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, 2005
Commission File Number: 0-25064
HEALTH FITNESS CORPORATION
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1580506
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
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 if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes No X
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Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 of 15(d) of the Exchange Act. Yes No X
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Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
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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. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer. (See definition of accelerated and
large accelerated filer in Exchange Act Rule 12b-2).
Large accelerated filer Accelerated Filer Non-Accelerated filer X
--- --- ---
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes No X
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As of June 30, 2005, 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 $22,550,500. As of March 27, 2006, 18,930,368 shares of the
registrant's common stock, $.01 par value, were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
PORTIONS OF THE PROXY STATEMENT FOR THE 2006 ANNUAL MEETING OF SHAREHOLDERS ARE
INCORPORATED BY REFERENCE INTO PART III OF THIS REPORT.
ITEM 1. BUSINESS
OVERVIEW
As a leading provider of fitness and health management services and programs to
corporations, hospitals, communities and universities located in the United
States and Canada, we currently have agreements with approximately 157 customers
to manage more than 400 fitness and wellness centers, including 233 corporate
fitness centers, 61 corporate wellness programs, 12 corporate occupational
health programs, 15 hospital, commercial and university-based fitness centers
and wellness programs and 74 corporate sites that do not have full-time staff.
Approximately 70 of the Company's customers are Fortune 1000 companies.
On December 23, 2005, we acquired all of the capital stock of HealthCalc.Net,
Inc. ("HealthCalc"), a leading provider of web-based fitness, health management
and wellness programs to corporations, health care organizations, physicians and
athletic/fitness centers. Founded in 1997, and headquartered in Dallas, Texas,
HealthCalc's web-based platform provides customers with a variety of tools and
resources to identify opportunities to impact healthcare costs through lifestyle
improvement programs for individuals. In addition to other services, the
HealthCalc platform allows individuals to take periodic online health
assessments, track their daily exercise, receive online health coaching and
provide access to the latest health education and information in an
internet-based environment. We completed this acquisition to satisfy the demands
of current and potential customers regarding ownership of the technology
platform that has become increasingly important to the delivery of fitness and
health management services. By combining the best practices, programs and people
of both companies, we believe this acquisition uniquely positions us to meet the
growing demands of major corporations by providing solutions that address
employee health issues and the rising cost of corporate healthcare.
You may contact us at our executive offices at 3600 American Blvd W., Suite 560,
Bloomington, Minnesota 55431, telephone number is (952) 831-6830. We maintain an
internet website at www.hfit.com.
BUSINESS MODEL
Major corporations, hospitals and universities invest in fitness centers and
health improvement programs for several reasons. First, it is widely understood
that healthier employees are more productive, experience reduced levels of
stress and are absent from work less often due to illness. Additionally,
companies are struggling to deal with the escalating cost of providing employee
healthcare benefits, which has increased at double-digit rates due to
technological advancements and the decreasing overall health of employees within
the labor market. Many companies are beginning to recognize that employees are
their most important asset, and consider employee health improvement initiatives
a top priority.
To capitalize on the fitness and health management opportunities within the
corporate, hospital, community and university markets, we have organized our
business into two core areas: Fitness Management Services and Health Management
Services. Within each area, we provide two types of service: (i) Staffing
Services, and (ii) Program and Consulting Services. On a combined basis for
2005, Staffing Services currently accounts for 91.9% of total revenue, and
Program and Consulting Services accounts for 8.1% of total revenue.
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FITNESS MANAGEMENT SERVICES
STAFFING SERVICES. We have agreements with corporations to staff and manage
fitness centers that have been developed by these companies for use by
employees. Our customers invest the resources to develop and equip these fitness
centers, and generally pay for all operating expenses. We derive revenue from
these services through the reimbursement of staff costs, including wages, taxes
and benefits, reimbursement of the cost of liability insurance. We also receive
a management fee to cover the cost of regional and corporate support services.
PROGRAM AND CONSULTING SERVICES. Services in this category are generally
provided at our managed fitness centers and include personal training, weight
loss programs, seminars, specialty fitness classes and massage therapy. We
derive revenue from these programs, typically from the individual fitness center
member, on a fee-for-service basis.
Within our fitness management consulting practice, companies that are planning
new fitness centers employ us to develop floor plan designs, interior design
plans, selection and sourcing of fitness equipment and fitness program design.
For companies that desire to develop a commercial fitness center, we can perform
a comprehensive analysis of market potential for the center. Services can
include demographic analysis, market analysis, and multiple-year financial
business plan development.
HEALTH MANAGEMENT SERVICES
STAFFING SERVICES. We have agreements with corporations to staff and manage the
delivery of health promotion programs, lifestyle counseling services for onsite
and remote customer employees and injury prevention and treatment services.
These relationships may or may not involve the management of an on-site fitness
center. We derive revenue from these services through the reimbursement of staff
costs, including wages, taxes and benefits, reimbursement of the cost of
liability insurance. We also receive a management fee to cover the cost of
regional and corporate support services.
PROGRAM AND CONSULTING SERVICES. We offer a comprehensive menu of products and
services to assess the health risks of customer employees, as well as lifestyle
programs that target specific health risks. Such services are either internally
developed by us or are made available through third-party partners, and include
paper and web-based health risk assessments, biometric screenings to assess
blood profiles, data collection, management and reporting and educational
literature and programs. We also offer our customers access to the HFC e-Health
Platform, an electronic health education and service platform that we acquired
from HealthCalc.
We also offer health advisory services to customer employees. Such services can
range from interpretation of health risk assessment and screening results, to
individualized health improvement coaching support. These services can be
delivered face-to-face using our trained staff, or telephonically through
qualified partners.
Through our Occupational Health practice, we offer on-site programs to prevent,
manage and treat musculo-skeletal disorders in the work environment. Services
include ergonomic injury prevention, discomfort management and physical therapy
treatment.
Revenue from these program services are generally paid by the corporate
customer, although such customer may ask its employees to share in the cost.
Within our health management consulting practice, we provide our customers with
a comprehensive analysis of the effectiveness of employee health improvement
programs, with a focus on improving return on investment. This service also
creates a road map for companies that are looking to invest in an employee
health and wellness initiative. We also provide a suite of occupational health
consulting
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services, including injury prevention program design, work-hardening programs,
injury treatment and return-to-work programs and regulatory compliance
consulting.
Within these two areas of business, the duration of our management services
agreements vary widely, from those that are month-to-month, to those that have a
term of up to 5 years. A typical management services contract carries a term of
three years, with revenue recognized upon delivery of service. Contract duration
for Program and Consulting Services generally ranges from month-to-month to
twelve months, depending on the scope of services to be delivered. Revenues for
these services are recognized upon delivery of service.
The Company manages its business by looking at the component revenue derived
from its Fitness and Health Management Services areas of business. The following
table provides a breakout of these revenues for each of the years ending
December 31, 2005, 2004 and 2003:
Unaudited
---------------------------------------
2005 2004 2003
----------- ----------- -----------
Fitness Management Services
Staffing Services $38,226,444 $38,601,282 $28,330,612
Program and Consulting Services 2,392,272 1,762,756 866,440
----------- ----------- -----------
40,618,716 40,364,038 29,197,052
----------- ----------- -----------
Health Management Services
Staffing Services 12,267,973 11,323,162 2,192,085
Program and Consulting Services 2,055,516 767,468 89,685
----------- ----------- -----------
14,323,489 12,090,630 2,281,770
----------- ----------- -----------
Total Revenue
Staffing Services 50,494,417 49,924,444 30,522,697
Program and Consulting Services 4,447,788 2,530,224 956,125
----------- ----------- -----------
$54,942,205 $52,454,668 $31,478,822
----------- ----------- -----------
GROWTH STRATEGY
Our growth strategy is to continue expanding our Fitness and Health Management
Staffing Services, along with continuing to grow our Program and Consulting
Services revenue from existing and prospective customers. In the long-term,
management believes that we can be the leading integrator of fitness and health
management services for corporations and other large organizations. Key elements
of our growth strategy include:
- Further develop Fitness and Health Management Programs and Services through
internal expertise, partnerships and potential mergers or acquisitions.
- Expand existing Fitness Management customer relationships to include
comprehensive Health Management Services.
- Pursue customer opportunities with mid-sized companies and other smaller
organizations.
- Continue to pursue opportunities to offer on-site Fitness and Health
Management Services for large organizations.
- Explore international growth opportunities.
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OPERATIONS
Effective March 2005, we reorganized into two operational areas, Fitness
Management and Health Management. This reorganization both reflected and
formalized our focus on these two core areas of operation over the past two
years. In Fitness Management, we have two National Vice Presidents, each of whom
manages a number of regions. In Health Management, we have one National Vice
President, who manages all of the Company's health management customers. Each
region, which is generally organized along geographic lines, is headed by a
Regional Vice President, who is responsible for fitness center and wellness
program staffing, as well as managing service quality, financial performance and
client relationships. A typical fitness center is managed by a team of degreed
fitness professionals, under the leadership of the center Program Manager. The
Program Manager has day-to-day operating responsibility for the center,
including staff management, customer relations, membership sales, implementation
and promotion of fitness and health programs and the financial performance of
the center.
Our corporate office provides centralized administrative support, including
accounting and finance, human resources and payroll, information and technology
systems, sales and marketing, as well as general management for the development
and delivery of our Program Services.
SALES AND MARKETING
We market our services to both corporations and members of the fitness centers
we manage. Our sales force actively pursues new corporate customers across a
wide variety of industries. Our sales force is primarily responsible for
identifying potential corporate customers and sales lead partners, and managing
the overall sales process.
We have a corporate marketing department that supports its managed fitness
centers through the development of marketing programs and promotional materials.
SIGNIFICANT CUSTOMER RELATIONSHIP
At December 31, 2005, we had one customer relationship that provided 11.9% of
our total revenue. For this customer, we provide fitness center management and
wellness program administration services for approximately 53 locations. The
agreement expires December 31, 2006, and will automatically renew for successive
one year periods unless either party delivers written notice at least 90 days
prior to termination. We believe that our relationship with this customer is
good.
COMPETITION
Within the business-to-business fitness and health management services industry,
there are relatively few national competitors. However, virtually all markets
are home to regional providers that manage several sites within their geographic
areas. With our national presence and almost 30 years of history, management
believes that we are recognized as a leading provider of corporate fitness and
health management services, and that we are well positioned to compete in this
industry.
PROPRIETARY RIGHTS
The Company has three registered trademarks, "Insight"(R), "It Pays To Be
Healthy"(R) and "Live For Life"(R). The Company does not have any other
significant proprietary rights.
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GOVERNMENT REGULATION
Management believes that there currently is no significant government regulation
which materially limits our ability to provide fitness and health management
services to our corporate, hospital, community and university-based clients.
EMPLOYEES
At December 31, 2005, we had 783 full-time and 2,559 part-time and on-call
employees, of which approximately 85 were employed at our corporate, divisional
and regional offices, with the remainder primarily engaged in the staffing of
fitness, wellness and occupational health centers and programs. We have an
agreement with the United Auto Workers Union regarding approximately 54 of its
employees that work at fitness centers owned by Ford Motor Company and
DaimlerChrysler Corporation. Management believes our relationship with employees
is good.
INDEMNIFICATION OBLIGATIONS
A majority of our management agreements include a provision that obligates us 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 our
business. A majority of these management contracts also include a provision that
obligates the customer to indemnify and hold us harmless against all liabilities
arising out of the acts or omissions of the customer, their employees and
agents. We can make no assurance that claims by our customers, or their
employees, officers or directors, will not be made in the course of operating
our business.
INSURANCE
We maintain the following types of insurance policies: commercial general
liability, professional liability, automobile liability, commercial property,
employee dishonesty, employment practices, directors and officers liability,
workers compensation and excess umbrella liability. The policies provide for a
variety of coverages and are subject to various limitations, exclusions and
deductibles. While we believe our insurance policies are sufficient in amount
and coverage for our 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.
AVAILABLE INFORMATION
We file reports with the Securities and Exchange Commission, or as referred to
herein as the SEC, including annual reports on Form 10-K, quarterly reports on
Form 10-Q and other reports from time to time. We are an electronic filer and
the SEC maintains an Internet site at www.sec.gov that contains the reports,
proxy, information statements and other information filed electronically. In
addition, we maintain at our website (www.hfit.com), and make available free of
charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and all amendments to those reports as soon as reasonably
practicable after such information is filed electronically with the SEC. The
information provided on our website is not a part of this report, and is
therefore not incorporated by reference unless such information is otherwise
specifically referenced elsewhere in this report.
OUTLOOK AND TRENDS
The high cost of employee employer health care and lost employee productivity
has become a key concern for many corporations. According to published reports,
annual health care costs are expected to continue to increase at double digit
rates for the next several years due to a number of factors, including
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an aging workforce, unhealthy populations entering the workforce and
obesity-related medical conditions due to poor nutrition and inactivity. We
believe that many companies will be interested in addressing the health needs of
employees, their dependents and retirees, including implementation of specific
strategies to help "at-risk" individuals, as part of a broader strategy to
reduce health care costs and lost productivity. We believe that we can provide
the products, services, expertise and personnel to meet this objective.
The U.S. economy has experienced recessionary pressures in recent years, which
has negatively affected the corporate landscape. We continue to feel the effect
of these economic changes in the form of competitive prices we must offer for
our services in order to renew our customer agreements, or to obtain new
customers. Although we believe that price competition will not materially affect
results of operations, we believe that price competition will continue for the
foreseeable future.
A trend that may further develop within our fitness center management business
relates to companies asking service providers to operate their fitness centers
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
other sources of revenue. In connection with this form of business model, we
would derive our management fee revenue from the profits of the fitness center.
The application of this business model may require us to fund operating losses
until enough memberships are sold to realize profitability. We believe it may
have to fund operating losses for such centers up to twenty-four months before
profitability could be reached. However, we believe 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 present a material risk or represent a
material contribution to our results of operation. However, there is no
assurance that the number and scope of such contracts will not become material
in the future or that we will be able to manage such centers profitably or to
fund losses for these centers until profitability is achieved.
RISK FACTORS/FORWARD-LOOKING STATEMENTS
The foregoing discussion in this Item 1 and the discussion contained in Item 7
of this Form 10-K contain various "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. Forward-looking
statements are based on current expectations or beliefs concerning future
events. Such statements can be identified by the use of terminology such as
"anticipate," "believe," "estimate," "expect," "intend," "may," "could,"
"possible," "plan," "project," "will," "forecast" and similar words or
expressions. Our forward-looking statements generally relate to growth
strategies, recent reorganization, financial results, marketing efforts,
acquisition plans and cash requirements. Although it is not possible to foresee
all of the factors that may cause actual results to differ from our
forward-looking statements, such factors include, among others, the risk factors
that follow. However, Investors are cautioned that all forward-looking
statements involve risks and uncertainties.
THE TIMING OF NEW AND LOST MANAGEMENT SERVICE CONTRACTS MAY NOT BE INDICATIVE OF
TRENDS IN OUR BUSINESS OR OF FUTURE QUARTERLY FINANCIAL RESULTS. We evaluate our
business, in part, by reviewing trends in our financial performance. We believe
an important indicator of our outlook is revenue to be derived from fitness and
health management service contracts we secure with customers. Fitness and health
management service contracts are often long-term contracts (i.e., 3 - 5 years),
contain annual, automatic renewals and generally require 30 to 60 days notice to
terminate, or to avoid the automatic annual renewal feature. Revenue from new
contracts often is not recognized for a period of 90 to 180 days after proposal
acceptance due to lead times necessary to execute a contract and hire staff to
begin providing services. Since termination notice periods are considerably less
than the time it takes to begin servicing
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new contracts, the revenue lost in a reporting period may significantly exceed
the revenue gained from new contracts.
Because of these timing differences, management generally does not view changes
in quarterly revenue, whether sequential or comparable prior quarter changes, to
be indicative of its outlook or trends in our business or to be reflective of
revenue expected in succeeding quarters. Rather, management generally evaluates
revenue trends in our fitness and health management services business based upon
12- to 18-month periods since we believes this helps minimize the timing impact
from new and terminated contracts. Management cautions investors not to place
undue reliance upon fluctuations in quarterly revenue viewed in isolation from
revenue information over longer periods of time (e.g., comparative trailing
12-month information), and to not view quarterly revenue as necessarily being
indicative of our outlook or results to be expected in future quarters.
FAILURE TO IDENTIFY ACQUISITION OPPORTUNITIES MAY LIMIT OUR GROWTH. An important
part of our growth has been the acquisition of complementary businesses. We may
choose to continue this strategy in the future. Management's identification of
suitable acquisition candidates involves risks inherent in assessing the value,
strengths, weaknesses, overall risks and profitability of acquisition
candidates. Management may be unable to identify suitable acquisition
candidates. If we do not make suitable acquisitions, we may find it more
difficult to realize growth objectives and to enhance shareholder value.
In addition, future acquisitions may be dilutive to shareholders, cause us to
incur additional indebtedness and large one-time expenses or create intangible
assets that could result in significant amortization expense. If we spend
significant funds or incur additional debt, our ability to obtain necessary
financing may decline and we may become more vulnerable to economic downturns
and competitive pressures. Management cannot guarantee that we will be able to
successfully complete any future acquisitions, that we will be able to finance
acquisitions or that we will realize any anticipated benefits from completed
acquisitions.
WE MAY NOT REALIZE THE ANTICIPATED BENEFITS OF ACQUISITIONS WE COMPLETE. On
December 23, 2005, we acquired HealthCalc. Net, Inc. In the future, we may
acquire other businesses. The process of integrating new businesses into our
operations poses numerous risks, including:
- an inability to assimilate acquired operations, information systems
and technology platforms, and internal control systems and products;
- diversion of management's attention;
- difficulties and uncertainties in transitioning business relationships
from the acquired entity to us; and
- the loss of key employees of acquired companies.
If we are unsuccessful in integrating HealthCalc, or any other future
acquisitions, into our operations, we might not realize all of the anticipated
benefits of such acquisitions. In such instances, our acquisitions might not be
accretive to our earnings, the costs of such acquisitions may otherwise outweigh
the benefits of such acquisitions and the market price of our common stock might
decline.
WE MAY NOT BE ABLE TO SUCCESSFULLY CROSS-SELL OUR HEALTH MANAGEMENT PROGRAMS TO
OUR FITNESS MANAGEMENT CUSTOMERS. A part of our growth strategy involves
continuing and expanding our efforts to sell health management services to our
fitness management customers. Our cross-selling efforts may not be successful
since our experience indicates that some current customers have different
internal departments involved with procuring fitness management services, on the
one hand, and health management services on the other hand. As a result, we may
be required to establish new relationships with personnel within our customers,
which will limit the potential benefit of established relationships
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we have developed. We may also be required to overcome different purchasing
requirements and standards to the extent they vary within internal departments
of our customers. We may experience similar difficulties in cross-selling all of
our services to foreign operations of our domestic customers. If we experience
significant limitations as a result of the foregoing circumstances, or any other
circumstances, we may not be able to increase our revenues or profitability to
the extent we anticipate.
WE MAY EXPERIENCE DIFFICULTY MANAGING GROWTH, INCLUDING ATTRACTING QUALIFIED
STAFF. We have experienced substantial growth during the past few years, both
organically and by acquisition. Our ability to grow in the future will depend on
a number of factors, including the ability to obtain new customers, expand
existing customer relationships, develop additional fitness and health
improvement programs and services and hire and train qualified staff. We may
experience difficulty in attracting and retaining qualified staff in various
markets to meet growth opportunities. Further, in order to attract qualified
staff, we may be required to pay higher salaries and enhance benefits in more
competitive markets, which may result in a material adverse effect on our
results of operation and financial condition. Sustaining growth may require us
to sell our services at lower prices to remain competitive, which may result in
a material adverse effect on our results of operation and financial condition.
There can be no assurance that we will be able to manage expanding operations
effectively or that we will be able to maintain or accelerate our growth, and
any failure to do so may result in a material adverse effect on our results of
operation and financial condition.
WE ARE DEPENDENT ON MAINTAINING OUR CORPORATE RELATIONSHIPS. Our growth strategy
depends in part upon continuous development and improvement of attractive and
effective health management programs and services. Our failure to anticipate
trends or to successfully develop, improve or implement such programs or
services may have a material adverse effect on our results of operation and
financial condition. We currently contract with third party partners to provide
a portion of such programs and services and anticipate that this will continue
to be the case. If any of such third party partners no longer made these
programs and services available to us, there is no assurance that we would be
able to replace such third-party partner programs and services, and if we could
not do so, our ability to pursue our growth strategies would be seriously
compromised.
FAILURE TO RENEW EXISTING CUSTOMER CONTRACTS COULD HAVE A NEGATIVE EFFECT ON OUR
FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The majority of our contracts are
with large corporations for the management of on-site fitness centers. While the
specific terms of such agreements vary, some contracts are subject to early
termination by the corporate customer without cause. Although we have a history
of consistent contract renewals, there can be no assurance that future renewals
will be secured. The early termination or non-renewal of corporate contracts may
have a material adverse effect on our results of operation and financial
condition.
OUR FINANCIAL RESULTS ARE SUBJECT TO DISCRETIONARY SPENDING OF OUR CUSTOMERS.
Our revenue, expenses and net income are subject to general economic conditions.
A significant portion of our revenue is derived from companies who historically
have reduced their expenditures for on-site fitness management services during
economic downturns. Should the economy weaken, or experience more significant
recessionary pressures, corporate customers may reduce or eliminate their
expenditures for on-site fitness center management services, and prospective
customers may not commit resources to such services. Also, should the size of a
customer's workforce be reduced, we may have to reduce the number of staff
assigned to manage a customer's fitness center. Additionally, our operations in
Canada are subject to foreign currency risk, although these operations currently
represent less than 5% of our overall revenues. These factors may have a
material adverse effect on our results of operation and financial condition.
THE LOSS OF ANY OF OUR KEY EMPLOYEES COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR
PERFORMANCE AND RESULTS OF OPERATIONS. Our success is highly dependent on the
efforts, abilities and continued services of its executive officers and other
key employees. The loss of any of the executive officers or key employees may
have a material adverse effect on our results of operation and financial
condition. We believe that our future success will depend on our ability to
attract, motivate and retain highly-skilled
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corporate, divisional, regional and site-based personnel. Although historically
we have been successful in retaining the services of our senior management,
there can be no assurance that we will be able to do so in the future.
WE OPERATE WITHIN A HIGHLY COMPETITIVE MARKET AGAINST FORMIDABLE COMPANIES. We
compete for new and existing corporate customers in a highly fragmented and
competitive market. Management believes that our ability to compete successfully
depends on a number of factors, including quality and depth of service,
locational convenience and cost. The market for on-site fitness center
management services is price-sensitive. From time to time, we may be at a price
disadvantage with respect to the competition, as such competition may propose a
substantially lower price than us. There can be no assurance that we will be
able to compete successfully against current and future competitors, or that
competitive pressures faced by us will not have a material adverse effect on our
results of operation and financial condition.
OUR RESULTS OF OPERATIONS COULD BE ADVERSELY IMPACTED BY LITIGATION. Because of
the nature of our business, we may be subject to claims and litigation alleging
negligence or other grounds for liability arising from injuries or other harm to
our customers. We have occasionally been named a defendant in claims relating to
accidents that occurred in the fitness centers we manage. There can be no
assurance that additional claims will not be filed, and that our insurance will
be adequate to cover liabilities resulting from any claim.
WE COULD EXPERIENCE A POTENTIAL DEPRESSIVE EFFECT ON THE PRICE OF OUR COMMON
STOCK FOLLOWING THE EXERCISE AND SALE OF EXISTING CONVERTIBLE SECURITIES. At
December 31, 2005, the Company had outstanding stock options and warrants to
purchase an aggregate of 3,851,856 shares of common stock. The exercise of such
outstanding stock options and warrants and the sale of the common stock acquired
thereby, may have a material adverse effect on the price of our common stock. In
addition, the exercise of such outstanding stock options and warrants and sale
of such shares of our common stock could occur at a time when we might otherwise
be able to obtain additional equity capital on terms and conditions more
favorable to us.
WE HAVE IMPLEMENTED, ON A LIMITED BASIS, A BUSINESS MODEL FOR MANAGING CORPORATE
FITNESS CENTERS ON A COST-NEUTRAL OR FOR-PROFIT BASIS. We have, on a limited
basis, implemented a 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 we may not be successful in
sufficiently managing costs and/or in raising service levels and associated
revenues, as required to achieve profit objectives.
OUR COMMON STOCK IS THINLY TRADED, AND SUBJECT TO VOLATILITY. Our common stock
is traded on the Over the Counter Bulletin Board. Investing in OTC securities is
speculative and carries a high degree of risk. Many OTC securities are
relatively illiquid, or "thinly traded," which can enhance volatility in the
share price and make it difficult for investors to buy or sell without
dramatically affecting the quoted price or may be unable to sell a position at a
later date. As a result, an investor may find it more difficult to dispose of or
obtain accurate quotations as to the price of our shares of the common stock. If
limited trading in our stock continues, it may be difficult for investors to
sell their shares in the public market at any given time at prevailing prices.
ITEM 2. PROPERTIES
We lease approximately 10,000 square feet of commercial office space in
Bloomington, Minnesota, mostly under a lease that expires in October 2007. Our
monthly base rent for this office space is approximately $13,600, plus taxes,
insurance and other related operating costs. We also lease approximately 1,200
square feet of office space in Dallas, Texas under a lease that expires June
2008. Our minimum monthly base rent for this space is $6,222. Additionally, we
lease approximately 1,500 square feet of office space in Piscataway, New Jersey,
under a lease that expires on December 31, 2006. Our monthly rent for this
office space is $1,500.
10
ITEM 3. LEGAL PROCEEDINGS
We are, from time to time, subject to claims and suits arising in the ordinary
course of its business. Such claims have, in the past, generally been covered by
insurance. Management believes the resolution of other legal matters will not
have a material effect on our financial condition or results of operations,
although no assurance can be given with respect to the ultimate outcome of any
such actions. Furthermore, there can be no assurance that our insurance will be
adequate to cover all liabilities that may arise out of claims brought against
us.
EXECUTIVE OFFICERS OF THE REGISTRANT
Our Board of Directors has adopted a Code of Ethics & Business Conduct for all
employees and directors. A copy of this document is available on our website at
www.hfit.com, free of charge, under the Investor Relations section. We will
satisfy any disclosure requirements under Item 10 or Form 8-K regarding an
amendment to, or waiver from, any provision of the Code with respect to our
principal executive officer, principal financial officer, principal accounting
officer and persons performing similar functions by disclosing the nature of
such amendment or waiver on our website or in a report on Form 8-K.
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 of Ethics" and "Section 16(a)
Beneficial Ownership Reporting Compliance" which appear in our definitive proxy
statement for our 2006 Annual Meeting.
The names, ages and positions of our executive officers are as follows:
Name Age Position
---- --- --------
Jerry V. Noyce 61 President, Chief Executive Officer and
Director
Wesley W. Winnekins 44 Chief Financial Officer and Treasurer
Jeanne C. Crawford 48 Vice President-Human Resources and Secretary
James A. Narum 49 National Vice President of Account Services-
Fitness Management
David Hurt 40 National Vice President of Account Services-
Fitness Management
Katherine Hamlin 39 National Vice President of Account Services-
Health Management
Brian Gagne 43 Vice President-Program Services
Mike Seethaler 51 National Vice President-Business Development
Ralph Colao 51 Vice President-Health Management Consulting
Michael Zdychnec 49 Vice President-Marketing
John F. Ellis 46 Chief Information Officer
Peter A. Egan 44 Chief Science Officer
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
11
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.
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.
James A. Narum has been the Company's National Vice President of Account
Services-Fitness Management, 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.
David Hurt serves as National Vice President of Account Services-Fitness
Management, where he is responsible for the operation of accounts within the
Company's Fitness Management business area. He directs the overall development
and management of Corporate Hospital, Community, and University fitness center
operations. Mr. Hurt has been active in the industry for more than 16 years. His
experience in health and fitness management began in 1988 with the Valley
Wellness Center in Harrisonburg, Virginia. In recent years, he has been involved
in the successful development and management of several start-up fitness center
projects ranging in size from 45,000 - 150,000 square feet.
Katherine Hamlin was appointed as the Company's National Vice President of
Account Services-Health Management, in March 2005. In this role, she directs the
overall development and management of the Company's Health Management accounts.
From December 2003 to March 2005, she served as the Company's Vice President of
Marketing. Previously, Ms. Hamlin spent 15 years with the Health & Fitness
Division of Johnson & Johnson Health Care Systems Inc., a subsidiary of Johnson
& Johnson, a business acquired by the Company. Ms. Hamlin was the Director of
Marketing Services and National Sales leading business expansion in the United
States and internationally, while exploring new markets. Ms. Hamlin serves on
the board for International Council on Active Aging (ICAA), and American
Marketing Association (AMA). She is a member of the Alliance for Work Life
Progress (AWLP), National Business Group on Health (NBGH) and Wellness Councils
of America (WELCOA).
Brian Gagne has served as the Company's Vice President, Programs and
Partnerships, since December 2003. In this role, he is responsible for
establishing the direction and managing the resources that develop and deliver
the Company's branded fitness and health management programs and services. Mr.
Gagne brings more than 16 years of health, fitness and wellness experience in
the corporate, commercial and medical fitness markets. Mr. Gagne joined the
Company after the acquisition of Johnson & Johnson Health Care Systems in
December 2003. Prior to Health Fitness, he was the Director of Integrated
Behavioral Solutions and was responsible for the strategic design and
development of patient education programs and tools for the Johnson & Johnson
Family of Companies. Mr. Gagne started his career in 1987 as an Exercise
Physiologist at Gottlieb Health & Fitness Center (GHFC).
12
Mike Seethaler joined the Company as National Vice President of Business
Development in December 2003. In this role, Mr. Seethaler directs all new client
and prospective client relationships. Mr. Seethaler was formerly Sales Director,
Global Account Sales for Rockwell Automation, where he had responsibility for a
$400 million business line. During his 20 years at Rockwell, he held various
positions in training, performance, marketing, and customer support. He has been
a proven visionary with a consistent record of sales and sales management
experience in all aspects of value-added consultative selling. He also received
more than 13 awards and professional recognition for public speaking, sales
training, team building and financial performance from Rockwell.
Ralph Colao has been the Company's Vice President of Consulting and Best
Practices since December 2003. Mr. Colao leads the Company's initiatives to
expand its Health Management consulting businesses. Prior to joining the
Company, he was National Director of Operations for the Health & Fitness
Services Division of Johnson & Johnson Health Care Systems, a business acquired
by the Company. Mr. Colao has in excess of 24 years of related experience, and
is an active member of the American College of Sports Medicine and National
Business Group on Health.
Michael Zdychnec serves as the Company's Vice President of Marketing, and has
over 26 years of experience in the health care industry working directly with
consumers, health plans, employers and health care providers. Most recently, Mr.
Zdychnec was Senior Vice President of Marketing and product development for CAN
Group, a business unit within United HealthGroup. In this capacity, he was
responsible for the planning, development and launch of a consumer health and
wellness product line for the organization. Prior to joining CAN Group in 1996,
Mr. Zdychnec held a variety of senior management positions in marketing,
operations, product development and consulting with health care organizations
throughout the United States. He is a graduate of Iowa State University with his
B.S. in economics and marketing research.
John F. Ellis serves as the Company's Chief Information Officer. Mr. Ellis is
formerly the Founder and Chief Executive Officer of HealthCalc.Net, Inc., a
company we acquired in December 2005. From January 1995 to August 1999, Mr.
Ellis held a position of Senior Specialist with Perot Systems, an information
technology consulting group. From November 1989 to January 1995, Mr. Ellis held
a position of Vice President of Information Technology at People Karch
International, a health and fitness software development services firm. Mr.
Ellis holds a B.S. in Physical Education from The Citadel.
Peter A. Egan serves as the Company's Chief Science Officer. Mr. Egan is
formerly the Founder of HealthCalc.Net, Inc., a company we acquired in December
2005. From April 1994 to July 1996, Mr. Egan served as a Database Systems
Developer for Berger & Co., Dallas, Texas. From November 1993 to July 1995, Mr.
Egan served as a Database Systems Developer for Wellington Consulting, Fort Lee,
New Jersey. From March 1992 to November 1993, Mr. Egan was Director of
Development for People Karch International, Dallas, Texas and Chantilly,
Virginia. From June 1985 to March 1992, Mr. Egan was Manager of Preventative
Medicine at Sandia National Laboratories, Albuquerque, New Mexico. Mr. Egan
holds a Ph.D. in Exercise Physiology from the University of New Mexico and a
B.U.S. from the University of New Mexico in University Studies/Exercise Science.
13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
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 closing prices for the Company's common stock.
Fiscal Year 2005:
Low High
----- -----
Fourth quarter $1.95 $2.63
Third quarter 2.14 2.66
Second quarter 2.27 2.70
First quarter 2.45 2.90
Fiscal Year 2004:
Low High
----- -----
Fourth quarter $1.52 $2.95
Third quarter 1.37 1.75
Second quarter 1.40 1.90
First quarter 1.21 2.15
At March 27, 2006, the published high and low sale prices for the Company's
common stock were $2.45 and $2.35 per share respectively. On March 27, 2006,
there were issued and outstanding 18,930,368 shares of common stock of the
Company.
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.
14
ITEM 6. SELECTED FINANCIAL DATA
The data given below as of and for each of the five years in the period ended
December 31, 2005, 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,
------------------------------------------------
2005 2004 2003 2002 2001
------- ------- -------- ------- -------
STATEMENT OF OPERATIONS DATA (in thousands except per
share amounts):
REVENUE $54,942 $52,455 $ 31,479 $27,865 $25,910
NET EARNINGS (LOSS) APPLICABLE TO COMMON SHAREHOLDERS 1,204 1,588 (27) 3,001 1,806
NET EARNINGS PER COMMON SHARE:
Basic $ 0.09 $ 0.13 $ 0.00 $ 0.24 $ 0.15
Diluted $ 0.08 $ 0.10 $ 0.00 $ 0.24 $ 0.15
BALANCE SHEET DATA (in thousands):
TOTAL ASSETS $27,585 $20,934 $ 19,808 $12,956 $10,199
LONG-TERM DEBT -- $ 1,613 $ 4,350 -- --
SHAREHOLDERS' EQUITY $10,488 $11,484 $ 9,732 $ 9,079 $ 6,063
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
BUSINESS DESCRIPTION
As a leading provider of fitness and health management services and programs to
corporations, hospitals, communities and universities located in the United
States and Canada, we currently have agreements with approximately 157 customers
to manage more than 400 fitness and wellness centers, including 233 corporate
fitness centers, 61 corporate wellness programs, 12 corporate occupational
health programs, 15 hospital, commercial and university-based fitness centers
and wellness programs and 74 corporate sites that do not have full-time staff.
Approximately 70 of the Company's customers are Fortune 1000 companies.
On December 23, 2005, we acquired all of the capital stock of HealthCalc.Net,
Inc. ("HealthCalc"), a leading provider of web-based fitness, health management
and wellness programs to corporations, health care organizations, physicians and
athletic/fitness centers. Founded in 1997, and headquartered in Dallas, Texas,
HealthCalc's web-based platform provides customers with a variety of tools and
resources to identify opportunities to impact healthcare costs through lifestyle
improvement programs for individuals. In addition to other services, the
HealthCalc platform allows individuals to take periodic online health
assessments, track their daily exercise, receive online health coaching and
provide access to the latest health education and information in an
internet-based environment. We completed this acquisition to satisfy the demands
of current and potential customers regarding ownership of the technology
platform that has become increasingly important to the delivery of fitness and
health management services. By combining the best practices, programs and people
of both companies, we believe this acquisition uniquely positions us to meet the
growing demands of major corporations by providing solutions that address
employee health issues and the rising cost of corporate healthcare.
15
CRITICAL ACCOUNTING POLICIES
The following discussion and analysis of our financial condition and results of
operations is based upon our 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.
Management believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of our 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 these 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. We have 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 us based on transactions with the ultimate customer. We do
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.
We grant credit to customers in the ordinary course of business. We generally do
not require collateral or any other security to support amounts due. Management
performs ongoing credit evaluations of customers. We maintain 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. 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 - We utilize the intrinsic value method of accounting
for our 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, 2005, 2004, and 2003.
Valuation of Derivative Instruments - In accordance with the interpretive
guidance in EITF Issue No. 05-4, "The Effect of a Liquidated Damages Clause on a
Freestanding Financial Instrument Subject to EITF Issue No. 00-19, "Accounting
for Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock", we value warrants we issued in November 2005 in our
financing transaction as a derivative liability. We must make certain periodic
assumptions and estimates to value the
16
derivative liability. Factors affecting the amount of this liability include
changes in our stock price, the computed volatility of our stock price and other
assumptions. The change in value is reflected in our statements of operations as
non-cash income or expense, and the changes in the carrying value of derivatives
can have a material impact on our financial statements. For the year ended
December 31, 2005, we recognized a non-cash charge of $634,435 upon revaluation
of certain warrants that are subject to this accounting treatment. The
derivative liability associated with these warrants is reflected on our balance
sheets as a long-term liability. This warrant liability will remain until the
warrants are exercised, expire, or other events occur to cause the termination
of the derivative accounting, the timing of which may be outside our control.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2005 AND 2004
REVENUE. Revenue increased $2,487,000 or 4.7%, to $54,942,000 for 2005, from
$52,455,000 for 2004. Of this increase, $1,917,000 is attributable to an
increase in sales of our fitness and health program and consulting services, and
$570,000 is attributable to an increase in staffing revenue from health
management contracts.
GROSS PROFIT. Gross profit increased $358,000, or 2.7%, to $13,817,000 for 2005,
from $13,459,000 for 2004. Of this increase, $582,000 is attributable to growth
in our fitness and health program and consulting services. This increase was
offset by a $224,000 decrease in gross profit due primarily to higher costs for
employee medical benefits compared to 2004.
OPERATING EXPENSES AND OPERATING INCOME. Operating expenses increased $384,000,
or 3.9%, to $10,303,000 for 2005, from $9,919,000 for 2004. This increase is
primarily attributed to anticipated increases in salaries and other operating
expenses in our contract administration, programs management, sales and
corporate administration areas.
As a result of the previously discussed changes in gross profit and operating
expenses, operating income decreased $27,000, or 0.8%, to $3,514,000 for 2005,
from $3,541,000 for 2004.
OTHER INCOME AND EXPENSE. Interest expense decreased $440,000 to $26,000 for
2005, from $466,000 for 2004. This decrease is primarily due to the December
2004 repayment of our $2,000,000 Senior Subordinated Note held by Bayview
Capital Partners LP. In addition, we incurred a $475,000 one-time charge in
December 2004, of which $395,000 was non-cash, in connection with the early
repayment of the $2,000,000 Senior Secured Subordinated Note.
In December 2005, we incurred a $634,000 non-cash charge related to a change in
fair value for 1,530,000 warrants we issued in connection with the sale of $10.2
million of our Series B Convertible Preferred Stock in November 2005. Refer to
"Critical Accounting Policies", Valuation of Derivative Instrument, and the
section titled "Liquidity and Capital Resources" contained elsewhere in this
document for further discussion of the accounting we will follow for this equity
transaction.
INCOME TAXES. Current income tax expense increased $591,000 to $1,519,000 for
2005, from $928,000 for 2004. This increase is primarily attributable to the
disallowance of a tax deduction for the $634,000 non-cash charge we incurred due
to the change in fair value of warrants discussed above.
The changes in income tax expense between 2005 and 2004 had no material effect
on our cash position for 2005 due to available net operating loss carryforwards
and non-cash adjustments to tax assets.
Our effective tax rate increased to 53.0% for 2005, compared to 35.7% for 2004.
This increase is primarily attributable to the disallowance of a tax deduction
for the non-cash charge attributable to the revaluation of warrants.
17
NET EARNINGS. As a result of the above, net earnings for 2005 decreased $329,000
to $1,345,000, compared to net earnings of $1,674,000 for 2004.
DIVIDENDS TO PREFERRED SHAREHOLDERS. Dividend to preferred shareholders
increased $55,000 to $141,000 for 2005, from $86,000 for 2004. This increase is
entirely attributable to a dividend of 5% that we accrued on the $10.2 million
gross proceeds from the issuance of the Series B Convertible Preferred Stock on
November 14, 2005.
YEARS ENDED DECEMBER 31, 2004 AND 2003
REVENUE. Revenue increased $20,976,000, or 66.6%, to $52,455,000 for 2004, from
$31,479,000 for 2003. Of this increase, $18,761,000 is attributable to the
acquisition of JJHCS, and $641,000 is attributable to revenue from new
management contracts secured in 2004. Also contributing to this increase is a
$92,000 increase in consulting revenue. The remaining increase of $1,482,000 is
attributable to an increase in sales of our fitness and health improvement
program services.
GROSS PROFIT. Gross profit increased $6,924,000, or 105.9%, to $13,459,000 for
2004, from $6,535,000 for 2003. Of this increase, $6,298,000 is attributable to
growth of management and program services related to the acquisition of JJHCS.
The remaining increase of $626,000 is attributable to new management contracts
secured in 2004, as well as growth in our fitness and health improvement program
services.
OPERATING EXPENSES AND OPERATING INCOME. Operating expenses increased
$4,752,000, or 92.0%, to $9,919,000 for 2004, from $5,167,000 for 2003. Of this
increase, $805,000 represents a non-cash expense related to the amortization of
acquired intangible assets. The remaining increase of $3,947,000 is primarily
attributed to the cost of salaries, benefits and other expenses of the JJHCS
management team.
As a result of the previously discussed changes in gross profit and operating
expenses, operating income increased $2,173,000, or 158.8%, to $3,541,000 for
2004, from $1,368,000 for 2003.
OTHER INCOME AND EXPENSE. Interest expense increased $261,000 to $466,000 for
2004, from $204,000 for 2003. This increase is primarily due to the debt
facilities the Company secured to finance the JJHCS acquisition. In addition, we
incurred a $475,000 one-time charge in December 2004, of which $395,000 was
non-cash, in connection with the early repayment of a $2,000,000 Senior Secured
Subordinated Note.
INCOME TAXES. Current income tax expense increased $399,000 to $928,000 for
2004, from $529,000 for 2003. This increase is attributable to the increase in
earnings before income taxes.
The changes in income tax expense between 2004 and 2003 had no material effect
on our cash position for 2004 due to available net operating loss carryforwards.
Our effective tax rate decreased to 35.7% for 2004, compared to 45.5% for 2003.
This decrease is primarily attributable to an adjustment to deferred tax assets
relating to a change in our computation of state net operating loss utilization.
NET EARNINGS. As a result of the above, net earnings for 2004 increased
$1,041,000 to $1,674,000, compared to net earnings of $633,000 for 2003.
DIVIDENDS TO PREFERRED SHAREHOLDERS. To finance our acquisition of JJHCS, the
Company sold $1,000,000 in Series A Convertible Preferred Stock, or as referred
to herein as the Preferred Stock, to Bayview Capital Partners LP, or as referred
to herein as Bayview. The Preferred Stock was issued to
18
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, or as referred to herein as
the PIK Dividends. We accrued dividends of $86,400 and $3,834 for the years
ended December 31, 2004 and 2003.
When Bayview made its commitment to invest in the Company on August 25, 2003,
the fair value of our 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.
LIQUIDITY AND CAPITAL RESOURCES
Our working capital increased $939,000 to $4,895,000 for 2005, from $3,956,000
for 2004. This increase is largely attributable to increases in cash, accounts
receivable and prepaid expenses, which were offset by a decrease in deferred tax
assets.
In addition to cash flows generated from operating activities, our other source
of liquidity and working capital is provided by a $7,500,000 Credit Agreement
with Wells Fargo Bank, N.A. (the "Wells Loan"). At our option, the Wells Loan
bears interest at prime, or the one-month LIBOR plus a margin of 2.25% to 2.75%
based upon our Senior Leverage Ratio (effective rate of 7.25% and 5.25% at
December 31, 2005 and 2004). The availability of the Wells Loan decreases
$250,000 on the last day of each calendar quarter, beginning September 30, 2003,
and matures on June 30, 2007. Working capital advances from the Wells Loan are
based upon a percentage of our eligible accounts receivable, less any amounts
previously drawn. The facility provided maximum borrowing capacity of $5,000,000
and $6,000,000 at December 31, 2005 and 2004. Excluding current outstanding
balances, and based upon eligible accounts receivable, $5,000,000 and $3,758,851
was available for borrowing on such respective dates. All borrowings are
collateralized by substantially all of our assets. At December 31, 2005, we were
in compliance with all of our financial covenants.
On November 14, 2005 (the "Effective Date"), in a Private Investment in Public
Equity transaction (the "PIPE Transaction"), we issued an aggregate of 1,000
shares of Series B Convertible Preferred Stock (the "Series B Stock"), together
with warrants to purchase 1,530,000 shares of common stock at $2.40 per share,
to a limited number of accredited investors for aggregate gross proceeds of
$10.2 million. After selling commissions and expenses, we received net proceeds
of approximately $9.4 million. The Series B Stock automatically converts into
5,100,000 shares of our common stock upon the date the Securities and Exchange
Commission (the "SEC") first declares effective a registration statement
covering these shares. We used the proceeds from this PIPE Transaction to redeem
our Series A Convertible Preferred Stock and to fund the acquisition of
HealthCalc.Net, Inc.
In accordance with the terms of the PIPE Transaction, we were required to file
with the SEC, within sixty (60) days from the Effective Date, a registration
statement covering the common shares issued and issuable in the PIPE
Transaction. We were also required to cause the registration statement to be
declared effective on or before the expiration of one hundred twenty (120) days
from the Effective Date. We would have been subject to liquidated damages of one
percent (1%) per month of the aggregate gross proceeds ($10,200,000), if we
failed to meet these date requirements. On March 10, 2006, the SEC declared
effective our registration statement and, as a result, we did not pay any
liquidated damages for failure to meet the filing and effectiveness date
requirements. We could nevertheless be subject to the foregoing liquidated
damages if we fail to maintain the effectiveness of the registration statement.
The warrants, which were issued together with the Series B Stock, have a term of
five years, and gives the investors the option to require us to repurchase the
warrants for a purchase price, payable in cash
19
within five (5) business days after such request, equal to the Black Scholes
value of any unexercised warrant shares, only if, while the warrants are
outstanding, we initiate the following change in control transactions: (i) we
effect any merger or consolidation, (ii) we effect any sale of all or
substantially all of our assets, (iii) any tender offer or exchange offer is
completed whereby holders of our common stock are permitted to tender or
exchange their shares for other securities, cash or property, or (iv) we effect
any reclassification of our common stock whereby it is effectively converted
into or exchanged for other securities, cash or property.
Under EITF 00-19 "Accounting for Derivative Financial Instruments Indexed to,
and Potentially Settled in, a Company's Own Stock" (EITF 00-19"), the fair value
of the warrants issued under the PIPE Transaction have been reported as a
liability due to the requirement to net-cash settle the transaction. There are
two reasons for this treatment: (i) there are liquidated damages, payable in
cash, of 1% of the gross proceeds per month ($102,000) should we fail to
maintain effectiveness of the registration statement in accordance with the PIPE
Transaction; and (ii) our investors may put their warrants back to us for cash
if we initiate a change in control that meets the definition previously
discussed. On the Effective Date, the warrants had a value of approximately $1.6
million, which was determined using the Black-Scholes valuation method. The
assumptions utilized in computing the fair value of the warrants were as
follows: expected life of 5 years, estimated volatility of 61% and a risk free
interest rate of 4.54%. On the Effective Date, the Series B Stock was valued at
approximately $8.6 million, or the difference between the gross proceeds and the
value of the warrants. The warrants are considered a derivative financial
instrument and will be marked to fair value on a quarterly basis. Any changes in
fair value of the warrants will be recorded through the Consolidated Statement
of Operations as Other Income (Expense). For the three months ended December 31,
2005, we expensed $634,000 associated with the fair value adjustment of the
warrants. There was no fair value adjustment in any other periods presented.
On a short and long-term basis, we believe that sources of capital to meet our
obligations will be provided by cash generated through operations and our Wells
Loan. We do not believe that inflation has had a significant impact on our
results of operations.
The following table represents our contractual obligations at December 31, 2005:
Payments Due By Period
----------------------
Less Than 1 to 3 3 to 5 More Than
Total 1 Year Years Years 5 Years
-------- --------- -------- ------ ---------
Long-term obligations $ -- $ -- $ -- $-- $--
Operating leases 735,000 381,000 354,000 -- --
OFF-BALANCE SHEET ARRANGEMENTS
As of December 31, 2005, we have no off-balance sheet arrangements or
transactions with unconsolidated, limited purpose entities. Refer to the
footnotes of our Consolidated Financial Statements contained herein for
disclosure related to our "Commitments and Contingencies."
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 our Annual Report
to be filed with the Securities and Exchange Commission, and in other materials
filed or to be filed by us with the Securities and Exchange Commission (as well
as information included in oral statements or other written statements made or
to be made by us).
20
Forward-looking statements include all statements based on future expectations
and specifically include, among other things, all statements relating to growing
revenues and improving margins, growth of the market for corporate, hospital,
community and university-based fitness centers, the development of new business
models and our intention to expand our 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 us or on our behalf. These risks and uncertainties include, but are not
limited to those matters identified and discussed in Item 1 of this 10-K under
"Risk Factors/Forward-Looking Statements."
RECENTLY PASSED LEGISLATION
SARBANES-OXLEY. On July 30, 2002, President Bush signed into law the
Sarbanes-Oxley Act of 2002, referred to herein as 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 us. We do not
expect any material adverse effect on our business as a result of the passage of
this legislation. We expect to be in compliance with the Act by December 31,
2007.
Refer to management's certifications contained elsewhere in this report
regarding our compliance with Sections 302 and 906 of the Act.
HIPPA. The Administrative Simplification provisions of the Health Insurance
Portability and Accountability Act of 1996, referred to herein as HIPAA, require
group health plans and health care providers who conduct certain administrative
and financial transactions electronically, referred to herein as 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. Our occupational health, health risk assessment
and health coaching services, in addition to the group health plan we sponsor
for our employees, are subject to HIPAA's requirements. We expect to be in
compliance with HIPPA requirements within the timeline specified for our
affected business areas. Our corporate, hospital, community and university-based
fitness center management lines of business are not subject to the requirements
of HIPAA.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement 123R, Share-Based Payment. Statement 123R is a revision of FASB
Statement No. 123, Accounting for Stock-Based Compensation, and supercedes
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees. Statement 123R covers a wide range of share-based compensation
arrangements including share options, restricted share plans, performance-based
awards, share appreciation rights and employee share purchase plans, and
provides that the fair value of such share-based compensation be expensed in a
company's financial statements. We expect that the adoption of Statement 123R
will result in a decrease of net income in future periods due to additional
compensation expense attributed to employee stock options. We do not expect the
expense related to employee stock options to be materially different from
amounts previously disclosed on a proforma basis. We will be required to
implement Statement 123R in connection with our Quarterly Report on For 10-Q for
the period ended Mar 31, 2006.
In May 2005, the FASB issued Statement 154, Accounting Changes and Error
Corrections. Statement 154 replaces APB Opinion No. 20, Accounting Changes, and
FASB Statement 3, Reporting Accounting Changes in Interim Financial Statements.
Statement 154 is for accounting changes and corrections of
21
errors made in fiscal years beginning after December 15, 2005. Adoption of
Statement 154 is not anticipated to have an impact on our financial position or
results of operation.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have no history of, nor do we 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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our Consolidated Balance Sheets as of December 31, 2005 and 2004, and the
related Consolidated Statements of Operations, Stockholders' Equity and Cash
Flows, for each of the three years in the period ended December 31, 2005, and
the notes thereto, have been audited by Grant Thornton LLP, independent
registered public accounting firm.
CONTENTS
Page
----
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM.................. 23
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS........................................... 24
CONSOLIDATED STATEMENTS OF OPERATIONS................................. 25
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY....................... 26
CONSOLIDATED STATEMENTS OF CASH FLOWS................................. 27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS............................ 28
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS....................... 42
22
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Health Fitness Corporation
Minneapolis, Minnesota
We have audited the accompanying consolidated balance sheets of Health
Fitness Corporation and subsidiaries as of December 31, 2005 and 2004, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the three years in the period ended December 31, 2005. 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 the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform an audit of its internal
control over financial reporting. Our audit included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, 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 consolidated financial statements referred to
above present fairly, in all material respects, the financial position of Health
Fitness Corporation and subsidiaries as of December 31, 2005 and 2004, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2005, in conformity with accounting principles
generally accepted in the United States of America.
Our audits were conducted for the purpose of forming an opinion on the
basic consolidated financial statements taken as a whole. The accompanying
Schedule II of Health Fitness Corporation and subsidiaries is presented for
purposes of additional analysis and is not a required part of the basic
consolidated financial statements. This schedule has been subjected to the
auditing procedures applied in the audits of the basic consolidated financial
statements and, in our opinion, is fairly stated in all material respects in
relation to the basic consolidated financial statements taken as a whole.
/s/ Grant Thornton LLP
Minneapolis, Minnesota
March 10, 2006
23
HEALTH FITNESS CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2005 AND 2004
2005 2004
----------- -----------
ASSETS
CURRENT ASSETS
Cash $ 1,471,505 $ 241,302
Trade and other accounts receivable, less allowances of $200,700
and $210,700 at December 31, 2005 and 2004 8,839,046 8,147,430
Prepaid expenses and other 509,273 213,954
Deferred tax assets 337,800 1,660,100
----------- -----------
Total current assets 11,157,624 10,262,786
PROPERTY AND EQUIPMENT, net 347,820 150,308
OTHER ASSETS
Goodwill 12,919,689 9,022,501
Software, less accumulated amortization of $0 at December 31,
2005 and 2004 1,762,000 --
Customer contracts, less accumulated amortization of $1,626,100
and $875,700 at December 31, 2005 and 2004 188,889 854,306
Trademark, less accumulated amortization of $147,000 and $75,800
at December 31, 2005 and 2004 346,057 274,167
Other intangible assets, less accumulated amortization of
$88,000 and $81,300 at December 31, 2005 and 2004 441,086 61,493
Deferred tax assets 374,500 221,400
Other 47,105 87,015
----------- -----------
$27,584,770 $20,933,976
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Trade accounts payable $ 687,125 $ 840,155
Accrued salaries, wages, and payroll taxes 2,693,927 2,768,734
Other accrued liabilities 763,115 495,770
Accrued self funded insurance 250,000 225,500
Deferred revenue 1,868,446 1,977,093
----------- -----------
Total current liabilities 6,262,613 6,307,252
LONG-TERM OBLIGATIONS -- 1,612,759
COMMITMENTS AND CONTINGENCIES -- --
WARRANT OBLIGATION 2,210,889 --
PREFERRED STOCK, $0.01 par value; 10,000,000 shares authorized,
1,000 and 1,063,945 shares issued and outstanding at December
31, 2005 and 2004 8,623,546 1,530,232
STOCKHOLDERS' EQUITY
Common stock, $0.01 par value; 50,000,000 shares authorized;
13,787,349 and 12,582,170 shares issued and outstanding at
December 31, 2005 and 2004 137,874 125,822
Additional paid-in capital 15,625,425 17,836,675
Accumulated comprehensive income from foreign currency translation 1,245 2,459
Accumulated deficit (5,276,822) (6,481,223)
----------- -----------
10,487,722 11,483,733
----------- -----------
$27,584,770 $20,933,976
=========== ===========
See notes to consolidated financial statements.
24
HEALTH FITNESS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
2005 2004 2003
----------- ----------- -----------
REVENUE $54,942,205 $52,454,668 $31,478,822
COSTS OF REVENUE 41,125,031 38,995,451 24,943,625
----------- ----------- -----------
GROSS PROFIT 13,817,174 13,459,217 6,535,197
OPERATING EXPENSES
Salaries 5,769,082 5,600,203 3,244,639
Other selling, general and administrative 3,712,429 3,440,134 1,849,317
Amortization of acquired intangible assets 821,611 878,333 73,194
----------- ----------- -----------
Total operating expenses 10,303,122 9,918,670 5,167,150
----------- ----------- -----------
OPERATING INCOME 3,514,052 3,540,547 1,368,047
OTHER INCOME (EXPENSE)
Interest expense (25,965) (465,571) (204,430)
Interest costs - early debt repayment -- (474,669) --
Change in fair value of warrants (634,435) -- --
Other, net 10,585 1,642 (2,405)
----------- ----------- -----------
EARNINGS BEFORE INCOME TAXES 2,864,237 2,601,949 1,161,212
INCOME TAX EXPENSE 1,518,946 927,929 528,536
----------- ----------- -----------
NET EARNINGS 1,345,291 1,674,020 632,676
Deemed dividend to preferred shareholders -- -- 656,096
Dividend to preferred shareholders 140,890 86,400 3,834
----------- ----------- -----------
NET EARNINGS (LOSS) APPLICABLE TO COMMON SHAREHOLDERS $ 1,204,401 $ 1,587,620 $ (27,254)
=========== =========== ===========
NET EARNINGS PER COMMON SHARE:
Basic $ 0.09 $ 0.13 $ --
Diluted 0.08 0.10 --
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
Basic 12,780,724 12,503,345 12,332,363
Diluted 16,929,636 16,151,017 12,332,363
See notes to consolidated financial statements.
25
HEALTH FITNESS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
Common Stock Additional Accumulated Total
--------------------- Paid-in Comprehensive Accumulated Stockholders' Comprehensive
Shares Amount Capital Income Deficit Equity Income
---------- -------- ----------- ------------- ----------- ------------- -------------
BALANCE AT JANUARY 1, 2003 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
options 6,250 63 2,375 -- -- 2,438
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 translation -- -- -- 5,707 -- 5,707 5,707
---------- -------- ----------- ------- ----------- ----------- ----------
Comprehensive Income $ 638,383
==========
BALANCE AT DECEMBER 31, 2003 12,357,334 123,573 17,671,536 5,707 (8,068,843) 9,731,973
Issuance of common stock
through stock purchase plan 80,454 805 70,736 -- -- 71,541
Issuance of common stock for
options 66,100 661 34,586 -- -- 35,247
Issuance of common stock for
board of directors
compensation 40,000 400 60,200 -- -- 60,600
Issuance of common stock for
warrants 38,282 383 (383) -- -- --
Dividend to preferred
shareholders -- -- -- -- (86,400) (86,400)
Net earnings -- -- -- -- 1,674,020 1,674,020 $1,674,020
Foreign currency translation -- -- -- (3,248) -- (3,248) (3,248)
---------- -------- ----------- ------- ----------- ----------- ----------
Comprehensive Income $1,670,772
==========
BALANCE AT DECEMBER 31, 2004 12,582,170 125,822 17,836,675 2,459 (6,481,223) 11,483,733
Issuance of common stock
through stock purchase plan 89,227 892 162,116 -- -- 163,008
Issuance of common stock for
options 98,681 987 14,566 -- -- 15,553
Issuance of common stock for
acquisition 847,281 8,473 1,991,527 -- -- 2,000,000
Issuance of common stock for
warrants 169,990 1,700 (1,700) -- -- --
Net repurchase of Series A
preferred stock and
warrants -- -- (3,539,466) -- -- (3,539,466)
Payment of Series B preferred
stock financing costs -- -- (813,021) -- -- (813,021)
Reallocation of deferred
financing costs -- -- (25,272) -- -- (25,272)
Dividend to preferred
shareholders -- -- -- -- (140,890) (140,890)
Net earnings -- -- -- -- 1,345,291 1,345,291 $1,345,291
Foreign currency translation -- -- -- (1,214) -- (1,214) (1,214)
---------- -------- ----------- ------- ----------- ----------- ----------
Comprehensive Income $1,344,077
==========
BALANCE AT DECEMBER 31, 2005 13,787,349 $137,874 $15,625,425 $ 1,245 $(5,276,822) $10,487,722
========== ======== =========== ======= =========== ===========
See notes to consolidated financial statements.
26
HEALTH FITNESS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
2005 2004 2003
------------ ------------ -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 1,345,291 $ 1,674,020 $ 632,676
Adjustment to reconcile net earnings
to net cash provided by operating activities:
Common stock issued for Board of Directors compensation -- 60,600 --
Depreciation 88,663 93,030 152,538
Amortization 817,210 1,034,654 17,775
Interest on escrow account -- (2,611) (7,388)
Warrant valuation adjustment 634,435 -- --
Deferred taxes 1,169,200 655,101 449,775
Loss on disposal of assets 1,897 -- 5,796
Interest - early debt repayment -- 345,754 --
Change in assets and liabilities, net of amounts acquired:
Trade and other accounts receivable (554,637) (2,929,206) (1,181,336)
Prepaid expenses and other (295,319) (26,607) 119,387
Other assets 39,910 (22,557) 18,350
Trade accounts payable (222,537) 267,178 203,897
Accrued liabilities and other 127,031 1,204,508 529,616
Deferred revenue (175,294) 550,036 19,620
------------ ------------ -----------
Net cash provided by operating activities 2,975,850 2,903,900 960,706
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (232,485) (66,121) (89,761)
Business acquisitions, net of cash acquired (4,344,476) (296,927) (5,570,813)
Purchase of other intangible assets (7,085) -- --
------------ ------------ -----------
Net cash used in investing activities (4,584,046) (363,048) (5,660,574)
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under note payable 13,899,950 18,257,358 5,178,174
Repayments of note payable (15,512,709) (19,419,599) (4,957,763)
Proceeds from issuance of bridge note financing -- -- 3,000,000
Payment to cash escrow account -- -- (3,000,000)
Proceeds from cash escrow account -- 474,609 4,785,389
Net proceeds from issuance of preferred stock and warrants 9,386,979 -- --
Repurchase of equity securities (5,114,382) -- --
Repayments of long term obligations -- (2,000,000) --
Payment of financing costs -- -- (142,773)
Proceeds from the issuance of common stock 163,008 71,541 24,039
Proceeds from the exercise of stock options 15,553 35,247 2,438
------------ ------------ -----------
Net cash provided by (used in) financing activities 2,838,399 (2,580,844) 4,889,504
------------ ------------ -----------
NET INCREASE (DECREASE) IN CASH 1,230,203 (39,992) 189,636
CASH AT BEGINNING OF YEAR 241,302 281,294 91,658
------------ ------------ -----------
CASH AT END OF YEAR $ 1,471,505 $ 241,302 $ 281,294
============ ============ ===========
SUPPLEMENTAL CASH FLOW DISCLOSURES
Supplemental cash flow information:
Cash paid for interest $ 30,366 $ 438,111 $ 191,073
Cash paid for taxes 672,147 160,827 91,858
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 (140,890) (86,400) (3,834)
Common stock issued in business acquisition 2,000,000 -- --
Value of warrants issued to placement agents 114,191 -- --
See notes to consolidated financial statements.
27
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business - We provide fitness and health management services and programs
to corporations, hospitals, communities and universities located in the
United States and Canada. Fitness and health management services include
the development, marketing and management of corporate, hospital, community
and university based fitness centers, worksite health promotion, injury
prevention and work-injury management consulting, and on-site physical
therapy. Programs include fitness and health services 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 our Company and our wholly owned subsidiaries. All intercompany balances
and transactions have been eliminated in consolidation.
Cash - We maintain cash balances at several financial institutions, and at
times, such balances exceed insured limits. We have not experienced any
losses in such accounts and we believe we are not exposed to any
significant credit risk on cash. At December 31, 2005 and 2004, we had cash
of approximately $24,468 and $10,848 (U.S. Dollars) in a Canadian bank
account.
Trade and Other Accounts Receivable - Trade and other accounts receivable
represent amounts due from companies and individuals for services and
products. We grant credit to customers in the ordinary course of business,
but generally do not require collateral or any other security to support
amounts due. Management performs ongoing credit evaluations of customers.
Accounts receivable from sales of services are typically due from customers
within 30 to 90 days. Accounts outstanding longer than contractual payment
terms are considered past due. We determine our allowance for discounts and
doubtful accounts by considering a number of factors, including the length
of time trade accounts receivable are past due, our previous loss history,
the customer's current ability to pay its obligation to us, and the
condition of the general economy and the industry as a whole. We write 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. We
had bad debt expense of $3,870, $104,961 and $40,500 for the periods ended
December 31, 2005, 2004 and 2003.
Property and Equipment - Property and equipment are 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. 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. We elected to complete the annual
impairment test of goodwill on December 31 each year and determined that
our goodwill relates to one reporting unit for purposes of impairment
testing. We determined that there was no impairment of goodwill at December
31, 2005, 2004 and 2003.
28
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
Intangible Assets - Our intangible assets include customer contracts,
trademarks and tradenames, software and other intangible assets, all of
which are amortized on a straight-line basis. Customer contracts represent
the fair value assigned to acquired management contracts, which are
amortized over the remaining life of the contracts, approximately 13-23
months. Trademark and tradenames represent the value assigned to acquired
trademarks and tradenames, and are amortized over a period of five years.
Software represents the value assigned to an acquired web-based software
program and is amortized over a period of five years. Other intangible
assets include the value assigned to acquired customer lists, which is
amortized over a period of six years, as well as deferred financing costs,
which are amortized over the term of the related credit agreement.
Amortization expense for intangible assets totaled $817,210, $955,422, and
$83,800 for the twelve months ended December 31, 2005, 2004, and 2003.
Expected future amortization of intangible assets is as follows:
Years ending December 31
2006 $719,094
2007 526,843
2008 517,477
2009 451,433
Thereafter 523,267
Revenue Recognition - Revenue is recognized at the time the service is
provided to the customer. We determine our allowance for discounts by
considering historical discount history and current payment practices of
our customers. 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 these services are estimated in the month that the
service is performed. Accounts receivable related to estimated revenues
were $1,283,979 and $593,715 at December 31, 2005 and 2004.
We also provide services to companies located in Canada. Revenue recognized
from our Canadian customers totaled approximately $277,600, $253,200 and
$93,600 for the periods ended December 31, 2005, 2004 and 2003. Although we
invoice these customers in their local currency, we do not believe there is
a risk of material loss due to foreign currency translation.
Amounts received from customers in advance of providing contracted services
are treated as deferred revenue and recognized when the services are
provided. Accounts receivable relating to deferred revenue were $1,868,446
and $1,935,964 at December 31, 2005 and 2004.
We have 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 us based on transactions with the ultimate customer. We do
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.
Amounts received from new customers for website activation fees are treated
as deferred revenue and recognized over a period of three years, which is
the estimated life of a new customer.
29
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
Advertising - The Company expenses advertising costs as they are incurred.
Advertising expense for the periods ended December 31, 2005, 2004 and 2003
was $119,364, $118,074 and $79,218.
Comprehensive Income - Comprehensive income is net earnings plus certain
other items that are recorded directly to stockholders' equity. Our
comprehensive income represents net earnings adjusted for foreign currency
translation adjustments. Comprehensive income is disclosed in the
consolidated statement of stockholders' equity.
Net Earnings Per Common Share - Basic net earnings per common share is
computed by dividing net earnings applicable to common shareholders by the
number of basic weighted average common shares outstanding. Diluted net
earnings per common share is computed by dividing net earnings applicable
to common shareholders plus dividends to preferred shareholders by the
number of diluted weighted average common shares outstanding, which
includes common share equivalents relating to stock options and stock
warrants, when dilutive, and convertible preferred stock.
Common stock options and warrants to purchase 517,163, 400,100 and 491,000
shares of common stock with weighted average exercise prices of $2.78,
$2.54 and $1.92 were excluded from the 2005, 2004 and 2003 diluted
computation because they are anti-dilutive.
Stock-Based Compensation - We utilize the intrinsic value method of
accounting for our 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, 2005, 2004, and
2003. The following table illustrates the effect on net earnings and
earnings per share if we had applied the fair value method to its
stock-based compensation plans.
2005 2004 2003
----------- ----------- -----------
Net earnings applicable
to common shareholders -
basic $ 1,204,401 $ 1,587,620 $ (27,254)
Add: Dividends to
preferred shareholders 140,890 86,400 --
----------- ----------- -----------
Net earnings - diluted 1,345,291 1,674,020 (27,254)
----------- ----------- -----------
Less: Compensation
expense determined under
the fair value method,
net of tax (187,898) (171,500) (76,040)
----------- ----------- -----------
Proforma net earnings, basic $ 1,016,503 $ 1,416,120 $ (103,294)
=========== =========== ===========
Proforma net earnings, diluted $ 1,157,393 $ 1,502,520 $ (103,294)
=========== =========== ===========
Net earnings per common share:
Basic-as reported $ 0.09 $ 0.13 $ 0.00
=========== =========== ===========
Basic-proforma $ 0.08 $ 0.11 $ (0.01)
=========== =========== ===========
Diluted-as reported $ 0.08 $ 0.10 $ 0.00
=========== =========== ===========
Diluted-proforma $ 0.07 $ 0.09 $ (0.01)
=========== =========== ===========
The proforma information above should be read in conjunction with the
related historical information.
30
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
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:
2005 2004 2003
------------ ------------ -------------
Dividend yield None None None
Expected volatility 56%-78% 88% 88.4%-105.0%
Expected life of option 1 to 4 years 1 to 4 years 1 to 4 years
Risk-free interest rate 2.43%-3.85% 3.3% 2.90%-3.27%
Weighted average fair value
of options on grant date $1.24 $1.02 $0.48
Fair Values of Financial Instruments - Due to their short-term nature, the
carrying value of our 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.
Valuation of Derivative Instruments - In accordance with the interpretive
guidance in EITF Issue No. 05-4, "The Effect of a Liquidated Damages Clause
on a Freestanding Financial Instrument Subject to EITF Issue No. 00-19,
"Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company's Own Stock", we value certain warrants
we have issued in connection with certain equity financings that we have
completed as a derivative liability. We must make certain periodic
assumptions and estimates to value our derivative liability. Factors
affecting the amount of this liability include changes in our stock price,
the computed volatility of our stock price and other assumptions. The
change in value is reflected in our statements of operations as non-cash
income or expense, and the changes in the carrying value of derivatives can
have a material impact on our financial statements. For the year ended
December 31, 2005, we recognized a non-cash charge of $634,435 upon
revaluation of certain warrants that are subject to this accounting
treatment. The derivative liability associated with these warrants is
reflected on our balance sheets as a long-term liability. This warrant
liability will remain until the warrants are exercised, expire, or other
events, the timing of which may be outside our control.
Income Taxes - 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.
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.
31
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
2. FINANCING
On November 14, 2005 (the "Effective Date"), in a Private Investment in
Public Equity transaction (the "PIPE Transaction"), we issued an aggregate
of 1,000 shares of Series B Convertible Preferred Stock (the "Series B
Stock"), together with warrants to purchase 1,530,000 shares of common
stock at $2.40 per share, to a limited number of accredited investors for
aggregate gross proceeds of $10.2 million. After selling commissions and
expenses, we received net proceeds of approximately $9.4 million. The
Series B Stock automatically converts into 5,100,000 shares of our common
stock upon the date the Securities and Exchange Commission (the "SEC")
first declares effective a registration statement covering these shares.
Each share of Series B Stock is entitled to a number of votes equal to the
number of shares of common stock into which it is then convertible. Except
as required by law, holders of Series B Stock vote together as one class,
together with holders of common stock. Each share of Series B Stock has a
stated dividend rate of 5% per year calculated based upon the initial share
issuance price of $10,200. We used the proceeds from this PIPE Transaction
to redeem our Series A Convertible Preferred Stock and to fund the
acquisition of HealthCalc.Net, Inc.
In accordance with the terms of the PIPE Transaction, we were required to
file with the SEC, within sixty (60) days from the Effective Date, a
registration statement covering the common shares issued and issuable in
the PIPE Transaction. We were also required to cause the registration
statement to go effective on or before the expiration of one hundred twenty
(120) days from the Effective Date. We would have been subject to
liquidated damages of one percent (1%) per month of the aggregate gross
proceeds ($10,200,000), if we failed to meet these date requirements. On
March 10, 2006, the SEC declared effective our Form S-1 registration
statement and, as a result, we did not pay any liquidated damages for
failure to meet the filing and effectiveness date requirements. We could
nevertheless be subject to the foregoing liquidated damages if we fail to
maintain the effectiveness of the registration statement.
The warrants, which were issued together with the Series B Stock, have a
term of five years, and gives the investors the option to require us to
repurchase the warrants for a purchase price, payable in cash within five
(5) business days after such request, equal to the Black Scholes value of
any unexercised warrant shares, only if, while the warrants are
outstanding, we initiate the following change in control transactions: (i)
we effect any merger or consolidation, (ii) we effect any sale of all or
substantially all of our assets, (iii) any tender offer or exchange offer
is completed whereby holders of our common stock are permitted to tender or
exchange their shares for other securities, cash or property, or (iv) we
effect any reclassification of our common stock whereby it is effectively
converted into or exchanged for other securities, cash or property.
Under EITF 00-19 "Accounting for Derivative Financial Instruments Indexed
to, and Potentially Settled in, a Company's Own Stock" (EITF 00-19"), the
fair value of the warrants issued under the PIPE Transaction have been
reported as a liability due to the requirement to net-cash settle the
transaction. There are two reasons for this treatment: (i) there are
liquidated damages, payable in cash, of 1% of the gross proceeds per month
($102,000) should we fail to maintain effectiveness of the registration
statement in accordance with the PIPE Transaction; and (ii) our investors
may put their warrants back to us for cash if we initiate a change in
control that meets the definition previously discussed.
32
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
On the Effective Date, the warrants had a fair value of approximately $1.6
million, which was determined using the Black-Scholes valuation method. The
assumptions utilized in computing the fair value of the warrants were as
follows: expected life of 5 years, estimated volatility of 61% and a risk
free interest rate of 4.54%. On the Effective Date, the Series B Stock was
valued at approximately $8.6 million, or the difference between the gross
proceeds and the fair value of the warrants. The warrants are considered a
derivative financial instrument and will be marked to fair value on a
quarterly basis. Any changes in fair value of the warrants will be recorded
through the Consolidated Statement of Operations as Other Income (Expense).
For the three months ended December 31, 2005, we expensed $634,000
associated with the fair value adjustment of the warrants. There was no
fair value adjustment in any other periods presented.
3. REPURCHASE OF EQUITY SECURITIES
On November 15, 2005, using part of the proceeds from our PIPE Transaction,
we redeemed all of the outstanding shares of our Series A Convertible
Preferred Stock sold to Bayview Capital Partners LP ("Bayview"), which were
convertible into 2,222,210 shares of common stock, and warrants to purchase
1,213,032 shares of common stock if exercised for cash, or 916,458 shares
of common stock if exercised on a "cash-less" basis. The total cash we used
to make this repurchase was approximately $5.1 million. At December 31,
2005, Bayview held warrants to purchase an additional 62,431 shares of
common stock at exercise prices ranging from $2.24 to $2.70 per share,
which were obtained in connection with anti-dilution rights. We did not
repurchase these shares as they were out-of-the-money.
4. BUSINESS ACQUISITION
On December 23, 2005, using substantially all of the remaining proceeds
from our PIPE Transaction, we acquired all of the capital stock of
HealthCalc. Net, Inc, a leading provider of web-based fitness, health
management and wellness programs. We purchased HealthCalc because we
believe their proven technology platform will play a very important role in
the overall growth strategy related to the corporate health management area
of our business. We paid $3.9 million in cash and issued $2 million in
common stock, representing 847,281 shares, to HealthCalc's shareholders.
We may become obligated to pay or issue, as the case may be, an additional
amount of up to $2 million in cash, common stock, or a combination thereof,
to HealthCalc's shareholders under a 12-month earn-out formula based upon
revenue generated from HealthCalc's business during fiscal year 2006. When
the requirements of the earn-out formula are met, additional payments to
HealthCalc's shareholders will be accounted for as additional goodwill.
We accounted for this acquisition using the purchase method of accounting.
The fair market value of the assets acquired resulted in the following
purchase price allocation:
Cash price paid $3,934,108
Common stock issued 2,000,000
Acquisition costs 517,555
Cash acquired (107,187)
Liabilities assumed 159,277
----------
Total purchase price $6,503,753
==========
33
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
Purchase Price Allocation
Accounts receivable $ 136,978
Property and equipment 55,587
Software 1,762,000
Customer contracts 85,000
Trademark/Tradenames 136,000
Other intangibles (customer lists) 431,000
Excess of cost over assets acquired 3,897,188
----------
$6,503,753
==========
The following unaudited pro forma condensed consolidated results of
operations have been prepared as if the acquisition of HealthCalc had
occurred as of January 1, 2004:
Years Ended December 31
-------------------------
2005 2004
----------- -----------
Net revenues $56,574,309 $54,084,358
Net earnings 1,687,863 1,345,796
Net earnings to common shareholders 1,546,973 1,259,396
Net earnings per common share:
Basic $ 0.11 $ 0.09
Diluted $ 0.10 $ 0.08
Weighted average common shares outstanding
Basic 13,607,113 13,350,626
Diluted 17,756,025 16,998,298
The unaudited pro forma condensed consolidated results of operations are
not necessarily indicative of results that would have occurred had the
acquisition occurred as of January 1, 2004, nor are they necessarily
indicative of the results that may occur in the future.
5. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31:
Useful Life 2005 2004
------------- ---------- ----------
Leasehold improvements Term of lease $ 11,757 $ 11,757
Office equipment 3-7 years 1,243,844 1,075,003
Software 3 years 218,295 170,406
Health care equipment 1-5 years 453,583 388,850
---------- ----------
1,927,479 1,646,016
Less accumulated depreciation and amortization 1,579,659 1,495,708
---------- ----------
$ 347,820 $ 150,308
========== ==========
34
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
6. LONG-TERM OBLIGATIONS
Our primary source of liquidity and working capital is provided by a
$7,500,000 Credit Agreement with Wells Fargo Bank, N.A. (the "Wells Loan").
At our option, the Wells Loan bears interest at prime, or the one-month
LIBOR plus a margin of 2.25% to 2.75% based upon our Senior Leverage Ratio
(effective rate of 7.25% and 5.25% at December 31, 2005 and 2004). The
availability of the Wells Loan decreases $250,000 on the last day of each
calendar quarter, beginning September 30, 2003, and matures on June 30,
2007. Working capital advances from the Wells Loan are based upon a
percentage of our eligible accounts receivable, less any amounts previously
drawn. The facility provided maximum borrowing capacity of $5,000,000 and
$6,000,000 at December 31, 2005 and 2004. Excluding current outstanding
balances, and based upon eligible accounts receivable, $5,000,000 and
$3,758,851 was available for borrowing on such respective dates. All
borrowings are collateralized by substantially all of our assets.
At December 31, 2005 and 2004, we had a balance owing of $0 and $1,612,759,
respectively. At December 31, 2005 and 2004, we were in compliance with all
financial loan covenants.
7. COMMITMENTS AND CONTINGENCIES
Leases - We lease office space and equipment under various operating
leases. In addition to base rental payments, these leases require us to pay
a proportionate share of real estate taxes, special assessments, and
maintenance costs. The lease for our corporate headquarters, as well as the
office lease for HealthCalc, has escalating lease payments through 2007 and
2008. Costs incurred under operating leases are recorded as rent expense
and totaled approximately $302,000, $271,000 and $162,000 for the years
ended December 31, 2005, 2004 and 2003.
Minimum rent payments due under operating leases are as follows:
Years ending December 31:
2006 $381,000
2007 291,000
2008 62,000
2009 1,000
Thereafter --
Legal Proceedings - We are involved in various claims and lawsuits incident
to the operation of our business. We believe that the outcome of such
claims will not have a material adverse effect on our financial condition,
results of operation, or cash flows.
8. BENEFIT PLAN
We maintain 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 contribute up to 15% of their
earnings. We may make certain matching contributions, which were
approximately $261,000, $277,000 and $140,000 for the years ended December
31, 2005, 2004 and 2003.
35
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
9. EQUITY
Stock Options - We maintain a stock option plan for the benefit of certain
eligible employees and our directors. A total of 1,160,600 shares of common
stock are reserved for additional grants of options under the plan at
December 31, 2005. Generally, the options outstanding are granted at prices
equal to the market value of the stock on the date of grant, vest over
various terms and 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, 2003 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
Granted 320,100 1.87
Exercised (66,100) 0.53
Forfeited (43,350) 0.54
--------- -----
Outstanding at December 31, 2004 1,921,550 1.06
Granted 357,500 2.58
Exercised (109,625) 0.39
Forfeited (12,000) 1.94
--------- -----
Outstanding at December 31, 2004 2,157,425 $1.34
========= =====
Weighted
Number of Average
Shares Exercise Price
--------- --------------
Options exercisable at December 31:
2005 1,520,900 $1.18
2004 1,249,450 $1.05
2003 947,575 $1.05
36
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
The following table summarizes information about stock options at December
31, 2005:
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 - $0.39 406,750 1.76 $0.33 323,950 $0.32
0.47 - 0.69 597,325 2.45 0.56 537,425 0.56
0.95 - 1.25 282,750 4.64 1.17 165,750 1.16
1.26 - 2.27 330,100 4.42 1.88 181,275 1.70
2.28 - 3.00 540,500 3.83 2.74 312,500 2.82
--------- ---------
2,157,425 3.25 $1.34 1,520,900 $1.18
========= =========
Employee Stock Purchase Plan - We maintain an Employee Stock Purchase Plan,
which allows employees to purchase shares of our common stock at 90% of the
fair market value. A total of 700,000 shares of common stock are reserved
for issuance under this plan, of which 182,134 shares are unissued and
remain available for issuance at December 31, 2005. There were 89,227,
80,454 and 53,423 shares issued under the plan during 2005, 2004 and 2003.
Warrants - We have outstanding warrants to selling agents and investors
that were issued in connection with financing transactions.
In November 2005, we repurchased a warrant issued to Bayview representing
1,210,320 shares of common stock, which were converted on a cashless basis
into 916,458 shares of common stock. At various times during 2005, Bayview
was issued additional warrants, in connection with anti-dilution rights, to
purchase a total of 65,143 shares of common stock. These warrants have
exercise prices ranging from $0.50 to $2.70 per share, and are exercisable
at any time for a period of six years.
In December 2003, a warrant to purchase 100,000 shares of common stock, at
an exercise price equal to $0.50 per share, was issued to Goldsmith, Agio,
Helms Securities, Inc. for broker services provided to us in connection
with an acquisition, which are exercisable at any time for a period of five
years. In July 2005, these warrants were converted on a cashless basis into
78,723 shares of common stock.
In November 2005, we issued warrants to purchase 1,530,000 shares of common
stock, at an exercise price equal to $2.40 per share, to investors in our
PIPE transaction, which are exercisable at any time for a period of five
years. At the same time, we issued warrants to purchase 102,000 shares of
common stock, at an exercise price of $2.00 per share, to placement agents,
which are exercisable at any time for a period of five years.
37
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
A summary of the stock warrants activity is as follows:
Exercise
Number of Price
Shares Per Share
---------- ------------
Outstanding at January 1, 2003 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
Exercised (38,282) 0.30
Forfeited (6,718) 0.30
----------
Outstanding at December 31, 2004 1,415,320 0.30 - 0.50
Granted 1,697,143 0.50 - 2.70
Exercised (1,086,448) 0.30 - 0.50
Forfeited (331,584) 0.30 - 0.50
----------
Outstanding at December 31, 2005 1,694,431 2.00 - 2.70
==========
Warrants exercisable at December 31:
2005 1,694,431 $2.00 - 2.70
2004 1,415,320 0.30 - 0.50
2003 1,460,320 0.30 - 0.50
10. INCOME TAXES
Income tax expense (benefit) consists of the following:
2005 2004 2003
---------- -------- --------
Current $ 412,346 $272,828 $ 78,761
Deferred 1,106,600 655,101 449,775
---------- -------- --------
$1,518,946 $927,929 $528,536
========== ======== ========
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:
2005 2004 2003
---------- --------- --------
Tax expense computed at statutory rates $ 973,800 $ 884,700 $394,800
State tax benefit, net of federal effect 205,800 154,600 51,800
Nondeductible warrant expense 215,700 -- --
Adjustment to income tax provision accruals 110,700 (199,700) 76,000
Other 12,946 88,329 5,936
---------- --------- --------
$1,518,946 $ 927,929 $528,536
========== ========= ========
38
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
At December 31, 2005, we had no remaining federal operating loss
carryforwards. For 2005, 2004 and 2003, federal operating loss
carryforwards were used to reduce federal taxes payable by approximately
$1,091,000, $1,030,000 and $440,000.
The components of deferred tax assets at December 31 consist of the
following:
2005 2004
-------- ----------
Current:
Allowances $ 8,200 $ 39,200
Accrued employee benefits 185,300 179,300
Tax loss carryforwards 144,300 1,441,600
-------- ----------
Net current asset $337,800 $1,660,100
======== ==========
Noncurrent:
Depreciation and amortization $374,500 $ 221,400
======== ==========
11. ACCOUNTING PRONOUNCEMENTS
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement 123R, Share-Based Payment. Statement 123R is a revision of FASB
Statement No. 123, Accounting for Stock-Based Compensation, and supercedes
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees. Statement 123R covers a wide range of share-based compensation
arrangements including share options, restricted share plans,
performance-based awards, share appreciation rights and employee share
purchase plans, and provides that the fair value of such share-based
compensation be expensed in a company's financial statements. We expect
that the adoption of Statement 123R will result in a decrease of net income
in future periods due to additional compensation expense attributed to
employee stock options. We do not expect the expense related to employee
stock options to be materially different from amounts previously disclosed
on a proforma basis. We will be required to implement Statement 123R in
connection with our Quarterly Report on For 10-Q for the period ended March
31, 2006.
In May 2005, the FASB issued Statement 154, Accounting Changes and Error
Corrections. Statement 154 replaces APB Opinion No. 20, Accounting Changes,
and FASB Statement 3, Reporting Accounting Changes in Interim Financial
Statements. Statement 154 is for accounting changes and corrections of
errors made in fiscal years beginning after December 15, 2005. Adoption of
Statement 154 is not anticipated to have an impact on our financial
position or results of operation.
39
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
12. SIGNIFICANT CUSTOMER RELATIONSHIP
At December 31, 2005 and 2004, we had one customer relationship that
provided 11.9% and 10.3%, respectively, of our total revenue. For this
customer, we provide fitness center management and wellness program
administration services for approximately 53 locations. The agreement
expires December 31, 2006, and will automatically renew for successive one
year periods unless either party delivers written notice at least 90 days
prior to termination. We believe that our relationship with this customer
is good.
13. RELATED PARTY TRANSACTION
In December 2003, we entered into a services agreement with K. James Ehlen,
M.D., a member of our Board of Directors. The scope of services he provides
to us includes serving as our Medical Advisor, and supporting the
development of our strategy for corporate health management services. For
2005, 2004 and 2003, Dr. Ehlen was paid $66,336, $100,000 and $10,000 for
his services.
14. SUBSEQUENT EVENT
On March 10, 2006, the Securities and Exchange Commission declared
effective the Form S-1 registration statement we filed to register the
underlying common stock related to the Series B Stock and warrants we
issued to investors in November 2005. As a result of this declaration, the
1,000 shares of Series B Stock were converted into 5.1 million shares of
our common stock. In connection with this conversion, and in accordance
with EITF 98-5, Accounting for Convertible Securities with Beneficial
Conversion Features or Contingently Adjustable Conversion Ratios, we will
record a deemed dividend to preferred shareholders of $1,576,454, which is
attributable to us satisfying the contingency related to registration. We
will reflect this deemed dividend in our statement of operations for the
three-months ending March 31, 2006.
40
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
15. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Quarter ended
--------------------------------------------------------
March 31, June 30, September 30, December 31,
----------- ----------- ------------- ------------
2005
Revenue $13,465,101 $13,678,615 $13,464,278 $14,334,211
Gross profit 3,441,802 3,450,616 3,498,814 3,425,942
Net earnings (loss) applicable to common shareholders
627,934 498,183 506,488 (428,204)
Net earnings (loss) per common share
Basic $ 0.05 $ 0.04 $ 0.04 $ (0.03)
Diluted 0.04 0.03 0.03 (0.03)
Weighted average common shares outstanding
Basic 12,619,603 12,652,370 12,836,971 13,008,291
Diluted 16,614,522 16,618,997 16,662,753 13,008,291
Quarter ended
--------------------------------------------------------
March 31, June 30, September 30, December 31,
----------- ----------- ------------- ------------
2004
Revenue $12,666,374 $13,129,715 $13,154,340 $13,504,239
Gross profit 3,086,937 3,442,358 3,347,083 3,582,839
Net earnings applicable to common shareholders 336,707 470,754 465,164 314,995
Net earnings per common share
Basic $ 0.03 $ 0.04 $ 0.04 $ 0.03
Diluted 0.02 0.03 0.03 0.02
Weighted average common shares outstanding
Basic 12,409,619 12,483,979 12,550,679 12,566,735
Diluted 16,038,913 16,066,003 16,122,175 16,349,043
41
HEALTH FITNESS CORPORATION
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
Charged to
Balance at Charged to Other Balance
Beginning Costs and accounts Deductions at End
Description of Period Expenses Describe Describe of Period
----------- ---------- ---------- ---------- ---------- ---------
Trade and other accounts receivable allowances:
Year ended December 31, 2005 $210,700 $12,400 -- $(22,400)(a) $200,700
Year ended December 31, 2004 131,000 79,700 -- -- (a) 210,700
Year ended December 31, 2003 88,900 61,500 -- (19,400)(a) 131,000
(a) Accounts receivable written off as uncollectible
42
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Our Chief Executive Officer and Chief Financial Officer, referred to
collectively herein as the Certifying Officers, are responsible for establishing
and maintaining disclosure controls and procedures for us. 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 our
disclosure controls and procedures are effective to ensure that information
required to be disclosed by us in this report is accumulated and communicated to
the our 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 our 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.
ITEM 9B. OTHER INFORMATION
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Other than "Executive Officers of the Registrant," which is set forth at
the end of Part I of this Form 10-K, the information required by Item 10 is
incorporated by reference to the section entitled "Corporate Governance,"
"Executive Compensation" and "Section 16(a) Beneficial Ownership Reporting
Compliance," which appears in our definitive proxy statement for our 2006 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 our definitive
proxy statement for our 2006 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 our definitive proxy statement for our 2006 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 our definitive
proxy statement for our 2006 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 2006 Annual Meeting.
43
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(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, 2005 and 2004
and for each of the three years in the period ended December 31,
2005
Consolidated Balance Sheets as of December 31, 2005 and 2004
Consolidated Statements of Earnings for each of the three years
in the period ended December 31, 2005
Consolidated Statements of Shareholders' Equity for each of the
three years in the period ended December 31, 2005
Consolidated Statements of Cash Flows for each of the three years
in the period ended December 31, 2005
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
44
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this Report on Form 10-K to be signed
on its behalf by the undersigned, thereunto duly authorized.
Dated: March 30, 2006
HEALTH FITNESS CORPORATION
By /s/ Jerry V. Noyce By /s/ Wesley W. Winnekins
---------------------------------- -------------------------------------
Jerry V. Noyce Wesley W. Winnekins
Chief Executive Officer Chief Financial Officer
POWER OF ATTORNEY
Each person whose signature appears below constitutes JERRY V. NOYCE and
WESLEY W. WINNEKINS his true and lawful attorneys-in-fact and agents, each
acting alone, with full power of substitution and resubstitution, for him and in
his name, place and stead, in any and all capacities, to sign any or all
amendments to this Annual Report on Form 10-K 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, each acting alone, 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 said attorneys-in-fact and agents,
each acting alone, or his substitute or substitutes, may lawfully do or cause to
be done by virtue thereof. 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 in the capacities and on the dates indicated.
Signatures Title
---------- -----
/s/ Jerry V. Noyce Chief Executive Officer, March 30, 2006
------------------------------ President (principal executive
Jerry V. Noyce officer) and Director
/s/ Wesley W. Winnekins Chief Financial Officer March 30, 2006
------------------------------ (principal financial and
accounting officer)
/s/ James A. Bernards Director March 30, 2006
------------------------------
/s/ K. James Ehlen, M.D. Director March 30, 2006
------------------------------
/s/ Robert J. Marzec Director March 30, 2006
------------------------------
/s/ Cary Musech Director March 30, 2006
------------------------------
/s/ John C. Penn Director March 30, 2006
------------------------------
/s/ Mark W. Sheffert Director March 30, 2006
------------------------------
/s/ Linda Hall Whitman Director March 30, 2006
------------------------------
/s/ Rodney A. Young Director March 30, 2006
------------------------------
45
EXHIBIT INDEX
HEALTH FITNESS CORPORATION
FORM 10-K
Exhibit No. Description
----------- -----------
3.1 Articles of Incorporation, as amended on September 20, 2004 -
incorporated by reference to the Company's Annual Report on Form
10-K for the year ended December 31, 2004
3.2 Certificate of Designation, Preferences and Rights of Series A
Convertible Preferred Stock - incorporated by reference to the
Company's Registration Statement on Form S-1 (No. 333-131045)
filed January 13, 2006
3.3 Certificate of Designation, Preferences and Rights of Series B
Convertible Preferred Stock - incorporated by reference to the
Company's Form 8-K filed November 16, 2005
3.4 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 2005 Stock Option Plan - incorporated by reference to
the Company's Form 8-K dated June 7, 2005
*10.5 Forms of Incentive Stock Option Agreement and Form of
Non-Qualified Stock Option Agreement under the 2005 Stock Option
Plan - incorporated by reference to the Company's For 8-K dated
June 7, 2005
*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 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
*10.8 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
*10.9 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
*10.10 Employment agreement dated December 8, 2003 between the Company
and Brian Gagne - incorporated by reference to the Company's Form
10-Q for the quarter ended March 31, 2005
*10.11 Employment agreement dated December 22, 2003 between the Company
and Michael Seethaler - incorporated by reference to the Company's
Form 10-Q for the quarter ended March 31, 2005
46
Exhibit No. Description
----------- -----------
**10.12 Employment agreement dated August 13, 2001 between the Company
and Dave Hurt
**10.13 Employment agreement dated December 8, 2003 between the Company
and Katherine Hamlin
**10.14 Employment agreement dated December 8, 2003 between the Company
and Ralph Colao
**10.15 Employment agreement dated May 4, 2005 between the Company and
Michael Zdychnec
**10.16 Employment agreement dated December 23, 2005 between the Company
and John F. Ellis
**10.17 Employment agreement dated December 23, 2005 between the Company
and Peter A. Egan
10.18 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-Q for the quarter
ended September 30, 2003
10.19 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-Q for the quarter ended September 30,
2003
10.20 Second Amendment to Credit Agreement and Waiver of Defaults
between the Company and Wells Fargo Bank, N.A., dated May 14, 2004
- incorporated by reference to the Company's Quarterly Report on
form 10-Q for the quarter ended March 31, 2004
10.21 Third Amendment to Credit Agreement and Consent between the
Company and Wells Fargo Bank, N.A., dated December 29, 2004 -
incorporated by reference to the Company's Annual Report on Form
10-K for the year ended December 31, 2004
10.22 Securities Purchase Agreement dated November 14, 2005 between the
Company and the Purchasers listed on Exhibit A-1 - incorporated by
reference to the Company's For 8-K filed November 16,2005
10.23 Registration Rights Agreement dated November 14, 2005 between the
Company and the Purchasers listed on Exhibit A-1 - incorporated by
reference to the Company's Form 8-K filed November 16, 2005
10.24 Form of Warrant issued pursuant to the Securities Purchase
Agreement dated November 14, 2005 - incorporated by reference to
the Company's Form 8-K filed November 16, 2005
10.25 Stock Purchase Agreement dated December 23, 2005 between the
Company, HealthCalc.Net, Inc., Peter A. Egan and John F. Ellis,
among others - incorporated by reference to the Company's Form 8-K
filed on December 29, 2005
10.26 Escrow Agreement dated December 23, 2005 between the Company,
Wells Fargo Bank, National Association, Peter A. Egan and John F.
Ellis, among others - incorporated by reference to the Company's
Form 8-K filed December 29, 2005
10.27 Shareholders' Agreement dated December 23, 2005 between the
Company, Peter A. Egan and John F. Ellis - incorporated by
reference to the Company's Form 8-K filed December 29, 2005
**10.28 Director Compensation Arrangements
**10.29 2006 Executive Bonus Plan
**10.30 Compensation Arrangements for Executive Officer for Fiscal Year
2006
**11.0 Statement re: Computation of Earnings per Share
21.1 Subsidiaries - incorporated by reference to the Company's Annual
Report on Form 10-K for the year ended December 31, 2004
**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
47
Exhibit No. Description
----------- -----------
**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
(1) Previously Filed
48