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 June 30, 2004
[ ] 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 .
---------------
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.
---------------
- --------------------------------------------------------------------------------
(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: 14,516,605 shares of Issuer's voting
common stock were outstanding on August 11, 2004.
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..................................14
ITEM 4. Submission of Matters to a Vote of Security Holders..............14
ITEM 5. Other Information................................................14
ITEM 6. Exhibits and Reports on Form 8-K.................................15
SIGNATURE.....................................................................15
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
June 30,
2004
------------
(unaudited)
ASSETS
- ------
Current Assets
Cash and Cash Equivalents $ 1,791,376
Accounts Receivable, Net of Allowance for Doubtful Accounts of $54,000 857,841
Inventories 2,003,201
Prepaid Income Taxes 89,200
Prepaid Expenses and Other Current Assets 230,558
Deferred Tax Asset 13,771
------------
Total Current Assets 4,985,947
------------
Property and Equipment, Net 180,954
------------
Other Assets
Deposits 18,019
Due From Officer 42,541
Intangible Assets, Net of Amortization of $26,177 15,888
------------
Total Other Assets 76,448
------------
Total Assets $ 5,243,349
============
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current Liabilities
Accounts Payable $ 246,192
Accrued Liabilities (Note 3) 409,070
Income Taxes Payable 18,940
------------
Total Current Liabilities 674,202
------------
Commitments and Contingencies (Note 3)
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: 14,516,605 15,105
Additional Paid In Capital 1,149,705
Retained Earnings 3,683,938
Less: Treasury Stock, at cost (588,750 shares) (279,601)
------------
Total Stockholders' Equity 4,569,147
------------
Total Liabilities and Stockholders' Equity $ 5,243,349
============
See Notes to Condensed Consolidated Financial Statements.
3
ALLERGY RESEARCH GROUP, INC.
CONSOLIDATED INCOME STATEMENTS
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
2004 2003 2004 2003
---- ---- ---- ----
Revenues $ 3,832,360 $ 3,447,130 $ 7,557,259 $ 6,895,892
Cost of Sales 2,167,845 1,990,480 4,302,465 3,945,320
------------ ------------ ------------ ------------
Gross Profit 1,664,515 1,456,650 3,254,794 2,950,572
------------ ------------ ------------ ------------
Operating Expenses
Selling, General and Administrative 944,321 898,173 1,906,313 1,800,664
Research and Development 91,157 91,908 122,338 133,729
------------ ------------ ------------ ------------
Operating Expenses 1,035,478 990,081 2,028,651 1,934,393
------------ ------------ ------------ ------------
Earnings from Operations 629,037 466,569 1,226,143 1,016,179
------------ ------------ ------------ ------------
Other Income (Expense)
Interest Expense 0 (375) 0 (1,095)
Interest Income 4,609 2,705 7,210 4,788
------------ ------------ ------------ ------------
Other Income (Expense) 4,609 2,330 7,210 3,693
------------ ------------ ------------ ------------
Net Earnings Before Tax 633,646 468,899 1,233,353 1,019,872
Provision for Income Taxes 288,684 41,451 504,328 90,157
------------ ------------ ------------ ------------
Net Earnings Available to Common Stockholders $ 344,962 $ 427,448 $ 729,025 $ 929,715
============ ============ ============ ============
Basic and Diluted Earnings Per Common Share (Note 2) $ 0.02 $ 0.03 $ 0.05 $ 0.06
============ ============ ============ ============
See Notes to Condensed Consolidated Financial Statements.
4
ALLERGY RESEARCH GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
June 30,
2004 2003
---- ----
Cash Flows From Operating Activities
Net Earnings $ 729,025 $ 929,715
------------ ------------
Adjustments to Reconcile Net Earnings to Net Cash Provided by Operating Activities
Depreciation and Amortization 64,005 83,592
Changes in Assets and Liabilities
(Increase) Decrease in Accounts Receivable (179,894) (158,529)
(Increase) Decrease in Inventory (406,474) 58,536
(Increase) Decrease in Prepaid Expenses and Other Assets (221,654) (115,799)
(Increase) Decrease in Deferred Tax Assets 270,253 --
Increase (Decrease) in Accounts Payable and Accrued Liabilities (67,899) (183,551)
Increase (Decrease) in Income Taxes Payable (115,468) (16,718)
------------ ------------
Total Adjustments (657,131) (332,469)
------------ ------------
Net Cash Flows Provided By Operating Activities 71,894 597,246
Cash Flows From Investing Activities
Acquisition of Property and Equipment (8,036) (5,405)
Repayments From Officers 13,189 58,129
------------ ------------
Net Cash Flows Provided By Investing Activities 5,153 52,724
Cash Flows From Financing Activities
Exercise of Employee Stock Options 9,800
Repayment on Capital Lease Obligations -- (33,917)
------------ ------------
Net Cash Flows Provided By (Used In) Financing Activities 9,800 (33,917)
Increase in Cash and Cash Equivalents 86,847 616,053
Cash and Cash Equivalents, Beginning of Period 1,704,529 340,002
------------ ------------
Cash and Cash Equivalents, End of Period $ 1,791,376 $ 956,055
============ ============
See Notes to Condensed Consolidated Financial Statements.
5
ALLERGY RESEARCH GROUP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004
(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 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 complete 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 period ended June 30, 2004
are not necessarily indicative of the operating results that may be
expected for the entire year ending December 31, 2004. These financial
statements should be read in conjunction with the Management's
Discussion and Analysis and financial statements and notes thereto
included in the Company's financial statements and accompanying notes
thereto as of and for the year ended December 31, 2003, filed with the
Company's Annual Report on Form 10-KSB on March 30, 2004.
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." Total potential common shares not
included in the computation of dilutive EPS for all periods presented
was 150,000 options to purchase common shares, which expired in January
2004, because their impact would be antidilutive based on current
market prices.
The computation of basic and diluted earnings per share is as follows:
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
6/30/04 6/30/03 6/30/04 6/30/03
------- ------- ------- -------
Numerator-Net Earnings Available
to Common Stockholders $ 344,962 $ 427,448 $ 729,025 $ 929,715
===============================================================
Denominator:
Weighted average shares used in computing basic EPS 14,510,336 14,722,105 14,501,220 14,722,105
Net effect of dilutive common shares 205,686 -- 220,813 --
---------------------------------------------------------------
Weighted average shares used in computed diluted EPS 14,716,022 14,722,105 14,722,033 14,722,105
Basic Earnings Per Share $ 0.02 $ 0.03 $ 0.05 $ 0.06
===============================================================
Diluted Earnings Per Share $ 0.02 $ 0.03 $ 0.05 $ 0.06
===============================================================
6
NOTE 3 - ACCRUED EXPENSES AND CONTINGENCIES
- -------------------------------------------
Accrued expenses as of June 30, 2004 consist of the following:
Potential settlement $ 151,500
Operating expense 60,920
Vacation and bonus 184,879
Payroll 7,457
Sales Tax 4,314
----------
$ 409,070
==========
The potential settlement above refers to a loss provision associated
with a lawsuit that was settled during 2003. The Company was awarded a
$250,000 settlement and a Florida lawyer asserted a lien claim for 35%
of the proceeds, plus costs of $64,000. Management intends to continue
to contest the claim; however, outside counsel for the Company has
advised that an unfavorable outcome is reasonably possible.
NOTE 4 - LINE OF CREDIT
- -----------------------
The Company has a Merrill Lynch Working Capital Management Account
(WCMA) which provides for a line of credit up to $1,500,000 bearing
interest at the London Interbank Offered Rate (LIBOR) plus 2.75%, due
monthly. The LIBOR plus 2.75% at June 30, 2004 was 4.09%. The note is
secured by substantially all of the assets of the Company and is
personally guaranteed by the CEO 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 June 30, 2004 was .64%. The entire line was available for use as
of June 30, 2004.
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") 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 and to anticipate future trends in those
operations.
o RESULTS OF OPERATIONS. This section provides an analysis of
our results of operations for the second quarter 2004 compared
to the second quarter of 2003. 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 six months ended June 30, 2004.
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/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"), together with 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 vitamins and nutritional supplements throughout the
world under the NutriCology and Allergy Research Group(R) labels. Our products
are sold through distributors to medical and professional accounts, to
retailers, and directly to the consumer. We offer a line of approximately 200
products, 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) and liquids. 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) continue
to improve upon our comprehensive e-commerce plan, which includes a more
user-friendly and marketing-driven web site that has the ability to accommodate
wholesale orders. We believe that our history and reputation in the field,
multiple distribution channels, broad portfolio of products and packaging and
distribution capabilities position us 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 Allergy Research Group
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.
We also continue to collaborate with several entrepreneurs of cutting-edge
science-based products who have limited resources to bring their products to
market. We look towards working partnerships and/or acquisition of these
businesses to broaden our product line of innovative nutraceuticals, creating
potential for real growth in sales and profit while providing products that
promote general health. The Company's distribution channel to the medical and
professional-practitioners market is key to the successful introduction of
unique products.
We believe that the Company has good relations with all of its current
manufacturers and suppliers. During the period ending June 30, 2004, we
experienced a concentration of approximately 55% of our manufacturing with four
separate vendors. We do not currently have written contracts with any 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
9
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.
THREE AND SIX MONTHS ENDED JUNE 30, 2004 COMPARED TO JUNE 30, 2003
------------------------------------------------------------------
REVENUES. We had net sales of $3,832,360 for the second quarter and $7,557,259
for the six months ended June 30, 2004, compared with $3,447,130 and $6,895,892,
respectively, for the same periods in 2003. The increase of $385,230, or 11%, in
the second quarter is due to increased sales to our distributors and increased
demand at retail for current and new products. The increase of $661,367, or 10%,
for the six-month period also reflects the increased demand to new and existing
customers.
COSTS OF SALES. Cost of sales increased $177,365 to $2,167,845 for the three
months ended June 30, 2004, compared to $1,990,480 for the three months ended
June 30, 2003. For the six months ended June 30, 2004, cost of sales increased
$357,145 from $3,945,320 in 2003 to $4,302,465 in 2004. The increase in cost of
sales corresponds with the increase in sales. Gross profit margins remained
relatively stable for all periods presented, increasing approximately 1% for the
period over period comparison as a result of the higher profit margins
associated with retail sales. Gross profit margins were approximately 43% at
June 30, 2004.
OPERATING EXPENSES. Total operating expenses were $1,035,478 for the second
quarter and $2,028,651 for six months ended June 30, 2004, compared with
$990,081 and $1,934,393, respectively, for the same periods in 2003, an increase
of $45,397 and $94,258, respectively. The increase was primarily due to an
increase in payroll expense associated with increased wages and employer
matching contributions to the 401(k) plan and with spreading the effect of
year-end bonuses over the entire year, offset by a reduction in outside sales
staff and reduced rental expense due to a renegotiated lease for less warehouse
space. The increase in operating expense was also caused by increased newsletter
and related postage expense in the first quarter, offset by a reduction in
depreciation expense associated with fully depreciated assets that are still in
good working condition.
INTEREST EXPENSE. Interest expense was zero for the second quarter and for six
months ended June 30, 2004 compared to $375 and $1,095, respectively, for the
same periods in 2003. The decrease is a result of reducing the line of credit to
zero during the second quarter 2003.
PROVISION FOR INCOME TAXES. As of June 30, 2004, the Company recorded a deferred
tax asset of $13,771 to be realized as a result of future taxable income offset
by net operating loss carryforwards. As of fiscal year ended December 31, 2003,
we had approximately $560,000 and $1,400,000, respectively, available in federal
and state net operating loss carryforwards to offset future taxable income. We
have fully utilized our available federal net operating loss carryforwards and
almost fully utilized all of our available state net operating loss
carryforwards as of June 30, 2004, and expect to utilize all of the remaining
available state net operating loss carryforwards in the third quarter of 2004.
As a result, income taxes payable at June 30, 2004, represents estimated 2004
federal taxes based on income offset by prepayments made throughout the year.
NET EARNINGS. During the quarter and six-month period ended June 30, 2004, we
recorded net earnings of $344,962 and $729,025, respectively, compared to net
earnings of $427,448 and $929,715, respectively, for the same period in 2003.
The decrease of $82,486 and $200,690, respectively, is a result of an increase
in the provision for income taxes and change in deferred taxes. We have offset
taxable earnings to the extent of our available federal and state net operating
loss carryforwards and are subject to tax on the remaining earnings. We have
fully utilized our available federal net operating loss carryforwards and almost
fully utilized all of our available state net operating loss carryforwards as of
June 30, 2004, and expect to utilize all of the available net operating loss
carryforwards in the third quarter of 2004.
10
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Current Financial Condition
During the six-month period ended June 30, 2004, we increased our working
capital by approximately $800,000 to $4,311,745, compared to a working capital
at December 31, 2003 of $3,503,764. We continue to finance our inventory and
accounts receivable through cash generated by operating activities. 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 flows provided by operating activities was
$71,894 and $597,246 for the six months ended June 30, 2004 and 2003,
respectively. Net cash provided by operating activities for both periods
primarily reflects net income and net changes in operating assets and
liabilities, partially offset by non-cash expenses. The large decrease in cash
flows provided by operating activities from year to year is explained by our
increase in inventory which was necessary to meet the increased demand for new
products and because we are purchasing larger quantities of imported raw
materials in order to avoid delays in receiving the material. While our
inventory has increased, we have not experienced a corresponding increase in
accounts payable, because we have made a concerted effort to pay our vendors
quicker than we have in the prior year in order to take advantage of trade
discounts available and reduce our cost of the product.
INVESTING ACTIVITIES. Net cash flows provided by investing activities for the
six months ended June 30, 2004 was $5,153 primarily resulting from repayments
from officers for an outstanding loan, offset by purchases of computer equipment
and software. Net cash flows provided by investing activities for the six months
ended June 30, 2003 was $52,724 representing repayments from officers for an
outstanding loan offset by the acquisition of property and equipment.
FINANCING ACTIVITIES. Net cash flows provided by financing activities for the
six months ended June 30, 2004 was $9,800 as a result of the exercise of
employee stock options. Net cash flows used in financing activities was $33,917
for the six months ended June 30, 2003, representing repayments of capital lease
obligations.
CONCENTRATION OF CREDIT RISK.
(i) SALES. Approximately 12% of our total sales in 2003 were
attributable to a single distributor. In 2004, 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. However, we cannot assure that, if we were to lose this
distributor, all or any of the customers would transfer directly to us or that
current sales from this group would be maintained.
(ii) PURCHASES. We purchase raw materials and use outside vendors for
the manufacture of our products. For the six months ended June 30, 2004, we had
a concentration of approximately 55% of our manufacturing with four separate
vendors. We do not currently have written contracts with any of our
manufacturers, but rely on long-term personal and professional relationships. We
believe that, due to the large number of businesses performing this type of
service in the industry, we 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. We can give no assurance that
suitable, alternative manufacturers would be available to us when needed or that
such alternative manufacturers would not result in an increase in costs.
11
(iii) PRODUCT. We have two products that each individually account for
more than 10% of our sales dollars.
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 $137,671 $131,131 $6,540
- ----------------------- ------------------ ------------------ ------------------ -------------- -------------
Total Cash
Contractual
Obligations $137,671 $131,131 $6,540
- ----------------------- ------------------ ------------------ ------------------ -------------- -------------
(1) This represents the Company's borrowings under its line of credit with
Merrill Lynch, which had a zero balance throughout the six months ended
June 30, 2004 and through the date of this filing. The Merrill Lynch
line of credit provides for maximum financing of $1,500,000, bearing
interest at the London Interbank Offered Rate (LIBOR) plus 2.75%,
computed on a monthly basis. As of June 30, 2004, the interest rate on
the line of credit was 4.09% per annum. 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 material adverse impact on our business and
financial position. The CEO of the Company has personally guaranteed
the line of credit.
RELATED PARTY TRANSACTIONS. Stephen and Susan Levine loaned Nutricology
approximately $286,000 prior to its reverse acquisition with the Company in
1998. The loan has been offset and exceeded by advances made to the Levine's
between 1997 and 1999. Each advance was made as a non-interest bearing, due on
demand, loan on the books of the Company. Interest at 8% per annum has been
accrued and paid on these loans. As of June 30, 2004, the outstanding balance
was $42,541. During the six months ended June 30, 2004, the Levine's repaid
$13,189.
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. 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 needs are expected to
be provided by our cash flow from operations.
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. See "CAUTION CONCERNING
FORWARD-LOOKING STATEMENTS/RISK FACTORS" above for some of the variables which
may affect our business and financial results.
12
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. 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.
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 the Company's
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. In the
event that the Company 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. Deferred tax asset represents less than 1% of total assets at June 30,
2004. Based on our past 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, historical 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.
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
13
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.
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.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
Item 5. OTHER INFORMATION
Not Applicable.
14
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**
31 Certificate of Stephen A. Levine required by Rule 13a-14(a) or
Rule 15d-14(a) of The Securities Exchange Act of 1934, as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
32 Certificate of Stephen A. Levine Pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
99.1 Haight-Ashbury Free Medical Clinic Design Research Survey*
* 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.
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: August 11, 2004 By: /S/ STEPHEN A. LEVINE
---------------------------
Chief Executive Officer and
Chief Financial Officer
15