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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006
COMMISSION FILE NO. 000-25064
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HEALTH FITNESS CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
MINNESOTA NO. 41-1580506
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
3600 AMERICAN BOULEVARD WEST, BLOOMINGTON, MINNESOTA 55431
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER (952) 831-6830
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Indicate by check mark whether the registrant (1) filed all reports
required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indicated by check mark whether the registrant is a large accelerated
filerr, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act. (Check one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
The number of shares outstanding of the registrant's common stock as of
May 10, 2006 was: Common Stock, $0.01 par value, 18,930,368 shares
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HEALTH FITNESS CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited)
Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004 3
Consolidated Statements of Earnings for the three months ended March 31, 2005 and 2004 4
Consolidated Statements of Cash Flows for the three months ended March 31, 2005 and 2004 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 16
Item 4. Controls and Procedures 17
PART II. OTHER INFORMATION 17
Item 1. Legal Proceedings
Item 1A. Risk Factors 17
Items 2-5. Not Applicable
Item 6. Exhibits
Signatures 18
Exhibit Index 19
2
HEALTH FITNESS CORPORATION
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
March 31, December 31,
2006 2005
----------------- --------------
ASSETS
CURRENT ASSETS
Cash $ 416,597 $ 1,471,505
Trade and other accounts receivable, less allowances of $205,300 and $200,700 9,138,011 8,839,046
Prepaid expenses and other 557,211 509,273
Deferred tax assets 353,300 337,800
----------------- --------------
Total current assets 10,465,119 11,157,624
PROPERTY AND EQUIPMENT, net 394,955 347,820
OTHER ASSETS
Goodwill 12,983,762 12,919,689
Software, less accumulated amortization of $88,100 and $0 1,735,815 1,762,000
Customer contracts, less accumulated amortization of $1,686,300 and
$1,626,100 128,681 188,889
Trademark, less accumulated amortization of $171,800 and $147,000 321,244 346,057
Other intangible assets, less accumulated amortization of $110,000 and
$88,000 419,052 441,086
Deferred tax assets 567,401 374,500
Other 41,269 47,105
----------------- --------------
$ 27,057,298 $ 27,584,770
================= ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Trade accounts payable $ 739,339 $ 687,125
Accrued salaries, wages, and payroll taxes 1,853,831 2,693,927
Other accrued liabilities 855,811 763,115
Accrued self funded insurance 357,918 250,000
Deferred revenue 1,732,764 1,868,446
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Total current liabilities 5,539,663 6,262,613
LONG-TERM OBLIGATIONS - -
COMMITMENTS AND CONTINGENCIES - -
WARRANT OBLIGATION 1,776,367 2,210,889
PREFERRED STOCK, $0.01 par value; 10,000,000 shares authorized, 0 and 1,000
issued and outstanding - 8,623,546
STOCKHOLDERS' EQUITY
Common stock, $0.01 par value; 50,000,000 shares authorized;
18,930,368 and 13,787,349 shares issued and outstanding 189,304 137,874
Additional paid-in capital 24,266,420 15,625,425
Accumulated comprehensive income (898) 1,245
Accumulated deficit (4,713,558) (5,276,822)
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19,741,268 10,487,722
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$ 27,057,298 $ 27,584,770
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See notes to consolidated financial statements.
3
HEALTH FITNESS CORPORATION
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
Three Months Ended
March 31,
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2006 2005
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REVENUE $ 14,567,261 $ 13,465,101
COSTS OF REVENUE 10,962,781 10,023,299
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GROSS PROFIT 3,604,480 3,441,802
OPERATING EXPENSES
Salaries 1,678,834 1,387,923
Selling, general and administrative 1,436,241 736,866
Amortization of intangible assets 108,462 219,583
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Total operating expenses 3,223,537 2,344,372
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OPERATING INCOME 380,943 1,097,430
OTHER INCOME (EXPENSE)
Interest expense (1,680) (11,923)
Change in fair value of warrants 434,521 -
Other, net (4,010) (1,650)
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EARNINGS BEFORE INCOME TAX EXPENSE 809,774 1,083,857
INCOME TAX EXPENSE 150,101 434,323
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NET EARNINGS 659,673 649,534
Dividend to preferred shareholders 96,410 21,600
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NET EARNINGS APPLICABLE TO COMMON SHAREHOLDERS $ 563,263 $ 627,934
============== ============
NET EARNINGS PER COMMON SHARE:
Basic $ 0.04 $ 0.05
Diluted 0.01 0.04
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
Basic 15,001,832 12,619,603
Diluted 19,666,941 16,614,522
See notes to consolidated financial statements
4
HEALTH FITNESS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
March 31,
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2006 2005
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 563,263 $ 649,534
Adjustments to reconcile net earnings to net cash used in operating activities:
Depreciation 120,289 19,573
Amortization 110,142 213,490
Warrant valuation (434,521) -
Compensation for Stock Options 75,459 -
Deferred taxes (208,401) 405,100
Loss on disposal of assets 159 -
Change in assets and liabilities:
Trade and other accounts receivable (298,965) (545,129)
Prepaid expenses and other (47,939) (260,309)
Other assets 5,836 10,354
Trade accounts payable 50,072 (355,007)
Accrued liabilities and other (639,482) (293,984)
Deferred revenue (135,682) (70,491)
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Net cash used in operating activities (839,770) (226,869)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (144,486) (10,307)
Business acquisition (64,072) -
------------ -----------
Net cash used in investing activities (208,558) (10,307)
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under long-term obligations - 7,186,985
Repayments of long-term obligations - (7,225,956)
Costs from issuance of preferred stock (95,403) -
Proceeds from the issuance of common stock 85,698 73,328
Proceeds from the exercise of stock options 3,125 11,428
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Net cash provided by financing activities (6,580) 45,785
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NET INCREASE (DECREASE) IN CASH (1,054,908) (191,391)
CASH AT BEGINNING OF PERIOD 1,471,505 241,302
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CASH AT END OF PERIOD $ 416,597 $ 49,911
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See notes to consolidated financial statements.
5
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements for the first
quarter ended March 31, 2006 have been prepared in accordance with accounting
principles generally accepted in the United States of America for interim
financial information. Financial information as of December 31, 2005 has been
derived from our audited consolidated financial statements. In accordance with
the rules and regulations of the United States Securities and Exchange
Commission, the Company has omitted footnote disclosures that would
substantially duplicate the disclosures contained in the audited financial
statements of the Company. The unaudited consolidated financial statements
should be read together with the financial statements for the year ended
December 31, 2005, and footnotes thereto included in the Company's Form 10-K as
filed with the United States Securities and Exchange Commission on March 30,
2006.
In the opinion of management, the interim consolidated financial statements
include all adjustments (consisting of normal recurring accruals) necessary for
the fair presentation of the results for interim periods presented. These
financial statements include some amounts that are based on management's best
estimates and judgments. These estimates may be adjusted as more information
becomes available, and any adjustment could be significant. The impact of any
change in estimates is included in the determination of earnings in the period
in which the change in estimate is identified. Operating results for the three
months ended March 31, 2006 are not necessarily indicative of the operating
results that may be expected for the year ended December 31, 2006.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business - We provide fitness and health management services and programs to
corporations, hospitals, communities and universities located in the United
States and Canada. Fitness and health management services include the
development, marketing and management of corporate, hospital, community and
university based fitness centers, injury prevention and work-injury management
consulting, on-site physical therapy and employee health management services.
Programs include wellness and health programs for individual customers,
including health risk assessments, biometric screenings, nutrition and weight
loss programs, smoking cessation, massage therapy, back care and ergonomic
injury prevention.
Consolidation - The consolidated financial statements include the accounts of
our Company and our wholly owned subsidiaries. All intercompany balances and
transactions have been eliminated in consolidation.
Cash - We maintain cash balances at several financial institutions, and at
times, such balances exceed insured limits. We have not experienced any losses
in such accounts and believe we are not exposed to any significant credit risk
on cash. At March 31, 2006 and December 31, 2005, we had cash of approximately
$2,558 and $24,468 (U.S. Dollars) in a Canadian bank account.
Trade and Other Accounts Receivable - Trade and other accounts receivable
represent amounts due from companies and individuals for services and products.
We grant credit to customers in the ordinary course of business, but generally
do not require collateral or any other security to support amounts due.
Management performs ongoing credit evaluations of customers. We determine our
allowance for discounts and doubtful accounts by considering a number of
factors, including the length of time trade accounts receivable are past due,
our previous loss history, the customer's current ability to pay its obligation
to us, and the condition of the general economy and the industry as a whole. We
write off accounts receivable when they become uncollectible, and payments
subsequently received on such receivable are credited to the allowance.
Concentrations of credit risk with respect to trade receivables are limited due
to the large number of customers and their geographic dispersion.
6
Property and Equipment - Property and equipment are stated at cost. Depreciation
and amortization are computed using both straight-line and accelerated methods
over the useful lives of the assets.
Goodwill - Goodwill represents the excess of the purchase price and related
costs over the fair value of net assets of businesses acquired. The carrying
value of goodwill is not amortized, but is tested for impairment on an annual
basis or when factors indicating impairment are present. Projected discounted
cash flows are used in assessing these assets. We elected to complete the annual
impairment test of goodwill on December 31 of each year and determined that our
goodwill relates to one reporting unit for purposes of impairment testing.
Intangible Assets - Our intangible assets include customer contracts, trademarks
and tradenames, software and other intangible assets, all of which are amortized
on a straight-line basis. Customer contracts represent the fair value assigned
to acquired management contracts, which are amortized over the remaining life of
the contracts, approximately 10-20 months. Trademark and tradenames represent
the value assigned to acquired trademarks and tradenames, and are amortized over
a period of five years. Software represents the value assigned to an acquired
web-based software program and is amortized over a period of five years. Other
intangible assets include the value assigned to acquired customer lists, which
is amortized over a period of six year, as well as deferred financing costs,
which are amortized over the term of the related credit agreement.
Revenue Recognition - Revenue is recognized at the time the service is provided
to the customer. We determine our allowance for discounts by considering
historical discount history and current payment practices of our customers. For
annual contracts, monthly amounts are recognized ratably over the term of the
contract. Certain services provided to the customer may vary on a periodic basis
and are invoiced to the customer in arrears. The revenues relating to these
services are estimated in the month the service is performed based on the cost
of the services.
Amounts received from customers in advance of providing the services of the
contract are recorded as deferred revenue and recognized when the services are
provided.
We have contracts with third-parties to provide ancillary services in connection
with their fitness and wellness management services and programs. Under such
arrangements, the third-parties invoice and receive payments from us based on
transactions with the ultimate customer. We do not recognize revenues related to
such transactions as the ultimate customer assumes the risk and rewards of the
contract and the amounts billed to the customer are either at cost or with a
fixed markup.
Amounts received from new customers for website activation fees are treated as
deferred revenue and recognized over a period of three years, which is the
estimated life of a new customer.
Valuation of Derivative Instruments - In accordance with the interpretive
guidance in EITF Issue No. 05-4, "The Effect of a Liquidated Damages Clause on a
Freestanding Financial Instrument Subject to EITF Issue No. 00-19, "Accounting
for Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company's Own Stock", we value warrants we issued in November 2005 in our
financing transaction as a derivative liability. We must make certain periodic
assumptions and estimates to value the derivative liability. Factors affecting
the amount of this liability include changes in our stock price, the computed
volatility of our stock price and other assumptions. The change in value is
reflected in our statements of operations as non-cash income or expense, and the
changes in the carrying value of derivatives can have a material impact on our
financial statements. For the quarter ended March 31, 2006, we recognized
non-cash income of $434,521 upon revaluation of certain warrants that are
subject to this accounting treatment. The derivative liability associated with
these warrants is reflected on our balance sheets as a long-term liability. This
warrant liability will remain until the warrants are exercised, expire, or other
events occur to cause the termination of the derivative accounting, the timing
of which may be outside our control.
7
Comprehensive Income - Comprehensive income represents net earnings adjusted for
foreign currency translation adjustments. Total comprehensive income was
$673,898 and $628,389 for the three months ended March 31, 2006 and 2005.
Net Earnings Per Share - Basic net earnings per share is computed by dividing
net earnings applicable to common shareholders by the number of weighted average
common shares outstanding. For the three months ended March 31, 2006, diluted
net earnings per share is computed by dividing net earnings applicable to common
shareholders, plus dividends to preferred shareholders (net earnings), less the
non-cash benefit related to a change in fair value of warrants by the number of
weighted average common shares outstanding, and common share equivalents
relating to stock options, stock warrants, and stock warrants accounted for as a
liability, if dilutive. For the three months ended March 31, 2005, diluted net
earnings per share is computed by dividing net earnings applicable to common
shareholders, plus dividends to preferred shareholders (net earnings) by the
number of weighted average common shares outstanding, and common share
equivalents relating to stock options and stock warrants, if dilutive. Refer to
Exhibit 11.0 attached hereto for a detail computation of earnings per share.
Common stock options and warrants to purchase 824,798 and 277,500 shares of
common stock were excluded from the calculation for the three months ended March
31, 2006 and 2005 because their exercise price exceeded the average trading
price of the Company's common stock during each of the periods.
Stock-based Compensation - We maintain a stock option plan for the benefit of
certain eligible employees and directors of the Company. We have authorized
3,500,000 shares for grant under our 2005 Stock Option Plan, and a total of
811,350 shares of common stock are reserved for additional grants of options at
March 31, 2006. Our stock options generally vest ratably over four years of
service and have a contractual life of 6 years.
Commencing January 1, 2006, we adopted Statement of Financial Accounting
Standard No. 123R, "Share Based Payment" ("SFAS 123R"), which requires all
share-based payments, including grants of stock options, to be recognized in the
income statement as an operating expense, based on their fair values over the
requisite service period. The compensation cost we record for these awards will
be based on their grant date fair value as calculated for the pro forma
disclosures required by Statement 123. The Company recorded $75,459 of related
compensation expense, included in salaries within our operating expenses
section, for the three-months ended March 31, 2006. We also recorded a deferred
tax benefit of $30,184 in connection with recording this non-cash expense. This
deferred tax benefit will be adjusted based upon the actual tax benefit realized
from the exercise of the underlying stock options. The compensation expense
reduced diluted earnings per share by less than $0.01.
As of March 31, 2006, $961,000 of total unrecognized compensation costs related
to non-vested awards is expected to be recognized over a weighted average period
of approximately 3.2 years.
Prior to adopting SFAS 123R, we accounted for stock-based compensation under
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees." We have applied the modified prospective method in adopting SFAS
123R. Accordingly, periods prior to adoption have not been restated.
8
The following table illustrates the effect on net earnings and earnings per
share if the fair value recognition provisions of SFAS No. 123 had been applied
to the prior period.
Three months
ended
March 31, 2005
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Net earnings applicable to common shareholders $ 627,934
Stock-based employee compensation determined under the fair value based method, net of tax (37,183)
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Pro forma net earnings, basic $ 590,751
Add: Dividends to preferred shareholders 21,600
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Pro forma net earnings, diluted 612,351
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Earnings per share:
Basic -- as reported $ 0.05
Diluted -- as reported $ 0.04
Basic -- pro forma $ 0.05
Diluted -- pro forma $ 0.04
We use the Black-Scholes option pricing model to determine the weighted average
fair value of options. The weighted average fair value of options granted during
the three month periods ended March 31, 2006 and 2005 were $1.63 and $1.60,
respectively. The fair value of options at date of grant and the assumptions
utilized to determine such values are indicated in the following table:
Three Months Ended
March 31,
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2006 2005
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Risk-free interest rate 4.32% 2.55%
Expected volatility 76.0% 78.0%
Expected life (in years) 4.24 4.00
Dividend yield -- --
Option transactions under the 2005 Stock Option Plan during the first quarter
ended March 31, 2006 are summarized as follows:
Weighted Weighted
Average Aggregate Average
Exercise Intrinsic Remaining
Options Price Value Term
----------- -------- ----------- ----------
Outstanding at December 31, 2005 2,157,425 $ 1.34
Granted 350,500 $ 2.69
Exercised (2,500) $ 1.25
Canceled/Forfeited (1,250) $ 1.25
-------------------------------- ----------- -------- ----------- ----------
Outstanding at March 31, 2006 2,504,175 $ 1.53 $ 2,507,601 3.40
Exercisable at March 31, 2006 1,699,225 $ 1.19 $ 2,236,005 2.64
The aggregate intrinsic value of options exercised during the quarter ended
March 31, 2006 was $3,550. Cash received from the exercise of options for the
quarter ended March 31, 2006 was $3,125 and the related tax benefit realized was
$1,250. The total number of options that vested during the quarter ended March
31, 2006 was 182,075 with a fair value of $155,891.
Fair Values of Financial Instruments - Due to their short-term nature, the
carrying value of our current financial assets and liabilities approximates
their fair values. The fair value of long-term obligations, if recalculated
based on current interest rates, would not significantly differ from the
recorded amounts.
9
Use of Estimates - Preparing consolidated financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make certain estimates and assumptions that affect the
reported amounts of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
NOTE 3. FINANCING
On November 14, 2005 (the "Effective Date"), in a Private Investment in Public
Equity transaction (the "PIPE Transaction"), we issued an aggregate of 1,000
shares of Series B Convertible Preferred Stock (the "Series B Stock"), together
with warrants to purchase 1,530,000 shares of common stock at $2.40 per share,
to a limited number of accredited investors for aggregate gross proceeds of
$10.2 million. After selling commissions and expenses, we received net proceeds
of approximately $9.4 million. The Series B Stock automatically converted into
5,100,000 shares of our common stock on March 10, 2006, the date the Securities
and Exchange Commission (the "SEC") first declared effective a registration
statement covering these shares. Each share of Series B Stock was entitled to a
number of votes equal to the number of shares of common stock into which it was
then convertible. Except as required by law, holders of Series B Stock were
entitled to vote together as one class with holders of common stock. Each share
of Series B Stock had a stated dividend rate of 5% per year calculated based
upon the initial share issuance price of $10,200. We used the proceeds from this
PIPE Transaction to redeem our Series A Convertible Preferred Stock and to fund
the acquisition of HealthCalc.Net, Inc.
In accordance with the terms of the PIPE Transaction, we were required to file
with the SEC, within sixty (60) days from the Effective Date, a registration
statement covering the common shares issued and issuable in the PIPE
Transaction. We were also required to cause the registration statement to go
effective on or before the expiration of one hundred twenty (120) days from the
Effective Date. We would have been subject to liquidated damages of one percent
(1%) per month of the aggregate gross proceeds ($10,200,000), if we failed to
meet these date requirements. On March 10, 2006, the SEC declared effective our
Form S-1 registration statement and, as a result, we did not pay any liquidated
damages for failure to meet the filing and effectiveness date requirements. We
could nevertheless be subject to the foregoing liquidated damages if we fail to
maintain the effectiveness of the registration statement.
The warrants, which were issued together with the Series B Stock, have a term of
five years, and give the investors the option to require us to repurchase the
warrants for a purchase price, payable in cash within five (5) business days
after such request, equal to the Black Scholes value of any unexercised warrant
shares, only if, while the warrants are outstanding, any of the following change
in control transactions occurs: (i) we effect any merger or consolidation, (ii)
we effect any sale of all or substantially all of our assets, (iii) any tender
offer or exchange offer is completed whereby holders of our common stock are
permitted to tender or exchange their shares for other securities, cash or
property, or (iv) we effect any reclassification of our common stock whereby it
is effectively converted into or exchanged for other securities, cash or
property.
Under EITF 00-19 "Accounting for Derivative Financial Instruments Indexed to,
and Potentially Settled in, a Company's Own Stock" (EITF 00-19"), the fair value
of the warrants issued under the PIPE Transaction have been reported as a
liability due to the requirement to net-cash settle the transaction. There are
two reasons for this treatment: (i) there are liquidated damages, payable in
cash, of 1% of the gross proceeds per month ($102,000) should we fail (subject
to certain permitted circumstances) to maintain effectiveness of the
registration statement in accordance with the PIPE Transaction; and (ii) the
investors may put their warrants back to us for cash if a change in control
transaction that meets the definition previously discussed occurs.
10
NOTE 4. INCOME TAXES
The Company records income taxes in accordance with the liability method of
accounting. Deferred income taxes are provided for temporary differences between
the financial reporting and tax basis of assets and liabilities and federal
operating loss carryforwards. Deferred tax assets and liabilities are adjusted
for the effects of changes in tax laws and rates on the date of the enactment.
We do not record a tax liability or benefit in connection with the change in
fair value of certain of our warrants. Income taxes are calculated based on
management's estimate of the Company's effective tax rate, which takes into
consideration a federal tax rate of 34% and an effective state tax rate of 6%.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our interim consolidated financial
statements and related notes included in Item 1 of Part 1 of this Quarterly
Report, and the audited consolidated financial statements and notes thereto and
Management's Discussion and Analysis of Financial Condition and Results of
Operations contained in the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 2005.
CRITICAL ACCOUNTING POLICIES. Our most critical accounting policies, which are
those that require significant judgment, include: revenue recognition, trade and
other accounts receivable, goodwill and stock-based compensation. A more
in-depth description of these can be found in Note 2 to the Interim Consolidated
Financial Statements included in this Quarterly Report and our Annual Report on
Form 10-K for the fiscal year ended December 31, 2005.
GENERAL. We provide fitness and health management services and programs to
corporations, hospitals, communities and universities located in the United
States and Canada. Fitness and health management services include the
development, marketing and management of corporate, hospital, community and
university based fitness centers, injury prevention and work-injury management
consulting, on-site physical therapy and employee health management services.
Programs include wellness and health programs for individual customers,
including health risk assessments, biometric screenings, nutrition and weight
loss programs, smoking cessation, massage therapy, back care and ergonomic
injury prevention.
RESULTS OF OPERATIONS
The following table sets forth our statement of operations data as a percentage
of total revenues and also sets forth other financial and operating data for the
quarter ended March 31, 2006 and 2005:
Three Months Ended
March 31,
--------------------
2006 2005
-------- ---------
REVENUE 100.0% 100.0%
COSTS OF REVENUE 75.3 74.4
-------- ---------
GROSS PROFIT 24.7 25.6
OPERATING EXPENSES
Salaries 11.5 10.3
Other selling, general and administrative 9.9 5.5
Amortization of acquired intangible assets 0.7 1.6
-------- ---------
Total operating expenses 22.1 17.4
-------- ---------
OPERATING INCOME 2.6 8.2
OTHER INCOME (EXPENSE) 2.9 (0.1)
-------- ---------
EARNINGS BEFORE INCOME TAXES 5.5 8.1
INCOME TAX EXPENSE 1.0 3.2
-------- ---------
NET EARNINGS 4.5 4.9
Dividend to preferred shareholders 0.7 0.2
-------- ---------
NET EARNINGS APPLICABLE TO COMMON SHAREHOLDERS 3.8% 4.7%
======== =========
12
OTHER FINANCIAL AND OPERATING DATA:
Three Months Ended
March 31,
--------------------------
2006 2005
----------- -----------
Fitness Management Revenue
Staffing Services $ 9,597,391 $ 9,516,177
Program and Consulting Services 703,434 482,671
----------- -----------
10,300,825 9,998,848
----------- -----------
Health Management Revenue
Staffing Services 3,108,872 3,087,991
Program and Consulting Services 1,157,564 378,262
----------- -----------
4,266,436 3,466,253
----------- -----------
Total Revenue
Staffing Services 12,706,263 12,604,168
Program and Consulting Services 1,860,998 860,933
----------- -----------
$14,567,261 $13,465,101
----------- -----------
RESULTS OF OPERATIONS FOR THE QUARTER ENDED MARCH 31, 2006 COMPARED TO THE
QUARTER ENDED MARCH 31, 2005.
REVENUE. Revenues increased $1,102,000 or 8.2% to $14,567,000 for the three
months ended March 31, 2006, from $13,465,000 for the three months ended March
31, 2005. This increase is attributable to growth of $102,000 in fitness and
health management staffing services, and growth of $1,000,000 in fitness and
health program and consulting services.
The growth in fitness and health management staffing services is due to revenue
from new staffing contracts outpacing the revenue we lost from contracts that
canceled during the first quarter of 2006 compared to the same period in 2005.
The growth in fitness management program and consulting services is due to an
increase in service penetration at our managed fitness centers. The growth in
health management programs and consulting services is primarily attributed to
our acquisition of HealthCalc.Net, Inc. ("HealthCalc"), which accounted for
$591,000 of the growth. The remaining growth of $188,000 is due to the start-up
of two health management contracts in the energy industry.
GROSS PROFIT. Gross profit increased $162,000 or 4.7% to $3,604,000 for the
three months ended March 31, 2006, from $3,442,000 for the three months ended
March 31, 2005. This increase is due primarily to our revenue growth.
As a percent of revenue, gross profit decreased 0.9% to 24.7%, from 25.6% for
the first quarter of 2005. This decrease is due primarily to start-up costs we
incurred for a large fitness management contract in the automotive industry, and
two health management contracts in the energy industry. Our experience indicates
that as large management contracts enter into full production, gross margins
typically improve.
OPERATING EXPENSES. Operating expenses increased $880,000 to $3,224,000 for the
three months ended March 31, 2006 from $2,344,000 for the three months ended
March 31, 2005.
Of this increase, approximately $509,000 is due to salaries, other operating
expenses and asset depreciation related to the December 2005 acquisition of
HealthCalc. In addition, we incurred approximately $75,000 of stock option
compensation expense in the first quarter of 2006 in connection with our
adoption of FAS 123R on January 1, 2006. The remaining cost increase of $296,000
is primarily due to additional staff we hired during 2005 to further develop and
better execute our health management business plan. We expect that we will
continue to incur these costs at varying levels on a quarterly basis.
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OTHER INCOME AND EXPENSE. Interest expense decreased $10,000 to $2,000 for the
three months ended March 31, 2006, compared to $12,000 for the same period in
2005. This decrease is due to the repayment of our Wells Fargo credit line. The
Company's cost of borrowed funds was 6.0% for the first quarter of 2005.
For the quarter ended March 31, 2006, we recorded a $435,000 non-cash benefit
related to a change in fair value for 1,530,000 warrants we issued in connection
with the sale of $10.2 million of our Series B Convertible Preferred Stock in
November 2005. Refer to the section titled "Summary of Significant Accounting
Policies," Valuation of Derivative Instruments, contained elsewhere in this
document for further discussion of the accounting we use to value these
warrants.
INCOME TAXES. Income tax expense decreased $284,000 to $150,000 for the three
months ended March 31, 2006 compared to $434,000 for the same period in 2005.
The decrease is primarily due to a $716,000 decrease in operating income, and no
tax liability associated with the $435,000 non-cash benefit related to the
revaluation of our warrants.
NET EARNINGS APPLICABLE TO COMMON SHAREHOLDERS. As a result of the above, net
earnings applicable to common shareholders for the three months ended March 31,
2006 decreased $65,000 or 10.3% to $563,000 compared to $628,000 for the same
period in 2005.
LIQUIDITY AND CAPITAL RESOURCES
Our working capital increased $30,000 to $4,925,000 at March 31, 2006, compared
to working capital of $4,895,000 at December 31, 2005. The increase in working
capital is due primarily to an increase in accounts receivable and decreases in
accrued salaries, wages and payroll taxes and deferred revenue, which were
mostly offset by a decrease in cash and increases to accrued self funded
insurance, other accrued liabilities and trade accounts payable.
In addition to cash flows generated from operating activities, our other primary
source of liquidity and working capital is provided by a $7,500,000 Credit
Agreement with Wells Fargo Bank, N.A. (the "Wells Loan"). At our option, the
Wells Loan bears interest at prime, or the one-month LIBOR plus a margin of
2.25% to 2.75% based upon our Senior Leverage Ratio (effective rate of 7.75% and
7.25% at March 31, 2006 and December 31, 2005). The availability of the Wells
Loan decreases $250,000 on the last day of each calendar quarter, beginning
September 30, 2003, and matures on June 30, 2007. Working capital advances from
the Wells Loan are based upon a percentage of our eligible accounts receivable,
less any amounts previously drawn. The facility provided maximum borrowing
capacity of $4,750,000 and $5,000,000 at March 31, 2006 and December 31, 2005.
Excluding current outstanding balances, and based upon eligible accounts
receivable, $4,750,000 and $5,000,000 was available for borrowing on such
respective dates. All borrowings are collateralized by substantially all of our
assets. At March 31, 2006, we were in compliance with all of our financial
covenants.
On November 14, 2005 (the "Effective Date"), in a Private Investment in Public
Equity transaction (the "PIPE Transaction"), we issued an aggregate of 1,000
shares of Series B Convertible Preferred Stock (the "Series B Stock"), together
with warrants to purchase 1,530,000 shares of common stock at $2.40 per share,
to a limited number of accredited investors for aggregate gross proceeds of
$10.2 million. After selling commissions and expenses, we received net proceeds
of approximately $9.4 million. The Series B Stock automatically converted into
5,100,000 shares of our common stock on March 10, 2006, the date the Securities
and Exchange Commission (the "SEC") first declared effective a registration
statement covering these shares. We used the proceeds from this PIPE Transaction
to redeem our Series A Convertible Preferred Stock and to fund the acquisition
of HealthCalc.Net, Inc.
In accordance with the terms of the PIPE Transaction, we were required to file
with the SEC, within sixty (60) days from the Effective Date, a registration
statement covering the common shares issued and issuable in the PIPE
Transaction. We were also required to cause the registration statement to be
declared effective on or before the expiration of one hundred twenty (120) days
from the Effective Date. We would have been subject to liquidated
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damages of one percent (1%) per month of the aggregate gross proceeds
($10,200,000), if we failed to meet these date requirements. On March 10, 2006,
the SEC declared effective our registration statement and, as a result, we did
not pay any liquidated damages for failure to meet the filing and effectiveness
date requirements. We could nevertheless be subject to the foregoing liquidated
damages if we fail (subject to certain permitted circumstances) to maintain the
effectiveness of the registration statement.
The warrants, which were issued together with the Series B Stock, have a term of
five years, and give the investors the option to require us to repurchase the
warrants for a purchase price, payable in cash within five (5) business days
after such request, equal to the Black Scholes value of any unexercised warrant
shares, only if, while the warrants are outstanding, any of the following change
in control transactions occurs: (i) we effect any merger or consolidation, (ii)
we effect any sale of all or substantially all of our assets, (iii) any tender
offer or exchange offer is completed whereby holders of our common stock are
permitted to tender or exchange their shares for other securities, cash or
property, or (iv) we effect any reclassification of our common stock whereby it
is effectively converted into or exchanged for other securities, cash or
property.
Under EITF 00-19 "Accounting for Derivative Financial Instruments Indexed to,
and Potentially Settled in, a Company's Own Stock" (EITF 00-19"), the fair value
of the warrants issued under the PIPE Transaction have been reported as a
liability due to the requirement to net-cash settle the transaction. There are
two reasons for this treatment: (i) there are liquidated damages, payable in
cash, of 1% of the gross proceeds per month ($102,000) should we fail to
maintain effectiveness of the registration statement in accordance with the PIPE
Transaction; and (ii) our investors may put their warrants back to us for cash
if we initiate a change in control that meets the definition previously
discussed. On the Effective Date, the warrants had a value of approximately $1.6
million, which was determined using the Black-Scholes valuation method. The
assumptions utilized in computing the fair value of the warrants were as
follows: expected life of 5 years, estimated volatility of 61% and a risk free
interest rate of 4.54%. On the Effective Date, the Series B Stock was valued at
approximately $8.6 million, or the difference between the gross proceeds and the
value of the warrants. The warrants are considered a derivative financial
instrument and will be marked to fair value on a quarterly basis. Any changes in
fair value of the warrants will be recorded through the Consolidated Statement
of Operations as Other Income (Expense). For the three months ended March 31,
2006, we recognized a non-cash benefit of approximately $435,000. There was no
fair value adjustment in any other periods presented.
As of March 31, 2006, we have no off-balance sheet arrangements or transactions
with unconsolidated, limited purpose entities. Refer to the footnotes in our
Annual Report on Form 10-K for the year ended December 31, 2005 for disclosure
related to our "Commitments and Contingencies."
We believe that sources of capital to meet future obligations over the next 12
months will be provided by cash generated through operations and our Wells Loan.
Currently, we do not have plans to make any significant investments in capital
assets or any other one-time expenses that may affect our cash flows from
investing activities.
We do not believe that inflation has had a significant impact on the results of
our operations.
15
PRIVATE SECURITIES LITIGATION REFORM ACT
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward-looking statements. Such "forward-looking" information is included
in this Form 10-Q, including the MD&A section, as well as in our Annual Report
on Form 10-K for the year ended December 31, 2005 that was filed with the
Securities and Exchange Commission, and in other materials filed or to be filed
by the Company with the Securities and Exchange Commission (as well as
information included in oral statements or other written statements made or to
be made by the Company).
Forward-looking statements include all statements based on future expectations
and specifically include, among other things, all statements relating to
increasing revenue, improving margins, growth of the market for corporate,
hospital, community and university-based fitness centers, the development of new
business models, our ability to expand our programs and services and the
sufficiency of our liquidity and capital resources. Any statements that are not
based upon historical facts, including the outcome of events that have not yet
occurred and our expectations for future performance, are forward-looking
statements. The words "believe," "estimate," "expect," "intend," "may," "could,"
"will," "plan," "anticipate," and similar words and expressions are intended to
identify forward-looking statements. Such statements are based upon the current
beliefs and expectations of our management. Such forward-looking information
involves important risks and uncertainties that could significantly affect
anticipated results in the future and, accordingly, such results may differ from
those expressed in any forward-looking statements made by or on behalf of the
Company. These risks and uncertainties include, but are not limited to those
matters identified and discussed in Item 1 of the Company's Form 10-K for the
year ended December 31, 2005 under "Risk Factors/Forward-Looking Statements."
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks related to changes in U.S. and international
interest rates. All of the Company's long-term obligations bear interest at a
variable rate.
We have no history of, and do not anticipate in the future, investing in
derivative financial instruments, derivative commodity instruments or other such
financial instruments. Transactions with international customers are entered
into in U.S. dollars, precluding the need for foreign currency hedges. As a
result, our exposure to market risk is not material.
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ITEM 4. CONTROLS AND PROCEDURES
Our Chief Executive Officer and Chief Financial Officer (collectively, the
"Certifying Officers") are responsible for establishing and maintaining
disclosure controls and procedures for the Company. The Certifying Officers have
concluded (based upon their evaluation of these controls and procedures as of
the end of the period covered by this report) that our disclosure controls and
procedures are effective to ensure that information required to be disclosed by
us in reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
rules of the Securities and Exchange Commission. The Certifying Officers also
have indicated that there were no significant changes in our internal control
over financial reporting that occurred during the period covered by this report
that have materially affected, or are reasonably likely to materially affect,
our internal control over financial reporting.
PART II. - OTHER INFORMATION
Item 1. Legal Proceedings
Refer to Item 3 (Legal Proceedings) in the Company's Annual Report on Form 10-K
for the year ended December 31, 2005.
Item 1A. Risk Factors
In addition to the other information set forth in this report, including the
important information in "Private Securities Litigation Reform Act," you should
carefully consider the "Risk Factors" discussed in our Annual Report on Form
10-K for the year ended December 31, 2005. Those factors, if they were to occur,
could cause our actual results to differ materially from those expressed in our
forward-looking statements in this report, and materially adversely affect our
financial condition or future results. Although we are not aware of any other
factors that we currently anticipate will cause our forward-looking statements
to differ materially from our future actual results, or materially affect the
Company's financial condition or future results, additional risks and
uncertainties not currently known to us or that we currently deem to be
immaterial might materially adversely affect our actual business, financial
condition and/or operating results.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
(a) Although not required to be contained in a report on Form 8-K, Mr. Mark
W. Sheffert has replaced Mr. John C. Penn as Chairman of the Board
effective May 9, 2006.
Item 6. Exhibits
(a) Exhibits
See Exhibit Index on page following signatures
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this Report to be signed on its behalf
by the undersigned, thereunto duly authorized.
Dated: May 15, 2006 HEALTH FITNESS CORPORATION
By /s/ Jerry V. Noyce
--------------------------------------------
Jerry V. Noyce
Chief Executive Officer
(Principal Executive Officer)
By /s/ Wesley W. Winnekins
--------------------------------------------
Wesley W. Winnekins
Chief Financial Officer
(Principal Financial and Accounting Officer)
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EXHIBIT INDEX
HEALTH FITNESS CORPORATION
FORM 10-Q
Exhibit No. Description
**11.0 Statement re: Computation of Earnings per Share
**31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
**31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
**32.1 Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
**32.2 Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
----------
* Indicates management contract or compensatory plan or arrangement
** Filed herewith
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