FILED PURSUANT TO RULE 424(b)(3)
REGISTRATION NO. 333-131045
PROSPECTUS SUPPLEMENT NO. 5
(TO PROSPECTUS DATED APRIL 10, 2006)
HEALTH FITNESS CORPORATION
6,681,000 SHARES OF COMMON STOCK
This Prospectus Supplement No. 5 should be read in conjunction with the
prospectus dated April 10, 2006 (as previously supplemented by prospectus
supplements dated April 11, 2006, May 16, 2006, August 14, 2006 and September
28, 2006, collectively, the "Prospectus") relating to the offer and sale from
time to time by the selling shareholders identified in the Prospectus of up to
6,681,000 shares of the common stock of Health Fitness Corporation. We will not
receive any of the proceeds from the sale of the common stock covered by the
Prospectus.
On November 14, 2006, we filed with the U.S. Securities and Exchange
Commission the attached Quarterly Report for the three and six month periods
ended September 30, 2006.
The information contained in this Prospectus Supplement No. 5,
including the information attached hereto, supplements and supersedes, in part,
the information contained in the Prospectus. This Prospectus Supplement No. 5
should be read in conjunction with the Prospectus, and is qualified by reference
to the Prospectus except to the extent that the information in this Prospectus
Supplement No. 5 supersedes the information contained in the Prospectus.
INVESTING IN OUR COMMON STOCK IS SPECULATIVE AND INVOLVES RISK. SEE
"RISK FACTORS" BEGINNING ON PAGE 7 OF THE PROSPECTUS DATED APRIL 10, 2006,
TOGETHER WITH ANY ADDITIONAL OR MODIFIED RISK FACTORS CONTAINED IN
SUPPLEMENTS TO SUCH PROSPECTUS.
-----------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OR ACCURACY OF THIS PROSPECTUS SUPPLEMENT NO. 5. ANY REPRESENTATION TO
THE CONTRARY IS A CRIMINAL OFFENSE.
-----------------------
THE DATE OF THIS PROSPECTUS SUPPLEMENT NO. 5 IS NOVEMBER 14, 2006.
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
-----------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006
COMMISSION FILE NO. 000-25064
-----------------
HEALTH FITNESS CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MINNESOTA NO. 41-1580506
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
3600 AMERICAN BOULEVARD WEST, BLOOMINGTON, MINNESOTA 55431
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER (952) 831-6830
-----------------
Indicate by check mark whether the registrant (1) filed all reports
required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer or a non-accelerated filer. See definition
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act. (Check one):
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]
The number of shares outstanding of the registrant's common stock as of
November 10, 2006 was: Common Stock, $0.01 par value, 19,001,771 shares
================================================================================
HEALTH FITNESS CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited)
Consolidated Balance Sheets as of September 30, 2006 and
December 31, 2005 3
Consolidated Statements of Earnings for the three and nine
months ended September 30, 2006 and 2005 4
Consolidated Statements of Cash Flows for the nine
months ended September 30, 2006 and 2005 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition 12
and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk 19
Item 4. Controls and Procedures 19
PART II. OTHER INFORMATION 20
Item 1. Legal Proceedings 20
Item 1A. Risk Factors 20
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 20
Item 3. Defaults Upon Senior Securities 20
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 5. Other Information 20
Item 6. Exhibits 20
Signatures 21
Exhibit Index 22
2
HEALTH FITNESS CORPORATION
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
September 30, December 31,
2006 2005
-------------- -------------
ASSETS
CURRENT ASSETS
Cash ....................................................................... $ 713,043 $ 1,471,505
Trade and other accounts receivable, less allowances of $180,000 and
$200,700 ................................................................ 10,840,104 8,839,046
Prepaid expenses and other ................................................. 1,026,142 509,273
Deferred tax assets ........................................................ 347,700 337,800
-------------- -------------
Total current assets ................................................ 12,926,989 11,157,624
PROPERTY AND EQUIPMENT, net .................................................... 537,521 347,820
OTHER ASSETS
Goodwill ................................................................... 13,020,290 12,919,689
Software, less accumulated amortization of $265,500 and $0 ................. 1,774,061 1,762,000
Customer contracts, less accumulated amortization of $1,796,100 and
$1,626,100 .............................................................. 18,890 188,889
Trademark, less accumulated amortization of $221,500 and $147,000 .......... 271,620 346,057
Other intangible assets, less accumulated amortization of $149,300 and
$88,000 ................................................................. 379,774 441,086
Deferred tax assets ........................................................ 394,760 374,500
Other ...................................................................... 29,604 47,105
-------------- -------------
$ 29,353,509 $ 27,584,770
============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Trade accounts payable ..................................................... $ 874,562 $ 687,125
Accrued salaries, wages, and payroll taxes ................................. 2,144,943 2,693,927
Other accrued liabilities .................................................. 1,009,626 763,115
Accrued self funded insurance .............................................. 344,288 250,000
Deferred revenue ........................................................... 1,681,077 1,868,446
-------------- -------------
Total current liabilities ........................................... 6,054,496 6,262,613
LONG-TERM OBLIGATIONS .......................................................... -- --
COMMITMENTS AND CONTINGENCIES .................................................. -- --
WARRANT OBLIGATION ............................................................. -- 2,210,889
PREFERRED STOCK, $0.01 par value, 10,000,000 shares authorized, 0 and 1,000
shares issued and outstanding .............................................. -- 8,623,546
STOCKHOLDERS' EQUITY
Common stock, $0.01 par value; 50,000,000 shares authorized;
19,001,771 and 13,787,349 shares issued and outstanding ................. 190,017 137,874
Additional paid-in capital ................................................. 25,921,323 15,625,425
Accumulated comprehensive income ........................................... (85) 1,245
Accumulated deficit ........................................................ (2,812,242) (5,276,822)
-------------- -------------
23,299,013 10,487,722
-------------- -------------
$ 29,353,509 $ 27,584,770
============== =============
See notes to consolidated financial statements.
3
HEALTH FITNESS CORPORATION
CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
2006 2005 2006 2005
------------ ------------ ------------ ------------
REVENUE .......................................... $ 16,340,380 $ 13,464,278 $ 46,482,771 $ 40,607,994
COSTS OF REVENUE ................................. 11,061,752 9,965,464 33,439,649 30,216,762
------------ ------------ ------------ ------------
GROSS PROFIT ..................................... 5,278,628 3,498,814 13,043,122 10,391,232
OPERATING EXPENSES
Salaries ..................................... 2,045,284 1,449,297 6,187,653 4,243,782
Other selling, general and
administrative ............................ 1,133,118 945,540 3,471,455 2,625,037
Amortization of acquired
intangible assets ......................... 96,986 220,095 313,058 659,432
------------ ------------ ------------ ------------
Total operating expenses .............. 3,275,388 2,614,932 9,972,166 7,528,251
------------ ------------ ------------ ------------
OPERATING INCOME ................................. 2,003,240 883,882 3,070,956 2,862,981
OTHER INCOME (EXPENSE)
Interest expense ............................. (1,681) 4,035 (5,831) (24,214)
Change in fair value of warrants ............. -- -- 841,215 --
Other, net ................................... (2,529) (2,404) 7,532 (4,394)
------------ ------------ ------------ ------------
EARNINGS BEFORE INCOME TAXES ..................... 1,999,030 885,513 3,913,872 2,834,373
INCOME TAX EXPENSE ............................... 825,189 354,206 1,352,884 1,133,749
------------ ------------ ------------ ------------
NET EARNINGS ..................................... 1,173,841 531,307 2,560,988 1,700,624
Dividend to preferred shareholders............ -- 24,819 96,410 68,019
------------ ------------ ------------ ------------
NET EARNINGS APPLICABLE TO COMMON SHAREHOLDERS.... $ 1,173,841 $ 506,488 $ 2,464,578 $ 1,632,605
============ ============ ============ ============
NET EARNINGS PER SHARE:
Basic ........................................ $ 0.06 $ 0.04 $ 0.14 $ 0.13
Diluted ...................................... $ 0.06 $ 0.03 $ 0.09 $ 0.10
WEIGHTED AVERAGE COMMON SHARES:
Basic ........................................ 18,963,948 12,836,971 17,665,550 12,704,035
Diluted ...................................... 19,550,662 16,662,753 19,680,363 16,633,799
See notes to consolidated financial statements.
4
HEALTH FITNESS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended
September 30,
---------------------------
2006 2005
----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings ............................................................. $ 2,464,578 $ 1,700,624
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Depreciation ......................................................... 383,102 63,786
Amortization ......................................................... 305,747 653,350
Warrant valuation .................................................... (841,215) --
Compensation for stock options ....................................... 341,553 --
Deferred taxes ....................................................... (30,160) 1,046,400
Loss on disposal of assets ........................................... 158 --
Changes in operating assets and liabilities, net of assets acquired:
Trade and other accounts receivable ................................ (2,001,058) (280,907)
Prepaid expenses and other ......................................... (516,869) (626,622)
Other assets ....................................................... 17,501 31,062
Trade accounts payable ............................................. 187,437 (36,728)
Accrued liabilities and other ...................................... (209,515) (1,041,812)
Deferred revenue ................................................... (187,369) (162,958)
----------- ------------
Net cash provided by (used in) operating activities ......... (86,268) 1,346,195
----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment ...................................... (584,863) (104,059)
Other .................................................................... (100,599) (7,084)
----------- ------------
Net cash used in investing activities ....................... (685,462) (111,143)
----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under note payable ............................................ -- 13,837,389
Repayments of note payable ............................................... -- (15,450,148)
Costs from issuance of preferred stock ................................... (161,725) --
Proceeds from issuance of common stock ................................... 171,287 163,008
Proceeds from the exercise of stock options .............................. 3,706 11,428
----------- ------------
Net cash provided by (used in) financing activities ......... 13,268 (1,438,323)
----------- ------------
NET DECREASE IN CASH ........................................................ (758,462) (203,271)
CASH AT BEGINNING OF PERIOD ................................................. 1,471,505 241,302
----------- ------------
CASH AT END OF PERIOD ....................................................... $ 713,043 $ 38,031
=========== ============
Supplemental cash flow information:
Cash paid for interest .......................................... $ 788 $ 30,297
Cash paid for taxes ............................................. 521,640 403,651
Noncash financing activities affecting cash flow:
Conversion of warrant liability to additional paid in capital... 1,369,374 --
Dividend to preferred shareholders ............................. -- 68,019
See notes to consolidated financial statements.
5
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements for the three and
nine months ended September 30, 2006 have been prepared in accordance with
accounting principles generally accepted in the United States of America for
interim financial information. Financial information as of December 31, 2005 has
been derived from our audited consolidated financial statements. In accordance
with the rules and regulations of the United States Securities and Exchange
Commission, the Company has omitted footnote disclosures that would
substantially duplicate the disclosures contained in the audited financial
statements of the Company. The unaudited consolidated financial statements
should be read together with the financial statements for the year ended
December 31, 2005, and footnotes thereto included in the Company's Form 10-K as
filed with the United States Securities and Exchange Commission on March 30,
2006.
In the opinion of management, the interim consolidated financial statements
include all adjustments (consisting of normal recurring accruals) necessary for
the fair presentation of the results for interim periods presented. These
financial statements include some amounts that are based on management's best
estimates and judgments. These estimates may be adjusted as more information
becomes available, and any adjustment could be significant. The impact of any
change in estimate is included in the determination of earnings in the period in
which the change in estimate is identified. Operating results for the three and
nine months ended September 30, 2006 are not necessarily indicative of the
operating results that may be expected for the year ended December 31, 2006.
Certain 2006 operating expenses have been reclassified to conform with the
presentation of amounts in our Statement of Earnings for the quarter and nine
months ended September 30, 2006. These reclassifications had no effect on
revenue, net earnings, earnings per share or shareholders' equity as previously
reported.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business - We provide fitness and health management services and programs to
corporations, governmental units, 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, injury prevention and
work-injury management consulting, on-site physical therapy and employee health
management services. Programs include wellness and health programs for
individual customers, including health risk assessments, biometric screenings,
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 believe we are not exposed to any significant credit risk
on cash. At September 30, 2006 and December 31, 2005, we had cash of
approximately $8,800 and $24,000 (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. We determine our
allowance for discounts and doubtful accounts by considering a
6
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.
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 not amortized, but 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 of each year and determined that our
goodwill relates to one reporting unit for purposes of impairment testing.
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. 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.
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 the service is performed based on the cost
of the services.
Amounts received from customers in advance of providing the services of the
contract are recorded 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.
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.
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 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 quarter and nine months ended September 30, 2006,
we recognized non-cash income of $0 and $841,215, respectively, upon
7
revaluation of certain warrants that are subject to this accounting treatment.
The derivative liability associated with these warrants is reflected on our
balance sheet as of December 31, 2005 as a long-term liability.
On June 15, 2006, we reached an agreement with the investors owning these
warrants to amend the terms of the investment documents, which resulted in the
warrants to be reflected as equity. As a result of this accounting change, we
made a final valuation of our warrant liability on June 15, 2006, which resulted
in non-cash income of $406,694 for our second quarter, and the remaining warrant
liability of $1,369,674 was reclassified to additional paid in capital. We are
no longer required to revalue these warrants on a prospective basis.
Comprehensive Income - Comprehensive income represents net earnings adjusted for
foreign currency translation adjustments. Total comprehensive income was
$2,559,658 and $1,704,882 for the nine months ended September 30, 2006 and 2005.
Net Earnings Per Share - Basic net earnings per share is computed by dividing
net earnings applicable to common shareholders by the number of weighted average
common shares outstanding. For the three and nine months ended September 30,
2006, diluted net earnings per share is computed by dividing net earnings
applicable to common shareholders, plus dividends to preferred shareholders (net
earnings), less the non-cash benefit related to a change in fair value of
warrants by the number of weighted average common shares outstanding, and common
share equivalents relating to stock options, stock warrants, and stock warrants
accounted for as a liability, if dilutive. For the three and nine months ended
September 30, 2005, diluted net earnings per share is computed by dividing net
earnings applicable to common shareholders, plus dividends to preferred
shareholders (net earnings) by the number of weighted average common shares
outstanding, and common share equivalents relating to stock options and stock
warrants, if dilutive. Refer to Exhibit 11.0 attached hereto for a detail
computation of earnings per share.
Common stock options and warrants to purchase 2,807,156 and 584,163 shares of
common stock were excluded from the calculation for the three months ended
September 30, 2006 and 2005, and 2,425,806 and 481,298 were excluded from the
calculation for the nine months ended September 30, 2006 and 2005 because their
exercise price exceeded the average trading price of the Company's common stock
during each of the periods.
Stock-based Compensation - We maintain a stock option plan for the benefit of
certain eligible employees and directors of the Company. We have authorized
4,000,000 shares for grant under our 2005 Stock Option Plan, and a total of
1,260,400 shares of common stock are reserved for additional grants of options
at September 30, 2006. Our stock options generally vest ratably over four years
of service and have a contractual life of 6 years.
During the quarter ended September 30, 2006, we recorded compensation expense of
$32,000 for 20,000 shares of common stock that was granted to a newly appointed
member of our board of directors. Such grant was in accordance with our director
compensation plan.
Commencing January 1, 2006, we adopted Statement of Financial Accounting
Standard No. 123R, "Share Based Payment" ("SFAS 123R"), which requires all
share-based payments, including grants of stock options, to be recognized in the
income statement as an operating expense, based on their fair values over the
requisite service period. The compensation cost we record for these awards will
be based on their grant date fair value as calculated for the proforma
disclosures required by Statement 123. We recorded $71,150 and $309,553 of stock
option compensation expense, included in salaries within our operating expenses
section, for the three and nine months ended September 30, 2006. We also
recorded a deferred tax benefit of $28,460 and $123,822 for the three and nine
months ended September 30, 2006 in connection with recording this non-cash
expense. This deferred tax benefit will be adjusted based upon the actual tax
benefit realized from the exercise of the underlying stock options. The
compensation expense reduced diluted earnings per share by less than $0.01 for
the three months ended September 30, 2006, and by approximately $0.02 for the
nine months ended September 30, 2006.
As of September 30, 2006, approximately $726,000 of total unrecognized
compensation costs related to non-vested awards is expected to be recognized
over a weighted average period of approximately 2.77 years.
8
Prior to adopting SFAS 123R, we accounted for stock-based compensation under
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees." We have applied the modified prospective method in adopting SFAS
123R. Accordingly, periods prior to adoption have not been restated.
The following table summarizes information about stock options at September 30,
2006:
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 - $0.39 405,400 1.26 $0.33 364,675 $0.33
0.47 - 0.69 596,650 1.95 0.56 596,650 0.56
0.95 - 1.25 279,000 4.15 1.17 162,000 1.15
1.26 - 2.27 459,350 4.35 1.86 342,550 1.81
2.28 - 3.00 813,375 4.13 2.74 369,500 2.79
--------- ---------
2,553,775 3.21 $1.52 1,835,375 $1.25
========= =========
We use the Black-Scholes option pricing model to determine the weighted average
fair value of options. The weighted average fair value of options granted during
the three month periods ended September 30, 2006 and 2005 were $0.73 and $0.87,
respectively. The fair value of options at date of grant and the assumptions
utilized to determine such values are indicated in the following table:
Three Months Ended
September 30,
---------------------
2006 2005
---- ----
Risk-free interest rate ........................... 4.57% 3.45%
Expected volatility ............................... 54.8% 61.0%
Expected life (in years) .......................... 3.78 2.71
Dividend yield .................................... -- --
Option transactions under the 2005 Stock Option Plan during the third quarter
ended September 30, 2006 are summarized as follows:
Weighted Weighted
Average Aggregate Average
Exercise Intrinsic Remaining
Options Price Value Term
--------- --------- ---------- ---------
Outstanding at June 30, 2006 .......... 2,607,825 $ 1.55
Granted ............................... 40,000 $ 1.60
Exercised ............................. -- --
Canceled/Forfeited .................... (94,050) 2.45
--------- --------- ---------- ---------
Outstanding at September 30, 2006 ..... 2,553,775 $ 1.52 $1,237,446 2.99
Exercisable at September 30, 2006 ..... 1,835,375 $ 1.25 $1,142,423 2.40
9
Option transactions under the 2005 Stock Option Plan during the nine months
ended September 30, 2006 are summarized as follows:
Weighted Weighted
Average Aggregate Average
Exercise Intrinsic Remaining
Options Price Value Term
--------- -------- ----------- ---------
Outstanding at December 31, 2005 .... 2,157,425 $ 1.34
Granted ............................. 495,500 $ 2.44
Exercised ........................... (3,850) $ 0.96
Canceled/Forfeited .................. (95,300) $ 2.43
--------- -------- ----------- ---------
Outstanding at September 30, 2006 ... 2,553,775 $ 1.52 $ 1,237,446 2.99
Exercisable at September 30, 2006 ... 1,835,375 $ 1.25 $ 1,142,423 2.40
The were no options exercised during the quarter ended September 30, 2006. The
total number of options that vested during the quarter ended September 30, 2006
was 17,500 with a fair value of $9,725.
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.
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.
NOTE 3. 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 converted into
5,100,000 shares of our common stock on March 10, 2006, the date the Securities
and Exchange Commission (the "SEC") first declared effective a registration
statement covering these shares. Each share of Series B Stock was entitled to a
number of votes equal to the number of shares of common stock into which it was
then convertible. Except as required by law, holders of Series B Stock were
entitled to vote together as one class with holders of common stock. Each share
of Series B Stock had 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. On June 15, 2006, we
entered into an agreement with the accredited investors to amend the
Registration Rights Agreement to cap the amount of liquidated damages we could
pay at 9% of the aggregate purchase price paid by each accredited investor.
10
The warrants, which were issued together with the Series B Stock, have a term of
five years, and give 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, any of the following change
in control transactions occur: (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. On June 15, 2006, we entered into an agreement with the accredited
investors to amend the Warrant Agreement to give us the ability to repurchase
the warrants, in the case of a change in control transaction, using shares of
stock, securities or assets, including cash.
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 (subject
to certain permitted circumstances) to maintain effectiveness of the
registration statement in accordance with the PIPE Transaction; and (ii) the
investors may put their warrants back to us for cash if a change in control
transaction that meets the definition previously discussed occurs. On June 15,
2006, we reached an agreement with the investors owning these warrants to amend
the terms of the investment documents, which resulted in the warrants to be
reflected as equity. As a result of this accounting change, we made a final
valuation of our warrant liability on June 15, 2006, which resulted in non-cash
income of $406,694 for our second quarter, and the remaining warrant liability
of $1,369,674 was reclassified to additional paid in capital. We are no longer
required to revalue these warrants on a prospective basis.
NOTE 4. INCOME TAXES
The Company records income taxes in accordance with the liability method of
accounting. Deferred income taxes are provided for temporary differences between
the financial reporting and tax basis of assets and liabilities and federal
operating loss carryforwards. Deferred tax assets and liabilities are adjusted
for the effects of changes in tax laws and rates on the date of the enactment.
We do not record a tax liability or benefit in connection with the change in
fair value of certain of our warrants. Income taxes are calculated based on
management's estimate of the Company's effective tax rate, which takes into
consideration a federal tax rate of 34% and an effective state tax rate of 6%.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our interim consolidated financial
statements and related notes included in Item 1 of Part 1 of this Quarterly
Report, and the audited consolidated financial statements and notes thereto and
Management's Discussion and Analysis of Financial Condition and Results of
Operations contained in the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 2005.
CRITICAL ACCOUNTING POLICIES. Our most critical accounting policies, which are
those that require significant judgment, include: revenue recognition, trade and
other accounts receivable, goodwill and stock-based compensation. A more
in-depth description of these can be found in Note 2 to the interim consolidated
financial statements included in this Quarterly Report and our Annual Report on
Form 10-K for the fiscal year ended December 31, 2005.
GENERAL. We provide fitness and health management services and programs to
corporations, governmental units, 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, injury prevention and
work-injury management consulting, on-site physical therapy and employee health
management services. Programs include wellness and health programs for
individual customers, including health risk assessments, biometric screenings,
nutrition and weight loss programs, smoking cessation, massage therapy, back
care and ergonomic injury prevention.
RESULTS OF OPERATIONS
The following table sets forth our statement of operations data as a percentage
of total revenues and also sets forth other financial and operating data for the
three and nine months ended September 30, 2006 and 2005:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2006 2005 2006 2005
----- ----- ----- -----
REVENUE............................................ 100.0% 100.0% 100.0% 100.0%
COSTS OF REVENUE................................... 67.7 74.0 71.9 74.4
----- ----- ----- -----
GROSS PROFIT....................................... 32.3 26.0 28.1 25.6
----- ----- ----- -----
OPERATING EXPENSES
Salaries ...................................... 12.5 10.8 13.3 10.4
Other selling, general and administrative...... 6.9 7.0 7.5 6.5
Amortization of acquired intangible assets..... 0.6 1.6 0.7 1.6
----- ----- ----- -----
Total operating expenses ............... 20.0 19.4 21.5 18.5
----- ----- ----- -----
OPERATING INCOME .................................. 12.3 6.6 6.6 7.1
OTHER INCOME (EXPENSE) ............................ -- -- 1.8 (0.1)
----- ----- ----- -----
EARNINGS BEFORE INCOME TAXES ...................... 12.3 6.6 8.4 7.0
INCOME TAX EXPENSE ................................ 5.1 2.6 2.9 2.8
----- ----- ----- -----
NET EARNINGS ...................................... 7.2 4.0 5.5 4.2
Dividend to preferred shareholders ............ -- 0.2 0.2 0.2
----- ----- ----- -----
NET EARNINGS APPLICABLE TO
COMMON SHAREHOLDERS ........................... 7.2% 3.8% 5.3% 4.0%
===== ===== ===== =====
12
OTHER FINANCIAL AND OPERATING DATA: Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
2006 2005 2006 2005
----------- ----------- ----------- -----------
Fitness Management Revenue
Staffing Services......................... $10,089,452 $ 9,446,042 $29,781,528 $28,490,918
Program and Consulting Services........... 571,746 495,537 1,797,554 1,612,410
----------- ----------- ----------- -----------
10,661,198 9,941,579 31,579,082 30,103,328
----------- ----------- ----------- -----------
Health Management Revenue
Staffing Services......................... 3,692,693 3,040,491 10,068,096 9,139,830
Program and Consulting Services........... 1,986,489 482,208 4,835,593 1,364,835
----------- ----------- ----------- -----------
5,679,182 3,522,699 14,903,689 10,504,665
----------- ----------- ----------- -----------
Total Revenue
Staffing Services......................... 13,782,145 12,486,533 39,849,624 37,630,748
Program and Consulting Services........... 2,558,235 977,745 6,633,147 2,977,245
----------- ----------- ----------- -----------
$16,340,380 $13,464,278 $46,482,771 $40,607,993
----------- ----------- ----------- -----------
The following tables set forth certain reclassifications we made to operating
expenses for our first and second quarters ending March 31 and June 30, 2006, to
conform with the operating expense presentation for our three and nine months
ended September 30, 2006. Specifically, we made reclassifications for salaries
related to the employees of HealthCalc, a company we acquired in December 2005,
from other selling, general and administrative expenses to salaries expense for
the quarters ending March 31 and June 30, 2006. These reclassifications had no
effect on revenue, net earnings, earnings per share or shareholders' equity as
previously reported.
For the Three Months Ended
-----------------------------------------------------
March 31, March 31, June 30, June 30,
2006 2006 2006 2006
----------- ------------ ----------- ------------
OPERATING EXPENSES As Reported Reclassified As Reported Reclassified
----------- ------------ ----------- ------------
Salaries ...................................... $1,678,834 $1,995,899 $1,805,533 $2,146,470
Other selling, general and administrative...... 1,436,241 1,119,176 1,560,098 1,219,161
Amortization of acquired intangible assets..... 108,462 108,462 107,610 107,610
--------- --------- --------- ---------
Total operating expenses ................... $3,223,537 $3,223,537 $3,473,241 $3,473,241
--------- --------- --------- ---------
For the Six Months Ended
-------------------------
June 30, June 30,
2006 2006
----------- ------------
OPERATING EXPENSES As Reported Reclassified
----------- ------------
Salaries ..................................... $3,484,367 $4,142,369
Other selling, general and administrative..... 2,996,339 2,338,337
Amortization of acquired intangible assets.... 216,072 216,072
--------- ---------
Total operating expenses .................. $6,696,778 $6,696,778
--------- ---------
13
RESULTS OF OPERATIONS FOR THE QUARTER ENDED SEPTEMBER 30, 2006 AS COMPARED TO
THE QUARTER ENDED SEPTEMBER 30, 2005.
REVENUE. Revenues increased $2,876,000, or 21.4%, to $16,340,000 for the three
months ended September 30, 2006, from $13,464,000 for the three months ended
September 30, 2005. This increase is attributable to revenue growth of
$2,363,000 from new contracts and incremental business from existing contracts,
in addition to revenue growth of $513,000 from HealthCalc, a company we acquired
in December 2005. For the third quarter, health management revenue grew 61.2%
and fitness management grew 7.2% over the same period last year.
During the third quarter of 2006, we won two new contracts within our Health
Management business, which may realize annualized incremental revenue of
approximately $960,000. Within our Fitness Management business, we won three new
contracts, which may realize annualized incremental revenue of approximately
$455,000. The value of our new and expanded contracts is a forward looking
statement, is based upon an estimate of the anticipated annualized incremental
revenue, and should be used only as an indication of the sales activity we have
experienced in our two business areas. These estimates should not be considered
an indication of the total incremental revenue growth we expect to generate in
2006, or in any year, as actual growth may differ from these estimates due to
actual staffing levels, participation rates and contract duration, in addition
to other revenue we may lose due to contract termination.
GROSS PROFIT. Gross profit increased $1,780,000, or 50.8%, to $5,279,000 for the
three months ended September 30, 2006, from $3,499,000 for the three months
ended September 30, 2005. This increase is due primarily to the revenue growth
within our Health Management business area. Gross profit for the three months
ended September 30, 2006 and 2005 also includes a refund of $313,000 and
$225,000, respectively, for workers compensation premiums we paid for our 2005
and 2004 plan years.
As a percent of revenue, gross profit increased to 32.3%, from 26.0% for the
third quarter of 2005. This increase is due primarily to the new health
management business we have recently won. Excluding the effect of the workers
compensation premium refunds noted above, gross profit as a percent of revenue
would be 30.4% for the third quarter of 2006, compared to 24.3% for the third
quarter of 2005.
OPERATING EXPENSES. Operating expenses increased $660,000, or 25.2%, to
$3,275,000 for the three months ended September 30, 2006, from $2,615,000 for
the three months ended September 30, 2005.
Of this increase, approximately $395,000 is attributed to salaries, operating
expenses and asset depreciation related to our acquisition of HealthCalc. In
addition, we incurred approximately $103,000 of expense in the third quarter of
2006, including $32,000 of expense related to a grant of stock to a new
director, and $71,000 of stock option compensation expense in connection with
our adoption of SFAS 123R on January 1, 2006. The remaining cost increase of
$162,000 is primarily due to additional staff we hired since late 2005 to
execute our health management business plan. We expect to continue incurring
these costs at varying levels on a quarterly basis. These expense increases were
partially offset by a decrease in amortization expense related to a prior
acquisition.
OTHER INCOME AND EXPENSE. We had interest expense of $2,000 for the third
quarter of 2006, compared to interest income $4,000 for the third quarter of
2005. The cost of borrowed funds for both periods was inconsequential.
INCOME TAXES. Income tax expense increased $471,000 to $825,000 for the three
months ended September 30, 2006, compared to $354,000 for the same period in
2005. The increase is primarily due to a 125.7% increase in earnings before
income taxes, adjusted for changes in permanent and temporary timing differences
between book and tax balances for stock option expense, change in fair value of
warrants, depreciation and amortization, prepaid expenses and vacation accruals.
14
NET EARNINGS APPLICABLE TO COMMON SHAREHOLDERS. As a result of the above, and
the cessation of dividends payable to preferred shareholders, net earnings
applicable to common shareholders for the three months ended September 30, 2006
increased $668,000, or 132.0%, to $1,174,000, from $506,000 for the three months
ended September 30, 2005.
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AS COMPARED
TO THE NINE MONTHS ENDED SEPTEMBER 30, 2005.
REVENUE. Revenues increased $5,875,000, or 14.5%, to $46,483,000 for the nine
months ended September 30, 2006, from $40,608,000 for the nine months ended
September 30, 2005. This increase is attributable to revenue growth of
$4,385,000 from new contracts and incremental business from existing contracts,
in addition to revenue growth of $1,489,000 from HealthCalc. For the first nine
months, health management revenue grew 41.9% and fitness management grew 4.9%
over the same period last year.
During the first nine months of 2006, we have won twenty-eight new contracts,
and expanded five existing contracts in our Health Management business area,
which may realize annualized incremental revenue of approximately $7.4 million.
In Fitness Management, we have won ten new contracts, and expanded one existing
contract, which may realize annualized incremental revenue of $3.2 million. The
combined total for new, annualized revenue will be offset by a potential
annualized revenue loss of $1.2 million from contract cancellations through our
first nine months ended September 30, 2006. The value of our new and expanded
contracts is a forward looking statement, is based upon an estimate of the
anticipated annualized incremental revenue, and should be used only as an
indication of the sales activity we have recently experienced in our two
business areas. These estimates should not be considered an indication of the
total incremental revenue growth we expect to generate in 2006, or in any year,
as actual growth may differ from these estimates due to actual staffing levels,
participation rates and contract duration, in addition to other revenue we may
lose due to contract termination.
GROSS PROFIT. Gross profit increased $2,652,000, or 25.5%, to $13,043,000 for
the nine months ended September 30, 2006, from $10,391,000 for the nine months
ended September 30, 2005. This increase is due primarily to our revenue growth
within our Health Management business area. Gross profit for the nine months
ended September 30, 2006 and 2005 also includes a refund of $313,000 and
$225,000, respectively, for workers compensation premiums we paid for our 2005
and 2004 plan years.
As a percent of revenue, gross profit increased to 28.1%, from 25.6% for the
nine months ended September 30, 2005. This increase is due primarily to the new
health management business we have recently won. Excluding the effect of the
workers compensation premium refunds noted above, gross profit as a percent of
revenue would be 27.4% for the first nine months of 2006, compared to 25.0% for
the first nine months of 2005.
OPERATING EXPENSES. Operating expenses increased $2,444,000, or 32.5%, to
$9,972,000 for the nine months ended September 30, 2006, from $7,528,000 for the
nine months ended September 30, 2005.
Of this increase, approximately $1,278,000 is due to salaries, operating
expenses and asset depreciation related to our acquisition of HealthCalc. In
addition, we incurred approximately $342,000 of expense in the third quarter of
2006, including $32,000 of expense related to a grant of stock to a new
director, and $310,000 of stock option compensation expense in connection with
our adoption of SFAS 123R on January 1, 2006. The remaining cost increase of
$824,000 is primarily due to additional staff we hired during 2005 and 2006 to
execute our health management business plan. We expect to continue incurring
these costs at varying levels on a quarterly basis. These expense increases were
partially offset by a decrease in amortization expense related to a prior
acquisition.
OTHER INCOME AND EXPENSE. Interest expense decreased $18,000 to $6,000 for the
nine months ended September 30, 2006, compared to $24,000 for the same period in
2005. This decrease is due to the repayment of our Wells
15
Fargo credit line.
For the nine months ended September 30, 2006, we recorded an $841,000 non-cash
benefit 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 the section titled "Summary of Significant
Accounting Policies," Valuation of Derivative Instruments, contained elsewhere
in this document for further discussion of the accounting we used to value these
warrants.
INCOME TAXES. Income tax expense increased $219,000 to $1,353,000 for the nine
months ended September 30, 2006, compared to $1,134,000 for the same period in
2005. The increase is due primarily to the growth of our operating income.
NET EARNINGS APPLICABLE TO COMMON SHAREHOLDERS. As a result of the above
changes, which were partially offset by an increase in dividends paid to
preferred shareholders, net earnings applicable to common shareholders for the
nine months ended September 30, 2006 increased $832,000, or 51.0%, to
$2,465,000, from $1,633,000 for the nine months ended September 30, 2005.
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital increased $1,977,000 to $6,872,000 at September
30, 2006, compared to working capital of $4,895,000 at December 31, 2005. The
increase in working capital is due primarily to an increase in trade and other
accounts receivable and prepaid expense, and decreases in trade accounts
payable, other accrued liabilities and deferred revenue. These were offset by a
decrease in cash and increases to accrued salaries and accrued self funded
insurance.
In addition to cash flows generated from operating activities, our other 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 8.25% and
7.25% at September 30, 2006 and December 31, 2005). The availability of the
Wells Loan decreases $250,000 on the last day of each calendar quarter,
beginning September 30, 2003, and matures on September 30, 2008, as amended.
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 $4,250,000 and $5,000,000 at September
30, 2006 and December 31, 2005, which was available for borrowing on such
respective dates. All borrowings are collateralized by substantially all of our
assets. At September 30, 2006, 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 converted into
5,100,000 shares of our common stock on March 10, 2006, the date the Securities
and Exchange Commission (the "SEC") first declared 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
16
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 (subject to certain permitted circumstances) to maintain the
effectiveness of the registration statement. On June 15, 2006, we entered into
an agreement with the accredited investors to amend the Registration Rights
Agreement to cap the amount of liquidated damages we could pay at 9% of the
aggregate purchase price paid by each accredited investor.
The warrants, which were issued together with the Series B Stock, have a term of
five years, and give 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, any of the following change
in control transactions occur: (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. On June 15, 2006, we entered into an agreement with the accredited
investors to amend the Warrant Agreement to give us the ability to repurchase
the warrants, in the case of a change in control transaction, using shares of
stock, securities or assets, including cash.
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. As a result of the agreement amendments we structured with the
accredited investors on September 15, 2006, we were allowed to account for the
warrants as equity. On June 15, 2006, we reached an agreement with the investors
owning these warrants to amend the terms of the investment documents, which
resulted in the warrants to be reflected as equity. As a result of this
accounting change, we made a final valuation of our warrant liability on June
15, 2006, which resulted in non-cash income of $406,694 for our second quarter,
and the remaining warrant liability of $1,369,674 was reclassified to additional
paid in capital. We are no longer required to revalue these warrants on a
prospective basis.
OFF-BALANCE SHEET ARRANGEMENTS
As of September 30, 2006, we have no off-balance sheet arrangements or
transactions with unconsolidated, limited purpose entities.
We believe that sources of capital to meet future obligations over the next 12
months will be provided by cash generated through operations and our Wells Loan.
Currently, we do not have plans to make any significant investments in capital
assets or any other one-time expenses that may affect our cash flows from
investing activities.
We do not believe that inflation has had a significant impact on the results of
our operations.
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-Q, including the MD&A section, as well as in our Annual Report
on Form 10-K for the year ended December 31, 2005 that was filed with the
Securities and
17
Exchange Commission, and in other materials filed or to be filed by the Company
with the Securities and Exchange Commission (as well as information included in
oral statements or other written statements made or to be made by the Company).
Forward-looking statements include all statements based on future expectations
and specifically include, among other things, all statements relating to
increasing revenue, improving margins, growth of the market for corporate,
hospital, community and university-based fitness centers, the development of new
business models, our ability to expand our programs and services and the
sufficiency of our liquidity and capital resources. Any statements that are not
based upon historical facts, including the outcome of events that have not yet
occurred and our expectations for future performance, are forward-looking
statements. The words "believe," "estimate," "expect," "intend," "may," "could,"
"will," "plan," "anticipate," and similar words and expressions are intended to
identify forward-looking statements. Such statements are based upon the current
beliefs and expectations of our management. Such forward-looking information
involves important risks and uncertainties that could significantly affect
anticipated results in the future and, accordingly, such results may differ from
those expressed in any forward-looking statements made by or on behalf of the
Company. These risks and uncertainties include, but are not limited to those
matters identified and discussed in Part II, Item 1A of this Form 10-Q (if any),
and in Item 1 of the Company's Form 10-K for the year ended December 31, 2005
under "Risk Factors/Forward-Looking Statements."
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2006, the FASB ratified the consensus reached by the Emerging Issues
Task Force on Issue No. 06-3, "How Sales Taxes Collected From Customers and
Remitted to Governmental Authorities Should Be Presented in the Income
Statement" ("EITF 06-3"). EITF 06-3 requires a company to disclose its
accounting policy (i.e. gross vs. net basis) relating to the presentation of
taxes within the scope of EITF 06-3. Furthermore, for taxes reported on a gross
basis, an enterprise should disclose the amounts of those taxes in interim and
annual financial statements for each period for which an income statement is
presented. The guidance is effective for all periods beginning after December
15, 2006. We are currently in the process of assessing the impact the adoption
of EITF 06-3 will have on our financial position and results of operation.
In July 2006, the FASB issued FASB Interpretation No. 48 ("FIN 48"), "Accounting
for Uncertainty in Income Taxes - an interpretation of FASB Statement 109." FIN
48 prescribes a comprehensive model for recognizing, measuring, presenting and
disclosing in the financial statements, tax positions taken or expected to be
taken on a tax return, including the decision whether to file or not to file in
a particular jurisdiction. FIN 48 is effective for fiscal years beginning after
December 15, 2006. If there are changes in net assets as a result of application
of FIN 48, these changes will be accounted for as an adjustment to retained
earnings. We are currently assessing the impact of FIN 48 on our consolidated
financial position and results of operations.
In September 2006, the FASB issued SFAS 157, "Fair Value Measurements." SFAS 157
does not address "what" to measure at fair value; instead, it addresses "how" to
measure fair value. SFAS 157 applies (with limited exceptions) to existing
standards that require assets or liabilities to be measured at fair value. SFAS
157 establishes a fair value hierarchy, giving the highest priority to quoted
prices in active markets and the lowest priority to unobservable data and
requires new disclosures for assets and liabilities measured at fair value based
on their level in the hierarchy. SFAS 157 is effective for financial statements
issued for fiscal years beginning after November 15, 2007. We are currently
evaluating the impact of adopting SFAS 157.
In September 2006, the FASB issued SFAS 158, "Employer's Accounting for Defined
Benefit Pension and Other Postretirement Plans, an Amendment of SFAS No. 87, 88,
106 and 132R." SFAS 158 requires an employer to (i) recognize in its statement
of financial position an asset for a plan's over funded status or a liability
for a plan's under funded status; (ii) measure a plan's assets and its
obligations that determine its funded status as of the end of the employer's
fiscal year (with limited exceptions); and (iii) recognize changes in the funded
status of a defined benefit postretirement plan in the year in which the changes
occur. Those changes will be reported in
18
comprehensive income of a business entity. The requirement to recognize the
funded status of a benefit plan and the disclosure requirements are effective as
of the end of the fiscal year ending after December 15, 2006, for entities with
publicly traded equity securities, and at the end of the fiscal year ending
after June 15, 2007, for all other entities. The requirement to measure plan
assets and benefit obligations as of the date of the employer's fiscal year-end
statement of financial position is effective for fiscal years ending after
December 15, 2008. We do not believe that the adoption of SFAS 158 on January 1,
2007 will have a material effect on our consolidated financial statements.
In September 2006, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 108 ("SAB 108"), which becomes effective beginning on
January 1, 2007. SAB 108 provides guidance on the consideration of the effects
of prior period misstatements in quantifying current year misstatements for the
purpose of a materiality assessment. SAB 108 requires an entity to evaluate the
impact of correcting all misstatements, including both the carryover and
reversing effects of prior year misstatements, on current year financial
statements. If a misstatement is material to the current year financial
statements, the prior year financial statements should also be corrected, even
though such revision was, and continues to be, immaterial to the prior year
financial statements. Correcting prior year financial statements for immaterial
errors would not require previously filed reports to be amended. Such correction
should be made in the current period filings. We are currently evaluating the
impact of adopting SAB 108.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks related to changes in U.S. and international
interest rates. All of the Company's long-term obligations bear interest at a
variable rate.
We have no history of, and do not anticipate in the future, investing in
derivative financial instruments, derivative commodity instruments or other such
financial instruments. Transactions with international customers are entered
into in U.S. dollars, precluding the need for foreign currency hedges. As a
result, our exposure to market risk is not material.
ITEM 4. CONTROLS AND PROCEDURES
Our Chief Executive Officer and Chief Financial Officer (collectively, the
"Certifying Officers") are responsible for establishing and maintaining
disclosure controls and procedures for the Company. The Certifying Officers have
concluded (based upon their evaluation of these controls and procedures as of
the end of the period covered by this report) that our disclosure controls and
procedures are effective to ensure that information required to be disclosed by
us in reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
rules of the Securities and Exchange Commission. The Certifying Officers also
have indicated that there were no significant changes in our internal control
over financial reporting that occurred during the period covered by this report
that have materially affected, or are reasonably likely to materially affect,
our internal control over financial reporting.
19
PART II. - OTHER INFORMATION
Item 1. Legal Proceedings
Refer to Item 3 (Legal Proceedings) in the Company's Annual Report on Form 10-K
for the year ended December 31, 2005.
Item 1A. Risk Factors
In addition to the other information set forth in this report, including the
important information in "Private Securities Litigation Reform Act," you should
carefully consider the "Risk Factors" discussed in our Annual Report on Form
10-K for the year ended December 31, 2005. Those factors, if they were to occur,
could cause our actual results to differ materially from those expressed in our
forward-looking statements in this report, and materially adversely affect our
financial condition or future results. Although we are not aware of any other
factors that we currently anticipate will cause our forward-looking statements
to differ materially from our future actual results, or materially affect the
Company's financial condition or future results, additional risks and
uncertainties not currently known to us or that we currently deem to be
immaterial might materially adversely affect our actual business, financial
condition and/or operating results.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits
(a) Exhibits - See Exhibit Index on page following signatures
20
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 to be signed on its behalf
by the undersigned, thereunto duly authorized.
Dated: November 14, 2006 HEALTH FITNESS CORPORATION
By /s/ Jerry V. Noyce
------------------------------------------
Jerry V. Noyce
Chief Executive Officer
(Principal Executive Officer)
By /s/ Wesley W. Winnekins
------------------------------------------
Wesley W. Winnekins
Chief Financial Officer
(Principal Financial and Accounting Officer)
21
EXHIBIT INDEX
HEALTH FITNESS CORPORATION
FORM 10-Q
Exhibit No. Description
----------- --------------------------------------------------------------
**11.0 Statement re: Computation of Earnings per Share
**31.1 Certification of Chief Executive Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
**31.2 Certification of Chief Financial Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
**32.1 Certification of Chief Executive Officer Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
**32.2 Certification of Chief Financial Officer Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
----------
* Indicates management contract or compensatory plan or arrangement
** Filed herewith
22
EXHIBIT 11.0
Computation of Earnings per Share
The following represents the computation of earnings per share reflecting the
assumption that the granted shares under the option and warrants plan which
would be dilutive will be exercised.
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ----------------------------
2006 2005 2006 2005
------------ ------------ ------------ ------------
Net earnings applicable to common shareholders, basic....... $ 1,173,841 $ 531,307 $ 2,560,988 $ 1,700,624
Add: Dividend to preferred shareholders..................... -- 24,819 96,410 68,019
Less: Change in fair value of warrants...................... -- -- (841,215) --
------------ ------------ ------------ ------------
Net earnings, diluted....................................... $ 1,173,841 $ 506,488 $ 1,816,183 $ 1,632,605
============ ============ ============ ============
Weighted average common shares outstanding, basic .......... 18,963,948 12,836,971 17,665,550 12,704,035
Common share equivalents relating to:
Preferred stock........................................ -- 2,191,914 1,270,330 2,159,215
Stock options.......................................... 586,714 635,400 740,428 672,263
Warrants............................................... -- 998,468 4,055 1,098,286
------------ ------------ ------------ ------------
Weighted average common shares outstanding ................. 19,550,662 16,662,753 19,680,363 16,633,799
============ ============ ============ ============
Net earnings per share:
Basic.................................................. $ 0.06 $ 0.04 $ 0.14 $ 0.13
Diluted................................................ $ 0.06 $ 0.03 $ 0.09 $ 0.10
Anti-dilutive preferred stock, stock options and
warrants not included in the diluted earnings per share
computations................................................ 2,807,156 584,163 2,425,806 481,298
See notes to consolidated financial statements.