U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934
For Quarter Ended: MARCH 31, 2008
Commission File Number: 0-23100
HEALTHSPORT, INC.
(Exact name of small business issuer as specified in its charter)
DELAWARE 22-2649848
(State of Incorporation) (IRS Employer ID No)
7633 EAST 63RD PLACE, SUITE 220, TULSA, OKLAHOMA 74133
(Address of principal executive office)
(716) 691-6763
(Issuer's telephone number)
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 during the past 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [X] No [ ].
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of "large accelerated filer," "accelerated filer," and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller reporting company [X]
(Do not check if a smaller reporting company)
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 registrant's common stock, par value $.0001
per share, as of March 31, 2008, was 44,148,397.
HEALTHSPORT, INC. AND SUBSIDIARIES
INDEX
Page
----
PART I FINANCIAL INFORMATION (Unaudited)
Item 1: Condensed Consolidated Balance Sheet as of March 31, 2008 and
December 31, 2007 3
Condensed Consolidated Statements of Operations for the three
months ended March 31, 2008 and 2007 4
Condensed Consolidated Statements of Cash Flows for the three
months ended March 31, 2008 and 2007 5
Notes to Condensed Consolidated Financial Statements 6
Item 2: Management's Discussion and Analysis of Financial Condition and
Results of Operations 16
Item 3: Quantitative and Qualitative Disclosures About Market Risk 20
Item 4T: Controls and Procedures 20
PART II OTHER INFORMATION 21
Exhibits
2
HEALTHSPORT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
MARCH 31, 2008 (UNAUDITED) AND DECEMBER 31, 2007
2008
Unaudited 2007
--------- ----
Assets
Current assets:
Cash and cash equivalents $ 262,241 $ 167,323
Accounts receivable 67,431 107,312
Inventory 1,220,412 1,402,530
Prepaid expenses and other assets 470,184 734,245
------------ ------------
Total current assets 2,020,268 2,411,410
Property and equipment, net 783,057 636,370
Goodwill 10,326,948 10,326,948
Patent costs and other intangible assets, net 20,035,440 20,308,545
Other assets 118,131 21,524
------------ ------------
Total assets $ 33,283,844 $ 33,704,797
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,416,026 $ 1,037,172
Accrued expenses 417,046 114,903
Current portion of capital lease obligation 169,427 217,954
Deferred revenue 700,397 696,096
------------ ------------
Total current liabilities 2,702,896 2,066,125
------------ ------------
Capital lease obligation, less current portion 66,932 70,963
------------ ------------
Total liabilities 2,769,828 2,137,088
------------ ------------
Minority interest 486,100 --
Commitments and contingencies
Stockholders' equity:
Preferred stock: $2.75 par value; authorized 2,000,000
shares; no shares issued and outstanding -- --
Common stock: $.0001 par value; authorized 500,000,000
shares; 44,148,397 and 42,898,397 shares issued and outstanding
at March 31, 2008 and December 31, 2007, respectively 4,415 4,290
Additional paid-in capital 68,706,944 67,980,373
Intrinsic value of common stock options (2,056,374) (2,860,229)
Accumulated deficit (36,627,069) (33,556,725)
------------ ------------
Total stockholders' equity 30,027,916 31,567,709
------------ ------------
Total liabilities and stockholders' equity $ 33,283,844 $ 33,704,797
============ ============
See accompanying notes to condensed consolidated financial statements.
3
HEALTHSPORT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2008 AND 2007
(UNAUDITED)
2008 2007
------------ ------------
Revenue
Product sales $ 97,441 $ 5,897
License fees, royalties and services 18,750 --
------------ ------------
Total revenues 116,191 5,897
------------ ------------
Costs and expenses
Cost of product sold 40,741 3,877
General and administrative expense 1,150,877 262,771
Marketing and selling expense 475,343 409,173
Non-cash compensation expense 1,053,805 387,944
Manufacturing costs 415,928 --
Research and development costs 71,579 --
------------ ------------
Total costs and expenses 3,208,273 1,063,765
------------ ------------
Net loss from operations (3,092,082) (1,057,868)
------------ ------------
Other income (expense):
Other income 5,584 --
Interest income 408 9,227
Interest expense (3,154) --
------------ ------------
Other income 2,838 9,227
------------ ------------
Net loss before income taxes and minority interest (3,089,244) (1,048,641)
Provision for income taxes -- --
------------ ------------
Net loss before minority interest (3,089,244) (1,048,641)
Minority interest 18,900 --
------------ ------------
Net loss $ (3,070,344) $ (1,048,641)
============ ============
NET LOSS PER SHARE, BASIC AND DILUTED $ (0.07) $ (0.05)
============ ============
WEIGHTED AVERAGE SHARES OUTSTANDING,
BASIC AND DILUTED 43,127,793 19,995,308
============ ============
See accompanying notes to condensed consolidated financial statements.
4
HEALTHSPORT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 2008 AND 2007
(UNAUDITED)
2008 2007
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(3,070,344) $(1,048,641)
Adjustment to reconcile net loss to net cash used
in operating activities:
Minority interest (18,900) --
Amortization of non-cash stock compensation 1,053,805 387,944
Depreciation and amortization 365,463 29,232
Change in other assets and liabilities:
Accounts receivable 109,881 (5,497)
Inventory 182,117 3,877
Prepaid expenses and other assets 121,698 (51,720)
Accounts payable 378,855 85,110
Accrued expenses 236,445 183,495
----------- -----------
Net cash used in operating activities (640,980) (416,200)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Patent costs incurred (52,881) --
Loans to InnoZen prior to acquisition -- (500,000)
Acquisition of property and equipment (186,163) (42,335)
----------- -----------
Net cash used in investing activities (239,044) (542,335)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Collect stock subscription receivable 22,500 250,000
Capital contribution by joint venture partner 505,000 --
Capital lease payments (52,558) --
Sale of common stock 500,000 2,368,051
----------- -----------
Net cash provided by financing activities 974,942 2,618,051
----------- -----------
NET INCREASE IN CASH AND CASH EQUIVALENTS 94,918 1,659,516
CASH AND CASH EQUIVALENTS, beginning of period 167,323 318,144
----------- -----------
CASH AND CASH EQUIVALENTS, end of period $ 262,241 $ 1,977,660
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION
CASH PAID FOR INTEREST AND INCOME TAXES:
Interest $ 3,154 $ --
Income taxes -- --
See accompanying notes to condensed consolidated financial statements.
5
HEALTHSPORT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following notes to the condensed consolidated financial statements and
management's discussion and analysis or plan of operation contain
"forward-looking" statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. Such forward-looking statements may include projections or
expectations of future financial or economic performance of the Company, and
statements of the Company's plans and objectives for future operations. Words
such as "expects", "anticipates", "approximates", "believes", "estimates",
"hopes", "intends", "plans", and variations of such words and similar
expressions are intended to identify such forward-looking statements. No
assurance can be given that actual results or events will not differ materially
from those projected, estimated, assumed or anticipated in any such
forward-looking statements.
NOTE 1: ORGANIZATION AND NATURE OF BUSINESS
--------------------------------------------
ORGANIZATION AND BASIS OF PRESENTATION
The condensed consolidated financial statements include the accounts of
HealthSport, Inc. ("HealthSport") and its wholly owned subsidiaries: Enlyten,
Inc. ("Enlyten"); InnoZen, Inc. ("InnoZen") and InnoZen's majority owned
subsidiary Pacific Manufacturing Group LLC ("PMG"); Health Strip Solutions, LLC
("Health Strip"); Cooley Nutraceuticals, Inc. ("Nutraceuticals"); and the
following inactive subsidiaries, World Championship Poker, Inc. ("Poker"),
Strategic Gaming Consultants, LLC ("Gaming") and Maxx Motorsports, Inc.
("Maxx"), and its wholly owned subsidiary, Team Racing Auto Circuit, LLC
("TRAC") (collectively, the "Company" or the "Companies"). All significant
intercompany balances and transactions have been eliminated in consolidation.
The condensed consolidated financial statements included in this report have
been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission for interim reporting and include all
adjustments (consisting only of normal recurring adjustments) that are, in the
opinion of management, necessary for a fair presentation. These condensed
consolidated financial statements have not been audited.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States have been condensed or omitted pursuant to such rules and
regulations for interim reporting. The Company believes that the disclosures
contained herein are adequate to make the information presented not misleading.
However, these condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's Annual Report for the year ended December 31, 2007,
which is included in the Company's Form 10-K for the year ended December 31,
2007. The financial data for the interim periods presented may not necessarily
reflect the results to be anticipated for the complete year.
6
Certain reclassifications of the amounts presented for the comparative period
have been made to conform to the current presentation.
NATURE OF BUSINESS
HealthSport is a holding company with the following active wholly owned
subsidiaries.
Enlyten was formed to market and sell the Company's ENLYTEN(TM) edible film
strip products.
InnoZen is the preeminent formulator, developer and manufacturer of edible thin
film strips that deliver drug actives and was the first company to deliver a
drug active ingredient in a thin film strip. InnoZen completed the development
of Chloraseptic(R) Sore Throat Relief Strips in June 2003 and launched two new
film strip products under its own Suppress(R) brand (http://www.suppress.com) in
September 2004. All manufacturing operations will be performed by PMG commencing
during 2008 and InnoZen will primarily be involved in research and development
of new products.
All patent applications for the Companies are processed by InnoZen.
Health Strip, in conjunction with InnoZen, holds the proprietary technology for
the formulation of a thin film electrolyte strip and has filed a provisional
patent for this process. Along with water, electrolytes such as those found in
Health Strip's ENLYTEN(TM) SPORTSTRIPS, can be used in oral rehydration therapy
to replenish the body's electrolyte levels after dehydration caused by exercise,
diarrhea or vomiting. Health Strip and InnoZen also hold the proprietary
technology for ENLYTEN(TM) SURVIVAL STRIPS which are formulated with
antioxidants, non-cavity causing sweeteners, vitamins, herbal extracts,
electrolytes, caffeine and other proven beneficial compounds as a remedy to
fatigue, drowsiness and dehydration.
Nutraceuticals holds the proprietary technology for the formulation of a
nutritional supplement that quickly and effectively provides natural energy
enhancers, caffeine, electrolytes, antioxidants and other essential vitamins and
minerals. In conjunction with InnoZen, Nutraceuticals has designed the FIX
STRIPS(TM), as a formulation to supply the body with a healthy boost in energy,
while replenishing and maintaining the essential vitamins and minerals lost
during activity, after a long flight, bad night of sleep or over indulgence of
alcohol.
NOTE 2: ACQUISITIONS
---------------------
INNOZEN, INC.
-------------
On May 4, 2007, the Company completed the acquisition of InnoZen through a
merger of InnoZen with InnoZen Acquisition Sub, Inc. ("Acquisition Sub"), the
Company's wholly owned subsidiary, all Delaware corporations, in exchange for
18,249,952 shares of the Company's common stock. In accordance with Delaware
General Corporate Law and pursuant to the terms and conditions of the Merger
Agreement, Acquisition Sub was merged with and into InnoZen, after which,
InnoZen became the Company's wholly owned subsidiary and continues as the
surviving corporation and the separate existence of Acquisition Sub ceased.
7
InnoZen is the preeminent formulator, developer and manufacturer of edible thin
film strips that deliver drug actives and was the first company to deliver a
drug active ingredient in a thin film strip when it completed the development of
Chloraseptic(R) Sore Throat Relief Strips in June 2003. With Chloraseptic Relief
Strips, InnoZen established a new process which prevented irritants and
incorporated additional compounds to make the strips more suitable for various
drug delivery needs. Relying on its expertise in the development of edible film
strips that deliver drug actives, InnoZen moved forward with its proprietary
technology to develop two new thin film strip products for cough. InnoZen
launched its two new film strip products under its own Suppress(R) brand
(http://www.suppress.com) in September 2004.
The acquisition was accounted for using the purchase method of accounting and,
accordingly, the consolidated statements of operations include the results of
InnoZen beginning May 4, 2007. The assets acquired and the liabilities assumed
were recorded at estimated fair values as determined by the Company's management
based on information currently available and on current assumptions as to future
operations. A summary of the estimated fair value of assets acquired and
liabilities assumed in the acquisition follows:
Current assets, excluding cash and cash equivalents $ 584,993
Property and equipment 471,188
Other assets 10,583
Intangible assets 19,102,968
Goodwill 8,540,950
Research and development cost 847,336
--------------
Total assets 29,558,018
Liabilities assumed (1,449,922)
Liabilities to HealthSport (750,000)
--------------
Purchase price (net assets acquired) 27,358,096
Common stock issued (27,374,928)
--------------
Cash acquired in excess of cash paid $ 16,832
==============
Unaudited pro forma results of operations for the three-month period ended March
31, 2007, as if the Company and InnoZen had been combined as of the beginning of
the period follows. The pro forma results include estimates and assumptions
which management believes are reasonable. However, pro forma results are not
necessarily indicative of the results that would have occurred if the business
combination had been in effect on the dates indicated, or which may result in
the future. The Company and InnoZen are combined in 2008. Accordingly pro forma
results are not necessary for 2008.
2007
----
Net revenues $ 472,757
Net loss 1,320,380
Net loss per share, basic and diluted $ (0.03)
8
On February 1, 2008 HealthSport and InnoZen executed a Limited Liability Company
Operating Agreement ("LLC Agreement") with Migami, Inc. ("Migami") for PMG.
Among other things, the LLC Agreement calls for Migami to contribute $3,000,000
in cash to PMG for its intended 48% ownership and InnoZen to license its
technology to PMG for its 52% ownership. In summary, the agreement provides that
PMG will manufacture all strip and other products for each member at cost plus
25%. PMG's cash balance of $74,605 is not available for use for obligations of
HealthSport and its other subsidiaries.
NOTE 3: INVENTORY
Inventory at March 31, 2008 and December 31, 2007, consists of the following:
2008 2007
---- ----
Raw materials $ 370,020 $ 395,239
Work in progress 210,189 169,016
Finished goods 640,203 838,275
------------ ------------
$ 1,220,412 $ 1,402,530
============ ============
NOTE 4: PROPERTY AND EQUIPMENT
Property and equipment at March 31, 2008 and December 31, 2007 consists of the
following:
2008 2007
---- ----
Office furniture and equipment $ 83,393 $ 83,393
Computer software 106,800 101,150
Manufacturing equipment 662,507 487,578
Leasehold improvements 39,561 39,561
---------- ----------
892,261 711,682
Accumulated depreciation and amortization (109,204) (75,312)
---------- ----------
$ 783,057 $ 636,370
========== ==========
NOTE 5: INTANGIBLE ASSETS
--------------------------
The Company accounts for goodwill and intangible assets in accordance with SFAS
142 and SFAS 144. Goodwill and other intangible assets are tested annually, at a
minimum, for impairment. Patent costs are amortized over their life of seventeen
years from the date the patent application is filed. Patent costs include the
costs allocated to the proprietary technology for the formulation of thin film
electrolyte strip products and associated legal costs. Trade secrets include
costs allocated to InnoZen's formulations and are being amortized over seventeen
years. Trademarks represent the cost of acquired trademarks, which are not being
amortized. Client lists represents the cost of acquired client lists which are
being amortized over five years.
9
The Company's intangible assets consist of the following at March 31, 2008 and
December 31, 2007:
2008 2007
---- ----
Goodwill $ 10,326,948 $ 10,326,948
============= =============
Patent costs and other intangible assets:
Patent and trade secret costs $ 19,208,370 $ 19,155,124
Trademarks 1,188,000 1,188,365
Client lists 846,000 846,000
Web site 65,675 65,675
------------- -------------
21,308,045 21,255,164
------------- -------------
Accumulated amortization
Patent and trade secret costs (1,108,578) (828,176)
Client lists (155,100) (112,800)
Web site (8,927) (5,643)
------------- -------------
(1,272,605) (946,619)
------------- -------------
$ 20,035,440 $ 20,308,545
============= =============
NOTE 6: SHARE-BASED PAYMENTS
-----------------------------
STOCK OPTIONS
In December 2004, the FASB issued SFAS 123 (revised 2004), "Share-Based Payment"
(SFAS 123R). Among other things, SFAS 123R requires expensing the fair value of
stock options, previously optional accounting. For transition, upon adoption on
January 1, 2006, SFAS 123R required expensing any unvested options and also
required the Company to change the classification of certain tax benefits from
option deductions to financing rather than operating cash flows.
Prior to January 1, 2006, the Company accounted for options granted under its
employee compensation plan using the intrinsic value method prescribed in
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees" ("APB 25") and related interpretations including Financial
Accounting Standards Board ("FASB") Interpretation No. 44, "Accounting for
Certain Transactions involving Stock Compensation, an interpretation of APB
Opinion No. 25." Under APB 25, compensation expense was recognized for the
difference between the market price of the Company's common stock on the date of
grant and the exercise price. As permitted by Statement of Financial Accounting
Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"), stock-based compensation was included as a pro forma disclosure in the
notes to the consolidated financial statements.
10
Effective January 1, 2006, the Company adopted the provisions of SFAS 123R using
the modified prospective transition method for all stock options issued. SFAS
123R required measurement of compensation cost for all options granted based on
fair value on the date of grant and recognition of compensation over the service
period for those options expected to vest. The Company had no unvested options
outstanding prior to July 1, 2006. Stock-based compensation expense recorded for
the nine months ended September 30, 2007, includes the estimated expense for
stock options granted on or subsequent to January 1, 2006, based on the grant
date fair value estimated in accordance with the provisions of SFAS 123R. The
Company recorded the cost of stock options by increasing additional paid-in
capital and increasing intrinsic value of common stock options. The deferred
intrinsic value of common stock options is being amortized over the period which
the awards are expected to be exercised. As prescribed under the modified
prospective and prospective transition methods, results for the prior period
have not been restated.
The Company currently fully reserves all of its tax benefits. Accordingly, the
adoption of SFAS 123R, which requires the benefits of tax deduction in excess of
the compensation cost recognized for those options to be classified as financing
cash inflows rather than operating cash inflows, on a prospective basis, will
have no current impact on the Company.
The fair value of each option on the date of grant is estimated using the Black
Scholes option valuation model. The following weighted-average assumptions were
used for options granted during the three months ended March 31, 2008 and 2007:
2008 2007
---- ----
Expected term 1-3 years 2 years
Expected volatility 109.98% 102.91%
Expected dividend yield 0% 0%
Risk-free interest rate 4.75% 4.75%
Expected annual forfeiture rate 0% 0%
11
A summary of option activity as of March 31, 2008, and changes during the three
months then ended is presented below:
WEIGHTED
WEIGHTED AVERAGE AGGREGATE
AVERAGE REMAINING INTRINSIC
EXERCISE CONTRACTUAL VALUE
OPTIONS SHARES PRICE TERM (YRS) ($000)
------- ------ ----- ---------- ------
Outstanding, December 31, 2007 4,115,390
Granted 2,150,000
Exercised -
Forfeited or expired (285,000)
--------------
Outstanding, March 31, 2008 5,980,390 $ 1.42 2.84 $ 4,669
============== ============= ============ ============
Exercisable at March 31, 2008 3,965,390 $ 1.50 2.04 $ 4,476
============== ============= ============ ============
Options which are not a part of the Plans and are included in the option table
above, include fully vested options to acquire 325,000 shares of the Company's
common stock at an average exercise price of $1.86, an option to acquire
1,000,000 shares of the Company's common stock at an exercise price of $1.00
vest in March 2009 and an option to acquire 1,000,000 shares of the Company's
common stock at an exercise price of $1.50 vest in March 2010.
The weighted-average grant date fair value of options granted during the three
months ended March 31, 2008 and 2007 was $0.11 and $1.35, respectively. No
options have been exercised.
As of March 31, 2008, there was $2,056,374 of total unrecognized compensation
cost related to share-based option compensation arrangements.
As of March 31, 2008, there were 500,000 warrants with an exercise price of
$0.80 per share which expire in the first quarter of 2011.
NOTE 7: CAPITAL LEASE OBLIGATION
---------------------------------
During the year ended December 31, 2005, InnoZen entered into a sale-leaseback
agreement, under which it sold certain manufacturing equipment and leased it
back for a period of three years. The leaseback was accounted for as a capital
lease and no gain was recognized on the transaction. During 2007, InnoZen
entered into a five-year lease agreement for manufacturing software. The
following is a schedule by years of future minimum lease payments under capital
leases together with the present value of the net minimum lease payments as of
March 31, 2008.
Total minimum lease payments:
Nine months ended December 31, 2008 177,579
Year ended December 31, 2009 23,352
Year ended December 31, 2010 23,352
Year ended December 31, 2011 23,352
Year ended December 31, 2012 13,622
-------------
261,257
Amount representing interest (24,898)
-------------
Present value of minimum lease payments 236,359
Less current obligations (169,427)
-------------
Non-current obligations under capital lease $ 66,932
=============
12
The lease covers equipment and software with a cost of $518,866 and accumulated
depreciation of $79,125 at March 31, 2008.
NOTE 8: COMMITMENTS AND CONTINGENCIES
--------------------------------------
The Company maintains its corporate office in the office of its accountant at no
cost to the Company.
In January 2007, the Company executed a three-year non-cancelable lease
agreement for the Enlyten office in Amherst, New York. The lease requires
monthly payments of $2,364 for the year ending January 31, 2008, $2,409 for the
year ending January 31, 2009 and $2,455 for the year ending January 31, 2010.
InnoZen leases its facility in Woodland Hills, California pursuant to a
non-cancelable agreement which expires on January 1, 2010. InnoZen has the
option to extend the term for one additional year.
The Company leases a manufacturing facility in Ventura, California which
contains approximately 25,000 square feet. The lease term is from December 1,
2007 through January 31, 2015. No rent was due for January and February 2008
while the Company was working on equipment installation. This is the facility
which PMG occupies and the rent will be paid by PMG.
Future minimum lease payments for operating leases are: 2008 - $247,500; 2009 -
$381,000; 2010 - $199,000; 2011 - $202,000; 2012 - $206,000; and thereafter -
$447,000.
The Company has the following royalty obligations:
1. Royalty agreement expiring in October 2008 of .5% of sales of the
ENLYTEN(TM) SPORTSTRIPS. Annual minimum royalty of $18,000 and maximum
of $75,000;
2. Royalty agreement expiring in October 2008 of .5% of sales of the
ENLYTEN(TM) SPORTSTRIPS. Annual minimum royalty of $15,000 and maximum
of $50,000;
3. Royalty agreement for an indefinite period of .5% of sales of the
ENLYTEN(TM) SPORTSTRIPS. Annual minimum royalty of $36,000 and maximum
of $100,000;
4. Royalty agreement for an indefinite period of 1.0% of the first
$100,000,000 in sales of the ENLYTEN(TM) SPORTSTRIPS and .5% of the
next $150,000,000 in sales;
5. Royalty agreement for an indefinite period of 1.0% of the first
$20,000,000 in sales of the FIX STRIPS(TM) and ENLYTEN(TM) Energy
strips and .5% of the next $80,000,000 in sales; and
6. Royalty agreement for 2 years of 1.5% of sales of the ENLYTEN(TM)
SURVIVAL STRIP with annual minimum royalty payments of $4,200.
13
During 2006, InnoZen entered into a distribution contract with Schering-Plough
PTY Limited ("Schering") whereby InnoZen granted to Schering an exclusive,
royalty-free license to distribute, market, offer to sell and import InnoZen's
film strip products in Australia, New Zealand, Singapore, Indonesia, Pakistan,
Hong Kong, Taiwan, Vietnam, Malaysia, Thailand, Korea, Philippines, India and
China ("territories"). Schering appointed InnoZen as the exclusive supplier of
film strip products in the cough and cold market to Schering for distribution in
the territories. With respect to all purchase orders submitted by Schering to
InnoZen, Schering shall pay InnoZen 50% of the invoice amount upon submitting
the purchase order and the remaining 50% of the invoice amount when Schering
receives shipping notification of the order. The contract expires in May 2011.
On October 30, 2007, our wholly-owned subsidiary, Enlyten, Inc., filed a lawsuit
against The Gatorade Company and PepsiCo, Inc. (collectively referred to as
Gatorade) in the State of New York Supreme Court, County of Erie. The Complaint
alleges that Gatorade has tortiously interfered with Enlyten's contractual
agreement with the Buffalo Bills and with Enlyten's business relationships with
various third parties including other NFL teams, in an attempt to wrongfully
restrain trade. Enlyten is represented by Michael B. Powers of the law firm of
Phillips Lytle, LLP in Buffalo, New York. The alleged interference has severely
limited our ability to market and sell the ENLYTEN(TM) SPORT STRIP. The case is
currently in the early discovery phase with a discovery hearing scheduled for
June 3, 2008.
NOTE 9: GOING CONCERN
----------------------
At March 31, 2008 and December 31, 2007 we had current assets of $2,020,268 and
$2,411,410; current liabilities of $2,702,896 and $2,066,125; and negative
working capital of $682,628 and working capital of $345,285, respectively. We
incurred a loss of $3,070,344 during the first quarter of 2008, which included
depreciation and amortization of $365,463 and amortization of non-cash stock
compensation of $1,053,805.
On February 1, 2008 HealthSport and InnoZen executed a Limited Liability Company
Operating Agreement ("LLC Agreement") with Migami, Inc. ("Migami") for Pacific
Manufacturing Group, LLC ("PMG"). Among other things, the LLC Agreement calls
for Migami to contribute $3,000,000 in cash to PMG for its intended 48%
ownership and InnoZen to license its technology to PMG for its 52% ownership. In
summary, the agreement provides that PMG will manufacture all strip and other
products for each member at cost plus 25%. As of April 8, 2008, $1,000,000 of
Migami's contribution has been received by PMG ($505,000 at March 31, 2008) and
the remainder is due to be received by May 31, 2008. InnoZen owned 92% of PMG at
March 31, 2008.
We currently anticipate that our only capital equipment requirements will be in
PMG for which the $3 million capital to be contributed by Migami should be
adequate to fund PMG's requirements.
14
In 2007, the Company projected sales to be as high as $10 million, based on
forecasts for SPORTSTRIPS, PEDIASTRIPS and FIX STRIPS. The alleged tortuous
interference by Gatorade in our agreement with the Buffalo Bills, other NFL
teams and NFL players substantially hindered our ability to market and sell our
SPORTSTRIPS product, which was our first product to market. PEDIASTRIPS and FIX
STRIPS sales did not commence until the fourth quarter of 2007 and were
substantially below initial forecasts from consultants. At the end of the fourth
quarter of 2007 the Company changed its sales direction and reduced staff with
the goal of selling product through distributors rather than making all sales
directly to its customers.
On March 11, 2008, we completed a five-year distribution deal with Unico
Holdings, Inc. ("Unico"), wherein they will market our PEDIASTRIPS product as
well as negotiate for our electrolyte strips to be manufactured for private
label usage. Unico markets its products through numerous sales channels,
including large retail merchandisers, drug store chains, grocery stores and
pharmaceutical distributors. Unico's customers include most of the larger
retailers and distributors in the U.S. in each of these sales channels. The
agreement calls for a minimum of $22 million of product purchases over the
five-year term in order for Unico to maintain its exclusive distribution right.
The Unico distribution deal is initially for PEDIASTRIPS and should commence
during the third quarter of 2008. We are attempting to establish similar
arrangements for our SPORTSTRIPS and FIX STRIPS. In addition, we expect to begin
sales of our ENERGY FILM STRIPS and SURVIVAL STRIPS before the end of 2008. The
Company is also seeking opportunities to establish film strip products for a
number of products which are currently delivered in a different manner, such as
liquids and pills. The Company expects this to develop into a large part of its
business in the future.
The Company will continue to require substantial working capital until sales
develop to the level required to support operations. The current level of
overhead is approximately $325,000 per month, excluding the PMG manufacturing
operation. The Company is analyzing its current costs and is attempting to make
additional cost reductions where possible. Current sales will not be adequate to
support this level of operating costs. We estimate that sales will develop to
the level necessary to be at or near cash flow break-even by the end of the
third quarter of 2008. Based on this time-frame, the Company would need from
$1.5 to $2 million to meet its minimum requirements, excluding PMG. The Company
has made private placements of its common stock and as of April 10, 2008 had
received $610,000 in net proceeds ($500,000 at March 31, 2008) and another
$250,000 was received on May 14, 2008. The Company expects to continue to make
private placements of its common stock or to borrow additional funds as needed.
These conditions raise substantial doubt about the Company's ability to continue
as a going concern. The consolidated financial statements do not include any
adjustments that may result from the outcome of these uncertainties.
15
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
From time to time, we may publish forward-looking statements relative to such
matters as anticipated financial results, business prospects, technological
developments and similar matters. The Private Securities Litigation Reform Act
of 1995 provides a safe harbor for forward-looking statements. The following
discussion and analysis should be read in conjunction with the Consolidated
Financial Statements and the accompanying Notes to Consolidated Financial
Statements appearing earlier in this report. All statements other than
statements of historical fact included in this report are, or may be deemed to
be, forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Exchange Act of 1934,
as amended. Important factors that could cause actual results to differ
materially from those discussed in such forward-looking statements include, but
are not limited to, the following: our current liquidity needs, as described in
our periodic reports; changes in the economy; our inability to raise additional
capital; our involvement in potential litigation; volatility of our stock price;
the variability and timing of business opportunities; changes in accounting
policies and practices; the effect of internal organizational changes; adverse
state and federal regulation and legislation; and the occurrence of
extraordinary or catastrophic events and terrorist acts. These factors and
others involve certain risks and uncertainties that could cause actual results
or events to differ materially from management's views and expectations.
Inclusion of any information or statement in this report does not necessarily
imply that such information or statement is material. We do not undertake any
obligation to release publicly revised or updated forward-looking information,
and such information included in this report is based on information currently
available and may not be reliable after this date.
PLAN OF OPERATION AND GOING CONCERN
At March 31, 2008 and December 31, 2007 we had current assets of $2,020,268 and
$2,411,410; current liabilities of $2,702,896 and $2,066,125; and negative
working capital of $682,628 and working capital of $345,285, respectively. We
incurred a loss of $3,070,344 during the first quarter of 2008, which included
depreciation and amortization of $365,463 and amortization of non-cash stock
compensation of $1,053,805.
On February 1, 2008 HealthSport and InnoZen executed a Limited Liability Company
Operating Agreement ("LLC Agreement") with Migami, Inc. ("Migami") for Pacific
Manufacturing Group, LLC ("PMG"). Among other things, the LLC Agreement calls
for Migami to contribute $3,000,000 in cash to PMG for its intended 48%
ownership and InnoZen to license its technology to PMG for its 52% ownership. In
summary, the agreement provides that PMG will manufacture all strip and other
products for each member at cost plus 25%. As of April 8, 2008, $1,000,000 of
Migami's contribution has been received by PMG ($505,000 at March 31, 2008) and
the remainder is due to be received by May 31, 2008. InnoZen owned 92% of PMG at
March 31, 2008.
We currently anticipate that our only capital equipment requirements will be in
PMG for which the $3 million capital to be contributed by Migami should be
adequate to fund PMG's requirements.
16
In 2007, the Company projected sales to be as high as $10 million, based on
forecasts for SPORTSTRIPS, PEDIASTRIPS and FIX STRIPS. The alleged tortuous
interference by Gatorade in our agreement with the Buffalo Bills, other NFL
teams and NFL players substantially hindered our ability to market and sell our
SPORTSTRIPS product, which was our first product to market. PEDIASTRIPS and FIX
STRIPS sales did not commence until the fourth quarter of 2007 and were
substantially below initial forecasts from consultants. At the end of the fourth
quarter of 2007 the Company changed its sales direction and reduced staff with
the goal of selling product through distributors rather than making all sales
directly to its customers.
On March 11, 2008, we completed a five-year distribution deal with Unico
Holdings, Inc. ("Unico"), wherein they will market our PEDIASTRIPS product as
well as negotiate for our electrolyte strips to be manufactured for private
label usage. Unico markets its products through numerous sales channels,
including large retail merchandisers, drug store chains, grocery stores and
pharmaceutical distributors. Unico's customers include most of the larger
retailers and distributors in the U.S. in each of these sales channels. The
agreement calls for a minimum of $22 million of product purchases over the
five-year term in order for Unico to maintain its exclusive distribution right.
The Unico distribution deal is initially for PEDIASTRIPS and should commence
during the third quarter of 2008. We are attempting to establish similar
arrangements for our SPORTSTRIPS and FIX STRIPS. In addition, we expect to begin
sales of our ENERGY FILM STRIPS and SURVIVAL STRIPS before the end of 2008. The
Company is also seeking opportunities to establish film strip products for a
number of products which are currently delivered in a different manner, such as
liquids and pills. The Company expects this to develop into a large part of its
business in the future.
The Company will continue to require substantial working capital until sales
develop to the level required to support operations. The current level of
overhead is approximately $325,000 per month, excluding the PMG manufacturing
operation. The Company is analyzing its current costs and is attempting to make
additional cost reductions where possible. Current sales will not be adequate to
support this level of operating costs. We estimate that sales will develop to
the level necessary to be at or near cash flow break-even by the end of the
third quarter of 2008. Based on this time-frame, the Company would need from
$1.5 to $2 million to meet its minimum requirements, excluding PMG. The Company
has made private placements of its common stock and as of April 10, 2008 had
received $610,000 in net proceeds ($500,000 at March 31, 2008) and another
$250,000 was received on May 14, 2008. The Company expects to continue to make
private placements of its common stock or to borrow additional funds as needed.
These conditions raise substantial doubt about the Company's ability to continue
as a going concern. The consolidated financial statements do not include any
adjustments that may result from the outcome of these uncertainties.
ACQUISITION OF INNOZEN
On May 4, 2007, we issued 18,249,952 shares of our common stock to the
shareholders of InnoZen and completed the acquisition of InnoZen through a
merger of InnoZen with our wholly owned subsidiary, Acquisition Sub.
17
On February 1, 2008 HealthSport and InnoZen executed a Limited Liability Company
Operating Agreement ("LLC Agreement") with Migami, Inc. ("Migami") for Pacific
Manufacturing Group, LLC ("PMG"). Among other things, the LLC Agreement calls
for Migami to contribute $3,000,000 in cash to PMG for its intended 48%
ownership and InnoZen to license its technology to PMG for its 52% ownership. In
summary, the agreement provides that PMG will manufacture all strip and other
products for each member at cost plus 25%.
LAWSUIT
On October 30, 2007, our wholly-owned subsidiary, Enlyten, Inc., filed a lawsuit
against The Gatorade Company and PepsiCo, Inc. (collectively referred to as
Gatorade) in the State of New York Supreme Court, County of Erie. The Complaint
alleges that Gatorade has tortiously interfered with Enlyten's contractual
agreement with the Buffalo Bills and with Enlyten's business relationships with
various third parties including other NFL teams, in an attempt to wrongfully
restrain trade. Enlyten is represented by Michael B. Powers of the law firm of
Phillips Lytle, LLP in Buffalo, New York. The alleged interference has severely
limited our ability to market and sell the ENLYTEN(TM) SPORT STRIP. The case is
currently in the early discovery phase with a discovery hearing scheduled for
June 3, 2008.
COMPARISON OF THREE MONTHS ENDED MARCH 31, 2008 AND 2007
REVENUES
During the three months ended March 31, 2008, we had product sales of $97,441
and revenues from license fees, royalties and services of $18,750, a total of
$116,191. There were product sales of $5,897 ($472,757 pro forma) in the
corresponding 2007 period. The pro forma sales in 2007 included a one-time
licensing fee of $150,000 and sales from InnoZen to the Company before
acquisition of approximately $150,000. The remainder of the 2007 pro forma
revenue was primarily InnoZen's sales of Suppress and Optizen, which have been
substantially lower since the first quarter of 2007.
COSTS AND EXPENSES
Cost of product sold includes the direct cost of product sold plus freight.
General and administrative expenses ("G&A") increased to $1,150,877 in the three
months ended March 31, 2008, from $262,771 in the 2007 period. The increase of
$888,106 in G&A is primarily the G&A of InnoZen and PMG in the amount of
$850,584. InnoZen and PMG were not a part of the Company in 2007.
Selling and marketing costs ("SMC") are $475,343 in the three months ended March
31, 2008, as compared to $409,173 in the 2007 period. SMC increased $66,170 in
the 2008 period as compared to the 2007 period. The increase includes
approximately $230,000 in product support and advertising for InnoZen's Suppress
18
product, which should not reoccur due to our change in sales direction. Other
costs are down from the year earlier period, primarily due to the elimination of
endorsements and sponsorship fees as a result of re-directing our marketing
efforts toward distributors rather than direct sales to customers.
Non-cash compensation expense was $1,150,877 in 2008 and $262,771 in 2007 and
includes the amortization of stock grants and amortization of the intrinsic
value of stock options to employees, consultants and spokespersons over the
relevant service periods to both employees and as a part of endorsement
contracts. The 2008 amount is higher that normal due to terminations of certain
employees and consultants and should be substantially lower in the second
quarter.
Manufacturing costs represent the costs incurred during the manufacturing
process that are not capitalized into inventory based on current production
volume. The Company had only nominal production in 2008 while they were
installing equipment and preparing the new manufacturing facility for operation.
Research and development ("R&D") costs amounted to $71,579 in 2008 and include
contract services, supplies, materials and analytical testing costs incurred for
new products to be developed by the Company.
19
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 4T: CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
The Company's Chief Executive Officer and Acting Chief Financial Officer have
reviewed and evaluated the effectiveness of the Company's disclosure controls
and procedures (as defined in Rules 240.13a-15(e) and 15d-15(e) promulgated
under the Securities Exchange Act of 1934) as of March 31, 2008. Based on that
review and evaluation, which included inquiries made to certain other employees
of the Company, the CEO and Acting CFO concluded that the Company's current
disclosure controls and procedures, as designed and implemented, are effective
in ensuring that information relating to the Company required to be disclosed in
the reports the Company files or submits under the Securities Exchange Act of
1934 is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms, including
insuring that such information is accumulated and communicated to the Company's
management, including the CEO and Acting CFO, as appropriate to allow timely
decisions regarding required disclosure.
(b) Changes in Internal Controls
There have been no significant changes in internal controls or in other factors
that could significantly affect these controls subsequent to the date of the
evaluation described above, including any corrective actions with regard to
significant deficiencies and material weaknesses.
20
PART II - OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
Not applicable.
ITEM 1A: RISK FACTORS
Not applicable.
ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The Company sold 1,250,000 shares of its common stock for $500,000 in cash
during the three months ended March 31, 2008. All of the shares issued were sold
pursuant to an exemption from registration under Section 4(2) promulgated under
the Securities Act of 1933, as amended.
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5: OTHER INFORMATION
Not applicable.
ITEM 6: EXHIBITS
The following exhibits are filed with this report on Form 10-Q.
Exhibit 31 Certification pursuant to 18 U.S.C.
Section 1350 Section 302 of the
Sarbanes-Oxley Act of 2002
Exhibit 32 Certification pursuant to 18 U.S.C.
Section 1350 Section 906 of the
Sarbanes-Oxley Act of 2002
21
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
HEALTHSPORT, INC.
May 15, 2008 By: /s/ Robert Kusher
----------------------------------
Robert Kusher, Chief Executive Officer
(Principal Executive Officer)
22