UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
[x] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
Commission File Number: 0-25064
HEALTH FITNESS CORPORATION
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(Exact name of registrant as specified in its charter)
MINNESOTA 41-1580506
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
3600 AMERICAN BLVD W., SUITE 560, BLOOMINGTON, MINNESOTA, 55431
(Address of principal executive offices) (Zip Code)
Registrant's telephone number: (952) 831-6830
Securities registered under Section 12(b) of the Act:
NONE
Securities registered under Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [X]
As of June 30, 2003, the aggregate market value of the voting stock
held by non-affiliates of the registrant, computed by reference to the last
quoted price at which such stock was sold on such date as reported by the OTC
Bulletin Board, was approximately $5,070,000.
As of March 26, 2004, 12,438,245 shares of the registrant's common
stock, $.01 par value, were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
PORTIONS OF THE PROXY STATEMENT FOR THE ANNUAL MEETING OF SHAREHOLDERS TO BE
HELD MAY 19, 2004 ARE INCORPORATED BY REFERENCE INTO PART III OF THIS REPORT.
ITEM 1. BUSINESS
OVERVIEW
Health Fitness Corporation, and its wholly-owned subsidiaries (collectively, the
"Company"), provides fitness and wellness management services and programs to
corporations, hospitals, communities and universities located in the United
States and Canada. Additionally, the Company provides injury prevention programs
and on-site physical therapy services. The Company's executive offices are
located at 3600 American Blvd W., Suite 560, Bloomington, Minnesota 55431, and
its telephone number is (952) 831-6830. The Company maintains an internet
website at www.hfit.com. On its website, the Company makes available free of
charge its annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and all amendments to those reports.
On December 8, 2003, the Company completed its purchase of the business assets
of the Health & Fitness Services Division of Johnson & Johnson Health Care
Systems Inc. for approximately $4,800,000 pursuant to an Asset Purchase
Agreement dated August 25, 2003. The Company financed the acquisition primarily
with private equity financing from Bayview Capital Partners LP, supplemented by
a bank term loan from Wells Fargo Bank, N.A. The purchase price is subject to
certain post-closing adjustments.
The assets acquired by the Company consist primarily of client contracts,
proprietary wellness, lifestyle and health promotion programs and other health
and wellness services. As part of the transaction, the Company entered into a
multi-year management contract with another subsidiary of Johnson & Johnson to
manage more than 50 Johnson & Johnson affiliate sites, making the Johnson &
Johnson family of companies the Company's largest client.
The Health & Fitness Services Division of Johnson & Johnson Health Care Systems
Inc. has been serving clients since 1986, providing corporate fitness and
wellness services and programs to companies across the United States and Canada.
Services include: health and fitness center management, consulting, occupational
health services, health risk assessment programs, wellness, fitness, injury
prevention and treatment programs and data analysis services. The Company
intends to continue the same services and programs.
Effective January 1, 2001, the Company sold its International Fitness Club
Network (IFCN) line of business, which organized and maintained a network of
commercial fitness and health clubs and marketed memberships in such clubs to
employees and insurance companies.
FITNESS AND WELLNESS CENTER MANAGEMENT SERVICES
Since the Company's inception in 1975, the Company has established itself as the
leading provider of results-oriented fitness and wellness center management and
consulting services. The Company currently has contracts to manage a total of
393 sites across the United States and Canada, including 223 corporate fitness
centers, 47 corporate wellness programs, 12 corporate occupational health
programs, 15 hospital, commercial and university based fitness centers and
wellness programs, and 96 corporate sites that do not have full-time staff.
Major corporations, hospitals and universities invest in fitness centers and
wellness programs for several reasons. First, there is a body of research that
indicates that healthier employees are more productive, experience reduced
levels of stress and are absent from work less often due to illness.
Additionally, wellness benefits, and fitness benefits in particular, are
considered high priorities as potential employees evaluate job opportunities
with a given employer. Hospitals invest in fitness centers to create a new
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revenue source that is not subject to insurance or government reimbursements and
to address community health initiatives. The Company's sales staff markets to
corporations, hospitals, communities and universities through telemarketing,
direct sales and direct mail initiatives.
CONSULTING SERVICES
The Company provides a full range of analytic, development, management and
marketing consulting services. These services include the following:
- STRATEGIC ASSESSMENT. Provides companies with a comprehensive analysis
of the effectiveness of current employee health, wellness, fitness,
injury prevention and treatment programs, with recommendations for
areas of improvement that can translate into an improved return on
investment. This service also creates a road map for companies that
are considering investing in an employee health and wellness
initiative.
- BUSINESS ANALYSIS. Organizations that are considering the development
of a new health and fitness center, or are concerned with the
performance of existing facilities, employ the Company to perform a
comprehensive analysis of market potential for their program. Services
can include demographic analysis, market analysis, and multiple-year
financial business plan development.
- FACILITIES PLANNING. Organizations that are planning new fitness
centers employ the Company to help develop plans for these facilities.
Such plans may include space planning, interior design, floor plan
design, selection and sourcing of fitness equipment and fitness
program design.
- EMPLOYEE PRODUCTIVITY SERVICES. The Company provides a full range of
occupational health consulting services, including injury prevention
program design and development, work screening services, work
hardening programs, injury treatment programs and return to work
programs.
PROGRAM SERVICES
The Company has invested considerable time and resources developing a full menu
of fee-for-service programs and services to better meet the fitness, wellness
and health needs of its customers and individual employees. These programs and
services, which are generally delivered through the Company's managed sites,
include the following:
HFC ASSESSMENT SERVICES. A full range of tools to assess the health and
well-being of selected individuals, including health risk assessments,
screenings, data management and education. General wellness or specific
assessments provide measurable results and a pathway for effective
intervention.
HFC WELLNESS PROGRAMS. A comprehensive menu of lifestyle programs
addressing the specific issues facing a company's workforce, including
nutrition, weight loss, smoking cessation, stress management, back care,
massage therapy and educational seminars.
HFC FITNESS PROGRAMS. Customized exercise-based programs to meet
individual, group and company needs, including personal training, back care
and specialty group exercise classes.
HFC TREATMENT SERVICES. On-site services designed to provide an effective
model to prevent, manage and treat musculo-skeletal disorders in the work
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environment. Services include needs analysis and regulatory compliance
consulting, ergonomic injury prevention and discomfort management.
INTEGRATED HEALTH MANAGEMENT SERVICES
The high cost of employee health care has become a key concern for U.S.
corporations. It is expected that annual health care costs will continue to
increase at double digit rates for the next several years. This trend is being
fueled by a number of factors, including an aging workforce, unhealthy
populations entering the workforce and obesity-related medical conditions due to
poor nutrition and inactivity.
Companies that understand and address the health needs of employees, their
dependents and retirees are better able to proactively manage and control the
rate of increase in health care costs. The implementation of specific strategies
to help "at-risk" individuals is now considered a top priority by companies
looking to reduce health care costs.
The Company, through its network of fitness and wellness centers, and its health
assessment, fitness, wellness, and injury prevention and treatment programs, is
well-positioned to provide an integrated health management solution that will
address the health and wellness needs of a company's entire workforce, from low
risk individuals to employees managing a chronic disease.
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COMPETITION
Within the business-to-business fitness center management industry, there are
relatively few national competitors. However, virtually all markets are home to
regional providers that manage anywhere from one or two sites to several sites
across state lines. With its national presence and almost 30 years of history,
management believes that the Company is recognized as the leader in providing
fitness management services and is well positioned to compete in this industry.
PROPRIETARY RIGHTS
The Company does not believe it has any significant proprietary rights.
GOVERNMENT REGULATION
Management believes that there currently is no significant government regulation
which materially limits the Company's ability to provide fitness management and
consulting services to its corporate, hospital, community and university-based
clients.
EMPLOYEES
At December 31, 2003, the Company had 740 full-time and 2,225 part-time
employees. The Company's employees are primarily engaged in the staffing of
fitness, wellness and occupational health centers and programs. The Company
currently does not have a collective bargaining relationship. However, employees
working at certain of the Company's automotive sites have voted to accept
unionization. At this time, the company has not begun the process to establish a
collective bargaining relationship. Management believes its relationship with
employees is good.
INDEMNIFICATION OBLIGATIONS
A majority of the Company's management contracts with its customers include a
provision that obligates the Company to indemnify and hold harmless the customer
and their employees, officers and directors from any and all claims, actions
and/or suits (including attorneys' fees) arising directly or indirectly from any
act or omission of the Company or its employees, officers or directors in
connection with the operation of the Company's business. A majority of these
management contracts also include a provision that obligates the customer to
indemnify and hold the Company harmless against all liabilities arising out of
the acts or omissions of the customer, their employees and agents. The Company
can make no assurance that claims by its customers, or their employees, officers
or directors, will not be made in the course of operating the Company's
business.
INSURANCE
The Company maintains general premises liability insurance of $10,000,000 per
occurrence and $10,000,000 in the aggregate per location for each of its fitness
centers and its executive office. While the Company believes its insurance
policies to be sufficient in amount and coverage for its current operations,
there can be no assurance that coverage will continue to be available in
adequate amounts or at a reasonable cost, and there can be no assurance that the
insurance proceeds, if any, will cover the full extent of loss resulting from
any claims. The Company does not expect to incur any material rate increases
relative to the renewal of its liability insurance policies.
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ITEM 2. PROPERTIES
The Company leases approximately 8,000 square feet of commercial office space in
Bloomington, Minnesota, under a lease that expires in October 2007. The
Company's monthly base rent for this office space is approximately $8,500, plus
taxes, insurance and other related operating costs.
ITEM 3. LEGAL PROCEEDINGS
In April 2000, HealthSouth Corporation ("HealthSouth") filed a lawsuit against
the Company and two former employees in U.S. District Court in Minnesota arising
out of HealthSouth's purchase of several rehabilitation and physical therapy
clinics from the Company in May 1999. HealthSouth claimed that the two former
employees improperly diverted business away from the purchased clinics.
HealthSouth claimed damages in excess of $3,000,000, alleging misrepresentations
and breaches of warranties in the purchase agreement.
In February 2002, the U.S District Court in Minneapolis dismissed all of
HealthSouth's claims in connection with a summary judgment motion filed by the
Company, and issued an order awarding the Company a judgment of $43,156 for its
counter claim relating to certain accounts receivable. The final outcome of this
matter is pending on the outcome of an appeal made by HealthSouth.
In June 2003, while awaiting the final outcome of an appeal made by HealthSouth,
the Company paid HealthSouth approximately $25,000 in settlement of all of
HealthSouth's remaining claims.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company did not submit any matters to a vote of security holders during the
quarter ended December 31, 2003.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Trading of the Company's common stock is conducted in the over-the-counter
markets (often referred to as "pink sheets") or on the OTC Bulletin Board.
The following table sets forth, for the periods indicated, the range of low and
high sale prices for the Company's common stock.
Fiscal Year 2003: Low High
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Fourth quarter $1.01 $1.33
Third quarter 0.51 1.01
Second quarter 0.39 0.55
First quarter 0.38 0.50
Fiscal Year 2002: Low High
--- ----
Fourth quarter $0.35 $0.59
Third quarter 0.34 0.60
Second quarter 0.45 0.76
First quarter 0.31 0.51
At March 24, 2004, the published high and low sale prices for the Company's
common stock were $1.89 and $1.70 per share respectively. On March 24, 2004,
there were issued and outstanding 12,438,245 shares of common stock of the
Company held by 378 registered shareholders of record. Record ownership includes
ownership by nominees who may hold for multiple owners.
The Company has never declared or paid any cash dividends on its common stock
and does not intend to pay cash dividends on its common stock in the foreseeable
future. The Company presently expects to retain any earnings to finance the
development and expansion of its business. The payment of dividends, if any, is
subject to the discretion of the Board of Directors, and will depend on the
Company's earnings, financial condition, capital requirements and other relevant
factors.
In 2002 and 2003, 32,411 and 53,423 common shares respectively, were issued to
Company employees in connection with their purchase of stock through the
Company's Employee Stock Purchase Plan. The Company did not issue shares under
the plan during 2001.
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ITEM 6. SELECTED FINANCIAL DATA
The data given below as of and for each of the five years in the period ended
December 31, 2003, has been derived from the Company's Audited Consolidated
Financial Statements. Such data should be read in conjunction with the Company's
Consolidated Financial Statements and Notes thereto included elsewhere herein
and in conjunction with Managements Discussion and Analysis of Financial
Condition and Results of Operation.
Years Ended December 31,
2003 2002 2001 2000 1999
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STATEMENT OF OPERATIONS DATA:
REVENUE 31,479,000 $27,865,000 $25,910,000 $26,191,000 $26,195,000
INCOME (LOSS) FROM CONTINUING OPERATIONS (27,000) 3,001,000 1,806,000 930,000 (1,402,000)
INCOME (LOSS) PER SHARE FROM CONTINUING
OPERATIONS:
Basic 0.00 0.24 0.15 0.08 (0.12)
Diluted 0.00 0.24 0.15 0.07 (0.12)
BALANCE SHEET DATA (AT DECEMBER 31):
TOTAL ASSETS 19,808,000 12,956,000 10,199,000 10,399,000 11,324,000
LONG-TERM DEBT 4,350,000 -- -- 25,000 424,000
SHAREHOLDERS' EQUITY 9,732,000 9,079,000 6,063,000 4,195,000 3,198,000
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
BUSINESS DESCRIPTION
Health Fitness Corporation provides fitness and wellness management services and
programs to corporations, hospitals, communities and universities located in the
United States and Canada. Fitness center based services include the development,
marketing, and management of corporate, hospital, and community-based fitness
centers, health related programming, and on-site physical therapy and
occupational health services. While consumers of these services are typically
corporate employees and individuals interested in a healthy lifestyle, revenues
are generated almost exclusively through business to business, contractual
relationships.
CRITICAL ACCOUNTING POLICIES
The following discussion and analysis of the Company's financial condition and
results of operations is based upon their consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States. Preparation of the consolidated financial
statements requires management to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues, expenses and related
disclosures. On an on-going basis, management evaluates its estimates and
judgments, including those related to revenue recognition, trade and other
accounts receivable, goodwill, and stock-based compensation. By their nature,
these estimates and judgments are subject to an inherent degree of uncertainty.
Management bases its estimates and judgments on historical experience,
observation of trends in the industry, information provided by customers and
other outside sources and on various other factors that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying value of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
8
Management believes the following critical accounting policies, among others,
affect its more significant judgments and estimates used in the preparation of
their consolidated financial statements.
Revenue Recognition - Revenue is recognized at the time the service is provided
to the customer. For annual contracts, monthly amounts are recognized ratably
over the term of the contract. Certain services provided to the customer may
vary on a periodic basis. The revenues relating to theses services are estimated
in the month that the service is performed. Amounts received from customers in
advance of providing services are treated as deferred revenue and recognized
when the services are provided. The Company has contracts with third-parties to
provide ancillary services in connection with their fitness and wellness
management services and programs. Under such arrangements, the third-parties
invoice and receive payments from the Company based on transactions with the
ultimate customer. The Company does not recognize revenues related to such
transactions as the ultimate customer assumes the risk and rewards of the
contract and the amounts billed to the customer are either at cost or with a
fixed markup.
Trade and Other Accounts Receivable - Trade and other accounts receivable
represent amounts due from companies and individuals for services and products.
The Company grants credit to customers in the ordinary course of business, but
generally does not require collateral or any other security to support amounts
due. Management performs ongoing credit evaluations of customers. The Company
maintains allowances for potential credit losses which, when realized, have been
within management's expectations. Concentrations of credit risk with respect to
trade receivables are limited due to the large number of customers and their
geographic dispersion.
Goodwill - Goodwill represents the excess of the purchase price and related
costs over the fair value of net assets of businesses acquired. Prior to January
1, 2002 goodwill was amortized on a straight-line basis over 15 to 20 years. On
January 1, 2002, the Company adopted SFAS 142 "Goodwill and Intangible Assets",
and discontinued the amortization of goodwill. The carrying value of goodwill
and other intangible assets is tested for impairment on an annual basis or when
factors indicating impairment are present. Projected discounted cash flows are
used in assessing these assets.
Stock-Based Compensation - The Company utilizes the intrinsic value method of
accounting for its stock based employee compensation plans. All options granted
had an exercise price equal to the market value of the underlying common stock
on the date of grant and accordingly, no compensation cost is reflected in net
earnings for the years ended December 31, 2003, 2002, and 2001.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2003 AND 2002
REVENUE. Revenue increased $3,614,000 or 13.0% to $31,479,000 for 2003, from
$27,865,000 for 2002. Of this increase, $1,220,000 is attributed to the
acquisition of the Health & Fitness Services Division of Johnson & Johnson
Health Care Systems Inc. The remaining increase of $2,394,000 is attributed to
the addition of new contracts in our current lines of business and the expansion
of services under existing contracts.
GROSS PROFIT. Gross profit increased $608,000 or 10.3% to $6,535,000 for 2003,
from $5,927,000 for 2002. Of this increase, $379,000 is attributed to the
acquisition of the Health & Fitness Services Division of Johnson & Johnson
Health Care Systems Inc. The remaining increase of $229,000 is attributed to the
addition of new contracts in our current lines of business and the expansion of
services under existing contracts. As a percent of revenue, gross profit
decreased to 20.8% for 2003 from 21.3% for 2002. This decrease is primarily due
to start-up expenses for two corporate fitness centers the Company began
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managing during 2003 on an at-risk basis. The Company believes that gross
margins at these centers will improve over time as new memberships are sold.
OPERATING EXPENSES AND OPERATING INCOME. Operating expenses increased $550,000
or 11.9% to $5,167,000 for 2003, from $4,617,000 for 2002. This increase is due
to a $379,000 increase in salary expense, which is primarily attributed to
additional staff related to the Company's acquisition of the Health & Fitness
Services Division of Johnson & Johnson Health Care Systems Inc., and higher
employee benefits costs. The $171,000 increase in selling, general, and
administrative expenses is primarily due to the Company's acquisition, including
approximately $74,000 of acquisition-related depreciation and amortization and
$60,000 of professional fees that could not be capitalized.
As a result of the previously discussed changes in gross profit and operating
expenses, operating income increased $59,000 or 4.5%, to $1,368,000 for 2003,
from $1,309,000 for 2002.
OTHER INCOME AND EXPENSE. Interest expense decreased $317,000 to $204,000 for
2003, from $521,000 for 2002. This decrease is primarily due to lower debt
levels and interest rates during 2003 compared to 2002.
INCOME TAXES. Current income tax expense increased $82,000 to an expense of
$79,000 for 2003, from a benefit of $3,000 for 2002. This increase is due to the
utilization of net operating losses for various states in 2002, which were not
available to the Company in 2003.
The Company's deferred income tax expense increased $2,659,000 to $450,000 for
2003, from a benefit of $2,209,000 for 2002. This increase is attributable to
the Company recognizing its remaining deferred tax asset valuation allowance by
December 31, 2002.
The changes in income tax expense between 2003 and 2002 had no effect on the
Company's cash position for 2003.
NET EARNINGS. As a result of the above, net earnings for 2003 decreased
$2,368,000 to $633,000, compared to net earnings of $3,001,000 for 2002.
DIVIDENDS TO PREFERRED SHAREHOLDERS. To finance the Company's acquisition of the
Health & Fitness Services Division of Johnson & Johnson Health Care Systems
Inc., the Company sold $1,000,000 in Series A Convertible Preferred Stock (the
"Preferred Stock") to Bayview Capital Partners LP ("Bayview"). The Preferred
Stock was issued to Bayview at a price of $1.00 per share, resulting in the
issuance of 1,000,000 shares. The Preferred Stock has a stated dividend rate of
6% per year, computed on a simple interest basis, paid in kind in the form of
additional shares of Preferred Stock using a price of $1.00 per share ("PIK
Dividends"). As of December 31, 2003, the Company accrued dividends of $3,834.
At the option of the holder, the Preferred Stock, including any PIK Dividends,
may be converted, at any time and from time to time, into common stock of the
Company at a price of $0.50 per share. When Bayview made its commitment to
invest in the Company on August 25, 2003, the fair value of the Company's common
stock to be received upon conversion of the Preferred Stock was greater than the
conversion price of the preferred stock, which resulted in a beneficial
conversion feature. Accordingly, the Company calculated a $656,096 beneficial
conversion feature which has been recorded as a deemed dividend in the
consolidated statement of operations for the year ended December 31, 2003.
YEARS ENDED DECEMBER 31, 2002 AND 2001
REVENUE. Revenue increased $1,955,000 or 7.5% to $27,865,000 for 2002, from
$25,910,000 for 2001. Management fees and consulting revenue increased
$1,761,000 or 7.1% while occupational health services revenue increased $194,000
or 23.1%. These increases are attributed to the addition of new contracts in our
current lines of business and the expansion of our services under existing
contracts.
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GROSS PROFIT. Gross profit increased $122,000 or 2.1% to $5,927,000 for 2002,
from $5,805,000 for 2001. This increase in gross profit is due to the increase
in revenue discussed previously. Gross profit as a percent of revenue decreased
to 21.3% for 2002 from 22.4% for 2001. This decrease as a percent of revenue is
primarily due to higher costs to manage certain contracts, including one
contract the Company obtained in early 2002 whereby the Company agreed to pay
for all operating costs of 24 corporate fitness centers.
OPERATING EXPENSES AND OPERATING INCOME. Operating expenses increased 174,000 or
3.9% to $4,617,000 for 2002, from $4,443,000 for 2001. This increase is due to a
$749,000 increase in salary expense, which was partially offset by a $575,000
decrease in selling, general and administrative expenses. The increase in
salaries expense is primarily attributed to an investment in additional sales
and marketing staff and increased employee benefits costs. The decrease in
selling, general, and administrative expenses is due to lower contract employee
and professional service expenses, as well as the adoption of SFAS 142, which
eliminated amortization expense of $401,000 associated with goodwill and
intangible assets with indefinite lives.
As a result of the previously discussed changes in gross profit and operating
expenses, operating income decreased $53,000 or 3.9% to $1,309,000 for 2002,
from $1,362,000 for 2001.
OTHER INCOME AND EXPENSE. Interest expense increased $57,000 to $521,000 for
2002, from $464,000 for 2001. This increase is primarily due to the write-off of
unamortized financing costs and loan termination charges incurred in connection
with the Company's termination of its credit agreement with Coast Business
Credit.
The gain on sale of subsidiary in 2001 of $229,000 represents the net proceeds
received upon the sale of the Company's IFCN subsidiary in January 2001.
INCOME TAXES. Current income tax expense decreased $74,000 to a benefit of
$3,000 for 2002, from an expense of $71,000 for 2001. This decrease is primarily
due to the $311,000 decrease in the Company's earnings before income taxes.
The Company's deferred income tax benefit increased $1,432,000 to a benefit of
$2,209,000 for 2002, from a benefit of $777,000 for 2001. This increase is
primarily due to the recognition of the Company's remaining deferred tax
valuation allowance. As of December 31, 2002, there is no deferred tax asset
valuation allowance.
NET EARNINGS. As a result of the above, net earnings for 2002 increased
$1,195,000 to $3,001,000, compared to net earnings of $1,806,000 for 2001.
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LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital increased $1,005,000 to $2,255,000 for 2003, from
$1,250,000 for 2002. This increase is largely due to the increase in accounts
receivable.
On August 22, 2003, the Company entered into a $7,500,000 Credit Agreement with
Wells Fargo Bank, N.A. ("Wells Fargo") to provide the Company with acquisition
financing and general working capital (the "Wells Loan"). The initial draw on
the Wells Loan was in the amount of $1,255,204, which was used to refinance the
revolving line of credit the Company previously maintained with Merrill Lynch
Business Financial Services, Inc. ("Merrill Lynch"). The Company repaid all
amounts owed, and canceled the line of credit with Merrill Lynch, which accrued
interest at the one-month LIBOR rate plus 2.35% (effective rate of 3.77% at
December 31, 2002). On August 25, 2003, the Company made a draw of $2,250,000 on
the Wells Loan, the proceeds of which the Company placed into escrow to fund a
portion of the acquisition of the Health & Fitness Services Division of Johnson
& Johnson Health Care Systems Inc.
Future working capital advances from the Wells Loan will be based upon a
percentage of the Company's eligible accounts receivable, less any amounts
previously drawn. At the option of the Company, the Wells Loan bears interest at
prime or the one-month LIBOR plus a margin of 2.25% to 2.75% based upon the
Company's Senior Leverage Ratio. The availability of the Wells Loan will
decrease $250,000 on the last day of each calendar quarter, beginning September
30, 2003, and will expire on June 30, 2007. Borrowings under the Wells Loan are
collateralized by substantially all of the Company's assets. The Company is
required to comply with certain monthly financial covenants, including a senior
cash flow leverage ratio, senior leverage ratio and current ratio. At December
31, 2003, the Company had $2,775,000 outstanding under the Wells Loan, and was
in compliance with all of its financial covenants.
On August 25, 2003, the Company entered into a $3,000,000 Securities Purchase
Agreement with Bayview Capital Partners LP ("Bayview") to provide the Company
with acquisition financing and general working capital (the "Bayview
Investment"). The Bayview Investment was initially structured as a bridge note
(the "Bridge Note"), the proceeds of which the Company placed into escrow to
fund a portion of the acquisition of the Health & Fitness Services Division of
Johnson & Johnson Health Care Systems Inc.
On December 8, 2003, (the "Acquisition Effective Date"), the $3,000,000 Bridge
Note issued to Bayview was converted into a $2,000,000 term note (the "Term
Note"), $1,000,000 in Series A Convertible Preferred Stock (the "Preferred
Stock") and a warrant to purchase common stock of the Company (the "Warrant")
per the terms set forth in the August 25, 2003 Securities Purchase Agreement.
The Term Note will bear interest at 12% per year, payable monthly, and will
mature on the fifth anniversary of the Acquisition Effective Date. The Term Note
may be prepaid, in whole or in part, at any time, provided that the prepayment
is accompanied by a premium ranging from 5% in year 1 to 1% in year 5. The
Bayview Investment is secured by a subordinated security interest in
substantially all of the Company's assets. The Company is required to comply
with certain monthly financial covenants, including a senior cash flow leverage
ratio, senior leverage ratio and current ratio. At December 31, 2003, the
Company was in compliance with all of its financial covenants.
The Preferred Stock was issued to Bayview at a price of $1.00 per share,
resulting in 1,000,000 shares issued on the Effective Date. The Preferred Stock
has a stated dividend rate of 6% per year, computed on a simple interest basis,
paid in kind in the form of additional shares of Preferred Stock using a price
of $1.00 per share ("PIK Dividends"). At the option of the holder, the Preferred
Stock, including any PIK Dividends, may be converted, at any time and from time
to time, into common stock of the Company at a price of $0.50 per share. In
addition, Bayview may require redemption of the Preferred Stock and PIK
Dividends upon a change of control or default (including default under the Term
Note).
12
The following table represents the Company's contractual obligations at December
31, 2003:
Payments Due By Period
-----------------------------
Less Than More Than
Total 1 Year 1 to 3 Years 3 to 5 Years 5 Years
---------- ---------- ------------ ------------ ----------
Long-term obligations $4,775,000 $ -- $ -- $4,775,000 $--
Operating leases 916,000 251,000 472,000 193,000 --
As of December 31, 2003, the Company has no off-balance sheet arrangements or
transactions with unconsolidated, limited purpose entities. Refer to the
footnotes to the Company's Consolidated Financial Statements contained herein
for disclosure related to the Company's "Commitments and Contingencies."
On a short and long-term basis, the Company believes that sources of capital to
meet its obligations will be provided by cash generated through operations and
the Company's Wells Loan. The Company does not believe that inflation has had a
significant impact on its results of its operations.
OUTLOOK AND TRENDS
The high cost of employee health care has become a key concern for U.S.
corporations. It is expected that annual health care costs will continue to
increase at double digit rates for the next several years. This trend is being
fueled by a number of factors, including an aging workforce, unhealthy
populations entering the workforce and obesity-related medical conditions due to
poor nutrition and inactivity.
Companies that understand and address the health needs of employees, their
dependents and retirees are better able to proactively manage and control the
rate of increase in health care costs. The implementation of specific strategies
to help "at-risk" individuals is now considered a top priority by companies
looking to reduce health care costs.
The U.S. economy has been experiencing recessionary pressures, which has
negatively affected the corporate landscape. This economic downturn has resulted
in a more competitive environment with respect to the prices the Company charges
for its services. Although the Company believes that price competition will not
materially affect results of operations, the Company believes that price
competition will continue for the foreseeable future.
An emerging trend within corporate fitness center management relates to
companies asking service providers to operate their fitness center on a
cost-neutral or for-profit basis. These cost-conscious companies desire to
minimize or eliminate the subsidization of fitness center operating costs by
keeping costs within the revenues being realized from employee memberships and
13
other sources of revenue. In connection with this form of business model, the
Company would derive its management fee revenue not from its corporate client,
but from the profits of the fitness center. The application of this business
model may require the Company to fund operating losses until enough memberships
are sold to realize profitability. The Company believes it may have to fund
operating losses for such centers up to twenty-four months before profitability
is reached. However, the Company believes this model will enable the Company to
leverage its experience managing for-profit fitness centers, and may result in
higher gross margins and profitability. Currently, existing contracts
representing this business model do not represent a material contribution to
the Company's results of operation. There can be no assurance that the Company
will be able to manage such centers profitably or to fund losses for these
centers until profitability is achieved.
Lastly, the Company intends to continue expanding its revenue opportunities by
offering additional wellness services and programs to its existing client base,
including health assessment and screening services, wellness programs and
educational seminars, personal fitness programming and workplace injury
assessment, prevention and treatment services. There can be no assurance that
the Company will be successful introducing these additional programs and
services to its existing customers.
PRIVATE SECURITIES LITIGATION REFORM ACT
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward-looking statements. Such "forward-looking" information is included
in this Form 10-K, including the MD&A section, as well as in the Company's
Annual Report to be filed with the Securities and Exchange Commission, and in
other materials filed or to be filed by the Company with the Securities and
Exchange Commission (as well as information included in oral statements or other
written statements made or to be made by the Company).
Forward-looking statements include all statements based on future expectations
and specifically include statements relating to improving margins, growth of the
market for corporate, hospital, community and university-based fitness centers,
the development of new business models and the intention to expand the Company's
programs and services. Such forward-looking information involves important risks
and uncertainties that could significantly affect anticipated results in the
future and, accordingly, such results may differ from those expressed in any
forward-looking statements made by or on behalf of the Company. These risks and
uncertainties include, but are not limited to, leverage and debt service
(including sensitivity to fluctuations in interest rates) continued expansion of
corporate, hospital, community and university-based fitness center
opportunities, and availability of sufficient working capital.
The following risks and uncertainties also should be noted:
POTENTIAL DEPRESSIVE EFFECT ON PRICE OF COMMON STOCK ARISING FROM EXERCISE AND
SALE OF EXISTING CONVERTIBLE SECURITIES:
At December 31, 2003, the Company had outstanding stock options and stock
purchase warrants to purchase an aggregate of 3,171,220 shares of common stock.
The exercise of such outstanding stock options and stock purchase warrants and
sale of stock acquired thereby may have a material adverse effect on the price
of the Company's common stock. In addition, the exercise of such outstanding
stock options and stock purchase warrants and sale of such shares of the
Company's common stock could occur at a time when the Company would otherwise be
able to obtain additional equity capital on terms and conditions more favorable
to the Company.
MANAGEMENT OF COST-NEUTRAL OR FOR-PROFIT CENTERS:
The Company has, on a limited basis, implemented its model of managing corporate
fitness centers on a cost-neutral or for-profit basis without receiving a
management fee from the corporate owner of such centers. Corporate owned centers
are resistant to significant membership fees and fee increases, and the
14
Company may not be successful in sufficiently managing costs and/or in raising
service levels and associated revenues, as required to achieve profit
objectives.
RECENTLY PASSED LEGISLATION
SARBANES-OXLEY. On July 30, 2002, President Bush signed into law the
Sarbanes-Oxley Act of 2002 (the "Act"), which immediately impacts Securities and
Exchange Commission registrants, public accounting firms, lawyers and securities
analysts. This legislation is the most comprehensive securities legislation
since the passage of the Securities Acts of 1933 and 1934. It has far reaching
effects on the standards of integrity for corporate management, board of
directors, and executive management. Additional disclosures, certifications and
procedures will be required of the Company. We do not expect any material
adverse effect on the Company as a result of the passage of this legislation.
Refer to management's certifications contained elsewhere in this report
regarding the Company's compliance with Sections 302 and 906 of the
Sarbanes-Oxley Act of 2002.
HIPPA. The Administrative Simplification provisions of the Health Insurance
Portability and Accountability Act of 1996 ("HIPAA") require group health plans
and health care providers who conduct certain administrative and financial
transactions electronically ("Standard Transactions") to (a) comply with a
certain data format and coding standards when conducting electronic
transactions; (b) use appropriate technologies to protect the security and
integrity of individually identifiable health information transmitted or
maintained in an electronic format; and (c) protect the privacy of patient
health information. The Company's occupational health, health risk assessment
and health coaching services, in addition to the group health plan the Company
sponsors for its employees, are subject to HIPAA's requirements. The Company
expects to be in compliance with HIPPA requirements within the timeline
specified for the Company's affected business areas. The Company's corporate,
hospital, community and university-based fitness center management lines of
business are not subject to the requirements of HIPAA.
RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board (FASB) issued
Financial Interpretations No. 46 (FIN 46), "Consolidation of Variable Interest
Entities." FIN 46 is an interpretation of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," and addresses consolidation by business
enterprises of variable interest entities. FIN 46 applies immediately to
variable interest entities created or obtained after January 31, 2003 and
applies in the first fiscal year or interim period beginning after June 15,
2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. This interpretation is not
anticipated to have an impact on the Company's consolidated financial position
or results of operations.
In April 2003, the FASB issued Statement 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. Statement 149 clarifies
implementation issues and amends Statement 133, to include the conclusions
reached by the FASB on certain FASB Staff Implementation Issues that, while
inconsistent with Statement 133's conclusions, were considered by the Board to
be preferable, amends discussion of financial guarantee contracts and the
application of the shortcut method to an interest-rate swap agreement that
includes an embedded option, and amends other pronouncements. Statement 149 is
effective to contracts entered into or modified, and hedging arrangements
designated after June 30, 2003, with various exceptions as outlined in the
statement. Adoption of Statement 149 is not anticipated to have an impact on the
Company's consolidated financial position or results of operations.
In May 2003, the FASB issued Statement 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. Statement 150
15
changes the classification in the statement of financial position of certain
common financial instruments from either equity or mezzanine presentation to
liabilities and requires an issuer of those financial statements to recognize
changes in fair value or redemption amount, as applicable, in earnings. SFAS
150 is effective for financial instruments entered into or modified after May
31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. Adoption of Statement 150 is not
anticipated to have an impact on the Company's financial position or results
of operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has no history of, and does not anticipate in the future, investing
in derivative financial instruments, derivative commodity instruments or other
such financial instruments. Transactions with international customers are
entered into in U.S. dollars, precluding the need for foreign currency hedges.
As a result, the exposure to market risk is not material.
16
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Balance Sheets of the Company as of December 31, 2003 and
2002, and the related Consolidated Statements of Operations, Stockholders'
Equity, and Cash Flows for each of the three years in the period ended December
31, 2003, and the notes thereto have been audited by Grant Thornton LLP,
independent certified public accountants.
CONTENTS
Page
----
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS..................... 18
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS......................................... 19
CONSOLIDATED STATEMENTS OF OPERATIONS............................... 20
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY..................... 21
CONSOLIDATED STATEMENTS OF CASH FLOWS............................... 22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.......................... 23
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS..................... 37
17
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors
Health Fitness Corporation
Minneapolis, Minnesota
We have audited the accompanying consolidated balance sheets of Health Fitness
Corporation and subsidiaries as of December 31, 2003 and 2002 and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 2003. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Health Fitness
Corporation and subsidiaries as of December 31, 2003 and 2002 and the
consolidated results of their operations and their consolidated cash flows for
each of the three years in the period ended December 31, 2003, in conformity
with accounting principles generally accepted in the United States of America.
As discussed in Note 8 to the consolidated financial statements, the Company
adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" on January 1, 2002.
We have also audited Schedule II of Health Fitness Corporation and subsidiaries
for each of the three years in the period ended December 31, 2003. In our
opinion, this schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the
information therein.
/s/Grant Thornton LLP
Minneapolis, Minnesota
February 25, 2004
18
HEALTH FITNESS CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2003 AND 2002
2003 2002
----------- -----------
ASSETS
CURRENT ASSETS
Cash $ 281,294 $ 91,658
Trade and other accounts receivable, less allowances of $131,000
and $88,900 at December 31, 2003 and 2002 5,218,224 4,036,888
Prepaid expenses and other 187,347 266,734
Deferred tax assets 850,300 731,500
----------- -----------
Total current assets 6,537,165 5,126,780
PROPERTY AND EQUIPMENT, net 177,217 176,206
OTHER ASSETS
Goodwill 8,725,574 5,308,761
Customer contracts, less accumulated amortization of $67,400 at
December 31, 2003 1,662,639 -
Trademark, less accumulated amortization of $5,800 at December 31, 2003 344,166 -
Other intangible assets, less accumulated amortization of $4,200
and $1,300 at December 31, 2003 and 2002 138,582 6,380
Cash held in escrow 471,999 -
Deferred tax assets 1,686,301 2,254,876
Other 64,458 82,808
----------- -----------
$19,808,101 $12,955,811
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Note payable $ - $ 304,589
Trade accounts payable 569,730 409,150
Accrued salaries, wages, and payroll taxes 1,607,157 1,072,982
Other accrued liabilities 450,255 415,856
Accrued self funded insurance 228,084 267,042
Deferred revenue 1,427,057 1,407,437
----------- -----------
Total current liabilities 4,282,283 3,877,056
LONG-TERM OBLIGATIONS 4,350,012 -
COMMITMENTS AND CONTINGENCIES - -
PREFERRED STOCK, $0.01 par value; 5,000,000 shares authorized,
1,003,833 issued and outstanding 1,443,833 -
STOCKHOLDERS' EQUITY
Common stock, $0.01 par value; 25,000,000 shares authorized;
12,357,334 and 12,297,661 shares issued and outstanding at 123,573 122,977
December 31, 2003 and 2002
Additional paid-in capital 17,671,536 16,997,367
Accumulated comprehensive income from foreign currency translation 5,707 -
Accumulated deficit (8,068,843) (8,041,589)
----------- -----------
9,731,973 9,078,755
----------- -----------
$19,808,101 $12,955,811
=========== ===========
See notes to consolidated financial statements.
19
HEALTH FITNESS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
2003 2002 2001
------------ ------------ ------------
REVENUE $ 31,478,822 $ 27,864,997 $ 25,909,978
COSTS OF REVENUE 24,943,625 21,938,385 20,105,139
------------ ------------ ------------
GROSS PROFIT 6,535,197 5,926,612 5,804,839
OPERATING EXPENSES
Salaries 3,244,639 2,866,200 2,117,407
Selling, general, and administrative 1,922,511 1,751,228 2,325,583
------------ ------------ ------------
Total operating expenses 5,167,150 4,617,428 4,442,990
------------ ------------ ------------
OPERATING INCOME 1,368,047 1,309,184 1,361,849
OTHER INCOME (EXPENSE)
Interest expense (204,430) (521,106) (464,039)
Gain on sale of subsidiary - - 228,613
Other, net (2,405) 950 (26,707)
------------ ------------ ------------
EARNINGS BEFORE INCOME TAXES 1,161,212 789,028 1,099,716
INCOME TAX EXPENSE (BENEFIT) 528,536 (2,211,643) (706,285)
------------ ------------ ------------
NET EARNINGS 632,676 3,000,671 1,806,001
Deemed dividend to preferred shareholders 656,096 - -
Dividend to preferred shareholders 3,834 - -
------------ ------------ ------------
NET EARNINGS (LOSS) APPLICABLE TO COMMON SHAREHOLDERS $ (27,254) $ 3,000,671 $ 1,806,001
============ ============ ============
NET EARNINGS PER COMMON SHARE:
Basic $ - $ 0.24 $ 0.15
Diluted - 0.24 0.15
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic 12,332,363 12,284,364 12,232,283
Diluted 12,332,363 12,428,440 12,433,715
See notes to consolidated financial statements.
20
HEALTH FITNESS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Common Stock Additional Accumulated Total
------------ Paid-in Comprehensive Accumulated Stockholders' Comprehensive
Shares Amount Capital Income Deficit Equity Income
------ ------ ------- ------ ------- ------ ------
BALANCE AT JANUARY 1, 2001 12,165,250 $121,653 $16,921,503 $ - $ (12,848,261) $4,194,895
Issuance of common stock for
board of directors compensation 100,000 1,000 54,000 - - 55,000
Repricing of warrants previously - - 3,234 - - 3,234
issued
Issuance of options in connection
with professional services - - 3,785 - - 3,785
rendered
Net earnings - - - - 1,806,001 1,806,001
---------- -------- ----------- ------ ------------- ----------
BALANCE AT DECEMBER 31, 2001 12,265,250 122,653 16,982,522 - (11,042,260) 6,062,915
Issuance of common stock through
stock purchase plan 32,411 324 14,845 - - 15,169
Net earnings - - - - 3,000,671 3,000,671
---------- -------- ----------- ------ ------------- ----------
BALANCE AT DECEMBER 31, 2002 12,297,661 122,977 16,997,367 - (8,041,589) 9,078,755
Issuance of common stock through
stock purchase plan 53,423 533 23,506 - - 24,039
Issuance of common stock for 6,250 63 2,375 - - 2,438
options
Issuance of warrants - - 648,288 - - 648,288
Deemed dividend to preferred
shareholders - - - - (656,096) (656,096)
Dividend to preferred shareholders - - - - (3,834) (3,834)
Net earnings - - - - 632,676 632,676 $632,676
Foreign currency transalation - - - 5,707 - 5,707 5,707
---------- -------- ----------- ------ ------------- ---------- --------
BALANCE AT DECEMBER 31, 2003 12,357,334 $123,573 $17,671,536 $5,707 $ (8,068,843) $9,731,973 $638,383
========== ======== =========== ====== ============= ========== ========
See notes to consolidated financial statements.
21
HEALTH FITNESS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
2003 2002 2001
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 632,676 $ 3,000,671 $ 1,806,001
Adjustment to reconcile net earnings
to net cash provided by operating activities:
Common stock, options, and warrants issued for professional - - 62,019
services and compensation
Depreciation and amortization 152,538 175,239 699,969
Amortization of financing costs 10,572 175,774 116,332
Amortization of discount on long-term obligation 7,203 - -
Interest on escrow account (7,388) - -
Deferred taxes 449,775 (2,209,076) (777,300)
(Gain) loss on disposal of assets 5,796 - (16,907)
Gain on sale of subsidiary - - (228,613)
Change in assets and liabilities, net of assets acquired:
Trade and other accounts receivable (1,181,336) (648,032) (55,802)
Prepaid expenses and other 119,387 (136,644) (84,401)
Other assets 18,350 (71,398) (7,962)
Trade accounts payable 203,897 267,414 (84,754)
Accrued liabilities and other 529,616 447,707 (422,285)
Deferred revenue 19,620 163,491 31,003
Discontinued operations - - (106,734)
------------ ------------ ------------
Net cash provided by operating activities 960,706 1,165,146 930,566
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (89,761) (114,293) (124,384)
Net proceeds from sale of subsidiary - - 392,198
Net cash payment made for acquisition (5,570,813) - -
Payment of non-compete agreement - - (30,000)
------------ ------------ ------------
Net cash provided by (used in) investing activities (5,660,574) (114,293) 237,814
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under note payable 5,178,174 24,663,045 26,568,592
Repayments of note payable (4,957,763) (25,800,760) (27,812,090)
Proceeds from issuance of bridge note financing 3,000,000 - -
Payment to cash escrow account (3,000,000) - -
Proceeds from cash escrow account 4,785,389 - -
Repayments of long term obligations - - (126,804)
Payment of financing costs (142,773) (57,657) (50,000)
Proceeds from the issuance of common stock 24,039 15,169 -
Proceeds from the exercise of stock options 2,438 - -
------------ ------------ ------------
Net cash provided by (used in) financing activities 4,889,504 (1,180,203) (1,420,302)
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH 189,636 (129,350) (251,922)
CASH AT BEGINNING OF YEAR 91,658 221,008 472,930
------------ ------------ ------------
CASH AT END OF YEAR $ 281,294 $ 91,658 $ 221,008
============ ============ ============
SUPPLEMENTAL CASH FLOW DISCLOSURES
Supplemental cash flow information:
Cash paid for interest $ 191,073 $ 362,100 $ 358,980
Cash paid for taxes 91,858 18,400 18,700
Noncash investing and financing activities affecting cash flows:
Proceeds from the Wells Loan placed in escrow 2,250,000 - -
Conversion of bridge note to term note, preferred stock and warrants (3,000,000) - -
Deemed dividend to preferred shareholders (656,096) - -
Dividend to preferred shareholders (3,834) - -
See notes to consolidated financial statements.
22
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business - Health Fitness Corporation and its wholly owned subsidiaries
(the Company) provide fitness and wellness management services and
programs to corporations, hospitals, communities and universities
located in the United States and Canada. Fitness and wellness
management services include the development, marketing and management
of corporate, hospital, community and university based fitness centers,
injury prevention and work-injury management consulting, and on-site
physical therapy. Programs include wellness and health programs for
individual customers, including health risk assessments, nutrition and
weight loss programs, smoking cessation, massage therapy, back care and
ergonomic injury prevention.
Consolidation - The consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries. All
intercompany balances and transactions have been eliminated in
consolidation.
Cash - The Company maintains cash balances at several financial
institutions, and at times, such balances exceed insured limits. The
Company has not experienced any losses in such accounts and believes it
is not exposed to any significant credit risk on cash.
Trade and Other Accounts Receivable - Trade and other accounts
receivable represent amounts due from companies and individuals for
services and products. The Company grants credit to customers in the
ordinary course of business, but generally does not require collateral
or any other security to support amounts due. Management performs
ongoing credit evaluations of customers. The Company determines its
allowance for discounts and doubtful accounts by considering a number
of factors, including the length of time trade accounts receivable are
past due, the Company's previous loss history, the customer's current
ability to pay its obligation to the Company, and the condition of the
general economy and the industry as a whole. The Company writes off
accounts receivable when they become uncollectible, and payments
subsequently received on such receivable are credited to the allowance.
Concentrations of credit risk with respect to trade receivables are
limited due to the large number of customers and their geographic
dispersion.
Property and Equipment - Property and equipment is stated at cost.
Depreciation and amortization are computed using both straight-line and
accelerated methods over the useful lives of the assets.
Goodwill - Goodwill represents the excess of the purchase price and
related costs over the fair value of net assets of businesses acquired.
Prior to January 1, 2002 goodwill was amortized on a straight-line
basis over 15 to 20 years. On January 1, 2002, the Company adopted
Statement of Financial Standards, ("SFAS") No. 142 "Goodwill and
Intangible Assets", and discontinued the amortization of goodwill (see
note 8).
The carrying value of goodwill is tested for impairment on an annual
basis or when factors indicating impairment are present. Projected
discounted cash flows are used in assessing these assets. Goodwill
totaling $74,000 was written off during 2001 relating to the sale of a
subsidiary (see note 2).
23
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Intangible Assets - The Company's intangible assets include customer
contracts, trademark, and deferred financing costs and are amortized on
a straight-line basis. Customer contracts represent the fair value
assigned to acquired management contracts and will be amortized over
the remaining life of the contracts, approximately 25-35 months.
Trademark represents the value assigned to an acquired trademark and is
amortized over a period of five years. Deferred financing costs are
amortized over the term of the related credit agreement. Amortization
expense for intangible assets totaled $83,800, $238,000, and $157,500
for the twelve months ended December 31, 2003, 2002, and 2001.
Expected future amortization of intangible assets is as follows:
Years ending December 31
------------------------
2004 $907,600
2005 850,000
2006 203,200
2007 98,300
2008 85,600
Cash Held In Escrow - Cash held in escrow represents the funds
remaining after payment of the purchase price for the Company's
acquisition. Such funds will remain in escrow until all parties subject
to the escrow agreement agree that all conditions related to the
acquisition have been satisfied. At that time, any funds remaining in
escrow will be used to pay down the Company's long-term obligations.
Revenue Recognition - Revenue is recognized at the time the service is
provided to the customer. For annual contracts, monthly amounts are
recognized ratably over the term of the contract. Certain services
provided to the customer may vary on a periodic basis and are invoiced
to the customer in arrears. The revenues relating to theses services
are estimated in the month that the service is performed. Accounts
receivable related to estimated revenues were $610,139 and $451,100 at
December 31, 2003 and 2002.
Amounts received from customers in advance of providing the services of
the contract are treated as deferred revenue and recognized when the
services are provided. Accounts receivable relating to deferred revenue
were $1,381,002 and $1,158,626 at December 31, 2003 and 2002.
The Company has contracts with third-parties to provide ancillary
services in connection with their fitness and wellness management
services and programs. Under such arrangements the third-parties
invoice and receive payments from the Company based on transactions
with the ultimate customer. The Company does not recognize revenues
related to such transactions as the ultimate customer assumes the risk
and rewards of the contract and the amounts billed to the customer are
either at cost or with a fixed markup.
Comprehensive Income - The Company follows the provisions of SFAS No.
130, "Reporting Comprehensive Income", which establishes standards for
reporting and display of comprehensive income and its components.
Comprehensive income is net earnings plus certain other items that are
recorded directly to stockholders' equity. For the Company,
comprehensive income represents net earnings adjusted for foreign
currency translation adjustments. Comprehensive income is disclosed in
the consolidated statement of stockholders' equity.
24
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Net Earnings Per Common Share - Basic net earnings per common share is
computed by dividing net earnings by the number of weighted average
common shares outstanding. Diluted net earnings per common share is
computed by dividing net earnings plus dividends to preferred
shareholders by the number of weighted average common shares
outstanding, and common share equivalents relating to stock options and
stock warrants, when dilutive.
Common stock options and warrants to purchase 491,000, 1,290,697 and
1,935,527 shares of common stock with weighted average exercise prices
of $1.92, $1.88 and $2.25 were excluded from the 2003, 2002 and 2001
diluted computation because they are anti-dilutive.
Stock-Based Compensation - The Company utilizes the intrinsic value
method of accounting for its stock based employee compensation plans.
All options granted had an exercise price equal to the market value of
the underlying common stock on the date of grant and accordingly, no
compensation cost is reflected in net earnings for the years ended
December 31, 2003, 2002, and 2001. The following table illustrates the
effect on net earnings and earnings per share if the Company had
applied the fair value recognition provisions of SFAS No. 123,
"Accounting for Stock-based Compensation", to its stock-based
compensation plans.
2003 2002 2001
----------- ----------- -----------
Net earnings (loss) applicable to common
shareholders, basic and diluted $ (27,254) $ 3,000,671 $ 1,806,001
Less: Compensation expense determined under the fair value
method, net of tax (76,040) (74,474) (89,928)
----------- ----------- -----------
Proforma net earnings, basic $ (103,294) $ 2,926,197 $ 1,716,073
=========== =========== ===========
Proforma net earnings, diluted $ (103,294) $ 2,926,197 $ 1,716,073
=========== =========== ===========
Earnings per Share:
Basic-as reported $ 0.00 $ 0.24 $ 0.15
=========== =========== ===========
Basic-proforma $ (0.01) $ 0.24 $ 0.14
=========== =========== ===========
Diluted-as reported $ 0.00 $ 0.24 $ 0.15
=========== =========== ===========
Diluted-proforma $ (0.01) $ 0.24 $ 0.14
=========== =========== ===========
The proforma information above should be read in conjunction with the
related historical information.
The fair value of each option grant is estimated on the grant date
using the Black-Scholes option-pricing model with the following
assumptions and results for the grants:
2003 2002 2001
------------ ------------ ------------
Dividend yield None None None
Expected volatility 88.4%-105.0% 105.0% 105.0%
Expected life of option 1 to 4 years 1 to 4 years 1 to 5 years
Risk-free interest rate 2.90%-3.27% 5.50% 5.50%
Weighted average fair value of options
on grant date $0.48 $0.33 $0.35
25
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Fair Values of Financial Instruments - Due to their short-term nature,
the carrying value of the Company's current financial assets and
liabilities approximates their fair values. The fair value of long-term
obligations, if recalculated based on current interest rates, would not
significantly differ from the recorded amounts.
Use of Estimates - Preparing consolidated financial statements in
conformity with accounting principles generally accepted in the United
States of America requires management to make certain estimates and
assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the
consolidated financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ
from those estimates.
Income Taxes - The Company records income taxes in accordance with the
liability method of accounting. Deferred income taxes are provided for
temporary differences between the financial reporting and tax basis of
assets and liabilities and federal operating loss carryforwards.
Deferred tax assets and liabilities are adjusted for the effects of
changes in tax laws and rates on the date of the enactment.
Reclassifications - Certain 2002 and 2001 amounts have been
reclassified to conform to the 2003 presentation. These
reclassifications had no effect on net earnings or stockholders' equity
as previously reported.
2. SALE OF ASSETS
On January 1, 2001, the Company sold the stock of a wholly owned
subsidiary, David W. Pickering, Inc., a fitness club network provider.
The Company received $425,000 and recorded a gain on sale of $228,613.
3. PURCHASE OF ASSETS
On December 8, 2003 (the "Effective Date"), the Company purchased the
business assets of the Health & Fitness Services Business of Johnson &
Johnson Health Care Systems Inc. (JJHCS) for $4,785,389. Assets
acquired by the Company consist primarily of client contracts,
proprietary wellness, lifestyle and health promotion programs,
software, and other health and wellness services. As part of the
transaction, the Company entered into a multi-year management contract
with another subsidiary of Johnson & Johnson whereby the Company will
manage more than 50 Johnson & Johnson affiliate fitness center sites.
The Company also entered into a one-year agreement to use 660 square
feet of office space of JJHCS for a fee of $1,500 per month.
The acquisition has been accounted for using the purchase method of
accounting. The fair market value of the assets acquired resulted in
the following purchase price allocation:
Cash price paid for assets $4,785,389
Acquisition costs incurred 785,424
----------
Total purchase price $5,570,813
==========
26
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Purchase Price Allocation
-------------------------
Inventory $ 40,000
Property and equipment
34,000
Customer contracts 1,730,000
Trademark 350,000
Excess of cost over assets acquired 3,416,813
----------
$5,570,813
==========
Up to $205,000 of additional purchase price may be paid to JJHCS as a
result of additional contract assignments.
4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31:
Useful Life 2003 2002
----------- ---------- ----------
Leasehold improvements Term of lease $ 4,127 $ 37,612
Office equipment 3-7 years 1,034,365 960,262
Software 3 years 159,772 156,581
Health care equipment 1-5 years 383,906 366,017
---------- ----------
1,582,170 1,520,472
Less accumulated depreciation and amortization 1,404,953 1,344,266
---------- ----------
$ 177,217 $ 176,206
========== ==========
5. FINANCING
On August 22, 2003, the Company entered into a $7,500,000 Credit
Agreement with Wells Fargo Bank, N.A. to provide the Company with
acquisition financing and general working capital (the "Wells Loan").
The initial draw on the Wells Loan was in the amount of $1,255,204,
which was used to refinance the revolving line of credit ("Merill Lynch
Loan") the Company previously maintained with Merrill Lynch Business
Financial Services, Inc. ("Merrill Lynch"). The Company repaid all
amounts owed, and canceled the line of credit with Merrill Lynch, which
accrued interest at the one-month LIBOR rate plus 2.35% (effective rate
of 3.77% at December 31, 2002). On August 25, 2003, the Company made a
draw of $2,250,000 on the Wells Loan, the proceeds of which the Company
placed into escrow to fund a portion of the JJHCS asset purchase on the
Effective Date.
Future working capital advances from the Wells Loan will be based upon
a percentage of the Company's eligible accounts receivable, less any
amounts previously drawn. At the option of the Company, the Wells Loan
bears interest at prime or the one-month LIBOR plus a margin of 2.25%
to 2.75% based upon the Company's Senior Leverage Ratio. The
availability of the Wells Loan will decrease $250,000 on the last day
of each calendar quarter, beginning September 30, 2003, and will expire
on June 30, 2007. Borrowings under the Wells Loan are collateralized by
substantially all of the Company's assets. The Company is required to
comply with certain monthly financial covenants, including a senior
27
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
cash flow leverage ratio, senior leverage ratio and current ratio. At
December 31, 2003, the Company had $2,775,000 outstanding under the
Wells Loan, and was in compliance with all of its financial covenants.
On August 25, 2003, the Company entered into a $3,000,000 Securities
Purchase Agreement with Bayview Capital Partners LP ("Bayview") to
provide the Company with acquisition financing and general working
capital (the "Bayview Investment"). The Bayview Investment was
initially structured as a bridge note (the "Bridge Note"), the proceeds
of which the Company placed into escrow to fund a portion of the JJHCS
asset purchase on the Effective Date.
On the Effective Date, the $3,000,000 Bridge Note issued to Bayview was
converted into a $2,000,000 term note (the "Term Note"), $1,000,000 in
Series A Convertible Preferred Stock (the "Preferred Stock") and a
warrant to purchase common stock of the Company (the "Warrant") per the
terms set forth in the August 25, 2003 Securities Purchase Agreement.
The Term Note will bear interest at 12% per year, payable monthly, and
will mature on the fifth anniversary of the Effective Date. The Term
Note may be prepaid, in whole or in part, at any time, provided that
the prepayment is accompanied by a premium ranging from 5% in year 1 to
1% in year 5. The Bayview Investment is secured by a subordinated
security interest in substantially all of the Company's assets. The
Company is required to comply with certain monthly financial covenants,
including a senior cash flow leverage ratio, senior leverage ratio and
current ratio. At December 31, 2003, the Company was in compliance with
all of its financial covenants.
The Preferred Stock was issued to Bayview at a price of $1.00 per
share, resulting in 1,000,000 shares issued on the Effective Date. The
Preferred Stock has a stated dividend rate of 6% per year, computed on
a simple interest basis, paid in kind in the form of additional shares
of Preferred Stock using a price of $1.00 per share ("PIK Dividends").
At the option of the holder, the Preferred Stock, including any PIK
Dividends, may be converted, at any time and from time to time, into
common stock of the Company at a price of $0.50 per share. In addition,
Bayview may require redemption of the Preferred Stock and PIK Dividends
upon a change of control or default (including default under the Term
Note).
The Warrant issued to Bayview on the Effective Date represents the
right to purchase 1,210,320 shares of common stock, which represents 8%
of the Company's common stock outstanding on a fully diluted basis at
the Effective Date, excluding the common stock issuable to Bayview upon
conversion of the Preferred Stock. The Warrant will be exercisable at
any time for a period of ten years at an exercise price equal to $0.50
per share, and the shares obtainable upon exercise of the Warrant may
be put to the Company at fair market value (net of the exercise price)
upon a change of control or default.
The investment proceeds received from Bayview were allocated based upon
the relative fair value of each instrument, which resulted in the
following allocation:
Value assigned to Preferred Stock $ 783,904
Value assigned to Warrants 648,288
Value assigned to Term Note 1,567,808
The $432,192 difference between the $2,000,000 face value of the Term
Note and its assigned relative fair value will be amortized as interest
expense over the 5-year term of the Term Note.
28
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
When Bayview made its commitment to invest in the Company on August 25,
2003, the fair value of the Company's common stock to be received upon
conversion of the Preferred Stock was greater than the conversion price
of the preferred stock, which resulted in a beneficial conversion
feature. Accordingly, the Company calculated a $656,096 beneficial
conversion feature which has been recorded as a deemed dividend in the
statement of operations for the year ended December 31, 2003.
Balances of long-term obligations as of December 31:
2003 2002
----------- -----------
Merrill Lynch Loan $ - $ 304,589
Wells Loan 2,775,000 -
Bayview Term Note 2,000,000 -
----------- -----------
4,775,000 304,589
Discount on Bayview Term Note (424,988) -
----------- -----------
$ 4,350,012 $ 304,589
=========== ===========
Balances on the Wells Loan and Bayview Term Note mature in June 2007
and August 2008, respectively.
6. COMMITMENTS AND CONTINGENCIES
Leases - The Company leases office space and equipment under operating
leases. In addition to base rental payments, these leases require the
Company to pay its proportionate share of real estate taxes, special
assessments, and maintenance costs. Costs incurred under operating
leases are recorded as rent expense and totaled approximately $162,000,
$136,000 and $148,000 for the years ended December 31, 2003, 2002 and
2001.
Minimum rent payments due under operating leases are as follows:
Years ending December 31:
2004 $252,000
2005 236,000
2006 236,000
2007 177,000
2008 15,000
Thereafter -
Legal Proceedings - The Company is involved in various claims and
lawsuits incident to the operation of its business. The Company
believes that the outcome of such claims will not have a material
adverse effect on its financial condition, results of operation, or
cash flows.
7. BENEFIT PLAN
The Company maintains a 401(k) plan whereby employees are eligible to
participate in the plan providing they have attained the age of 18 and
have completed one month of service. The plan was amended in December
2002 to allow participants to contribute up to 20% of their earnings
effective April 1, 2003. Previously, participants were able to
29
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
contribute up to 15% of their earnings. The Company may make certain
matching contributions which were approximately $140,000, $132,000
and $122,000 for the years ended December 31, 2003, 2002 and 2001.
8. EQUITY
Stock Options - The Company maintains a stock option plan for the
benefit of certain eligible employees and directors of the Company and
its subsidiaries. A total of 282,850 shares of common stock are
reserved for additional grants of options under the plan at December
31, 2003. Generally, the options outstanding (1) are granted at prices
equal to the market value of the stock on the date of grant, (2) vest
over various terms and, (3) expire over a period of five or ten years
from the date of grant.
A summary of the stock option activity is as follows:
Weighted
Number of Average
Shares Exercise Price
------ --------------
Outstanding at January 1, 2001 968,905 $ 2.12
Granted 412,000 0.66
Forfeited (147,075) 2.83
--------- ------
Outstanding at December 31, 2001 1,233,830 1.54
Granted 330,700 0.49
Forfeited (142,230) 2.64
--------- ------
Outstanding at December 31, 2002 1,422,300 1.19
Granted 496,300 0.80
Exercised (6,250) 0.39
Forfeited (201,450) 2.88
--------- ------
Outstanding at December 31, 2003 1,710,900 $ 0.88
========= ======
Weighted
Number of Average
Shares Exercise Price
------ --------------
Options exercisable at December 31:
2003 947,575 $1.05
2002 852,500 $1.67
2001 799,663 $2.12
30
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
The following table summarizes information about stock options at
December 31, 2003:
Options Outstanding Options Exercisable
----------------------------------------------- ------------------------
Weighted Average Weighted Weighted
Remaining Average Average
Range of Number Contractual Life Exercise Number Exercise
Exercise Prices Outstanding In Years Price Exercisable Price
--------------- ----------- ---------------- -------- ----------- --------
$0.30 - $0.39 495,600 3.57 $0.33 215,000 $0.30
0.47 - .69 724,300 4.46 0.55 465,075 0.57
0.95 - 1.25 291,000 6.62 1.17 67,500 1.04
3.00 200,000 3.36 3.00 200,000 3.00
--------- -------
1,710,900 4.44 $0.88 947,575 $1.05
========= =======
Employee Stock Purchase Plan - The Company maintains an Employee Stock
Purchase Plan which allows employees to purchase shares of the
Company's common stock at 90% of the fair market value. On November 6,
2002 the Company amended the plan to increase the available shares by
300,000. A total of 700,000 shares of common stock are reserved for
issuance under this plan, of which 351,815 shares are unissued and
remain available for issuance at December 31, 2003. There were 53,423
and 32,411 shares issued under the plan during 2003 and 2002. The
Company did not issue shares under the plan in 2001.
Warrants - The Company has outstanding warrants to directors, selling
agents, and consultants in consideration for services performed and in
connection with the issuance of debt.
In December 2003, a warrant to purchase 1,210,320 shares of common
stock was issued to Bayview in connection with acquisition financing
provided to the Company. The Warrant will be exercisable at any time
for a period of ten years at an exercise price equal to $0.50 per
share, and the shares obtainable upon exercise of the Warrant may be
put to the Company at fair market value (net of the exercise price)
upon a change of control or default.
In December 2003, a warrant to purchase 100,000 shares of common stock
was issued to Goldsmith, Agio, Helms Securities, Inc. for broker
services provided to the Company in connection with the JJHCS
acquisition (the "Goldsmith Warrant"). The Goldsmith Warrant will be
exercisable at any time for a period of five years at an exercise price
equal to $0.50 per share.
31
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
A summary of the stock warrants activity is as follows:
Exercise
Number of Price
Shares Per Share
------ ---------
Outstanding at January 1, 2001 1,617,497 0.30 - 4.00
Forfeited (250,800) 2.19 - 3.00
---------
Outstanding at December 31, 2001 1,366,697 0.30 - 4.00
Forfeited (750,000) 2.25
---------
Outstanding at December 31, 2002 616,697 0.30 - 4.00
Granted 1,310,320 0.50
Forfeited (466,697) 1.00 - 4.00
---------
Outstanding at December 31, 2003 1,460,320 0.30 - 0.50
=========
Warrants exercisable at December 31:
2003 1,460,320 $ 0.30 - 0.50
2002 616,697 0.30 - 4.00
2001 1,366,697 0.30 - 4.00
9. INCOME TAXES
Income tax expense (benefit) consists of the following:
2003 2002 2001
--------- ----------- ---------
Current $ 78,760 $ (2,567) $ 71,015
Deferred 449,776 (2,209,076) (777,300)
--------- ----------- ---------
$ 528,536 $(2,211,643) $(706,285)
========= =========== =========
A reconciliation between taxes computed at the expected federal income
tax rate and the effective tax rate for the years ended December 31 is
as follows:
2003 2002 2001
--------- ----------- -----------
Tax expense computed at statutory rates $ 394,800 $ 268,300 $ 322,700
State tax benefit, net of federal effect 51,800 38,400 46,900
Nondeductible goodwill amortization - 10,200 156,600
Change in valuation allowance - (2,501,200) (1,237,300)
Adjustment to income tax provision accruals 76,000 (53,200) -
Other 5,936 25,857 4,815
--------- ----------- -----------
$ 528,536 $(2,211,643) $ (706,285)
========= =========== ===========
At December 31, 2003, the Company had approximately $6,156,000 of
federal operating loss carryforwards. The carryforwards expire through
2019. A portion of the operating loss carryforwards were used in 2003
to reduce federal taxes payable by approximately $440,000.
32
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
The components of deferred tax assets (liabilities) at December 31
consist of the following:
2003 2002
----------- -----------
Current:
Allowances $ 52,400 $ 33,400
Accrued employee benefits 141,900 98,200
Self funded insurance - 79,900
Tax loss carryforwards 656,000 520,000
----------- -----------
Net current asset 850,300 731,500
Noncurrent:
Depreciation and amortization 31,900 (500)
Tax loss carryforwards 1,608,400 2,225,276
Other 46,001 30,100
----------- -----------
Net non-current asset 1,686,301 2,254,876
----------- -----------
Net deferred tax asset 2,536,601 2,986,376
Less valuation allowance - -
----------- -----------
$ 2,536,601 $ 2,986,376
=========== ===========
10. ACCOUNTING PRONOUNCEMENTS
ADOPTION OF ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2002 the Company adopted SFAS 141, "Business
Combinations," and SFAS 142, "Goodwill and Intangible Assets,". SFAS
141 eliminates the pooling-of-interest method of accounting for
business combinations and requires intangible assets acquired in
business combinations to be recorded separately from goodwill. The
adoption of SFAS 141 did not affect the Company's consolidated
financial position or statement of earnings. SFAS 142 eliminates the
amortization of goodwill and other intangible assets with indefinite
lives and requires that these assets be tested for impairment annually
or whenever an impairment indicator arises using a two step impairment
test outlined in SFAS 142. Effective January 1, 2002, the Company
discontinued the amortization of goodwill.
The Company completed its transitional goodwill impairment test at June
30, 2002 and determined that no potential impairment exists. The
Company elected to complete the annual impairment test of goodwill on
December 31 each year and determined that its goodwill relates to one
reporting unit for purposes of impairment testing. The Company
determined that there was no impairment of goodwill at December 31,
2003 and 2002.
The pro forma effect of adopting SFAS 142 on net earnings and net
earnings per share for the years ended December 31, 2001 is as follows:
2001
----------
Net earnings applicable to common shareholders, as reported $1,806,001
Goodwill amortization 400,661
----------
Adjusted net earnings applicable to common shareholders $2,206,662
==========
33
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Basic net earnings per share:
Net earnings applicable to common shareholders, as reported $0.15
Goodwill amortization 0.03
-----
Adjusted net earnings applicable to common shareholders $0.18
=====
Diluted net earnings per share:
Net earnings applicable to common shareholders, as reported $0.15
Goodwill amortization 0.03
-----
Adjusted net earnings applicable to common shareholders $0.18
=====
Effective for the year ended December 31, 2002 the Company adopted SFAS
148, Accounting for Stock-based Compensation-Transition and Disclosure.
SFAS 148 amends the disclosure and certain transition provisions of
statement 123, Accounting for Stock-Based Compensation. The disclosure
requirements of this pronouncement are included in the financial
statements for the year ended December 31, 2003.
RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board (FASB) issued
Financial Interpretations No. 46 (FIN 46), "Consolidation of Variable
Interest Entities." FIN 46 is an interpretation of Accounting Research
Bulletin No. 51, "Consolidated Financial Statements," and addresses
consolidation by business enterprises of variable interest entities.
FIN 46 applies immediately to variable interest entities created or
obtained after January 31, 2003 and applies in the first fiscal year or
interim period beginning after June 15, 2003, to variable interest
entities in which an enterprise holds a variable interest that it
acquired before February 1, 2003. This interpretation is not
anticipated to have an impact on the Company's consolidated financial
position or results of operations.
In April 2003, the FASB issued Statement 149, Amendment of Statement
133 on Derivative Instruments and Hedging Activities. Statement 149
clarifies implementation issues and amends Statement 133, to include
the conclusions reached by the FASB on certain FASB Staff
Implementation Issues that, while inconsistent with Statement 133's
conclusions, were considered by the Board to be preferable, amends
discussion of financial guarantee contracts and the application of the
shortcut method to an interest-rate swap agreement that includes an
embedded option, and amends other pronouncements. Statement 149 is
effective to contracts entered into or modified, and hedging
arrangements designated after June 30, 2003, with various exceptions as
outlined in the statement. Adoption of Statement 149 is not anticipated
to have an impact on the Company's consolidated financial position or
results of operations.
In May 2003, the FASB issued Statement 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and
Equity. Statement 150 changes the classification in the statement of
financial position of certain common financial instruments from either
equity or mezzanine presentation to liabilities and requires an issuer
of those financial statements to recognize changes in fair value or
redemption amount, as applicable, in earnings. SFAS 150 is effective
for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective at the beginning of the first interim period
34
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
beginning after June 15, 2003. Adoption of Statement 150 is not
anticipated to have an impact on the Company's financial position or
results of operations.
11. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Quarter ended
------------------------------------------------------------
March 31, June 30, September 30, December 31,
------------ ------------ ------------ ------------
2003
Revenue $ 7,518,205 $ 7,732,626 $ 7,445,094 $ 8,782,897
Gross profit 1,654,399 1,581,142 1,465,768 1,833,888
Net earnings applicable to common shareholders 267,980 217,333 87,786 (600,353)
Net earnings per share
Basic $ 0.02 $ 0.02 $ 0.01 $ (0.05)
Diluted 0.02 0.02 0.01 (0.05)
Weighted average common shares outstanding
Basic 12,308,321 12,322,908 12,341,284 12,356,315
Diluted 12,404,312 12,467,821 12,743,441 13,356,315
Quarter ended
------------------------------------------------------------
March 31, June 30, September 30, December 31,
------------ ------------ ------------ ------------
2002
Revenue $ 6,687,394 $ 6,686,808 $ 6,934,758 $ 7,556,037
Gross profit 1,474,291 1,453,537 1,420,449 1,578,335
Net earnings 787,321 771,188 777,465 664,697
Net earnings per share
Basic $ 0.06 $ 0.06 $ 0.06 $ 0.05
Diluted 0.06 0.06 0.06 0.05
Weighted average common shares outstanding
Basic 12,265,250 12,265,250 12,289,558 12,297,661
Diluted 12,396,891 12,486,488 12,413,530 12,400,022
Quarter ended
------------------------------------------------------------
March 31, June 30, September 30, December 31,
------------ ------------ ------------ ------------
2001
Revenue $ 6,426,456 $ 6,578,716 $ 6,356,489 $ 6,548,317
Gross profit 1,366,985 1,487,600 1,519,422 1,430,832
Net earnings 457,458 222,178 182,876 943,489
Net earnings per share
Basic $ 0.04 $ 0.02 $ 0.01 $ 0.08
Diluted 0.04 0.02 0.01 0.08
Weighted average common shares outstanding
Basic 12,165,250 12,165,250 12,264,163 12,265,250
Diluted 12,690,417 12,711,750 12,503,377 12,429,049
35
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
12. SUBSEQUENT EVENT
In February 2003, the Company paid $142,411 of additional purchase
price to Johnson & Johnson Healthcare Systems Inc for the acquisition
of its Health & Fitness Services Business. The additional purchase
price was paid as a result of two fitness center management contracts
that assigned to the Company subsequent to the close of the
acquisition. The entire amount will be recorded to goodwill in 2004.
36
HEALTH FITNESS CORPORATION
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Balance at Charged to Charged to Balance
Beginning Costs and Other accounts Deductions at End
Description of Period Expenses Describe Describe of Period
---------------------------- --------- ---------- -------------- ---------- ---------
Trade and other accounts
receivable allowances:
Year ended December 31, 2003 $ 88,900 $ 61,500 - $ (19,400)(a) $ 131,000
Year ended December 31, 2002 84,700 5,400 - (1,200)(a) 88,900
Year ended December 31, 2001 262,600 (28,000) - (149,900)(a) 84,700
(a) Accounts receivable written off as uncollectible
37
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
The Company's Chief Executive Officer and Chief Financial Officer (collectively,
the "Certifying Officers") are responsible for establishing and maintaining
disclosure controls and procedures for the Company. The Certifying Officers have
concluded (based upon their evaluation of these controls and procedures as of a
date within 90 days of the filing of this report) that the Company's disclosure
controls and procedures are effective to ensure that information required to be
disclosed by the Company in this report is accumulated and communicated to the
Company's management, including its principal executive officers as appropriate,
to allow timely decisions regarding required disclosure. The Certifying Officers
also have indicated that there were no significant changes in the Company's
internal controls or other factors that could significantly affect such controls
subsequent to the date of their evaluation, and there were no corrective actions
with regard to significant deficiencies and material weaknesses.
38
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The names, ages and positions of the Company's executive officers are
as follows:
Name Age Position
Jerry V. Noyce 59 President, Chief Executive Officer and Director
Wesley W. Winnekins 42 Chief Financial Officer and Treasurer
James A. Narum 47 Senior Vice President-Corporate Business Development
Jeanne C. Crawford 46 Vice President-Human Resources and Secretary
Jerry V. Noyce has been President and Chief Executive Officer of the
Company since November 2000 and a director since January 2001. From October 1973
to March 1997, he was Chief Executive Officer and Executive Vice President of
Northwest Racquet, Swim & Health Clubs. From March 1997 to November 1999, Mr.
Noyce served as Regional Chief Executive Officer of CSI/Wellbridge Company, the
successor to Northwest Racquet, where he was responsible for all operations at
the Northwest Clubs and the Flagship Athletic Club.
Wesley W. Winnekins has been Chief Financial Officer and Treasurer of
the Company since February 2001. Prior to joining the Company, Mr. Winnekins
served as CFO (from January 2000 to February 2001) of University.com, Inc., a
privately held provider of on line learning solutions for corporations. From
June 1995 to April 1999 he served as CFO and vice president of operations for
Reality Interactive, a publicly held developer of CD-ROMs and online training
for the corporate market. From June 1993 to May 1995 he served as controller and
director of operations for The Marsh, a Minneapolis-based health club, and was
controller of the Greenwood Athletic Club in Denver from October 1987 to January
1989.
James A. Narum has been the Company's National Vice President of
Account Services since December 2003, Senior Vice President-Corporate Business
Development from December 2001 to December 2003, and served as Corporate Vice
President of Operations-Corporate Health and Fitness Division from November 2000
to December 2001. From 1995 until November 2000, Mr. Narum was responsible for
national operations in the Company's Corporate Health and Fitness Division. From
1983 to 1995, Mr. Narum was responsible for regional operations, sales,
consulting, and client account management for Fitness Systems Inc., a provider
of fitness center management services the Company acquired in 1995.
Jeanne C. Crawford has been the Company's Vice President of Human
Resources since July 1998 and Secretary of the Company since February 2001. From
July 1996 through July 1998, Ms. Crawford served as a Human Resource consultant
to the Company. From October 1991 through September 1993, Ms. Crawford served as
Vice President of Human Resources for RehabClinics, Inc. a publicly held
outpatient rehabilitation company. From May 1989 through October 1991, Ms.
Crawford served as Director of Human Resources for Greater Atlantic Health
Service, an HMO and physicians medical group. From 1979 through 1989, Ms.
Crawford served in various human resources management positions in both the
retail and publishing industries.
The information required by Item 10 relating to directors and
compliance with Section 16 of the Exchange Act is incorporated herein by
reference to the sections entitled "Election of Directors", "Code
39
of Ethics" and "Section 16(a) Beneficial Ownership Reporting Compliance" which
appear in the Company's definitive proxy statement for its 2004 Annual Meeting.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated herein by reference
to the section entitled "Executive Compensation" which appears in the Company's
definitive proxy statement for its 2004 Annual Meeting.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by Item 12 is incorporated herein by reference
to the section entitled "Principal Shareholders and Management Shareholdings"
which appears in the Company's definitive proxy statement for its 2004 Annual
Meeting.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated herein by reference
to the section entitled "Certain Transactions" which appears in the Company's
definitive proxy statement for its 2004 Annual Meeting.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by Item 14 is incorporated herein by reference to the
section entitled "Audit Fees", which appears in our definitive proxy statement
for our 2004 Annual Meeting.
40
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report.
(1) Financial Statements. The following financial
statements are included in Part II, Item 8 of this
Annual Report on Form 10-K:
Report of Grant Thornton LLP on Consolidated
Financial Statements and Financial Statement Schedule
as of December 31, 2003 and 2002 and for each of the
three years in the period ended December 31, 2003
Consolidated Balance Sheets as of December 31, 2003
and 2002
Consolidated Statements of Earnings for each of the
three years in the period ended December 31, 2003
Consolidated Statements of Shareholders' Equity for
each of the three years in the period ended December
31, 2003
Consolidated Statements of Cash Flows for each of the
three years in the period ended December 31, 2003
Notes to Consolidated Financial Statements
(2) Financial Statement Schedules. The following
consolidated financial statement schedule is included
in Item 8:
Schedule II-Valuation and Qualifying Accounts
All other financial statement schedules have been
omitted, because they are not applicable, are not
required, or the information is included in the
Financial Statements or Notes thereto
(3) Exhibits. See "Exhibit Index to Form 10-K"
immediately following the signature page of this Form
10-K
(b) Reports on Form 8-K
A Form 8-K dated November 11, 2003 was filed on November 13,
2003 to report that a press release had been issued to announce the
Company's financial results for the third quarter ending September 30,
2003.
A Form 8-K dated and filed on December 8, 2003 to report that
a press release had been issued to announce the Company had completed
its purchase of the business assets of the Health & Fitness Services
Division of Johnson & Johnson Health Care Systems Inc. pursuant to an
Asset Purchase Agreement for $4,785,389.
41
SIGNATURES
In accordance with the requirements of Section 13 or 15(d) of the
Exchange Act, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Dated: March 30, 2004 HEALTH FITNESS CORPORATION
By /s/ Jerry Noyce.
--------------------------------------
Jerry Noyce
Chief Executive Officer
(Principal Executive Officer)
42
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears above or below constitutes and appoints Jerry Noyce and Wesley
Winnekins, or either of them, his true and lawful attorneys-in-fact, and agents,
with full power of substitution and resubstitution, for him and in his name,
place and stead, in any and all capacities, to sign any and all amendments to
this Report, and to file the same, with all exhibits thereto and other documents
in connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents, full power and authority to do and
perform each and every act and thing requisite and necessary to be done in and
about the premises, as fully to all intents and purposes as he might or could do
in person, hereby ratifying and confirming all that said attorneys-in-fact and
agents, or their substitutes, may lawfully do or cause to be done by virtue
hereof.
Signature Date
--------- ----
/s/ Jerry Noyce Chief Executive Officer and Director
------------------------------ (principal executive officer) March 30, 2004
Jerry Noyce
/s/ Wesley Winnekins Chief Financial Officer
------------------------------ (principal financial and accounting officer) March 30, 2004
Wesley Winnekins
/s/ James A. Bernards
------------------------------
James A. Bernards Director March 30, 2004
/s/ K. James Ehlen, MD
------------------------------
K. James Ehlen, MD Director March 30, 2004
/s/ John C. Penn
------------------------------
John C. Penn Director March 30, 2004
/s/ Mark W. Sheffert
------------------------------
Mark W. Sheffert Director March 30, 2004
/s/ Linda Hall Whitman
------------------------------
Linda Hall Whitman Director March 30, 2004
/s/ Rodney A. Young
------------------------------
Rodney A. Young Director March 30, 2004
43
EXHIBIT INDEX
HEALTH FITNESS CORPORATION
FORM 10-K
Exhibit No. Description
----------- -----------
3.1 Articles of Incorporation, as amended, of the Company - incorporated by
reference to the Company's Quarterly Report on Form 10-QSB for the quarter
ended June 30, 1997
3.2 Restated By-Laws of the Company - incorporated by reference to the
Company's Registration Statement on Form SB-2 No. 33-83784C
4.1 Specimen of Common Stock Certificate - incorporated by reference to the
Company's Registration Statement on Form SB-2 No. 33-83784C
10.1 Standard Office Lease Agreement (Net) dated as of June 13, 1996 covering a
portion of the Company's headquarters - incorporated by reference to the
Company's Annual Report on Form 10-KSB for the year ended December 31, 1996
10.2 Amendment dated March 1, 2001 to Standard Office Lease Agreement (Net)
dated as of June 13, 1996 covering a portion of the Company's
headquarters-incorporated by reference to the Company's Form 10K for the
year ended December 31, 2000.
10.3 Second Amendment, dated June 12, 2002, to Standard Office Lease Agreement
dated as of June 13, 1996- incorporated by reference to the Company's Form
10-Q for the quarter ended June 30, 2002.
*10.4 Company's 1995 Stock Option Plan - incorporated by reference to the
Company's Annual Report on Form 10-KSB for the year ended December 31, 1995
*10.5 Amendment to Company's 1995 Stock Option Plan - incorporated by reference
to Part II, Item 4 of the Company's Form 10-QSB for the quarter ended June
30, 1997
*10.6 Employment agreement dated November 30, 2000 between Company and Jerry V.
Noyce-incorporated by reference to the Company's Form 10-K for the year
ended December 31, 2000.
*10.7 Employment agreement dated April 21, 1995 between the Company and James A.
Narum, as amended October 19, 1999, November 2, 2000 and March 25,
2003-incorporated by reference to the Company's Form 10-K for the year
ended December 31, 2002.
*10.8 Employment agreement dated February 9, 2001 between Company and Wesley W.
Winnekins-incorporated by reference to the Company's Form 10K for the year
ended December 31, 2000.
*10.9 Employment agreement dated March 1, 2003 between Company and Jeanne
Crawford-incorporated by reference to the Company's Form 10-K for the year
ended December 31, 2002.
44
Exhibit No. Description
----------- -----------
10.10 Agreement of Purchase and Sale of Stock of David W. Pickering, Inc. dated
January 1, 2001 - incorporated by reference to the Company's Quarterly
Report on form 10-QSB for the quarter ended September 30, 2001
10.11 WCMA Loan and Security Agreement dated October 31, 2002 between the Company
and Merrill Lynch Business Financial Services, Inc. incorporated by
reference to the Company's Form 10Q for the quarter ended September 30,
2002
10.12 Credit Agreement, dated August 22, 2003, between the Company and Wells
Fargo Bank, National Association - incorporated by reference to the
Company's Quarterly Report on form 10-QSB for the quarter ended September
30, 2003
10.13 Securities Purchase Agreement, dated August 25, 2003, between the Company
and certain of its subsidiaries, on the one hand, and Bayview Capital
Partners LP, on the other hand - incorporated by reference to the Company's
Quarterly Report on form 10-QSB for the quarter ended September 30, 2003
10.14 Asset Purchase Agreement, dated August 25, 2003, between the Company and
Johnson & Johnson Health Care Systems Inc. - incorporated by reference to
the Company's Quarterly Report on form 10-QSB for the quarter ended
September 30, 2003
10.15 Third Amendment, dated August 25, 2003, to Standard Office Lease Agreement
dated as of June 13, 1996, between the Company and NEOC Holdings LLC -
incorporated by reference to the Company's Quarterly Report on form 10-QSB
for the quarter ended September 30, 2003
**11.0 Statement re: Computation of Earnings per Share
**21.1 Subsidiaries
**23.1 Consent of Grant Thornton LLP
**31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
**31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
**32.1 Certification of Chief Executive Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
**32.2 Certification of Chief Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
---------------------
* Indicates management contract or compensatory plan or arrangement
**Filed herewith
45