FORM 10-QSB
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20429
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________________ to _______________________
Commission File Number 0-27227 .
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ALLERGY RESEARCH GROUP, INC.
(Exact name of registrant as specified in its charter)
Florida 13-3940486
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
30806 Santana Street, Hayward, California 94544
(Address of principal executive offices)
(Issuer's telephone number) (800) 545-9960.
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- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Checkmark whether the issuer (1) has filed all reports required to be filed by
Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes [X] No [ ]
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: 14,732,105 shares of Issuer's voting
common stock were outstanding on October 31, 2003.
ALLERGY RESEARCH GROUP, INC.
INDEX TO QUARTERLY REPORT
ON FORM 10-QSB
PART I. FINANCIAL INFORMATION PAGE
ITEM 1. Condensed Consolidated Financial Statements (Unaudited):
Consolidated Balance Sheet...........................................3
Consolidated Income Statements.......................................4
Consolidated Statements of Cash Flows................................5
Notes to Condensed Consolidated Financial Statements.................6
ITEM 2. Management's Discussion and Analysis..............................8
ITEM 3. Controls and Procedures..........................................14
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings................................................14
ITEM 2. Changes in Securities and Use of Proceeds........................14
ITEM 3. Defaults Upon Senior Securities..................................15
ITEM 4. Submission of Matters to a Vote of Security Holders..............15
ITEM 5. Other Information................................................15
ITEM 6. Exhibits and Reports on Form 8-K.................................15
SIGNATURE.....................................................................16
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
In the opinion of management, the accompanying unaudited financial statements
included in this Form 10-QSB reflect all adjustments (consisting only of normal
recurring accruals) necessary for a fair presentation of the results of
operations for the periods presented. The results of operations for the periods
presented are not necessarily indicative of the results to be expected for the
full year.
ALLERGY RESEARCH GROUP, INC.
CONSOLIDATED BALANCE SHEET
(Unaudited)
September 30,
2003
------------
ASSETS
- ------
Current Assets
Cash & Cash Equivalents $ 1,478,101
Accounts Receivable, Net of Allowance for Doubtful Accounts of $53,884 697,584
Inventories 1,681,823
Prepaid Expenses and Other Current Assets 191,331
Deferred Tax Asset 404,085
------------
Total Current Assets 4,452,924
------------
Property and Equipment, Net 223,155
------------
Other Assets
Deposits 18,019
Due From Officer 62,715
Intangible Assets, Net of Amortization of $17,242 18,782
------------
Total Other Assets 99,516
------------
Total Assets $ 4,775,595
============
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current Liabilities
Accounts Payable $ 778,459
Accrued Liabilities 206,207
Income Taxes Payable 73,644
------------
Total Current Liabilities 1,058,310
------------
Total Liabilities 1,058,310
------------
Stockholders' Equity
Preferred Stock, $.25 Par Value, Authorized 1,000,000 Shares, Issued and Outstanding None
Common Stock, $.001 Par Value, Authorized 100,000,000 Shares
Issued: 15,105,355, Outstanding: 14,732,105 15,105
Additional Paid-In Capital 1,143,249
Retained Earnings 2,638,375
Less: Treasury Stock, at cost, 373,250 shares (79,444)
------------
Total Stockholders' Equity 3,717,285
------------
Total Liabilities and Stockholders' Equity $ 4,775,595
============
See Notes to Condensed Consolidated Financial Statements.
3
ALLERGY RESEARCH GROUP, INC.
CONSOLIDATED INCOME STATEMENTS
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2003 2002 2003 2002
---- ---- ---- ----
Revenues $ 3,326,957 $ 3,000,925 $ 10,222,850 $ 9,241,237
Cost of Sales 1,898,692 1,816,288 5,844,012 5,649,631
------------- ------------- ------------- -------------
Gross Profit 1,428,265 1,184,637 4,378,838 3,591,606
------------- ------------- ------------- -------------
Operating Expenses
Selling, General and Administrative 954,843 1,012,048 2,794,614 2,829,081
Research and Development 39,988 44,696 134,612 136,866
------------- ------------- ------------- -------------
Total Operating Expenses 994,831 1,056,744 2,929,226 2,965,947
------------- ------------- ------------- -------------
Operating Income 433,434 127,893 1,449,612 625,659
------------- ------------- ------------- -------------
Other Income (Expense)
Interest Expense (75) (7,675) (1,170) (29,591)
Interest Income 2,706 2,753 7,495 6,351
------------- ------------- ------------- -------------
Total Other Income (Expense) 2,631 (4,922) 6,325 (23,240)
------------- ------------- ------------- -------------
Net Income Before Income Taxes 436,065 122,971 1,455,937 602,419
------------- ------------- ------------- -------------
Provision (Benefit) for Income Taxes 38,548 907 128,705 (34,293)
Net Income Available to Common Stockholders $ 397,517 $ 122,064 $ 1,327,232 $ 636,712
============= ============= ============= =============
Weighted Average Common Shares Outstanding 14,725,292 14,849,977 14,723,179 15,016,436
Basic and Diluted Income Per Common Share $ 0.03 $ 0.01 $ 0.09 $ 0.04
============= ============= ============= =============
See Notes to Condensed Consolidated Financial Statements.
4
ALLERGY RESEARCH GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
(Unaudited)
Nine Months Ended
September 30,
2003 2002
---- ----
Cash Flows From Operating Activities
Net Income $ 1,327,232 $ 636,712
------------ ------------
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities
Depreciation and Amortization 125,749 166,292
Due From Officer Adjustment -- 10,000
Changes in Assets and Liabilities
(Increase) Decrease in Accounts Receivable (106,027) (71,324)
(Increase) Decrease in Inventory (80,204) (202,999)
(Increase) Decrease in Prepaid Expenses and Other Assets (72,520) (18,099)
(Increase) Decrease in Deferred Tax Assets -- (36,000)
(Increase) Decrease in Deposits 11,711 --
Increase (Decrease) in Accounts Payable and Accrued Liabilities (79,165) (38,394)
Increase (Decrease) in Income Taxes Payable 2,929 (862)
------------ ------------
Total Adjustments (197,527) (191,386)
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Net Cash Flows Provided By Operating Activities 1,129,705 445,326
------------ ------------
Cash Flows From Investing Activities
Acquisition of Property and Equipment (11,811) (36,496)
Repayments From (Advances To) Officers 64,976 (6,219)
------------ ------------
Net Cash Flows Provided By (Used In) Investing Activities 53,165 (42,715)
------------ ------------
Cash Flows From Financing Activities
Proceeds from the exercise of stock options 4,000 --
Purchase of Treasury Shares -- (65,950)
Repayment on Notes Payable -- (327,567)
Repayment on Capital Lease Obligations (48,771) (40,775)
------------ ------------
Net Cash Flows Used In Financing Activities (44,771) (434,292)
------------ ------------
Increase (Decrease) in Cash and Cash Equivalents 1,138,099 (31,681)
Cash and Cash Equivalents, Beginning of Period 340,002 199,499
------------ ------------
Cash and Cash Equivalents, End of Period $ 1,478,101 $ 167,818
============ ============
See Notes to Condensed Consolidated Financial Statements.
5
ALLERGY RESEARCH GROUP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003
(UNAUDITED)
Note 1 - Statement of Information Furnished
- -------------------------------------------
The accompanying unaudited Consolidated Financial Statements of Allergy
Research Group, Inc. (the "Company") have been prepared in accordance
with generally accepted accounting principles in the United States of
America for interim financial information and the instructions to Form
10-QSB. Accordingly, they do not include all the information and
footnotes required by generally accepted accounting principles for
annual financial statements. In the opinion of management, all
adjustments (which include only normal recurring adjustments) necessary
to present fairly the financial position, results of operations and
cash flows for all periods presented have been made. Preparing
financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities,
revenue and expenses. Examples include provisions for returns,
accounting for income taxes, bad debts, and length of product life
cycles and property, plant and equipment lives for depreciation
purposes. Actual results may differ from these estimates. The results
of operations for the nine-month period ended September 30, 2003 are
not necessarily indicative of the operating results that may be
expected for the entire year ending December 31, 2003. These financial
statements should be read in conjunction with the Management's
Discussion and Analysis of Results of Operations and Financial
Condition and financial statements and notes thereto as of and for the
year ended December 31, 2002, filed with the Company's Annual Report on
Form 10-KSB on March 31, 2003.
Certain accounts from prior years have been reclassified to conform to
the current year's presentation. These changes had no effect on
previously reported results of operations or total stockholders'
equity.
Note 2 - Earnings Per Share
- ---------------------------
Basic earnings per share is based on the weighted average number of
common shares outstanding. Diluted earnings or loss per share is based
on the weighted average number of common shares outstanding and
dilutive common stock equivalents. All earnings per share amounts in
these financial statements are basic earnings per share as defined by
SFAS No. 128, "Earnings Per Share." Diluted weighted average shares
outstanding exclude the potential common shares from options because to
do so would be antidilutive.
The computation of basic and diluted earnings per share is as follows:
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
9/30/03 9/30/02 9/30/03 6/30/02
------- ------- ------- -------
Numerator-Net Income Available
to Common Stockholders $ 397,517 $ 122,064 $1,327,232 $ 636,712
========== ========== ========== ==========
Denominator-Weighted Average Number
of Common Shares Outstanding 14,725,292 14,849,977 14,723,179 15,016,436
========== ========== ========== ==========
Basic and Diluted Earnings Per Common
Share $ 0.03 $ 0.01 $ 0.09 $ 0.04
========== ========== ========== ==========
6
Note 3 - Line of Credit and Subsequent Events
- ---------------------------------------------
On August 19, 2002, a Merrill Lynch Working Capital Management Account
(WCMA) was activated. The WCMA replaced the line of credit with City
National Bank and provides for a line of credit up to $500,000 for
twelve months bearing interest at the London Interbank Offered Rate
(LIBOR) plus 3.15%. The LIBOR plus 3.15% at September 30, 2003 was
4.27%. Interest is due monthly; however, the balance due on the line of
credit was zero throughout the first three quarters of 2003. The note
is secured by substantially all of the assets of the Company and is
personally guaranteed by the chief executive officer of the Company.
The WCMA account immediately pays down the line of credit when deposits
are received. When checks are issued, the line of credit is utilized if
no cash is available. If the line of credit has a zero balance, the
WCMA account pays interest on deposits at Merrill Lynch's money market
rate, which as of September 30, 2003 was .56%.
Effective October 31, 2003 our line of credit with Merrill Lynch was
increased to $1,500,000 bearing interest at LIBOR plus 2.75%. The note
requires the Company to maintain a net worth of $3,000,000 and a total
debt to EBITDA Ratio not to exceed two to one.
Note 4 - Stockholders' Equity
- -----------------------------
On May 3, 2002, the Company announced a stock repurchase plan, whereby
the Company may repurchase between 1,000,000 and 2,500,000 shares of
the Company's common stock in open market transactions, from time to
time for a two-year period in compliance with Rule 10b-18 of the
Securities Exchange Act of 1934 and all other applicable securities
regulations. As of September 30, 2003, the Company repurchased 383,250
shares at a cost of $81,573 under this program.
One of the primary purposes of the repurchase program was to provide
shares for issuance to employees under stock option and stock purchase
plans. On May 13, 2003, the Company issued 383,250 stock options,
exercisable at $0.40 per share, based on the closing price of the
Company's common stock on the Over-The-Counter Bulletin Board on the
grant date. The options vest immediately and terminate on the five-year
anniversary of the grant date. The options were issued to many of the
Company's employees and to selected independent contractors who are
sales representatives for the Company.
When the treasury shares are reissued, any excess of the proceeds over
the average acquisition cost are recorded as additional paid-in
capital. Any excess of the average acquisition cost of the shares over
the proceeds from reissuance is charged to additional paid-in capital
to the extent of previous credits on similar transactions, with any
remaining amounts charged to retained earnings.
On August 29, 2003, 10,000 options were exercised for proceeds of
$4,000 and net proceeds of $1,872 were credited to additional paid-in
capital.
7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
INTRODUCTION
- ------------
Management's discussion and analysis of results of operations and financial
condition ("MD&A") is provided as a supplement to the accompanying consolidated
financial statements and footnotes to help provide an understanding of Allergy
Research Group, Inc.'s (the "Company's") financial condition, changes in
financial condition and results of operations. The MD&A is organized as follows:
o CAUTION CONCERNING FORWARD-LOOKING STATEMENTS AND RISK
FACTORS. This section discusses how certain forward-looking
statements made by the Company throughout the MD&A and in the
consolidated financial statements are based on our present
expectations about future events and are inherently
susceptible to uncertainty and changes in circumstances.
o OVERVIEW. This section provides a general description of the
Company's business, as well as recent developments that we
believe are important in understanding the results of
operations, as well as to anticipate future trends in those
operations.
o RESULTS OF OPERATIONS. This section provides an analysis of
our results of operations for the three and nine months ended
September 30, 2003 compared to the same periods in 2002. A
brief description is provided of transactions and events,
including related party transactions that impact the
comparability of the results being analyzed.
o LIQUIDITY AND CAPITAL RESOURCES. This section provides an
analysis of our financial condition and cash flows as of and
for the nine months ended September 30, 2003.
o CRITICAL ACCOUNTING POLICIES. This section provides an
analysis of the significant estimates and judgments that
affect the reported amounts of assets, liabilities, revenues
and expenses, and related disclosure of contingent assets and
liabilities.
CAUTION CONCERNING FORWARD-LOOKING STATEMENTS AND RISK FACTORS
- --------------------------------------------------------------
The following discussion should be read in conjunction with the Company's
financial statements and the notes thereto and the other financial information
appearing elsewhere in this document. In addition to historical information, the
following discussion and other parts of this document contain certain
forward-looking information. When used in this discussion, the words "believes,"
"anticipates," "expects," and similar expressions are intended to identify
forward-looking statements. Such statements are subject to certain risks and
uncertainties, which could cause actual results to differ materially from those
projected due to a number of factors beyond our control. The Company does not
undertake to publicly update or revise any of its forward-looking statements
even if experience or future changes show that the indicated results or events
will not be realized. You are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof. You are also
urged to carefully review and consider our discussions regarding the various
factors which affect our business, included in this section and elsewhere in
this report.
Factors that might cause actual results, performance or achievements to differ
materially from those projected or implied in such forward-looking statements
include, among other things: (i) the impact of competitive products; (ii)
changes in law and regulations; (iii) adequacy and availability of insurance
coverage; (iv) limitations on future financing; (v) increases in the cost of
borrowings and unavailability of debt or equity capital; (vi) the effect of
adverse publicity regarding nutritional supplements; (vii) the inability of the
Company to gain and/or hold market share; (viii) exposure to and expense of
resolving and defending product liability claims and other litigation; (ix)
consumer acceptance of the Company's products; (x) managing and maintaining
growth; (xi) customer demands; (xii) market and industry conditions including
pricing, demand for products, levels of trade inventories and raw materials
availability; (xiii) the success of product development and new product
introductions into the marketplace; (xiv) slow or negative growth in the
nutritional supplement industry; (xv) the departure of key members of
management; (xvi) the ability of the Company to efficiently manufacture its
products; as well as other risks and uncertainties that are described from time
to time in the Company's filings with the Securities and Exchange Commission.
8
OVERVIEW
- --------
BUSINESS DESCRIPTION. Allergy Research Group, Inc. (SYMBOL: ALRG) (the "Company"
or "ARG"), through its wholly owned subsidiary, Nutricology, Inc., strives to be
an innovative leader in nutraceutical research and product formulation. Our
shares are traded on the Over The Counter Bulletin Board. Since 1980, the
Company has produced quality, hypoallergenic nutritional supplements and
supplies products to physicians and health care practitioners worldwide. These
professionals recognize the Company for the quality, purity and efficacy of its
targeted nutritional supplement line. Currently, we supply products to
approximately 4,000 physicians and health care practitioners, including accounts
in the United States, Japan, Taiwan, the United Kingdom, South Korea, Jamaica,
New Zealand, Mexico, Turkey, Norway, Sweden, Switzerland, Italy, Ireland,
Philippines, Russia, South Africa and Singapore. We develop, contract
manufacture, market and sell branded and private label products, including
vitamins and nutritional supplements, throughout the world under the
NutriCology(R) and Allergy Research Group(R) labels. Our products are
distributed through distributors, medical and professional accounts, retailers,
and consumers. We offer a line of approximately 200 products under two brands,
including vitamins in both multivitamin and single-entity formulas, minerals,
and herbals. Our products are manufactured in various forms, including capsules,
tablets, softgels, powders (drink mixes), liquids and creams. Our principal
executive offices are located at 30806 Santana Street, Hayward, California 94544
and the telephone number is (800) 545-9960.
FUTURE OPERATIONS. The success of our future operations will depend to a great
extent on the operations, financial condition, and management of the Company. We
intend to expand our position in the vitamin and nutritional supplements
markets. Specifically, our strategy continues to be to: (i) develop new brands
and product line extensions, as well as new products, through our commitment to
research and development; (ii) continue the growth of our balanced distribution
network; (iii) build our execution skills through new operations processes and
decision support systems; (iv) achieve cost superiority through formal
productivity benchmarking and continuous improvement programs; and (v) improve
our e-commerce platform. We believe that our history and reputation in the
field, multiple distribution channels, broad portfolio of products and packaging
and distribution capabilities position the Company to be a long-term competitor
in the vitamin and nutritional supplements industries.
We continue to work with Dr. Ba Hoang on his proprietary herbal formulas with a
view to developing additional research that can be marketed to the
pharmaceutical and nutraceutical industries. This process is limited to
literature work, including patent submissions for potential products. The
research can be marketed to pharmaceutical companies either through direct sell
of the research to the pharmaceutical company, or through a joint venture
arrangement between the pharmaceutical company and the Company whereby the
parties will jointly own the patent and continue development of the products. It
is our hope that, during the process of research into possible pharmaceutical
and nutraceutical products, we will test new herbal products, or additional uses
for existing herbal products, that can be added to our current line of products
as health food or dietary supplements.
PRODUCT DEVELOPMENT. In addition to our work in the pharmaceutical and
nutraceutical fields of research, we continue to add new products to our
existing product line. During the latter part of 2002 and through the date of
this filing, the Company has added the following new products to its existing
product line: AndroBalance Androstenedione Cream (may enhance hormonal balance
in men), Progestex Natural Progesterone Cream (natural progesterone cream),
Progestex Plus Progesterone Cream with Phytoestrogens (same pure formulation of
natural progesterone as Progestex with weak estrogenic phytochemicals added that
can help regulate and support estrogenic function), Hepagenesis (Ayurvedic herb
Eclipta alba used to support the liver), Liver Saver (contains three herbs from
traditional Chinese Medicine), Phytostatin (immune support), Artemininin Gel
(supports normalization of topical conditions), Bindweed Extract (concentrated
extract of the herb CONVOLVULUS ARVENSIS), PhytoArtemisinin (contains pure
artemisinin, QINGHAOSU, enhanced with phytosaponins), Chemogen (green tea
extract), Prima Una de Gato (Cat's Claw extract), Pantethine (derivative of
pantothenic acid), Metaboliczyme (enzyme formulation to support circulation and
modulate the immune function), Cell Food and Cell Saver (proprietary blend of
herbs.) These statements have not been evaluated by the Food and Drug
Administration. The products are not intended to diagnose, treat, cure, or
prevent any disease.
We believe that the Company has good relations with all of its current
manufacturers and suppliers. During the nine-month period ending September 30,
2003, we experienced a concentration of approximately 58% of our manufacturing
with four separate vendors. We do not currently have written contracts with any
9
of our manufacturers, but rely on long-term personal and professional
relationships with our four largest vendors. However, we believe that, due to
the large number of businesses performing this type of service in the industry,
the Company would have little difficulty in finding viable alternatives in the
event any one of these vendors became unable or determined not to continue
manufacturing our products.
RESULTS OF OPERATIONS
- ---------------------
Please refer to the consolidated financial statements, which are a part of this
report, for further information regarding the results of operations of the
Company.
PERIOD ENDED SEPTEMBER 30, 2003 COMPARED TO SEPTEMBER 30, 2002
--------------------------------------------------------------
REVENUES. We had net sales of $3,326,957 for the third quarter and $10,222,850
for the nine months ended September 30, 2003, compared with $3,000,925 and
$9,241,237 for the same periods in 2002. The increase of $326,032, or 11%, in
the third quarter is due to increased sales to our distributors and increased
demand at retail for current and new products. The increase of $981,613, or 11%,
for the nine-month period also reflects the increased demand. Average monthly
sales have increased from approximately $1,000,000 per month in 2002 to
approximately $1,100,000 in 2003.
COSTS OF SALES. Cost of sales increased $82,404 to $1,898,692 for the three
months ended September 30, 2003, compared to $1,816,288 for the three months
ended September 30, 2002. The increase in cost of sales corresponds with the
increase in sales. For the nine months ended September 30, 2003 cost of sales
increased $194,381 from $5,649,631 in 2002 to $5,844,012 in 2003. This increase
corresponds with the increase in sales with offsets for reduced freight and
royalty costs realized in the second quarter. Gross profit margins increased
approximately 3.4% for the third quarter and 3.9% year to date, approximating
42.8% for the nine months ended September 30, 2003 as a result of higher margins
associated with retail sales. Although no specific price adjustments are
contemplated, there is the possibility that the increase in gross profit may not
be sustained throughout the year due to price adjustments that may be necessary
to respond to pricing pressures from our competitors.
OPERATING EXPENSES. Total operating expenses were $994,831 for the third quarter
and $2,929,226 for nine months ended September 30, 2003, compared with
$1,056,744 and $2,965,947 for the same periods in 2002, a decrease of $61,913
and $36,721, respectively. The decrease in the third quarter was primarily due
to (1) decreased professional services associated with outside consultants; (2)
reduced selling expenses such as advertising, conventions, travel and
entertainment; offset in part by (i) an increase in rent expense due to loss of
sublease income (less of our warehouse space is being sublet); and (ii) an
increase in liability insurance. The following items contributed to the decrease
in the year-to-date expense: (1) a reduction in telephone expense associated
with obtaining a new contract for services; (2) a decrease in depreciation
expense; (3) reduced expense associated with bad debts, and (4) reduced selling
expenses such as advertising, conventions, travel and entertainment. These
decreases were offset in part by: (1) an increase in rent expense resulting from
the loss of sublease income associated with excess warehouse space (our lease
was renegotiated effective June 1, 2003 and the excess warehouse space was
eliminated); (2) an increase in liability insurance; and (3) an increase in
credit card fees.
INTEREST EXPENSE. Interest expense was $75 for the third quarter and $1,170 for
nine months ended September 30, 2003 compared to $7,675 and $29,591,
respectively, for the same periods in 2002. The decrease is a result of paying
down the line of credit from $570,064 at December 31, 2001 to zero at September
30, 2003.
PROVISION FOR INCOME TAXES. As of September 30, 2003, the Company recorded a
deferred tax asset of $404,085 to be realized as a result of future taxable
income offset by net operating loss carryforwards. As of fiscal year ended
December 31, 2002, we have approximately $2,200,000 and $1,400,000,
respectively, available in federal and state net operating loss carryforwards to
offset future taxable income, which expire principally in the year 2021
(federal) and 2013 (state). For taxable years beginning in 2002 and 2003, the
State of California has suspended the net operating loss carryover deduction for
two years for losses incurred before January 1, 2002, and for one year for
losses incurred after January 1, 2002. As a result, income taxes payable at
September 30, 2003, represent estimated 2003 California taxes based on income.
NET INCOME. During the quarter and nine-month period ended September 30, 2003,
we recorded net income of $397,517 and $1,327,232, respectively, compared to net
income of $122,064 and $636,712 for the same periods in 2002. The increase of
$275,453 for the quarter and $690,520 for year-to-date is a result of the
increase in sales, higher profit margins, and reduced operating expenses.
10
EARNINGS PER SHARE. Earnings per share have increased to $0.03 per share for the
quarter ended September 30, 2003 from $0.01 per share for the same period in
2002. For the nine-months ended September 30, earnings per share was $0.09 in
2003 and $0.04 in 2002.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Current Financial Condition
During the nine-month period ended September 30, 2003, the Company increased its
working capital by $1,521,399 to $3,394,614 compared to a working capital at
December 31, 2002 of $1,873,215. The Company reduced outstanding current
liabilities by approximately $125,000 through cash flows available from
operating activities. The Company continues to finance its inventory and
accounts receivable through its income from operations and did not require the
use of its line of credit during the period then ended. Management believes that
the Company's operating cash flow, cash and equivalents, and borrowing capacity
under committed bank credit agreements is sufficient to fund its capital and
liquidity needs for the next twelve months.
Cash Flows
OPERATING ACTIVITIES. Net cash flow provided by operating activities was
$1,129,705 for the nine months ended September 30, 2003. This was primarily the
result of net income of $1,327,232, increased by depreciation expense of
$125,749 and a decrease in deposits of $11,711. These figures were offset by an
increase in accounts receivable of $106,027, an increase in inventory of
$80,204, an increase in prepaid expenses and other assets of $72,520, and a
decrease of accounts payable and accrued liabilities of $79,165. Net cash flow
provided by operating activities for the nine months ended September 30, 2002
was $445,326, due to net income of $636,712, increased predominately by
depreciation of $166,292. Offsetting these amounts was an increase in accounts
receivable of $71,324, an increase in inventory of $202,999, an increase in
prepaid expenses and other assets of $18,099, an increase in deferred tax assets
of $36,000, and a decrease in accounts payable and accrued liabilities of
$38,394.
INVESTING ACTIVITIES. Net cash flow provided by investing activities was $53,165
for the nine months ended September 30, 2003, representing repayments of loans
to officers of $64,976 offset by the acquisition of property and equipment for
$11,811. Net cash flows used in investing activities as of September 30, 2002
was $42,715 representing the acquisition of property and equipment for $36,496
and advances to officers of $6,219 (representing accrued interest on outstanding
loans only).
FINANCING ACTIVITIES. Net cash flow used in financing activities was $44,771 for
the nine months ended September 30, 2003, representing repayments of capital
lease obligations of $48,771 offset by cash received from the exercise of 10,000
employee stock options for $4,000. For the same period ended September 30, 2002,
net cash flows used in financing activities was $434,292, representing
repayments on the line of credit and capital lease obligations of $368,342 and
$65,950 for the purchase of treasury shares.
CONCENTRATION OF CREDIT RISK. Approximately 11% of our total sales in 2002 were
attributable to a single distributor. In 2003, this distributor continued to
account for over 10% of sales. In the event we were to lose that account, we
anticipate that we would be able to convert the business to sales directly to
the customers of that distributor. As converted sales would be at a higher
margin, we do not believe the loss of the account would have a material negative
impact on sales.
11
CONTRACTUAL OBLIGATIONS. The Company's Contractual Obligations and Commercial
Commitments are detailed below:
- ----------------------- -------------------------------------------------------------------------------------
Payments Due by Period
- ----------------------- ------------------ ------------------ ------------------ -------------- -------------
Less
Contractual Than 1 1-3 4 - 5 After 5
Obligations Total Year Years Years Years
- ----------------------- ------------------ ------------------ ------------------ -------------- -------------
Line of Credit (1)
- ----------------------- ------------------ ------------------ ------------------ -------------- -------------
Operating Leases $229,509 $218,064 $11,445
- ----------------------- ------------------ ------------------ ------------------ -------------- -------------
Total Cash Contractual
Obligations $229,509 $218,064 $11,445
- ----------------------- ------------------ ------------------ ------------------ -------------- -------------
(1) This represents the Company's borrowings under its line of credit with
Merrill Lynch. The Merrill Lynch line of credit was activated on August
19, 2002 and provides for maximum financing of $500,000, bearing
interest at the London Interbank Offered Rate (LIBOR) plus 3.15%,
computed on a monthly basis. As of September 30, 2003, the interest
rate on the line of credit was 4.27% per annum. Interest is due
monthly; however, the line has not been utilized throughout the first
three quarters of 2003, thus no interest was due. Because the line of
credit is secured by substantially all of the assets of the Company, if
the Company were to fall into default under the terms of our agreement
with Merrill Lynch it could have a material adverse impact on our
business and financial position. The chief executive officer of the
Company has personally guaranteed the line of credit.
Effective October 31, 2003 our line of credit with Merrill Lynch was
increased to $1,500,000 bearing interest at LIBOR plus 2.75%. The note
requires the Company to maintain a net worth of $3,000,000 and a total
debt to EBITDA Ratio not to exceed two to one.
RELATED PARTY TRANSACTIONS. In 1999, Dr. Stephen A. Levine, CEO, and his wife,
Susan Levine, formed Inventive Biomedical, LLC, a California limited liability
company ("IBM"), as a research and development firm. For the year ended December
31, 2001, the Company paid approximately $9,000 to IBM for research and
development and for market testing of new products. As of September 30, 2003,
IBM owes Allergy Research Group approximately $6,400 associated with inventory
purchased on IBM's behalf.
LIQUIDITY RESOURCES. Our future funding requirements will depend on numerous
factors, some of which are beyond our control. These factors include our ability
to operate profitably, our ability to recruit and train management and
personnel, and our ability to compete with other, better-capitalized and more
established competitors who offer alternative or similar products to those of
the Company. We believe that, given our positive working capital position, we
can satisfy our cash requirements over the next twelve months from operations if
we continue to operate at a profit. Our capital resources and liquidity are
expected to be provided by our cash flow from operations and we have available
for use a $1,500,000 line of credit, when necessary. We anticipate our future
taxable income to be generated with potentially little or no federal income tax
consequences until our federal net operating loss carryforwards of approximately
$2,200,000 are utilized. .
The Company expects to continue to purchase equipment and hire new employees as
is commensurate with the growth of the business. In addition, we will continue
to invest time and effort in research for product development. We know of no
trends that are expected to affect the cost of labor or materials, and sales are
expected to be stable over the next twelve months.
CRITICAL ACCOUNTING POLICIES
- ----------------------------
Our discussion and analysis or plan of operations are based upon our
consolidated financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States of America. The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosure of contingent assets and liabilities. On an
on-going basis, we evaluate our estimates, including those related to bad debts,
inventories, intangible assets, income taxes and contingencies. We base our
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.
12
We believe the following critical accounting policies reflect our more
significant estimates and assumptions used in the preparation of our
consolidated financial statements:
INCOME TAXES
SFAS 109, Accounting for Income Taxes, establishes financial accounting and
reporting standards for the effect of income taxes. The objectives of accounting
for income taxes are to recognize the amount of taxes payable or refundable for
the current year and deferred tax liabilities and assets for the future tax
consequences of events that have been recognized in an entity's financial
statements or tax returns. Judgment is required in assessing the future tax
consequences of events that have been recognized in our financial statements or
tax returns. Fluctuations in the actual outcome of these future tax consequences
could materially impact our financial position or our results of operations. Our
deferred tax asset on the consolidated balance sheet is recognized primarily as
a result of net operating loss carryforwards. If we did not generate any taxable
income within the next year, the asset would be overstated.
We record a valuation allowance to reduce our deferred tax assets to the amount
that is more likely than not to be realized. We have considered future market
growth, forecasted earnings, and future taxable income in determining the need
for a valuation allowance. In the event we were to determine that we would not
be able to realize all or part of our net deferred tax assets in the future, an
adjustment to the deferred tax assets would be charged to earnings in the period
such determination is made. Likewise, if we later determine that it is more
likely than not that the net deferred tax assets would be realized, the
previously provided valuation allowance would be reversed. This asset represents
approximately 8.46% of total assets at September 30, 2003. Based on our
operating results for the prior two years, and the current interim period, we
believe our estimate of deferred tax assets to be reasonable.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We evaluate the collectibility of our trade receivables based on a combination
of factors. We regularly analyze our significant customer accounts, and, when we
become aware of a specific customer's inability to meet its financial
obligations to us, such as in the case of bankruptcy filings or deterioration in
the customer's operating results or financial position, we record a specific
reserve for bad debt to reduce the related receivable to the amount we
reasonably believe is collectible. The allowances are calculated based on
detailed review of certain individual customer accounts, delinquency reports,
historical collection rates, and an estimation of the overall economic
conditions affecting our customer base. We review a customer's credit history
before extending credit. If the financial condition of our customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required. The allowance represents approximately 7%
of total receivables at September 30, 2003.
INVENTORY
Our inventory purchases and commitments are made in order to build inventory to
meet future shipment schedules based on forecasted demand for our products. We
perform a detailed assessment of inventory for each period, which includes a
review of, among other factors, demand requirements, product life cycle and
development plans, component cost trends, product pricing and quality issues.
Based on this analysis, we record adjustments to inventory for excess,
obsolescence or impairment, when appropriate, to reflect inventory at net
realizable value. Revisions to our inventory adjustments may be required if
actual demand, component costs or product life cycles differ from our estimates.
Our inventory reserve currently represents approximately 3% of total inventory
at September 30, 2003.
RECENT ACCOUNTING PRONOUNCEMENTS
- --------------------------------
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46 "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51" (FIN 46). FIN 46 requires certain variable
interest entities to be consolidated by the primary beneficiary of the entity if
the equity investors in the entity do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN 46 is effective for all new variable interest
13
entities created or acquired after January 31, 2003. For variable interest
entities created or acquired prior to February 1, 2003, the provisions of FIN 46
must be applied for the first interim or annual period beginning after June 15,
2003. We do not anticipate that FIN 46 will have any effect on the Company.
In April 2003, the FASB issued SFAS No. 149, "Accounting for Amendment of
Statement 133 on Derivative Instruments and Hedging Activities," which amends
and clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. This Statement is generally effective for
contracts entered into or modified after June 30, 2003, and all provisions
should be applied prospectively. This statement does not affect the Company.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity," which
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). This Statement is effective
for financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003. It is to be implemented by reporting the cumulative effect
of a change in an accounting principle for financial instruments created before
the issuance date of the Statement and still existing at the beginning of the
interim period of adoption. Restatement is not permitted. This statement does
not affect the Company.
ITEM 3. CONTROLS AND PROCEDURES
a. Evaluation of Disclosure Controls and Procedures:
Disclosure controls and procedures are designed to ensure that information
required to be disclosed in the reports filed or submitted under the
Exchange Act is recorded, processed, summarized and reported, within the
time period specified in the SEC's rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed in the reports filed under
the Exchange Act is accumulated and communicated to management, including
the Chief Executive Officer and Chief Financial Officer, as appropriate, to
allow timely decisions regarding required disclosure. Within 90 days of
this report, the Company carried out an evaluation, under the supervision
and with the participation of the Company's management, including the
Company's Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of the Company's disclosure
controls and procedures. Based upon and as of the date of that evaluation,
the Chief Executive Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures are effective to ensure that
information required to be disclosed in the reports the Company files and
submits under the Exchange Act is recorded, processed, summarized and
reported as and when required.
b. Changes in Internal Control over Financial Reporting.
There were no significant changes in the Company's internal controls over
financial reporting identified in connection with the Company's evaluation
of these controls as of the end of the period covered by this report that
could have significantly affected these controls subsequent to the date of
such evaluation referred to in the previous paragraph, including any
correction action with regard to significant deficiencies and material
weaknesses.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not Applicable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable.
14
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On September 2, 2003, the Company held its annual meeting of
shareholders at which the shareholders voted to (1) re-elect each of the
Company's directors and (2) ratify the selection of the Company's independent
auditor for the fiscal year ending December 31, 2003. The voting totals were as
follows:
For Against Abstain
--- ------- -------
(1) Directors - Stephen Levine 14,210,906 - 18,579
(1) Directors - Susan Levine 14,210,706 200 18,579
(1) Directors - Edward Kane 14,210,906 - 18,579
(2) Independent Auditors 14,222,506 3,879 3,100
ITEM 5. OTHER INFORMATION
On August 12, 2003, Fred Salomon was appointed President of the
Company. Mr. Salomon was hired in 2002 to fill the role of Director of
Operations. Mr. Salomon brings 40 years of executive management experience. He
comes from the home-sewing and craft industry where he managed and grew several
businesses. He also founded his own company, which he sold to the McCall Pattern
Company, where he served as Chief Operating Officer of their national
distribution company, NMI, Inc. For the last 20 years, Mr. Salomon was general
manager of Lion Notions, Inc. and Fantasy Importers, Inc., both privately held
corporations. The Company has no written employment agreement with Mr. Salomon.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
3.1 Registrant's Articles of Incorporation*
3.2 Registrant's Articles of Amendment to Articles of Incorporation dated
January 15, 1998*
3.3 Registrant's Bylaws*
4.1 Form of Common Stock Certificate*
4.2 Form of Non-Qualified Stock Option*
4.3 Form of Incentive Stock Option*
4.4 Form of Common Stock Purchase Warrant*
4.5 1998 Stock Option Plan*
10.1 License Agreement between Registrant and Jim Cassidy dated March 21,
2000*
10.2 Option Agreement between Registrant, Dr. Ba Hoang and PhytoPharm PLC*#
10.3 Loan and Security Agreement between Registrant and Aerofund Financial,
Inc.*
10.4 Code of Business Conduct and Ethics**
99.1 Haight-Ashbury Free Medical Clinic Design Research Survey*
99.2 Certificate of Stephen A. Levine Pursuant to Section 1350 of Chapter 63
of Title 18 U.S. Code
* Incorporated by reference to the corresponding Exhibit previously filed as an
Exhibit to Registrant's Form 10-SB (File #0-27227).
** Incorporated by reference to the corresponding Exhibit previously filed as an
exhibit to Registrant's Form 10-KSB on March 31, 2003.
# Registrant requested confidential treatment pursuant to Rule 406 for a portion
of the referenced exhibit and separately filed such exhibit with the Commission
in conjunction with the filing of its registration statement on Form 10-SB.
(b) Reports on Form 8-K
None
15
ALLERGY RESEARCH GROUP, INC.
SIGNATURE
Pursuant to 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.
ALLERGY RESEARCH GROUP, INC.
Registrant
Dated: November 14, 2003
By: /s/ Stephen A. Levine
-------------------------
Chief Executive Officer and
Chief Financial Officer
16
ALLERGY RESEARCH GROUP, INC.
a Florida corporation
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
AND CHIEF FINANCIAL OFFICER
I, Stephen A. Levine, certify that:
1. I have reviewed this quarterly report on Form 10QSB of Allergy
Research Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: November 14, 2003
/s/ Stephen A. Levine
- --------------------
Stephen A. Levine
Chief Executive Officer and Chief Financial Officer