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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------------------------
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2005
-OR-
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from...to...
Commission File No. 333-36379
PACIFICHEALTH LABORATORIES, INC.
(Exact name of Small Business Issuer as specified in its charter)
DELAWARE 22-3367588
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
100 Matawan Road, Suite 420
Matawan, NJ 07747
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (732) 739-2900
Check whether the issuer (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 [_]
At August 15, 2005, there were 10,237,045 shares of common stock, par value
$.0025 per share, of the issuer outstanding.
Transitional small business disclosure format: Yes [ ] No [X]
PACIFICHEALTH LABORATORIES, INC.
TABLE OF CONTENTS
---------------------------------
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Balance Sheets as of June 30, 2005 (Unaudited) and December 31, 2004...................................4
Statements of Operations (Unaudited) for the three and six months ended
June 30, 2005 and June 30, 2004...............................................................5
Statements of Cash Flows (Unaudited) for the six months ended
June 30, 2005 and June 30, 2004...............................................................6
Notes to Financial Statements..........................................................................7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF
OPERATIONS......................................................10
ITEM 3. CONTROLS AND PROCEDURES.........................................................................13
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings...............................................................................14
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds.....................................14
ITEM 3. Defaults Upon Senior Securities.................................................................14
ITEM 4. Submission of Matters to a Vote of Security Holders.............................................14
ITEM 5. Other Information...............................................................................14
ITEM 6. Exhibits........................................................................................15
SIGNATURES.....................................................................................................15
2
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Report contains forward-looking statements concerning our
financial condition, results of operations and business, including, without
limitation, statements pertaining to:
o The development and testing of new products and the expansion of
the market for our current products;
o Implementing aspects of our business plans;
o Financing goals and plans;
o Our existing cash and whether and how long these funds will be
sufficient to fund our operations; and
o Our raising of additional capital through future equity
financings.
These and other forward-looking statements are primarily in the section
entitled "Management's Discussion and Analysis of Financial Conditions and
Results of Operations". Generally, you can identify these statements because
they use phrases like "anticipates," "believes," "expects," "future," "intends,"
"plans," and similar terms. These statements are only predictions. Although we
do not make forward-looking statements unless we believe we have a reasonable
basis for doing so, we cannot guarantee their accuracy, and actual results may
differ materially from those we anticipated due to a number of uncertainties,
many of which are unforeseen. You should not place undue reliance on these
forward-looking statements, which apply only as of the date of this Report on
Form 10-QSB. Our actual results could differ materially from those anticipated
in these forward-looking statements for many reasons, including those stated in
this Report. We undertake no obligation to update publicly any forward-looking
statements, whether as a result of new information, future events or otherwise.
We cannot be sure when or if we will be permitted by regulatory agencies to
undertake clinical trials or to commence any particular phase of clinical
trials. Because of this, statements regarding the expected timing of clinical
trials cannot be regarded as actual predictions of when we will obtain
regulatory approval for any "phase" of clinical trials.
We believe it is important to communicate our expectations to our
investors. There may be events in the future, however, that we are unable to
predict accurately or over which we have no control. Cautionary language in this
Report provides examples of risks, uncertainties and events that may cause our
actual results to differ materially from the expectations we describe in our
forward-looking statements.
3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PACIFICHEALTH LABORATORIES, INC.
BALANCE SHEETS
ASSETS
June 30, December 31,
2005 2004
(Unaudited)
------------ ------------
Current assets:
Cash and cash equivalents $ 292,476 $ 25,832
Accounts receivable, net 958,382 430,580
Inventories 1,437,740 1,760,064
Prepaid expenses 193,630 215,091
------------ ------------
Total current assets 2,882,228 2,431,567
Property and equipment, net 90,054 111,273
Deposits 34,396 34,396
------------ ------------
Total assets $ 3,006,678 $ 2,577,236
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable $ 596,657 $ 373,781
Accounts payable and accrued expenses 1,848,394 1,580,094
Deferred revenue 502,971 376,000
------------ ------------
Total current liabilities 2,948,022 2,329,875
------------ ------------
Stockholders' equity:
Preferred stock:
Series A, no par value; 90,909 shares authorized,
issued and outstanding at June 30, 2005
(liquidation value $1,008,333) 948,053 -
Series B, no par value; 45,455 shares authorized,
0 shares issued and outstanding at June 30, 2005
Common stock, $.0025 par value; authorized
50,000,000 shares; issued and outstanding:
10,237,045 shares at June 30, 2005 and
December 31, 2004, respectively 25,592 25,592
Additional paid-in capital 15,779,138 15,778,865
Accumulated deficit (16,694,127) (15,557,096)
------------ ------------
58,656 247,361
------------ ------------
Total liabilities and stockholders' equity $ 3,006,678 $ 2,577,236
============ ============
See accompanying notes to financial statements.
4
PACIFICHEALTH LABORATORIES, INC.
STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30,2005 AND 2004
(UNAUDITED)
Three Months Six Months
Ended June 30, Ended June 30,
--------------------------- -------------------------
2005 2004 2005 2004
----------- ----------- ----------- -----------
Revenues:
Net product sales $ 2,042,382 $ 2,204,522 $ 3,040,043 $ 4,508,119
Cost of goods sold 1,294,909 1,099,830 1,899,307 2,229,645
----------- ----------- ----------- -----------
Gross Profit 747,473 1,104,692 1,140,736 2,278,474
Selling, general and administrative expenses 1,065,721 1,312,345 2,071,075 2,406,039
Research & development expense 46,095 34,961 119,118 73,333
Depreciation expense 16,141 11,770 32,303 21,279
----------- ----------- ----------- -----------
1,127,957 1,359,076 2,222,496 2,500,651
----------- ----------- ----------- -----------
Loss before other income and expense (380,484) (254,384) (1,081,760) (222,177)
Other income (expense):
Interest income 1,315 2,191 2,922 4,792
Interest expense (28,181) (30,616) (47,743) (57,647)
----------- ----------- ----------- -----------
(26,866) (28,425) (44,821) (52,855)
----------- ----------- ----------- -----------
Loss before provision for income taxes (407,350) (282,809) (1,126,581) (275,032)
Provision for income taxes - 7,306 2,115 7,306
----------- ----------- ----------- -----------
Net loss attributable to common stockholders' $ (407,350) $ (290,115) $(1,128,696) $ (282,338)
=========== =========== =========== ===========
Basic and diluted loss per share (0.04) $ (0.03) $ (0.11) $ (0.03)
=========== =========== =========== ===========
Weighted average common shares:
Basic and diluted 10,237,045 10,240,545 10,237,045 10,229,616
=========== =========== =========== ===========
See accompanying notes to financial statements.
5
PACIFICHEALTH LABORATORIES, INC.
STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30,2005 AND 2004
(UNAUDITED)
2005 2004
----------- -----------
Cash flows from operating activities:
Net loss attributable to common stockholders' $(1,128,696) $ (282,338)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation 32,303 21,279
Equity instrument based consulting expense 272 16,139
Changes in assets and liabilities:
Decrease (increase) in accounts receivable (527,802) (581,258)
Decrease (increase) in inventories 322,324 (703,984)
Decrease (increase) in prepaid expenses 21,461 (27,594)
Decrease (increase) in deposits - (8,425)
Increase (Decrease) in accounts payable/accrued expenses 259,967 841,098
Increase (Decrease) in deferred revenue 126,971 -
----------- -----------
Net cash used in operating activities (893,2OO) (725,083)
----------- -----------
Cash flows from investing activity:
Purchase of property and equipment (11,085) (74,709)
----------- -----------
Net cash used in investing activity (11,085) (74,709)
----------- -----------
Cash flows from financing activities:
Proceeds from issuance of notes payable 2,982,815 3,732,575
Repayments of notes payable (2,759,939) (3,587,962)
Preferred stock issued 1,000,000 -
Costs associated with preferred stock issuance (51,947) -
Common stock issued - 42,750
Fees in connection with private placement - (68,635)
----------- -----------
Net cash provided by financing activities 1,170,929 118,728
----------- -----------
Net increase (decrease) in cash and cash equivalents 266,644 (681,064)
Cash and cash equivalents, beginning balance 25,832 1,798,703
----------- -----------
Cash and cash equivalents, ending balance $ 292,476 $ 1,117,639
=========== ===========
Supplemental disclosures of cash flow information:
Cash paid for interest $ 47,743 $ 54,647
=========== ===========
Accrued dividends on preferred stock $ 8,333 $ -
=========== ===========
See accompanying notes to financial statements.
6
PACIFICHEALTH LABORATORIES, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004
(UNAUDITED)
1. BASIS OF PRESENTATION:
The accompanying unaudited financial statements have been prepared in
accordance with accounting principles generally accepted in the United
States of America for interim financial information and with the
instructions for Form 10-QSB and Item 310 of Regulation S-B. Accordingly,
they do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of
normal recurring accruals) considered necessary for a fair presentation
have been included. Operating results for the three and six months ended
June 30, 2005 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2005. The unaudited financial
statements should be read in conjunction with the financial statements and
footnotes thereto included in the Company's annual report on Form 10-KSB
for the year ended December 31, 2004.
The accompanying financial statements have been prepared assuming that
PacificHealth Laboratories, Inc. (the "Company") will continue as a going
concern. The Company has incurred significant recurring operating losses
and significant negative cash flows from operations. The Company has an
accumulated deficit of $16,685,794 as of June 30, 2005. The Company also
has limited ability to borrow additional funds under its line of credit
and is dependent on the completion of a financing in order to continue
operations. Based on this, without any additional financing, the Company
can continue to operate for 30-60 days from August 15, 2005. These factors
raise substantial doubt about the Company's ability to continue as a going
concern. The financial statements do not include any adjustments that
might result from the outcome of this uncertainty.
The Company has raised approximately $1 million in cash from the sale of
its Series A Convertible Preferred Stock in January 2005. The Company
continues to seek additional financing from certain strategic partners and
other equity investors. The Company may explore other strategic
alternatives. In addition, the Company is considering reducing operating
expenses and has also been able to negotiate extended credit terms with
certain vendors, including the Company's contract manufacturer. While the
Company is aggressively pursuing the opportunities and actions described
above, there can be no assurance that the Company will be successful in
its efforts.
2. REVENUE RECOGNITION
Sales are recognized when all of the following criteria are met: (1)
persuasive evidence that an arrangement exists; (2) delivery has occurred
or services have been rendered; (3) the seller's price to the buyer is
fixed and determinable; and, (4) collectibility is reasonably assured.
Sales are recorded net of incentives paid to customers.
In December 2003, the Company entered into a purchasing agreement with a
significant customer for its strength training products whereby all unsold
product is subject to a right of return provision if certain minimum
levels of retail sales in a 12-month period of time from the date of
initial sale are not achieved. In March 2005, its major customer informed
the Company that they would discontinue carrying the Company's strength
training products. The Company and the customer agreed to a significant
discount program in the second quarter of 2005 to transfer these products
to the customer with no further recourse to the Company. Given the ongoing
significant business relationship between the Company and the customer,
the Company discounted product to the customer even though it was not
contractually obligated to so.
In April 2004, the Company entered into a purchasing agreement with the
same significant customer for all other products sold to this customer
whereby all unsold product is subject to return provisions identical or
similar to the one disclosed above. Through December 31, 2004, in addition
to the four criteria described above, the Company recognized revenue
related to these products after analyzing retail sell-through data
provided by the customer and the Company's expectation of future customer
sell-through trends. A new agreement was signed in April 2005 that
increased minimum levels of retail sell-through requirements. Starting
January 1, 2005, the Company will recognize revenue when its major
customer sells through its products to the consumer. This change was made
due to the inability to accurately estimate future returns from this
customer as the Company has previously agreed to accept returns/discounts
of product from this customer that it was not contractually obligated to
do so as well as because the Company entered into a new purchasing
agreement with this customer that increased certain sell-through minimums.
7
3. INVENTORIES
As of June 30, 2005 and December 31, 2004, inventories consisted of the
following:
06/30/05 12/31/04
---------- ----------
Raw Materials $ 63,692 $ 104,745
Work in process - 70,020
Packaging supplies 30,305 70,015
Finished goods 1,111,913 1,324,284
Finished goods on consignment 231,830 191,000
---------- ----------
$1,437,740 $1,760,064
========== ==========
4. STOCK BASED COMPENSATION
The Company did not grant any options to employees during the three and
six months ended June 30, 2005. During the first six months of 2005,
311,200 options previously issued to employees expired.
The Company granted 1,500 stock options to consultants during the three
and six months ended June 30, 2005. These 1,500 options vested upon grant
with an exercise price of $0.28 per share. These options were determined
to have a value of $272 for the six months ended June 30, 2005 and this
amount was charged to operations and added to paid-in capital in
accordance with SFAS 123. In addition, 83,375 options issued to
consultants expired during the first six months of 2005.
The following table illustrates the effect on net loss and loss per share
if the fair value based method had been applied to all awards:
Three Months Ended June 30, Six Months Ended June 30,
2004 2005 2004 2005
--------- --------- ----------- ---------
Reported net loss $(407,350) $(290,115) $(1,128,696) $(282,338)
Stock-based employee compensation
determined under the fair value based
method, net of related tax effects (21,160) (43,855) (80,227) (86,657)
--------- --------- ----------- ---------
Pro forma net loss $(428,510) $(333,970) $(1,208,923) $(368,995)
========= ========= =========== =========
Basic and diluted loss per share:
As reported ($0.04) ($0.03) ($0.11) ($0.03)
Pro forma ($0.04) ($0.03) ($0.12) ($0.04)
5. INCOME TAXES
The Company has approximately $14,874,000 in Federal net operating loss
carryovers that were generated through June 30, 2005 and are available to
offset future taxable income in calendar years 2005 through 2025. The net
operating losses for federal income tax purposes expire beginning in 2017.
The valuation allowance increased $577,000 during the six months ended
June 30, 2005 solely attributable to net operating losses.
The components of the Company's deferred tax assets as of June 30, 2005
and December 31, 2004 are as follows:
06/30/05 12/31/04
------------ -----------
Net operating loss carry forwards $ 6,075,000 $ 5,498,000
Inventory reserve 272,000 272,000
Valuation allowance (6,347,000) (5,770,000)
------------ -----------
Deferred tax asset $ - $ -
============ ===========
8
6. NOTES PAYABLE
Included in notes payable at June 30, 2005 is $517,216 payable to USA
Funding expiring May 31, 2006. The amount of available credit is based on
the value of the Company's eligible receivables from time to time up to
$1,000,000. Eligible receivables include those receivables that have
payment terms equal to or less than net 45 days or have been outstanding
for less than 90 days. The receivables are financed with recourse. This
credit facility bears interest at a rate of prime plus 1.75% as well as a
0.75% discount rate on all advances. At June 30, 2005, the Company had
approximately $125,000 of availability under this credit facility and as
of August 15, 2005 the Company had approximately $ - 0 - of availability
under this credit facility.
7. CONCENTRATION
Our two largest customers accounted for approximately 30% and 14%,
respectively, of net sales for the three months ended June 30, 2005 and
30% and 17%, respectively, of net sales for the three months ended June
30, 2004. Our two largest customers accounted for approximately 38% and
25%, respectively, of net sales for the six months ended June 30, 2005 and
37% and 18%, respectively, of net sales for the six months ended June 30,
2004. At June 30, 2005, the Company has deferred $502,971 in revenues
related to one of these customers. At June 30, 2005, amounts due from
these two customers represented approximately 30% and 22%, respectively,
of accounts receivable. At December 31, 2004, amounts due from these two
customers represented approximately 23% and 13%, respectively, of accounts
receivable.
Our two largest suppliers accounted for approximately 28% and 17%,
respectively, of total purchases for the three months ended June 30, 2005
and 46% and 0%, respectively, of total purchases for the three months
ended June 30, 2004. Our two largest suppliers accounted for approximately
16% and 13%, respectively, of total purchases for the six months ended
June 30, 2005 and 45% and 0%, respectively, of total purchases for the six
months ended June 30, 2004. At June 30, 2005, amounts due to these vendors
represented approximately 34% and 34%, respectively, of accounts payable
and accrued expenses. At December 31, 2004, amounts due to these vendors
represented approximately 69% and 0%, respectively, of accounts payable
and accrued expenses.
8. PREFERRED STOCK
On January 28, 2005, the Company entered into a Series A Preferred Stock
Purchase Agreement and related agreements with Hormel pursuant to which
the Company issued and sold 90,909 shares of Series A Preferred Stock for
an aggregate purchase price of $1,000,000 or $11.00 per share. The Series
A Preferred Stock issued to Hormel is convertible into an aggregate
909,090 shares of common stock, subject to adjustment. In connection with
the Series A Preferred Stock Purchase Agreement, the Company and Hormel
entered into an Investors' Rights Agreement on the same date. Under the
Investors Rights Agreement, the Company agreed, upon request by the
holders of the Series A Preferred Stock, and subject to customary terms
and conditions, to file a registration statement with the Securities and
Exchange Commission (the "SEC") registering for resale the shares of
common stock issuable upon conversion of the Series A Preferred Stock. In
addition, the Company agreed to include the common stock issuable upon
conversion of the Series A Preferred Stock in any other registration
statement the Company may file with the SEC. Furthermore, the Company is
prohibited from granting registration rights superior to those under the
Investors Rights Agreement. Finally, the holders of the Series A Preferred
Stock were granted a right to participate on a pro rata basis in future
sales of equity securities (or securities exercisable for or convertible
into equity securities). As long as at least 50% of the original shares of
the Series A Preferred Stock remain outstanding, the holders have the
right to designate an individual to be nominated to the Company Board of
Directors, provided that such designee would be considered an independent
director under the Securities Exchange Act of 1934 as amended (the
"Exchange Act"). Hormel has exercised this right by designating Mr. Gary
Paxton to the Company's Board of Directors. Also, in connection with this
transaction, the Company, Hormel and Dr. Robert Portman, the Chairman of
the Company's Board of Directors and Chief Scientific Officer, entered
into a Right of First Refusal and Co-Sale Agreement on January 28, 2005.
Under this agreement, the Company and Hormel have the right of first
refusal to purchase shares of the Company's common stock which are held by
Dr. Portman and which he wishes to sell, at the price and terms offered by
a third party. In addition, if the right of first refusal is not exercised
in connection with any sale by Dr. Portman, Hormel will have the right to
require a portion of its shares to be included with Dr. Portman's sale to
a third party only. Certain sales by Dr. Portman will be exempt from these
restrictions, including public sales by Dr. Portman pursuant to Rule 144
of the Securities Act of 1933, as amended.
In the event of a liquidation of the Company, sale of substantially all of
its assets, and certain mergers and consolidations involving the Company,
the holders of the Series A Preferred Stock are entitled to be paid an
amount equal to the greater of: (i) the original purchase price for the
Series A Preferred Stock ($11 per share) plus accrued dividends ($8,333 as
of June 30, 2005 included in accounts payable and accrued expenses on the
balance sheet), if any, or (ii) the amount they would have received as
holders of the number of shares of commons stock into which the Series A
9
Preferred Stock is then convertible (the "Series A Liquidation
Amount"-Liquidation value at June 30, 2005 is $1,008,333). In the event of
the sale of substantially all of the Company's assets and certain mergers
and consolidations involving the Company, if the Company does not effect a
dissolution of the Company under the General Corporation Law of the State
of Delaware within 60 days after such event, then the holders of a
majority of the shares of the Series A Preferred Stock then outstanding
will have the right to require the redemption of such shares at a price
per share equal to the Series A Liquidation Amount. There are no sinking
fund provisions applicable to the Series A Preferred Stock. Cumulative
annual dividends will accrue at the rate of $.022 on each share of Series
A Preferred Stock outstanding. The Company is not required to pay accrued
dividends except in connection with liquidation, merger or sale of the
Company and certain other events. However, no dividends may be paid on
common stock unless all accrued dividends on the Series A Preferred Stock
have been paid. The holders of the Series A Preferred Stock are also
entitled to participate in any dividends paid to the holders of common
stock on an as-converted basis. The holders of outstanding shares of
Series A Preferred Stock shall be entitled to cast the number of votes
equal to the number of whole shares of Common Stock into which the shares
of Series A Preferred Stock held by such holder are convertible as of the
record date for determining stockholders entitled to vote on such matter.
Subject to certain adjustments, each share of the Series A Preferred Stock
is convertible at the option of the holder into ten shares of common
stock. The number of shares of common stock issuable upon conversion of
the Series A Preferred Stock will increase, pursuant to a weighted average
formula in the event that the Company issues common stock at a price below
$1.10 per share, with certain exceptions.
On April 28, 2005, the Company filed a Certificate of Designations (the
"Certificate") creating the Series B Preferred Stock with the Secretary of
the State of the State of Delaware. The Certificate was effective as of
the date filed. Under the Certificate, 45,455 shares of authorized but
unissued preferred stock were designated as Series B Preferred Stock. The
Company filed the Certificate in contemplation of proposed financing
transactions, but does not have a binding agreement as to an any
financing. The Company has not issued any shares of Series B Preferred
Stock to date. Cumulative annual dividends will accrue at the rate of
$.022 on each share of Series B Preferred Stock outstanding. The Company
will not be required to pay accrued dividends except in connection with
liquidation, dissolution, merger, consolidation or sale all or
substantially all of the assets of the Company and certain other events.
However, no cash dividends may be paid on common stock unless all accrued
but unpaid dividends, if any, on Series B Preferred Stock have been paid.
The holders of Series B Preferred Stock will also be entitled to
participate in any dividends paid to the holders of common stock on an
as-converted basis. In the event of a liquidation of the Company, sale of
all or substantially all of its assets, and certain mergers and
consolidations involving the Company, the holders of the Series B
Preferred Stock will be entitled to be paid an amount equal to the greater
of: (i) the original purchase price for the Series B Preferred Stock plus
accrued but unpaid dividends, if any, or (ii) the amount they would have
received as holders of the number of shares of common stock into which
their shares of Series B Preferred Stock then convertible. Subject to
certain adjustments, each share of Series B Preferred Stock will be
convertible at the option of the holder into ten shares of common stock.
The number of shares of common stock issuable upon conversion of the
Series B Preferred Stock will increase, pursuant to a weighted average
formula set forth in the Certificate, in the event the Company issues
common stock at a price below $1.10 per share, with certain exceptions.
The holders of the Series B Preferred Stock will be entitled to vote on an
as-converted basis with the holders of the common stock and the Series A
Preferred Stock together as a single class on all matters submitted for a
vote of the holders of common stock. The Certificate also provides that in
certain instances, the consent of the holders of at least 66% of the
outstanding shares of Series B Preferred Stock will be required for the
Company to take certain actions including: (i) liquidate, dissolve, merge
or consolidate the Company or sell all or substantially all of its assets,
unless the transaction would result in a certain rate of return for the
holders of Series B Preferred Stock; (ii) amend the Company's Certificate
of Incorporation or Bylaws in a manner adverse to the Series B Preferred
Stock; (iii) create an additional class or series of stock senior to or on
par with the Series B Preferred Stock; (iv) purchase, redeem or pay cash
dividends on common stock; or (v) incur certain types of debt in excess of
$750,000.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
In this Report on Form 10-QSB, the terms the "Company," "we", "us," and
"our" refer to PacificHealth Laboratories, Inc.
(A) INTRODUCTION
The Company was incorporated in April 1995 as a nutrition technology
company that researches, develops, and commercializes functionally unique
proprietary products for sports performance, weight loss and Type 2 diabetes.
SPORTS PERFORMANCE
------------------
The Company's first sports performance product, ENDUROX(R), was
introduced in March 1996 with commercial sales beginning in May 1996. In March
1997, the Company extended the ENDUROX line of products with ENDUROX EXCEL(R).
In February 1999, the Company introduced ENDUROX(R) R(4)(R) Performance/Recovery
Drink to be taken following exercise. In clinical studies performed or funded by
the Company, ENDUROX R(4) has demonstrated a number of exercise-related benefits
including enhanced performance, extended endurance, and decreased post-exercise
muscle damage. In June 2001, the Company introduced ACCELERADE(R) Sports Drink,
to be taken during exercise using the same, patented technology as ENDUROX R(4).
Research studies funded by the Company have shown that ACCELERADE is
significantly better than conventional sports drinks in improving endurance
during exercise. In 2003, the Company introduced a ready-to-drink form of
ACCELERADE. In December 2003, the Company acquired all of the outstanding shares
of Strong Research Corp. ("STRONG"), a research-based educational sports
nutrition company, in exchange for 150,000 shares of the Company's common stock.
STRONG had no material revenues but is actively involved in the scientific
education of athletes on proper nutrition utilizing leading Ph.D.-level
scientists in sports nutrition. In March 2004, the Company introduced The
NUTRIENT TIMING SYSTEM ("NTS"), the first suite of products specifically
engineered for during, immediate post-workout, and subsequent use by
strength-training athletes. The NTS product line was launched in GNC in March
2004 and sold exclusively in GNC locations through January 2005. In March 2005,
the Company was informed by representatives of GNC that GNC would discontinue
the NTS line of products.
WEIGHT LOSS
-----------
In weight loss, the Company has focused its research and development
efforts on development of novel nutritional compositions that stimulate the
body's major satiety peptide, or cholecystokinin (CCK). In April 2000, the
Company introduced our first weight loss product, SATIETROL(R), a natural
appetite control product based on this research. Clinical studies performed or
funded by the Company have shown that SATIETROL, a pre meal beverage, can reduce
hunger up to 43% three and one-half hours after eating. In January 2001, the
Company extended our weight loss product line with the introduction of SATIETROL
COMPLETE(R), a 220-calorie meal replacement product that incorporates the
patented SATIETROL technology. In June 2001, the Company signed an exclusive
worldwide Licensing Agreement with GlaxoSmithKline ("GSK") for its SATIETROL
technology. Under the Agreement, the Company received an initial payment of
$1,000,000 and received a subsequent milestone payment of $250,000. GSK
subsequently terminated the Licensing Agreement in September 2002 with all
rights reverting back to the Company. In the third quarter of 2003, the Company
funded clinical studies performed at a private research firm that showed a
statistically significant reduction in caloric intake in overweight individuals
using a new improved form of SATIETROL in both beverage and tablet form. The
Company has and will conduct additional studies on SATIETROL in 2005.
TYPE 2 DIABETES
---------------
Type 2 diabetes has become the fastest growing chronic condition in the
United States. Obesity and poor glucose regulation appear to be the primary
characteristics of Type 2 diabetes. Research has suggested that cholecystokinin
(CCK) may play a role in insulin release and glucose regulation. The Company's
research in this area has focused upon the development of nutritional products
that can help Type 2 diabetics lose weight by controlling appetite while
improving glucose regulation. The Company will initiate clinical trials in the
Type 2 diabetes area during the second half of 2005.
11
(B) RESULTS OF OPERATIONS - THREE- AND SIX- MONTHS ENDED JUNE 30, 2005 VS. JUNE
30, 2004
We recorded a net loss of ($407,350), or ($0.04) per share, for the
second quarter ended June 30, 2005 compared to a net loss of ($290,115), or
($0.03) per share, for the second quarter ended June 30, 2004. We recorded a net
loss of ($1,128,696), or ($0.11) per share, for the six-month period ended June
30, 2005, compared to a net loss of ($282,338), or ($0.03) per share, for the
six-month period ended June 30, 2004. The increased net loss for the three- and
six- month periods ended June 30, 2005 as compared to the same periods in 2004
is due primarily to decreased revenues as detailed below.
Revenues in the quarter ended June 30, 2005 were $2,042,382 compared to
$2,204,522 for the same period in 2004. Revenues in the six-month period ended
June 30, 2005 were $3,040,043 compared to revenues of $4,508,119 for the same
period in 2004. Revenues decreased in the three-month period ending June 30,
2005 as compared to the same period in 2004 as promotional expenses paid to
promote the Company's products that are deducted from revenues increased
significantly. Revenues decreased in the six-month period ending June 30, 2005
as compared to the same period in 2004 primarily because the first six months of
2004 included significant opening orders for the NTS suite of products that the
Company's major customer discontinued in 2005 as well as the aforementioned
significant increases in promotional expenses that are deducted from revenues.
The Company has started to recognize revenue sold to its major customer based
upon when this major customer sells through the products to the consumer. This
change was made due to the inability to accurately estimate future returns from
this customer as well as because the Company entered into a new purchasing
agreement that increased certain sell-through minimums. As a result, the Company
has deferred approximately $38,000 in revenues to its major customer for the
three months ended June 30, 2005 and approximately $503,000 in revenues to its
major customer for the six months ended June 30, 2005. In the second quarter of
2005, the Company entered into an agreement with its major customer to resolve
certain products previously sold to this customer amounting to $597,781 and
recorded as deferred revenue by the Company. In connection with this settlement,
the customer agreed to accept $257,957 of inventory as final product purchases
from the Company with no future obligations on behalf of the Company. The
balance of $339,824, which is included in accounts payable and accrued expenses
in the balance sheet, is to be repaid to the customer over 12 months commencing
in July 2005. As a result, $257,957 previously recorded as deferred was taken
into revenue.
Gross profit margin on product sales was 36.6% for the three months
ended June 30, 2005, compared to 50.1% for the three months ended June 30, 2004.
Gross profit margin on product sales was 37.5% for the six-month period ended
June 30, 2005 versus 50.5% for the six-month period ended June 30, 2004. The
decrease in gross profit margin for the three- and six-month periods ended June
30, 2005 compared to the same periods in 2004 is primarily due to the previously
mentioned promotional expenses paid to promote the Company's products that are
deducted from revenues and lower gross profit margins on newer products. From
time to time, the Company may incur additional promotional expenses in
connection with the sale of its products. These promotional expenses should
result in higher unit volumes of sales of these products.
Selling, general, and administrative ("S, G, & A") expenses decreased
to $1,065,721 for the three-month period ended June 30, 2005 from $1,312,345 for
the three-month period ended June 30, 2004. S, G, & A expenses decreased to
$2,071,075 for the six-month period ended June 30, 2005 from $2,406,039 for the
six-month period ended June 30, 2004. S, G, & A expenses decreased due primarily
to decreases in advertising and marketing expenses associated with the
discontinued NTS suite of products.
Research and development ("R & D") expenses increased to $46,095 for
the three months ended June 30, 2005 from $34,961 for the three months ended
June 30, 2004. R & D expenses increased to $119,118 for the six months ended
June 30, 2005 from $73,333 for the six months ended June 30, 2004. The increases
were due to our aggressive R & D plan put in place as we continue to seek out
additional patents and claims for our products. We anticipate R & D expenses
will increase as we conduct additional clinical trials on all of our products.
Interest expense decreased to $28,181 for the three months ended June
30, 2005 from $30,616 for the three months ended June 30, 2004. Interest expense
decreased to $47,743 for the six months ended June 30, 2005 from $57,647 for the
six months ended June 30, 2004. Interest expense is incurred in connection with
our accounts receivable funding from USA Funding described in the "Liquidity and
Capital Resources" section below. The decrease in interest expense in the three-
and six-month periods was due to decreased use of available funding under the
Company's existing line of credit.
(C) LIQUIDITY AND CAPITAL RESOURCES
As of August 15, the Company's cash balance was approximately $200,000.
Based on this, without any additional financing, the Company can continue to
operate for 30-60 days from August 15, 2005. As a result of its current
liquidity position, the Company's auditors in the December 31, 2004 financial
statements have expressed doubt that the Company can continue as a going
concern. The Company's financial statements do not include any adjustments
related to this uncertainty.
12
Management has responded to the aforementioned risks by continuing to
seek additional financing. In January 2005, the Company obtained an investment
of $1,000,000 from Hormel Health Labs, LLC ("Hormel"), the terms of which are
discussed below. The Company may explore other strategic alternatives. In
addition, the Company is considering reducing operating expenses. The Company
has also been able to finance its operations through an increase in accounts
payable by negotiating extended terms from its vendors. While the Company is
aggressively pursuing the opportunities and actions described above, there can
be no assurance that the Company will be successful in its efforts.
At June 30, 2005, the Company's current liabilities exceeded its
current assets by approximately $57,000 with a ratio of current assets to
current liabilities of approximately 0.98 to 1. At June 30, 2005, cash on hand
was $292,476, an increase of $266,644 from December 31, 2004, primarily as the
result of the investment by Hormel (see below) as well as an increase of
$527,802 in accounts receivable, a decrease in inventory of $322,324, an
increase in accounts payable and accrued expenses of $259,967, and an increase
in deferred revenue of $126,971 from December 31, 2004. Accounts receivable
increased and inventory decreased at June 30, 2005 from December 31, 2004 due to
higher revenues in the second quarter of 2005 as compared to fourth quarter of
2004. Accounts payable and accrued expenses increased primarily as a result of a
reclass from deferred revenue to accrued expenses resulting from a settlement
with a major customer as further disclosed previously in MD&A under Results of
Operations. Deferred revenue increased as the Company has deferred revenues
related to shipments to a major customer.
At June 30, 2005, notes payable increased $222,876 to $596,657 from
December 31, 2004 primarily as a result of the increased use of our accounts
receivable funding from USA Funding due to higher second quarter sales in 2005
compared to fourth quarter 2004. The amount of available credit is based on the
value of the Company's eligible receivables from time to time up to $1,000,000.
This credit facility bears interest at a rate of prime plus 1.75% as well as a
0.75% discount rate on all advances. At June 30, 2005, we had approximately
$125,000 of availability under this credit facility and as of August 15, 2005 we
had approximately $ - 0 - of availability under this credit facility.
On January 28, 2005, the Company entered into a Series A Preferred
Stock Purchase Agreement and related agreements with Hormel pursuant to which
the Company issued and sold 90,909 shares of Series A Preferred Stock for an
aggregate purchase price of $1,000,000 or $11.00 per share. The Series A
Preferred Stock issued to Hormel is convertible into an aggregate 909,090 shares
of common stock, subject to adjustment. In connection with the Series A
Preferred Stock Purchase Agreement, the Company and Hormel entered into an
Investors' Rights Agreement on the same date. Under the Investors Rights
Agreement, the Company agreed, upon request by the holders of the Series A
Preferred Stock, and subject to customary terms and conditions, to file a
registration statement with the Securities and Exchange Commission (the "SEC")
registering for resale the shares of common stock issuable upon conversion of
the Series A Preferred Stock. In addition, the Company agreed to include the
common stock issuable upon conversion of the Series A Preferred Stock in any
other registration statement the Company may file with the SEC. Furthermore, the
Company is prohibited from granting registration rights superior to those under
the Investors Rights Agreement. Finally, the holders of the Series A Preferred
Stock were granted a right to participate on a pro rata basis in future sales of
equity securities (or securities exercisable for or convertible into equity
securities). As long as at least 50% of the original shares of the Series A
Preferred Stock remain outstanding, the holders have the right to designate an
individual to be nominated to the Company Board of Directors, provided that such
designee would be considered an independent director under the Securities
Exchange Act of 1934 as amended (the "Exchange Act"). Hormel has exercised this
right by designating Mr. Gary Paxton to the Company's Board of Directors. Also,
in connection with this transaction, the Company, Hormel and Dr. Robert Portman,
the Chairman of the Company's Board of Directors and Chief Scientific Officer,
entered into a Right of First Refusal and Co-Sale Agreement on January 28, 2005.
Under this agreement, the Company and Hormel have the right of first refusal to
purchase shares of the Company's common stock which are held by Dr. Portman and
which he wishes to sell, at the price and terms offered by a third party. In
addition, if the right of first refusal is not exercised in connection with any
sale by Dr. Portman, Hormel will have the right to require a portion of its
shares to be included with Dr. Portman's sale to a third party only. Certain
sales by Dr. Portman will be exempt from these restrictions, including public
sales by Dr. Portman pursuant to Rule 144 of the Securities Act of 1933, as
amended.
In the event of a liquidation of the Company, sale of substantially all
of its assets, and certain mergers and consolidations involving the Company, the
holders of the Series A Preferred Stock are entitled to be paid an amount equal
to the greater of: (i) the original purchase price for the Series A Preferred
Stock ($11 per share) plus accrued dividends, if any, or (ii) the amount they
would have received as holders of the number of shares of commons stock into
which the Series A Preferred Stock is then convertible (the "Series A
Liquidation Amount"). In the event of the sale of substantially all of the
Company's assets and certain mergers and consolidations involving the Company,
13
if the Company does not effect a dissolution of the Company under the General
Corporation Law of the State of Delaware within 60 days after such event, then
the holders of a majority of the shares of the Series A Preferred Stock then
outstanding will have the right to require the redemption of such shares at a
price per share equal to the Series A Liquidation Amount. There are no sinking
fund provisions applicable to the Series A Preferred Stock. Cumulative annual
dividends will accrue at the rate of $.022 on each share of Series A Preferred
Stock outstanding. The Company is not required to pay accrued dividends except
in connection with liquidation, merger or sale of the Company and certain other
events. However, no dividends may be paid on common stock unless all accrued
dividends on the Series A Preferred Stock have been paid. The holders of the
Series A Preferred Stock are also entitled to participate in any dividends paid
to the holders of common stock on an as-converted basis. The holders of
outstanding shares of Series A Preferred Stock shall be entitled to cast the
number of votes equal to the number of whole shares of Common Stock into which
the shares of Series A Preferred Stock held by such holder are convertible as of
the record date for determining stockholders entitled to vote on such matter.
Subject to certain adjustments, each share of the Series A Preferred Stock is
convertible at the option of the holder into ten shares of common stock. The
number of shares of common stock issuable upon conversion of the Series A
Preferred Stock will increase, pursuant to a weighted average formula in the
event that the Company issues common stock at a price below $1.10 per share,
with certain exceptions.
On April 28, 2005, the Company filed a Certificate of Designations (the
"Certificate") creating the Series B Preferred Stock with the Secretary of the
State of the State of Delaware. The Certificate was effective as of the date
filed. Under the Certificate, 45,455 shares of authorized but unissued preferred
stock were designated as Series B Preferred Stock. The Company filed the
Certificate in contemplation of proposed financing transactions, but does not
have a binding agreement as to an any financing. The Company has not issued any
shares of Series B Preferred Stock to date. Cumulative annual dividends will
accrue at the rate of $.022 on each share of Series B Preferred Stock
outstanding. The Company will not be required to pay accrued dividends except in
connection with liquidation, dissolution, merger, consolidation or sale all or
substantially all of the assets of the Company and certain other events.
However, no cash dividends may be paid on common stock unless all accrued but
unpaid dividends, if any, on Series B Preferred Stock have been paid. The
holders of Series B Preferred Stock will also be entitled to participate in any
dividends paid to the holders of common stock on an as-converted basis. In the
event of a liquidation of the Company, sale of all or substantially all of its
assets, and certain mergers and consolidations involving the Company, the
holders of the Series B Preferred Stock will be entitled to be paid an amount
equal to the greater of: (i) the original purchase price for the Series B
Preferred Stock plus accrued but unpaid dividends, if any, or (ii) the amount
they would have received as holders of the number of shares of common stock into
which their shares of Series B Preferred Stock then convertible. Subject to
certain adjustments, each share of Series B Preferred Stock will be convertible
at the option of the holder into ten shares of common stock. The number of
shares of common stock issuable upon conversion of the Series B Preferred Stock
will increase, pursuant to a weighted average formula set forth in the
Certificate, in the event the Company issues common stock at a price below $1.10
per share, with certain exceptions. The holders of the Series B Preferred Stock
will be entitled to vote on an as-converted basis with the holders of the common
stock and the Series A Preferred Stock together as a single class on all matters
submitted for a vote of the holders of common stock. The Certificate also
provides that in certain instances, the consent of the holders of at least 66%
of the outstanding shares of Series B Preferred Stock will be required for the
Company to take certain actions including: (i) liquidate, dissolve, merge or
consolidate the Company or sell all or substantially all of its assets, unless
the transaction would result in a certain rate of return for the holders of
Series B Preferred Stock; (ii) amend the Company's Certificate of Incorporation
or Bylaws in a manner adverse to the Series B Preferred Stock; (iii) create an
additional class or series of stock senior to or on par with the Series B
Preferred Stock; (iv) purchase, redeem or pay cash dividends on common stock; or
(v) incur certain types of debt in excess of $750,000.
The Company has no material commitments for capital expenditures.
(D) OFF-BALANCE SHEET ARRANGEMENTS
There are no off-balance sheet arrangements between the Company and any
other entity that have, or are reasonably likely to have, a current or future
effect on the Company's financial condition, revenues or expenses, results of
operations, liquidity, capital expenditures, or capital resources.
14
ITEM 3. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES. Based on their
evaluation of the Company's disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act as of June 30,
2005, the end of the period covered by this report, the Company's chief
executive officer and chief financial officer have concluded that the Company's
disclosure controls and procedures are designed to ensure that information
required to be disclosed by the Company in the reports that it files or submits
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in the SEC's rules and forms, that such information
is accumulated and disclosed to management, including the chief executive
officer and the chief financial officer, as appropriate to allow timely
decisions regarding required disclosure; and that such disclosure controls and
procedures are effective.
CHANGES IN INTERNAL CONTROLS. There were no significant changes in the
Company's internal controls or in other factors that could significantly affect
these controls subsequent to the date of their most recent evaluation.
II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
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
(a) On June 8, 2005, the Company held its Annual Meeting of Stockholders,
pursuant to information contained in the Company's Notice of Annual
Meeting of Stockholders and Proxy Statement that were mailed to
stockholders on May 10, 2005.
(b) One of the matters listed in the Company's Proxy for the meeting was the
annual Election of Directors. There were four nominees for election who
were elected by the shareholders to serve for a one-year term. The
results of the balloting were as follows (Shares voting: 8,461,092 of
11,146,135):
Nominee For Against Abstain
------- --- ------- -------
Robert Portman 7,713,473 -0- 747,619
Stephen P. Kuchen 8,259,709 -0- 201,383
David Portman 7,649,857 -0- 811,235
Michael Cahr 8,249,569 -0- 211,523
David Mastroianni 6,166,572 -0- 2,294,520
Although votes for Mr. Mastroianni were tabulated, Mr. Mastroianni
resigned from the Board effective June 7, 2005 and therefore did not
stand for re-election.
(c) Another matter voted upon by the stockholders was the ratification of
the appointment of Eisner, LLP as independent auditors for the Company
for the fiscal year ending December 31, 2005. This matter was approved.
The results of the balloting for this matter was as follows:
Matter For Against Abstain
------ --- ------- -------
Appointment of auditors 8,234,148 225,569 1,375
Eisner resigned as auditor of the Company effective June 17, 2005. The
Company has hired the firm of Weiser LLP to serve as the Company's
auditors for the fiscal year ending December 31, 2005.
15
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
Exhibit No. Description of Exhibit
31.1 Section 302 Certification of Robert Portman,
Chief Executive Officer.
31.2 Section 302 Certification of Stephen P. Kuchen,
Chief Financial Officer.
32 Certification of Chief Executive Officer and
Chief Financial Officer Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, the Registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PACIFICHEALTH LABORATORIES, INC.
By: /S/ STEPHEN P. KUCHEN
---------------------------------
STEPHEN P. KUCHEN
Vice President (Principal Financial
Officer and Principal Accounting
Officer)
Date: AUGUST 15, 2005
16