000 shares of our common stock. In addition, the Company issued these
advisors warrants to purchase 495,543 shares of common stock at a price of
$0.51 per share. The Company calculated that the fair value of the warrants
issued to the advisiors was $130,770 based upon the relative value of the
Black-Scholes valuation of the warrants and the underlying debt amount. The
fees paid to the advisors and the value of the warrants issued to the
advisors have been reflected as deferred financing costs in the
accompanying balance sheet and are being amortized over the life of the
loan.
7. SHAREHOLDER'S EQUITY
As part of the fee arrangement related to the secured financing
agreement (See Note 6), the Company issued 250,000 shares of common stock
valued at $127,500 to its financial advisor.
In conjunction with the secured financing agreement (See Note 6), the
Company recorded the value of warrants issued and a beneficial conversion
feature. The value of the warrants, computed using the fair value method,
was $719,222. The beneficial conversion feature related to the term note
was $588,452.
8. LOSS PER SHARE
Loss per common share - basic is computed based upon net loss divided
by the weighted average number of common shares outstanding during each
period. Loss per common share - assuming dilution is computed based upon
net loss 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 loss per common share - basic and loss per common share -
assuming dilution:
Income (Loss) Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Weighted average common shares
outstanding:
For the three months ended June 30, 2006:
Loss per common share:
Loss available to common stockholders $ (152,900) 7,545,708 $ (0.02)
========
Loss per common share - assuming dilution:
Options - 1,616
------------- ---------
Loss available to common stockholders
plus assumed conversions $ (152,900) 7,547,324 $ (0.02)
============= ========= ========
For the three months ended June 30, 2005:
Loss per common share:
Loss available to common stockholders $ (769,446) 7,187,171 $ (0.11)
========
Loss per common share - assuming dilution:
Options - -
------------- ---------
Loss available to common stockholders
plus assumed conversions $ (769,446) 7,187,171 $ (0.11)
============= ========= ========
For the six months ended June 30, 2006:
Loss per common share:
Loss available to common stockholders $ (469,215) 7,545,708 $ (0.06)
========
Loss per common share - assuming dilution:
Options - 10,160
------------- ---------
Loss available to common stockholders
plus assumed conversions $ (469,215) 7,555,868 $ (0.06)
============= ========= ========
For the six months ended June 30, 2005:
Loss per common share:
Loss available to common stockholders $ (2,107,869) 7,088,773 $ (0.30)
========
Loss per common share - assuming dilution:
Options - -
------------- ---------
Loss available to common stockholders
plus assumed conversion $ (2,107,869) 7,088,773 $ (0.30)
============= ========= ========
Options to purchase 2,350,009 shares of common stock at exercise
prices ranging from $1.30 to $6.00 per share were outstanding for the six
months ended June 30, 2006, but were not included in the computation of
income (loss) per common share - assuming dilution because there was a net
loss for the period then ended.
Options to purchase 2,044,315 shares of common stock at exercise
prices ranging from $1.30 to $6.00 per share were outstanding for the three
and six months ended June 30, 2005, but were not included in the
computation of income (loss) per common share - assuming dilution because
there was a net loss for the period then ended.
During the quarter ended June 30, 2006, the Company granted 2,272,727
warrants at a price of $0.53 and 495,543 warrants at a price of $0.51. The
warrants were issued in conjunction with the secured financing agreement
described in Note 6.
Warrants outstanding, January 1, 2006 -
Warrants granted 2,768,270
---------
Warrants outstanding, June 30, 2006 2,768,270
=========
9. DEFERRED 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. Valuation allowances have been
established for certain operating loss and credit carryforwards that reduce
deferred tax assets to an amount that will, more likely than not, be
realized. Uncertainties that may affect the realization of these assets
include tax law changes and the future level of product prices and costs.
The outlook for determination of this allowance is calculated on the
Company's historical taxable income, its expectations for the future based
on a rolling twelve quarters, and available tax-planning strategies. Based
on this determination, management does not expect that the net deferred tax
assets will be realized as offsets to reversing deferred tax liabilities
and as offsets to the tax consequences of future taxable income. As such, a
valuation allowance was provided for the entire deferred tax asset of
approximately $5,100,000 at June 30, 2006. The Company's effective tax rate
differs from its statutory tax rate for 2006 due to the tax valuation
allowance. The Company has net operating loss carryforwards of
approximately $11,000,000 available to reduce future taxable income, which
will begin to expire in 2021.
10. COMMITMENTS AND CONTINGENCIES
Recent Regulatory Developments - 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 the Company's
prior AM-300 product was ephedra, an herb that contains naturally-occurring
ephedrine alkaloids. The Company's manufacturer used a powdered extract of
that herb when manufacturing AM-300. The Company marketed AM-300
principally as an aid in weight management. The extract was an 8% extract,
which means that every 100 milligrams of the powdered extract contains
approximately eight milligrams of naturally occurring ephedrine alkaloids.
On February 11, 2004, the FDA issued and published in the Federal
Register its final rule on ephedrine-containing supplements, stating that
since an "unreasonable risk" had been determined, such supplements would be
considered "adulterated" under the Federal Food, Drug, and Cosmetic Act, or
FFDCA, and thus may not be sold. In essence, this final rule (or
regulation) imposed a national ban on ephedrine supplements. The effective
date of this regulation was April 12, 2004. The Company complied with the
new regulation and ceased all sales and advertisement of AM-300 and any
other ephedra-containing supplement as of April 12, 2004. The FDA has
continuously and vigilantly enforced this total ban on ephedra-containing
supplements. As recently as December 6, 2005, the FDA seized yet another
shipment of such supplements distributed by companies in Gainesville, Texas
and Eugene, Oregon.
For the future, the FDA and also Congress have indicated that they
will consider whether alternatives to ephedra, other weight loss and energy
stimulants (such as bitter orange), similarly carry an unreasonable risk to
the central nervous system, and thus to human health. These proposals to
limit stimulant ingredients, if finalized, may necessitate reformulations
of some of the Company's weight loss products.
Also, in the aftermath of the ephedra ban, on April 22, 2004, in
comments before a scientific meeting, then Acting FDA Commissioner, Lester
Crawford (and for some months during 2005, FDA Commissioner), outlined what
an FDA press release termed a "science-based plan for dietary supplement
enforcement". The press release went on to say that the agency "would soon
provide further details about its plan to ensure that the consumer
protection provisions of DSHEA are used effectively and appropriately".
Referring to its recent rulemaking on ephedra, the FDA also stated that it
"expects to evaluate the available pharmacology, published literature ...,
evidence-based reviews, and adverse event information" of "individual
dietary supplements". Soon afterwards, this promised FDA document was
issued, with the title "Regulatory Strategy for the Further Implementation
and Enforcement of the Dietary Supplement Health and Education Act of
1994". No new regulations or proposed rules pursuant to this strategy have
yet been issued, except that the FDA has recently welcomed and received
comments from the industry for a better procedure for the FDA to review a
company's safety information as to a new dietary ingredient, or NDI, in an
NDI Notification. The final guidance document concerning NDI Notifications
has not yet been issued by the FDA. At this time, NDI Notifications are not
required for any of the Company's products.
Anti-DSHEA Proposed Legislation. Finally, as the press, the FDA, and
members of Congress and of the supplement industry have all predicted, the
very issuance of the final rule on ephedra has caused Congress to rethink
the Dietary Supplement Health and Education Act of 1994, or DSHEA,
specifically as to how safety in supplements may be ensured, and also as to
whether specific categories of dietary ingredients should not be permitted
at all. In particular, there is growing sentiment (including from one
herbal trade association) to make Adverse Event Reporting (AERs) mandatory
for all manufacturers and marketers of dietary supplements, so that the FDA
may take action more quickly than it did on ephedra, when a harmful herb or
other ingredient is suspected. Since February 2003, there have been several
bills proposed in Congress that would amend DSHEA, make safety safeguards
stricter, even approaching the rigor and reporting required for
FDA-regulated drugs. Some examples are as follows:
S. 722 - The Dietary Supplement Safety Act was introduced by Senator
Richard Durbin in March 2003, and would greatly undermine DSHEA, especially
Section 4 regarding safety, giving the FDA new powers of oversight and
blanket authority over whole categories of supplements, including
stimulants. Stimulants are used in many weight loss products, including
some of our supplements. To the best of our knowledge, this bill and the
bill described below (though perhaps under different numbers) are still
pending.
H.R. 3377: Beginning on October 28, 2003, Senator McCain chaired Senate
Hearings on whether DSHEA adequately protects consumers. Also on October
28, Cong. Susan Davis and Cong. Henry Waxman introduced The Dietary
Supplement Access and Awareness Act, H.R. 3377, purporting to be about
safety and access for consumers to supplements, but actually recommending
severe restrictions and dramatic redefinitions of what constitutes a
dietary supplement. This bill would impose several requirements for
supplements, including unprecedented FDA pre-approval as well as strict AER
reporting, and excludes only vitamins and minerals from such new
requirements. Like S. 722, this bill would reverse the safety burden of
proof in Section 4 of DSHEA (one of the industry's victories in 1994), and
instead require the manufacturer to demonstrate safety, rather than the
burden being on the FDA to show "imminent hazard" or "unreasonable risk".
So far, neither of the bills above, nor any other proposed legislation
that would undermine DSHEA or impose additional requirements on
supplements, have passed. With the help of its regulatory attorney, the
Company will continue to monitor these anti-DSHEA bills, and determine if
any of them become a serious threat to its business. In addition, the two
major trade associations of the dietary supplement industry--the American
Herbal Products Association, or AHPA, and the National Natural Foods
Association, or NNFA--have both been actively lobbying against any bills
that would require or lead to unreasonable restraints on the manufacture,
labeling, and marketing of dietary supplements.
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 has evaluated the risk associated with consumption of
its current products and, based on the indemnification given by its
manufacturers and the current product mix, the Company cancelled its
product liability insurance in August 2005. Products containing ephedra,
which represented 31.0% of the Company's first quarter 2004 net revenues,
were not covered by the Company's product liability insurance.
Substantially all of the Company's product manufacturers carry product
liability insurance, which covers its products. Such product claims against
the Company could adversely affect product sales, results of operations,
financial condition and the value of the Company's common stock.
Legal Proceedings - The Company is currently involved in asserted and
unasserted claims, which arise in the ordinary course of business. The
Company routinely evaluates whether a loss is probable, and if so, whether
it can be estimated. Estimates are based on similar case law matters,
consultation with subject matter experts and information obtained through
negotiations with counter-parties. As such, accurately depicting the
outcome of pending litigation requires considerable judgment and is subject
to material differences on final settlement. Accruals for probable losses
are recorded in accrued expenses. If the Company's assessment of the
probability is inaccurate, the Company may need to record additional
accruals or reduce recorded accruals later. In addition, the Company may
need to adjust its estimates of the probable loss amounts as further
information is obtained or the Company considers settlements. See "Part II,
Item 1. Legal Proceedings" for a description of the most significant claims
by or against the Company.
Employment Agreements - In January 2006, the Company entered into a
written employment agreement with Jerry W. Grizzle, the Company's Chairman
of the Board, President and Chief Executive Officer. The contract is for a
two-year term, commencing January 25, 2006, followed by two successive
one-year terms unless either party elects not to renew the Agreement. Mr.
Grizzle's base salary is $150,000 per year for the first year of the
Initial Term, $200,000 for the second year of the Initial Term and $250,000
for each year after the Initial Term. Additionally, Mr. Grizzle will be
eligible to receive certain performance-based incentive bonuses. The
Company granted Mr. Grizzle options to purchase 250,000 shares of the
Company's common stock on February 15, 2006, with an exercise price of
$0.62 per share which was the closing price of the Company's common stock
on that day. The options vest in five equal annual installments beginning
February 15, 2007 and expire February 15, 2016. In the event the Company
terminates Mr. Grizzle without cause, he will receive certain severance pay
based upon his length of employment with the Company.
In April 2006, the Company entered into a written employment agreement
with Robin L. Jacob, the Company's Vice President, Secretary, Treasurer and
Chief Financial Officer. The contract is for a two-year term, commencing
February 12, 2006, followed by two successive one-year terms unless either
party elects not to renew the Agreement. Ms. Jacob's base salary is
$100,000 per year for the first year of the Initial Term, $112,500 for the
second year of the Initial Term and $125,000 for each year after the
Initial Term. Additionally, she is eligible to receive certain
performance-based incentive bonuses. The Company granted Ms. Jacob options
to purchase 150,000 shares of the Company's common stock at an exercise
price of $.64 per share, which was the closing price of the Company's
common stock on March 31, 2006, the last trading day prior to the date the
options were granted. The options vest in five equal annual installments
beginning April 1, 2007 and expire April 1, 2016. In the event the Company
terminates Ms. Jacob without cause, she will receive certain severance pay
based upon her length of employment with the Company.
11. DEFERRED COMPENSATION AND CONSULTING AGREEMENT
On November 4, 2003 the Company entered into a written employment
agreement with John W. Hail. The contract was for an initial two-year term,
commencing November 4, 2003, and extended for up to five successive
one-year terms if the Company and Mr. Hail agree in writing. The agreement
was extended on November 4, 2005. The contract calls for a base salary of
$249,600 per year, a monthly variable salary equal to one percent (1%) of
the Company's gross revenues, and a discretionary year-end bonus determined
by a majority vote of the Board of Directors. On November 4, 2005, the
Company extended Mr. Hail's employment agreement to November 4, 2006. In
connection with the extension, Mr. Hail's monthly variable salary ceased
and was replaced by a fixed supplemental payment to Mr. Hail, which was the
gross amount necessary to cover all federal, state and local taxes and all
employment taxes, and pay a net amount of $7,000 per month. Mr. Hail
retired as the Company's Chief Executive Officer and Chairman of the Board
effective February 12, 2006. At such time, the Company's obligations under
his employment agreement terminated. In April 2006, the Company signed a
consulting agreement with TVC Marketing regarding the services of Mr. Hail.
The agreement is for an initial six-month term, commencing March 1, 2006,
with the renewal option of any number of additional successive six-month
terms by mutual agreement between the parties. Such renewal(s) must be in
writing signed by both parties. The consulting fee is $5,000 per month for
the entire term of the agreement, plus reimbursement of reasonable travel
expenses.
12. LEASE ABANDONMENT
In January 2004, the Company commenced a relocation of its corporate
headquarters from 2601 NW Expressway (the Oil Center), Oklahoma City,
Oklahoma to its warehouse and distribution facility. A portion of the Oil
Center was maintained for storage, a portion was maintained for possible
relocation of Company personnel due to expansion of the business and a
portion was subleased to a third party under a short-term lease. In
September 2004, the Company purchased an existing building adjacent to its
corporate headquarters to be used for additional office, warehouse and
storage space. Company management believes the purchased building is
sufficient to meet expansion needs, and as such, abandoned the Oil Center
location. In determining lease abandonment, management assumed the
continuation of the existing sublease at the current rate. In addition, a
discount rate of 6.5% was used to calculate the present value of current
lease payments less sublease revenue. At June 30, 2006, the lease
abandonment accrual was approximately $152,000.
13. DISCONTINUED OPERATIONS
On March 31, 2006, the Company adopted a plan to discontinue the
operations of its Heartland Cup subsidiary. The Company has actively
marketed Heartland Cup to prospective buyers. At March 31, 2006, Heartland
Cup had reduced employee count to only those necessary to show the plant to
prospects. As of August 10, 2006, the Company was in negotiations with a
prospective buyer to purchase the plant, equipment and current customer
contracts. Management believes this purchase will conclude by the end of
the first quarter of 2007.
The results of operations of discontinued operations are summarized
below:
Three Months Six Months
Ended Ended
June 30, 2006 June 30, 2006
--------------- --------------
Revenues $ 207,771 $ 721,217
=============== ==============
Loss from operations of discontinued operations $ (185,517) $ (501,232)
Estimated costs to sell - (20,000)
Income tax effect - -
--------------- --------------
Loss from operations of discontinued operations, net of tax $ (185,517) $ (521,232)
Related to the sale of the Heartland operations, the Company expects
to incur attorney fees to draft the sales contracts, and complete the
transaction. As such, the Company has included an estimate of $20,000 in
the discontinued operations accrual at June 30, 2006.
The components of assets and liabilities of discontinued operations in
the accompanying consolidated balance sheets are as follows:
June 30, 2006
-------------
Current assets of discontinued operations:
Cash $ 1,092
Accounts receivable, net 93,434
Inventory 207,003
------------
Total $ 301,529
============
Noncurrent assets of discontinued operations:
Property and equipment, net $ 1,307,192
------------
Total $ 1,307,192
============
Current liabilities of discontinued operations:
Accounts payable $ 18,675
Current portion of long-term debt 444,434
Other current liabilities 22,063
------------
Total $ 485,172
============
Long-term liabilities of discontinued operations:
Long-term debt $ 1,548,241
============
14. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2006, the FASB issued Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes --- an Interpretation of FASB Statement No.
109" ("FIN 48"). FIN 48 clarifies the uncertainty in income taxes
recognized in a company's financial statements in accordance with SFAS No.
109, "Accounting for Income Taxes." FIN 48 prescribes a recognition
threshold and measurement attribute for the financial statement recognition
and measurement of a tax position taken or expected to be taken in a tax
return. FIN 48 is effective for fiscal years beginning after December 15,
2006. We are currently reviewing this new standard to determine its
effects, if any, on our results of operations or financial position.
15. CURRENT FINANCIAL CONDITION
Several factors have contributed to the Company's current financial
condition:
o The impact of several material non-recurring events, including
the one-time impairment of goodwill, the accrual of deferred
compensation related to the employment contract of the Company's
founder and then CEO, the implementation of a free trial program,
the write off of the Company's deferred tax asset, and a lease
abandonment charge related to the abandonment of the executive
offices;
o Excessive expenses incurred in the Heartland operations and a
continuing excess of monthly operating expenses over revenues;
and
o Declining net income, due to the FDA's ban on ephedra products.
The Company has taken the following steps to significantly reduce its
cost of sales and marketing, distribution and administrative costs:
o Reductions in force, encompassing all departments within the
Company;
o The termination of a discount sales program, designed to give
customers a cash discount after purchasing a certain dollar
amount of product; and
o The termination of several extra employee benefits, including
vehicle allowances and social and country-club privileges.
On March 31, 2006, the Company adopted a plan to discontinue the
operations of its Heartland Cup subsidiary. The Company has actively
marketed Heartland Cup to prospective buyers. At March 31, 2006,
Heartland Cup had reduced employee count to only those necessary to
show the plant to prospects. As of August 10, 2006, the Company was in
negotiations with a prospective buyer to purchase the plant, equipment
and current customer contracts. Management is also actively working
with several investment firms to raise equity capital, not only for
equity purposes, but also for cash flow purposes. Finally, the Company
is exploring strategic acquisitions of network marketing companies
with profitable, sustained operations.
The Company is seeing positive upswings and trends in associate
recruiting, as well as continued reductions in costs of goods sold and
administrative expenses. At June 30, 2006, the Company's ratios
compared to net sales are trending toward the levels that existed in
the Company's last profitable year. Finally, the Company is exploring
a new product offering that management believes will be the
replacement for the ephedra product banned in 2004.
On June 28, 2006, the Company completed a $2,000,000 private
placement financing through the sale of secured convertible notes to
Laurus Master Fund Ltd. The net proceeds of the funding will be used
primarily for sales and marketing. For a full description of the terms
of the note, see Note 6 to Consolidated Financial Statements.
******
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
AMS Health Sciences, Inc. and Subsidiaries
We have reviewed the accompanying consolidated balance sheet of AMS Health
Sciences, Inc. and Subsidiaries as of June 30, 2006, and the related
consolidated statements of operations for the three and six months ended June
30, 2006, and the consolidated statement of cash flows for the six months ended
June 30, 2006. These financial statements are the responsibility of the
Company's management.
We conducted our review in accordance with standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with the
standards of the Public Company Accounting Oversight Board (United States), the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to the consolidated financial statements, as of and for the
period ended June 30, 2006, for them to be in conformity with accounting
principles generally accepted in the United States of America.
We have previously audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated balance
sheet of AMS Health Sciences, Inc. and Subsidiaries as of December 31, 2005 and
the consolidated statements of operations, stockholders' equity and cash flows
for the year then ended (not presented herein) and, in our report dated March
28, 2006, we expressed an unqualified opinion on those statements. In our
opinion, the information set forth in the accompanying consolidated balance
sheet as of December 31, 2005 is fairly stated, in all material respects, in
relation to the consolidated balance sheet from which it has been derived.
/S/ COLE & REED P.C.
Oklahoma City, Oklahoma
August 14, 2006
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
General
We market a product line consisting of approximately sixty products in
three categories; weight management, dietary supplement and personal care
products. These products are marketed through a network marketing organization
in which independent associates purchase products for resale to retail customers
as well as for their own personal use.
On September 9, 2005, we entered into a definitive Stock Purchase Agreement
with Heartland and its principal shareholder for the purchase of all of the
principal shareholder's stock in Heartland. Upon closing of the Stock Purchase
Agreement, we acquired 2,000,000 shares, or approximately 83% of the outstanding
capital stock of Heartland, for 200,000 shares of our common stock. In addition,
we paid approximately $200,000 to acquire the remaining shares of Heartland.
Heartland is a manufacturer of foam cups, distributed through a number of
contracts. Heartland has exclusive contracts with the State of Oklahoma and the
Department of Defense, as well as a number of restaurants.
As described in Footnote 13 to the Financial Statements, we have made the
decision to sell or cease operations at Heartland Cup. As such, our consolidated
financial statements reflect Heartland Cup as a discontinued operation. As
described in Part II, Item 1. Legal Proceedings, we have filed suit against
Truett McCarty in the District Court of Oklahoma County, State of Oklahoma
relating to our acquisition of Heartland. We believe that Mr. McCarty has both
defrauded us regarding the financial conditions and results of operations of
Heartland, as well as breached certain representations and warranties in the
Stock Purchase Agreement relating to the Heartland acquisition. It is our belief
that, had we been aware of the true facts and circumstances regarding
Heartland's financial condition and historical results of operations, we would
not have purchased Heartland. We presently believe that the dedication of our
time and attention to Heartland is neither in our or our stockholders' best
interests. As a result, we have discontinued the Heartland operations, and are
in negotiations with a prospective buyer to purchase the plant, equipment and
existing customer contracts. Due to the above reasons, any further discussion of
Heartland and its operations in this report will be limited to the discussions
included in Part I, Item 2. Management's Discussion and Analysis or Plan of
Operation and Part II, Item 1. Legal Proceedings. Since the purchase offer for
Heartland Cup is not finalized, we cannot determine the ultimate impact of the
sale on our financial condition or results of operations.
On July 28, 2006, our Chief Executive Officer, outlined a strategic plan
for our future operations as follows:
o Sell Heartland Cup;
o Use additional capital to build a foundation that will allow us to
grow. Because of our consecutive years of losses, we have not had the
funds to develop marketing, training and support tools, and programs
to support our independent associates' efforts in the field. On June
28, 2006, we raised $2,000,000 in additional financing. We intend to
use these funds to begin an aggressive sales and marketing campaign,
which we believe will increase our top of line revenues. We intend to
produce better product videos, business builder videos, printed
material and other materials for use by our independent associates in
their marketing efforts. In addition we intend to upgrade our back
office to provide our independent associates with the most current
management tools available in network marketing.
o Establish a new binary commission system and allow our independent
associates to choose to use our existing commission system or the new
binary commission system depending on their primary method of
generating revenues. This will allow our independent associates to
tailor their commission system to their operating methods.
o Enter the International markets.
Critical Accounting Policies. We prepare our consolidated financial
statements in conformity with accounting principles generally accepted in the
United States, which require us to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosures of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenue and expenses during the year. Actual results could differ
from those estimates. We consider the following policies to be most critical in
understanding the judgments that are involved in preparing our financial
statements and the uncertainties that could impact our results of operations,
financial condition and cash flows.
Throughout this report, "net sales" represents the gross sales amounts
reflected on our invoices to our associates, less associate discounts and sales
returns. All of our products include a customer satisfaction guarantee. Our
products may be returned within 30 days of purchase for a full refund or credit
toward the purchase of another product. We also have a buy-back program whereby
we repurchase products sold to an independent associate (subject to a restocking
fee), provided the associate terminates his/her associateship agreement with us
and returns the product within 12 months of original purchase in marketable
condition. We receive our net sales price in cash or through credit card
payments upon receipt of orders from associates.
Our "gross profit" consists of net sales less:
o Commissions and bonuses, consisting of commission payments to
associates based on their current associate level within their
organization, and other one-time incentive cash bonuses to qualifying
associates;
o Cost of products, consisting of the prices we pay to our manufacturers
for products, and royalty overrides earned by qualifying associates on
sales within their associate organizations; and
o Cost of shipping, consisting of costs related to shipments, duties and
tariffs, freight expenses relating to shipment of products to
associates and similar expenses.
We recognize revenue upon shipment of products, training aids and
promotional material to our independent associates. All of our customers pay for
sales in advance of shipment. As such, we have no trade receivables. We used to
make loans to associates, which were repayable in five years or less, and which
were secured by commissions controlled by us. Associate loans are no longer
allowed. Interest rates on loans were typically two percent or more above the
Prime rate and were fixed. All loans were secured by guaranteed payment sources
that were within our control, but subject to increases and decreases depending
upon associate sales activity. Management determined that there was a
possibility of default on the associate loans. As such, we have reserved an
allowance for doubtful accounts in connection with the associate loans. At June
30, 2006, the allowance for doubtful accounts was approximately $132,000. Total
associate loans still outstanding at June 30, 2006 totaled approximately
$186,000.
In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets".
This standard requires companies to stop amortizing existing goodwill and
intangible assets with indefinite lives effective January 1, 2002. Under the new
rules, companies would only adjust the carrying amount of goodwill or indefinite
life intangible assets upon an impairment of the goodwill or indefinite life
intangible assets. Our intangible assets consist of non-compete covenants and
other intangibles, which have a significant residual value. These intangible
assets are being amortized over the life of the contracts. We evaluate all
intangible assets annually for indicators of impairment.
We use 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. All evidence, both positive and
negative, is considered to determine whether a valuation allowance is needed for
some or all of a deferred tax asset. Judgment must be used in considering the
relative impact of negative and positive evidence. The more negative evidence
that exists, (a) the more positive evidence is necessary and (b) the more
difficult it is to support a conclusion that a valuation allowance is not
needed. Based on the above factors and management's evaluation, we determined
that a valuation allowance should be established for our entire deferred tax
asset, which was approximately $5,100,000 at June 30, 2006.
We write down our inventory to provide for estimated obsolete or unsalable
inventory based on assumptions about future demand for our products and market
conditions. If future demand and market conditions are less favorable than
management's assumptions, additional inventory write-downs could be required.
Likewise, favorable future demand and market conditions could positively impact
future operating results if written-off inventory is sold. At June 30, 2006, we
have a marketing inventory obsolescence reserve of approximately $68,000 for
estimated obsolete or unsalable inventory.
We account for contingencies in accordance with SFAS No. 5, "Accounting for
Contingencies". SFAS 5 requires that we record an estimated loss from a loss
contingency when information available prior to issuance of our financial
statements indicates that it is probable than an asset has been impaired or a
liability has been incurred at the date of the financial statements, and the
amount of the loss can be reasonable estimated. Accounting for contingencies
such as legal and income tax matters requires us to use our judgment. Many legal
and tax contingencies can take years to resolve. Generally, as the time period
increases over which the uncertainties are resolved, the likelihood of changes
to the estimate of the ultimate outcome increases. However, an adverse outcome
in these matters could have a material impact on our results of operations,
financial condition and cash flows.
Results of Operations
The following table sets forth, as a percentage of our net sales, selected
results of operations for the three and six months ended June 30, 2006 and 2005.
The selected results of operations are derived from our unaudited consolidated
financial statements. The results of operations for the periods presented are
not necessarily indicative of our future operations.
For the Three Months Ended For the Six Months Ended
--------------------------------------------- ---------------------------------------------
June 30, June 30,
--------------------------------------------- ---------------------------------------------
2006 2005 2006 2005
--------------------- --------------------- --------------------- ---------------------
Amount Percent Amount Percent Amount Percent Amount Percent
---------- ------- ---------- ------- ---------- ------- ---------- -------
Net sales $2,397,975 100.0% $3,528,319 100.0% $4,749.688 100.0% $7,549,077 100.0%
---------- ----- ---------- ----- ---------- ----- ---------- -----
Cost of sales:
Commissions and bonuses 732,583 30.5 1,317,561 37.3 1,560,398 32.9 3,376,188 44.7
Cost of products 462,935 19.3 735,784 20.9 920,725 19.4 1,712,852 22.7
Cost of shipping 291,967 12.2 339,331 9.6 571,516 12.0 845,768 11.2
---------- ----- ---------- ----- ---------- ----- ---------- -----
Total cost of sales 1,487,485 62.0 2,392,676 67.8 3,052,639 64.3 5,934,808 78.6
---------- ----- ---------- ----- ---------- ----- ---------- -----
Gross profit 910,490 38.0 1,135,643 32.2 1,697,049 35.7 1,614,269 21.4
Marketing and
administrative expenses:
Marketing 101,851 4.3 322,357 9.1 242,995 5.1 634,478 8.4
Administrative 765,564 31.9 1,624,270 46.0 1,455,084 30.6 3,133,779 41.5
---------- ----- ---------- ----- ---------- ----- ---------- -----
Total marketing, and
administrative expenses 867,415 36.2 1,946,627 55.1 1,698,079 35.7 3,768,257 49.9
---------- ----- ---------- ----- ---------- ----- ---------- -----
Income from operations 43,075 1.8 (810,984) (22.9) (1,030) 0.0 (2,153,988) (28.5)
Other income (expense):
Interest, net 5,246 0.2 14,988 0.4 9,088 0.2 22,557 0.3
Other, net (15,704) (0.7) 4,094 0.1 43,959 .9 24,925 0.3
---------- ----- ---------- ----- ---------- ----- ---------- -----
Total other income (10,458) (0.5) 19,082 0.5 53,047 1.1 47,482 0.6
---------- ----- ---------- ----- ---------- ----- ---------- -----
Income (loss) from
continuing operations
before taxes 32,617 1.3 (791,902) (22.4) 52,017 1.1 (2,106,506) (27.9)
Tax Expense - - (22,456) (0.6) - - 1,363 0.0
---------- ----- ---------- ----- ---------- ----- ---------- -----
Income (loss) from
continuing operations $32,617 1.3 $(769,446) (21.8) $52,017 1.1 $(2,107,869) (27.9)
---------- ----- ---------- ----- ---------- ----- ---------- -----
Discontinued operations:
Loss from operations
of Heartland Cup (185,517) (7.7) - - (521,232) (11.0) - -
---------- ----- ---------- ----- ---------- ----- ---------- -----
Income Tax benefit - - - - - - - -
---------- ----- ---------- ----- ---------- ----- ---------- -----
Total loss on
discontinued operations (185,517) (7.7) - - (521,232) (11.0) - -
---------- ----- ---------- ----- ---------- ----- ---------- -----
Net loss $(152,900) (6.4)% $(769,446) (21.8)% $(469,215) (9.9)% $(2,107,869) (27.9)%
========= ==== ========= ===== ========= ==== =========== =====
Comparison of the Three Months ended June 30, 2006 and 2005
Our net sales during the three months ended June 30, 2006 decreased
$1,130,344 or 32.0%, to $2,397,975 from $3,528,319 during the three months ended
June 30, 2005.
Our cost of sales during the three months ended June 30, 2006 decreased
$905,191, or 37.8%, to $1,487,485 from $2,392,676 during the same period in
2005. Total cost of sales, as a percentage of net sales, decreased to 62.0%
during the three months ended June 30, 2006 from 67.8% during the same period in
2005. The decrease in cost of sales resulted in:
o A decrease of approximately $585,000 in associate commissions and
bonuses;
o A decrease of approximately $273,000 in the cost of products sold; and
o A decrease of approximately $47,000 in shipping costs.
The factors discussed above resulted in an decrease in gross profit of
$225,153, or 19.8%, to $910,490 for the three months ended June 30, 2006 from
$1,135,643 for the same period in 2005.
Marketing expenses decreased $220,506, or 68.4%, to $101,851 during the
three months ended June 30, 2006, from $322,357 during the same period in 2005.
The decrease in expense was primarily attributable to:
o A decrease in employee costs of approximately $103,000, related to
reductions in staff;
o A decrease in travel costs of approximately $20,000 related to reduced
outside travel of executives;
o A decrease in promotional costs of approximately $30,000;
o A decrease in repairs and maintenance expense of approximately $10,000
due to the sale of vehicles in 2006;
o A decrease in professional services of approximately $39,000 related
to maintenance of our websites; and
o A decrease in miscellaneous expense of approximately $8,000 related to
postage, printing, supplies and telephone expense.
Administrative expense decreased $858,706, or 52.9%, to $765,564 during the
three months ended June 30, 2006 from $1,624,270 during the same period of 2005.
The decrease in expense was primarily attributable to:
o A decrease in employee costs of approximately $555,000 related to
reductions in staff;
o A decrease in professional services of approximately $13,000 related
to decreased consulting and legal fees and less use of temporary
employees;
o A decrease in rent and insurance expense of approximately $70,000
related to adjustments to our lease abandonment accrual and a change
in insurance carriers resulting in better rates;
o A decrease in repairs and maintenance expense of approximately
$25,000;
o A decrease in shareholder relations of approximately $48,000;
o A decrease in promotional expense of approximately $9,000 related to
the national conference;
o A decrease in depreciation expense of approximately $30,000 due to the
sale of the motorcoach, vehicles, and other assets in 2006; and
o A decrease in general and administrative expense of approximately
$150,000 related to bank charges, supplies, telephone, etc.
The decrease in administrative expense was partially offset by:
o An increase in travel costs of $6,000; and
o An increase in website expenses of $23,000.
The marketing and administrative expenses as a percentage of net sales
decreased to 36.2% during the three months ended June 30, 2006 from 55.1% during
the same period in 2005. Management expects marketing and administrative
expenses to remain at the current dollar level based on expense reductions
implemented in 2005 and early 2006.
Our net other income (reduced by other expense) decreased by $29,540 to net
other expense of ($10,458) at June 30, 2006, from net other income of $19,082
during the same period in 2005, primarily due to:
o A decrease in gain on sale of assets of approximately $11,000 related
to the sale of excess office furniture and supplies;
o A decrease in gain on sale of marketable securities of approximately
$14,000 related to the decrease of marketable securities;
o A decrease in interest income of approximately $8,000 related to the
decrease of marketable securities; and
o An increase in other income of approximately $3,000 related to the
collection of reserved notes receivable.
Our income (loss) from continuing operations before taxes increased
$824,519 to income of $32,617 for the three months ended June 30, 2006, compared
to a net loss of ($791,902) during the same period in 2005. Income (loss) from
continuing operations before taxes as a percentage of net sales was 1.3% and
(22.4%) for the three months ended June 30, 2006 and 2005, respectively. Income
tax expense (benefit) for the second quarter 2006 and 2005 was $0 and ($22,456),
respectively. Our net income (loss) from continuing operations increased
$802,063, to net income of $32,617 for the three months ended June 30, 2006,
from a net loss of ($769,446) for the same period in 2005. This increase was
attributable to:
o The decrease in cost of goods sold to $1,487,485 during 2006 from
$2,392,676 during 2005; and
o The decrease in marketing and administrative expense to $867,415
during 2006 from $1,946,627 during 2005.
Net income (loss) from continuing operations as a percentage of net sales
increased to 1.3% for the three months ended June 30, 2006, from (21.8%) during
the same period in 2005.
Comparison of the Six Months ended June 30, 2006 and 2005
Our net sales during the six months ended June 30, 2006 decreased
$2,799,389, or 37.1%, to $4,749,688 from $7,549,077 during the six months ended
June 30, 2005. On April 5, 2005, we announced that we were ending our free trial
program that began in April, 2004, due to the lack of retention required to make
the program profitable long term. In connection with the reduction in sales, on
April 20, 2005, we announced the implementation of expense reductions designed
to better align expenses with revenue. Due to the continued decrease in sales we
implemented additional expense reductions and employee layoffs in August and
December 2005, and January 2006.
Our cost of sales during the six months ended June 30, 2006 decreased
$2,882,169, or 48.6%, to $3,052,639 from $5,934,808 during the same period in
2005. Total cost of sales, as a percentage of net sales, decreased to 64.3%
during the six months ended June 30, 2006 from 78.6% during the same period in
2005. The decrease in cost of sales was primarily attributable to the
cancellation of our free trial program, resulting in:
o A decrease of approximately $1,816,000 in associate commissions and
bonuses;
o A decrease of approximately $792,000 in the cost of products sold; and
o A decrease of approximately $274,000 in shipping costs.
The factors discussed above resulted in an increase in gross profit of
$82,780, or 5.1%, to $1,697,049 for the six months ended June 30, 2006 from
$1,614,269 for the same period in 2005.
Marketing expenses decreased $391,483, or 61.7%, to $242,995 during the six
months ended June 30, 2006, from $634,478 during the same period in 2005. The
decrease in expense was primarily attributable to:
o A decrease in employee costs of approximately $217,000, related to
reductions in staff;
o A decrease in travel costs of approximately $34,000 related to reduced
outside travel of executives;
o A decrease in professional services of approximately $80,000 related
to maintenance of our websites;
o A decrease in promotional expense of approximately $19,000 related to
mailers;
o A decrease in vehicle expense of approximately $11,000; and
o A decrease in miscellaneous expense of approximately $22,000 related
to postage, printing, supplies and telephone expense.
Administrative expense decreased $1,678,695, or 53.6%, to $1,455,084 during
the six months ended June 30, 2006 from $3,133,779 during the same period of
2005. The decrease in expense was primarily attributable to:
o A decrease in employee costs of approximately $1,049,000 related to
reductions in staff;
o A decrease in professional services of approximately $128,000 related
to decreased consulting and legal fees and less use of temporary
employees;
o A decrease in rent and insurance expense of approximately $186,000
related to adjustments to our lease abandonment accrual and a change
in insurance carriers resulting in better rates;
o A decrease in repairs and maintenance expense of approximately
$70,000;
o A decrease in shareholder relations of approximately $52,000;
o A decrease in depreciation expense of approximately $45,000 due to the
sale of the motorcoach, vehicles, and other assets in 2006; and
o A decrease in general and administrative expense of approximately
$181,000 related to bank charges, supplies, telephone, etc.
The decrease in administrative expense was partially offset by:
o An increase in travel costs of $7,000; and
o An increase in website expenses of $14,000.
The marketing and administrative expenses as a percentage of net sales
decreased to 35.8% during the six months ended June 30, 2006 from 49.9% during
the same period in 2005. Management expects marketing and administrative
expenses to remain at the current dollar level based on expense reductions
implemented in 2005 and early 2006.
Our net other income (reduced by other expense) increased by $5,565 to net
other income of $53,047 at June 30, 2006, from net other income of $47,482
during the same period in 2005, primarily due to:
o An increase in other income of approximately $16,000 related to the
collection of reserved notes receivable;
o An increase in gain on sale of assets of approximately $36,000 related
to the sale of excess office furniture and supplies and vehicles;
o An decrease in interest expense of approximately $10,000;
o A decrease in interest income of approximately $23,000 related to the
decrease of marketable securities; and
o A decrease in gain on sale of marketable securities of approximately
$6,000.
Our income (loss) from continuing operations before taxes increased
$2,158,523 to income of $52,017 for the first six months of 2006, compared to a
net loss of ($2,106,506) during the same period in 2005. Income (loss) from
continuing operations before taxes as a percentage of net sales was 1.1% and
(27.9%) for the six months ended June 30, 2006 and 2005, respectively. Income
tax expense for the second quarter of 2006 and 2005 was $0 and $1,363,
respectively. Our net income (loss) from continuing operations increased
$2,159,886, to net income of $52,017 for the six months ended June 30, 2006,
from a net loss of ($2,107,869) for the same period in 2005. This increase was
attributable to:
o The increase in gross profit to $1,697,049 during 2006 from $1,614,269
during 2005;
o The decrease in marketing and administrative expense to $1,698,079
during 2006 from $3,768.527 during 2005; and
o The increase in net other income to $53,047 during 2006 from $47,482
during 2005.
Net income (loss) from continuing operations as a percentage of net sales
increased to 1.1% for the six months ended June 30, 2006, from (27.9%) during
the same period in 2005.
Seasonality
No pattern of seasonal fluctuations exists due to the patterns that we are
currently experiencing. However, there is no assurance that we will not become
subject to seasonal fluctuations in operations.
Recently Issued Accounting Standards
On January 1, 2006, the Company adopted Statement of Financial Accounting
Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123R") which
requires the measurement and recognition of compensation expense based on
estimated fair values for all share-based payment awards made to employees and
directors, including employee stock options. SFAS 123R supersedes the Company's
previous accounting under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25") for periods beginning in
2006. In March 2005, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 107 ("SAB 107") relating to SFAS 123R. The Company has
utilized the guidance of SAB 107 in its adoption of SFAS 123R.
Liquidity and Capital Resources
Our primary source of liquidity has been cash provided by sales of our
common stock, debt instruments, marketable securities and operating activities.
At June 30, 2006, we had a working capital of $1,156,662, compared to a working
capital deficit of ($65,593) at December 31, 2005. Our working capital needs
over the next 12 months consist primarily of marketing and administrative
expenses, and will be provided by our operating activities and existing cash and
cash equivalents. During the six months ended June 30, 2006, net cash used in
operating activities was ($47,935), net cash provided by investing activities
was $91,534 and net cash provided by financing activities was $1,393,117. This
represented a net increase in cash during the period of $1,436,716.
Several factors have contributed to our current cash and cash equivalent
position:
o The impact of several material non-recurring events, including the
one-time impairment of goodwill, the accrual of deferred compensation
related to the employment contract of our founder and then CEO, the
implementation of a free trial program, the write off of our deferred
tax asset, and a lease abandonment charge related to the abandonment
of the executive offices;
o Excessive expenses incurred in the Heartland operations and a
continuing excess of monthly operating expenses over revenues; and
o Recurring losses due to the FDA's ban on ephedra products.
We have taken the following steps to significantly reduce our cost of sales
and marketing, distribution and administrative costs:
o Reductions in force, encompassing all departments within the Company;
o The termination of a discount sales program, designed to give
customers a cash discount after purchasing a certain dollar amount of
product; and
o The termination of several extra employee benefits, including vehicle
allowances and social and country-club privileges.
On March 31, 2006, we adopted a plan to cease the Heartland operations. We
have actively marketed the plant to prospective buyers, and have retained only
those employees necessary to facilitate tours of the plant to interested
parties. We have included an accrual for discontinued operations in the first
quarter of 2006, and as of August 10, 2006, we were in negotiations with a
prospective buyer to purchase the plant, equipment, and current customer
contracts. Finally, we are exploring strategic acquisitions of network marketing
companies with profitable, sustained operations.
On June 28, 2006, the Company entered into a series of agreements with
Laurus Master Fund, Ltd. ("Laurus") whereby the Company issued to Laurus (i) a
secured convertible term note ("Note") in the principal amount of $2,000,000,
and (ii) a warrant ("Warrant") to purchase up to 2,272,727 shares of the
Company's common stock at a price of $0.53 per share. Out of the loan proceeds,
the Company agreed to pay the sum of $74,000 to Laurus Capital Management, LLC,
the investment advisor to Laurus, the sum of $27,500 to Laurus Capital
Management, LLC as reimbursement for its due diligence and legal fees and
expenses incurred in connection with the transaction, and the sum of $1,500 to
Loeb & Loeb LLP, the escrow agent for Laurus. Total closing costs were $103,000.
The principal amount of the Note bears interest at a per annum rate equal
to the prime rate (as published in the Wall Street Journal from time to time)
plus three percent (3.0%); provided, however that the interest rate may not be
less than ten percent (10.0%). Interest payments are due monthly beginning July
1, 2006. Principal payments in the amount of $83,333.33 are due monthly
beginning July 1, 2007. The final maturity date of the Note is June 28, 2009
(the "Maturity Date"). The Company's obligations under the Note are secured by
all of the Company's assets, including its shares of AMS Manufacturing, Inc. and
by all of AMS Manufacturing's assets including its shares of Heartland Cup, Inc.
Additionally, the Company's obligations under the Note are guaranteed by AMS
Manufacturing.
The principal amount of the Note and accrued interest thereon is
convertible into shares of the Company's common stock at a price of $0.51 per
share, subject to anti-dilution adjustments. Under the terms of the Note, the
monthly payments of interest and/or principal (the "Monthly Amount") due on the
Note are payable in shares of the Company's common stock if the following
criteria are met: (i) the average closing price of the Company's common stock
for the five (5) days preceding the payment date is greater than or equal to
115% of the Fixed Conversion Price (defined below) and (ii) the amount of such
conversion does not exceed twenty five percent (25%) of the aggregate dollar
trading volume of the Company's common stock for the period of twenty-two
trading days immediately preceding such payment date. If subsection (i) above is
met but subsection (ii) above is not met as to the entire Monthly Amount, then
Laurus is required to convert only such part of the Monthly Amount that meets
the criteria of subsection (ii). The Company has agreed to register all of the
shares that are issuable upon conversion of the Note and exercise of the
2,272,727 Warrants. The Company has granted Laurus a right of first refusal with
respect to any debt or equity financings.
The Company calculated that the fair value of the Warrants issued to Laurus
was $588,452 based upon the relative value of the Black-Scholes valuation of the
warrants and the underlying debt amount. The Company determined that the
beneficial conversion feature ("BCF") of the note was $588,452. The closing
costs of $103,000, the value of the warrants issued to Laurus of $588,452 and
the $588,452 of calculated BCF have been reflected by the Company as a
valuation discount and offset to the face amounts of the Notes.
In conjunction with the financing, the Company also incurred fees to
various investment advisors that facilitated the transaction. These fees totaled
$287,500, of which $127,500 was paid through the issuance of 250,000 shares of
our common stock. In addition, the Company issued these advisors warrants to
purchase 495,543 shares of common stock at a price of $0.51 per share. The
Company calculated that the fair value of the warrants issued to the advisiors
was $130,770 based upon the relative value of the Black-Scholes valuation of the
warrants and the underlying debt amount. The fees paid to the advisors and the
value of the warrants issued to the advisors have been reflected as deferred
financing costs in the accompanying balance sheet and are being amortized over
the life of the loan.
Item 3. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, an evaluation was
carried out under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of
1934) as required by Rule 13a-15(b). Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that these disclosure
controls and procedures were effective. There have been no changes in our
internal control over financial reporting that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
The case of Ronald Potter et al v. Advantage Marketing Systems, Inc. et al,
a products liability claim, was filed in the Oklahoma County District Court in
March 2003. The Plaintiffs allege that the ingestion of ephedra included in
AM-300 resulted in the death of Pamela Sue Potter. We have filed an answer to
the petition. Written discovery and responses have been exchanged, and a limited
number of depositions have been taken. We have denied any wrongdoing and intend
to vigorously defend the claim. The amount of damages sought is unknown, but
includes compensatory and punitive damages. The loss of this case could have a
material adverse effect on the financial condition of the Company.
On February 6, 2006, AMS Health Sciences, Inc. and AMS Manufacturing, Inc.
filed a lawsuit against Truett McCarty. AMS Health Sciences, Inc. and AMS
Manufacturing, Inc. v. Truett McCarty, District Court of Oklahoma County, State
of Oklahoma, Case No. CJ-2006-981. We allege that Mr. McCarty defrauded us in
the sale of his stock in Heartland Cup, Inc. by failing to disclose the true
amount of Heartland Cup, Inc.'s accounts payable. In addition, we allege that
this failure was a breach of the stock purchase agreement Mr. McCarty signed.
Mr. McCarty has filed an answer denying our allegations. In addition, Mr.
McCarty has alleged several counterclaims against us. Mr. McCarty has alleged we
defrauded him with regard to the value of the stock he received in exchange for
his interest in Heartland Cup, Inc., that we breached the terms of the stock
purchase agreement by failing to take steps to remove Mr. McCarty as guarantor
of a certain promissory note, that we tortiously interfered with a promissory
note between Mr. McCarty and Heartland Cup, Inc. and that we tortiously
interfered with an employment agreement between Mr. McCarty and Heartland Cup,
Inc. In addition, Mr. McCarty has brought claims against Heartland Cup, Inc. for
breach of the promissory note and employment agreement. We deny liability to Mr.
McCarty and will vigorously defend these counterclaims. The parties are engaged
in written discovery and depositions. A pretrial conference will occur on
December 11, 2006, at which time it is likely that the court will set a trial
date.
On November 22, 2005, we filed a declaratory judgment action against Vaughn
Feather in the Oklahoma County District Court. The case was removed to federal
court on December 29, 2005 and is now styled as, AMS Heath Sciences, Inc. v.
Vaughn Feather, Western District of Oklahoma, Case no. CIV-05-1522. The action
is a request by us for a judicial declaration that we are no longer bound to pay
royalties to Feather under the terms of the previous Royalty Agreement between
us and Feather pursuant to which we were paying royalties for proprietary
products and formulas that we believed to no longer be proprietary. We are not
seeking damages or any return of previous royalties; however, a favorable
outcome would result in an end to our obligation to pay royalties to Feather,
which typically exceed $10,000 per month. We are awaiting a ruling on Feather's
motion to dismiss the action for lack of personal jurisdiction or to transfer
the action to California federal court. A scheduling order has been entered
requiring any mediation to occur before November 2006, and concluding all
discovery by December 2006.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On June 28, 2006, the Company entered into a Securities Purchase Agreement
("Securities Purchase Agreement") with Laurus Master Fund, LTD ("Laurus")
pursuant to which the Company issued, and Laurus purchased, a Secured
Convertible Term Note in the aggregate principal amount of $2,000,000 (the
"Note").
Laurus is required to convert the monthly payments of interest and/or
principal (the "Monthly Amount") due on the Note into shares of the Company's
common stock if (i) the average closing price of the Company's common stock for
the five (5) days preceding the payment date is greater than or equal to 115% of
the Fixed Conversion Price (defined below) and (ii) the amount of such
conversion does not exceed twenty five percent (25%) of the aggregate dollar
trading volume of the Company's common stock for the period of twenty-two
trading days immediately preceding such payment date. If the criteria set forth
in subsection (i) above is met but the criteria in subsection (ii) above is not
met as to the entire Monthly Amount, then Laurus is required to convert only
such part of the Monthly Amount that meets the criteria of subsection (ii). The
Fixed Conversion Price of the Note is $0.51, which is equal to the average
closing price of the Company's common stock for the ten (10) trading days
immediately prior to the date the Note was issued.
Laurus has the option to convert any portion of the outstanding principal
amount and/or accrued interest and fees and expenses payable into shares of the
Company's common stock at the Fixed Conversion Price. Laurus cannot optionally
convert payments due under the Note into shares of the Company's common stock,
if such conversion would result in Laurus or its affiliates owning more than
4.99% of the Company's common stock. This prohibition on Laurus' ability to
optionally convert amounts due under the Note into shares of the Company's
common stock may be waived by Laurus and becomes null and void upon (i) the
occurrence and during the continuance of an event of default, and (ii) receipt
of a notice of an optional redemption from the Company.
In connection with the issuance of the Note, the Company issued Laurus a
common stock purchase warrant (the "Laurus Warrant") granting Laurus the right
to purchase 2,272,727 shares of the Company's common stock at an exercise price
of $0.53.
The Company engaged Ascendiant Securities, LLC ("Ascendiant") as a
financial advisor and a non-exclusive placement agent in connection with the
Company's financing efforts. On June 28, 2006, in connection with the sale of
the Note to Laurus, the Company issued a common stock purchase warrant to
purchase 495,543 shares of the Company's common stock at an exercise price of
$0.51 per share (the "Ascendiant Warrant," and together with the Laurus Warrant,
the "Warrants"). Additionally, on June 28, 2006, in connection with the sale of
the Note to Laurus, the Company issued 250,000 shares of restricted stock (the
"Restricted Stock") to Ascendiant Capital Group, LLC.
The Note, the Warrants and the Restricted Stock were issued relying upon
the exemption from registration provided by Section 4(2) of the Securities Act
for "transactions by the issuer not involving a public offering." The issuance
of common stock upon the conversion of the Note or the exercise of the Warrants
will also be issued in reliance upon the exemption from registration provided in
Section 4(2) of the Securities Act.
Item 3. DEFAULTS UPON SENIOR SECURITIES
None
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
Item 5. OTHER INFORMATION
None
Item 6. EXHIBITS
(a) Exhibits
3.1 The Registrant's Certificate of Incorporation, incorporated by reference
to the Registration Statement on Form SB-2 (Registration No. 333-47801)
filed with the Commission on March 11, 1998.
3.2 The Registrant's Bylaws, incorporated by reference to the Registration
Statement on Form SB-2 (Registration No. 333-47801) filed with the
Commission on March 11, 1998.
10.1 Stock Option Agreement of Advantage Marketing Systems dated January 3,
2001, incorporated by reference to Form 8-K filed with the Commission on
January 8, 2001.
10.2* The Advantage Marketing Systems, Inc. 1995 Stock Option Plan,
incorporated by reference to Form SB-2 Registration Statement (No.
33-80629), filed with the Commission on November 20, 1996.
10.3* Employment Agreement by and between David D'Arcangelo and Registrant
dated effective as of November 25, 2002, incorporated by reference to
Form 10-K/A filed with the Commission on March 31, 2003.
10.4* Non-qualified Stock Option Agreement by and between David D'Arcangelo
and Registrant dated effective as of December 2, 2002, incorporated by
reference to Form 10-K/A filed with the Commission on March 31, 2003.
10.5* The Advantage Marketing Systems, Inc. 2003 Stock Incentive Plan,
incorporated by reference to Form S-8 Registration Statement (No.
333-109093), filed with the Commission on September 24, 2003.
10.6 Fulfillment Services Agreement with Vita Sales & Distribution
Multi-Country, dated January 19, 2004, incorporated by reference to Form
10-K filed with the Commission on March 29, 2004.
10.7* Employment Agreement by and between John W. Hail and Registrant dated
effective as of November 4, 2003, incorporated by reference to Form 10-K
filed with the Commission on March 29, 2004.
10.8 Commercial Industrial Real Estate Purchase Contract dated August 12,
2004 by and between Registrant and Keltronics Corporation, incorporated
by reference to Form 10-Q, filed with the commission on November 12,
2004.
10.9* Employment Agreement by and between Steven G. Kochen and Registrant
dated effective as of August 9, 2005, incorporated by reference to Form
8-K filed with the Commission on August 12, 2005.
10.10* Employment Agreement by and between Jerry W. Grizzle and Registrant
dated effective as of January 25, 2006, incorporated by reference to
Form 10-KSB filed with the Commission on April 3, 2006.
10.11* Employment Agreement by and between Robin L. Jacob and Registrant dated
effective as of February 12, 2006, incorporated by reference to Form 8-K
filed with the Commission on April 12, 2006.
10.12 Consulting Agreement by and between TVC Consulting and Registrant dated
effective as of March 1, 2006, incorporated by reference to Form 10-QSB
filed with the Commission on May 15, 2006 . 10.13 Securities Purchase
Agreement dated June 28, 2006 by and between the Company and Laurus
Master Fund, Ltd., filed herewith.
10.13 Securities Purchase Agreement dated June 28, 2006 by and between the
Company and laurus Master Fund, Ltd., filed herewith.
10.14 Secured Convertible Term Note dated June 28, 2006 by the Company in
favor of Laurus Master Fund, Ltd., filed herewith.
10.15 Common Stock Purchase Warrant dated June 29, 2006 by the Company in
favor of Laurus Master Fund, Ltd., filed herewith.
10.16 Registration Rights Agreement dated June 28, 2006 by and between the
Company and Laurus Master Fund, Ltd., filed herewith.
10.17 Stock Pledge Agreement dated June 28, 2006 by and among the Company, AMS
Manufacturing, Inc. and Laurus Master Fund, Ltd., filed herewith.
10.18 Master Security Agreement dated June 28, 2006 by and among the Company,
AMS Manufacturing, Inc. and Laurus Master Fund, Ltd., filed herewith.
10.19 Mortgage dated June 28, 2006 by and between the Company and Laurus
Master Fund, Ltd., filed herewith.
10.20 Grant of Security Interest in Patents and Trademarks dated June 28, 2006
by and between the Company and Laurus Master Fund, Ltd., filed herewith.
10.21 Common Stock Purchase Warrant dated June 28, 2006 by the Company in
favor of Ascendiant Securities, LLC, filed herewith.
10.22 Engagement Letter between the Company and Ascendiant Securities, LLC,
filed herewith.
15 Letter of independent accountants as to unaudited interim financial
information, filed herewith.
31.1 Chief Executive Officer Certification, filed herewith.
31.2 Chief Financial Officer Certification, filed herewith.
32.1 Section 1350 Certification of our Chief Executive Officer, filed
herewith.
32.2 Section 1350 Certification of our Chief Financial Officer, filed
herewith.
_______________
* Designates a compensatory plan.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
REGISTRANT:
AMS HEALTH SCIENCES, INC.
By: /s/ ROBIN L. JACOB
Dated: August 14, 2006 Robin L. Jacob, Vice President and Chief
Financial Officer
(Duly Authorized Officer of Registrant and
Principal Financial Officer)
INDEX OF EXHIBITS
Exhibit
No. Description Method of Filing
--- ----------- ----------------
3.1 The Registrant's Certificate of Incorporated herein by reference
Incorporation
3.2 The Registrant's Bylaws Incorporated herein by reference
10.1 Stock Option Agreement of Advantage Incorporated herein by reference
Marketing Systems dated January 3,
2001
10.2 The Advantage Marketing Systems, Inc. Incorporated herein by reference
1995 Stock Option Plan
10.3 Employment Agreement by and between Incorporated herein by reference
David D'Arcangelo and Registrant dated
effective as of November 25, 2002
10.4 Non-qualified Stock Option Agreement Incorporated herein by reference
by and between David D'Arcangelo and
Registrant dated effective as of
December 2, 2002
10.5 The Advantage Marketing Systems, Inc. Incorporated herein by reference
2003 Stock Incentive Plan
10.6 Fulfillment Services Agreement with Incorporated herein by reference
Vita Sales & Distribution
Multi-Country
10.7 Employment Agreement by and between Incorporated herein by reference
John W. Hail and Registrant dated
effective as of November 4, 2003.
10.8 Commercial Industrial Real Estate Incorporated herein by reference
Purchase Contract dated August 12,
2004 by and between Registrant and
Keltronics Corporation
10.9 Employment Agreement by and between Incorporated herein by reference
Steven G. Kochen and Registrant dated
effective as of August 9, 2005
10.10 Employment Agreement by and between Incorporated herein by reference
Jerry W. Grizzle and Registrant dated
effective as of January 25, 2006
10.11 Employment Agreement by and between Incorporated herein by reference
Robin L. Jacob and Registrant dated
effective as of February 12, 2006
10.12 Consulting Agreement by and between Incorporated herein by reference
TVC Consulting and Registrant dated
effective as of March 1, 2006
10.13 Securities Purchase Agreement dated Filed herewith electronically
June 28, 2006 by and between the
Company and Laurus Master Fund, Ltd.
10.14 Secured Convertible Term Note dated Filed herewith electronically
June 28, 2006 by the Company in favor
of Laurus Master Fund, Ltd.
10.15 Common Stock Purchase Warrant dated Filed herewith electronically
June 29, 2006 by the Company in favor
of Laurus Master Fund, Ltd.
10.16 Registration Rights Agreement dated Filed herewith electronically
June 28, 2006 by and between the
Company and Laurus Master Fund, Ltd.,
10.17 Stock Pledge Agreement dated June 28, Filed herewith electronically
2006 by and among the Company, AMS
Manufacturing, Inc. and Laurus Master
Fund, Ltd.
10.18 Master Security Agreement dated June Filed herewith electronically
28, 2006 by and among the Company, AMS
Manufacturing, Inc. and Laurus Master
Fund, Ltd.
10.19 Mortgage dated June 28, 2006 by and Filed herewith electronically
between the Company and Laurus Master
Fund, Ltd.
10.20 Grant of Security Interest in Patents Filed herewith electronically
and Trademarks dated June 28, 2006 by
and between the Company and Laurus
Master Fund, Ltd.
10.21 Common Stock Purchase Warrant dated Filed herewith electronically
June 28, 2006 by the Company in favor
of Ascendiant Securities, LLC.
10.22 Engagement Letter between the Company Filed herewith electronically
and Ascendiant Securities, LLC.
15 Letter of independent accountants as Filed herewith electronically
to unaudited interim financial
information.
31.1 Chief Executive Officer Certification. Filed herewith electronically
31.2 Chief Financial Officer Certification. Filed herewith electronically
32.1 Section 1350 Certification of our Filed herewith electronically
Chief Executive Officer.
32.2 Section 1350 Certification of our Filed herewith electronically
Chief Financial Officer.