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, 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
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
30806 Santana Street, Hayward, California 94544
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(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 November 1, 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.............................................15
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings...................................................16
ITEM 2. Changes in Securities and Use of Proceeds...........................16
ITEM 3. Defaults Upon Senior Securities.....................................16
ITEM 4. Submission of Matters to a Vote of Security Holders.................16
ITEM 5. Other Information...................................................16
ITEM 6. Exhibits and Reports on Form 8-K....................................16
SIGNATURE.....................................................................17
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 $ 2,565,550
Accounts Receivable 687,721
Inventories 2,081,038
Prepaid Income Taxes 93,881
Prepaid Expenses and Other Current Assets 174,695
Deferred Tax Asset --
------------
Total Current Assets 5,602,885
------------
Property and Equipment, Net 149,517
------------
Other Assets
Deposits 18,019
Due From Officer 36,330
Intangible Assets 15,757
------------
Total Other Assets 70,106
------------
Total Assets $ 5,822,508
============
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current Liabilities
Accounts Payable $ 200,620
Accrued Liabilities (Note 3) 574,268
Income Taxes Payable 124,135
------------
Total Current Liabilities 899,023
------------
Commitments and Contingencies (Note 3, 4)
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 1,149,707
Retained Earnings 4,038,274
Less: Treasury Stock, at cost (588,750 shares) (279,601)
------------
Total Stockholders' Equity 4,923,485
------------
Total Liabilities and Stockholders' Equity $ 5,822,508
============
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,
2004 2003 2004 2003
------------- ------------- ------------- -------------
Revenues $ 3,723,401 $ 3,326,957 $ 11,280,660 $ 10,222,850
Cost of Sales 2,076,622 1,898,692 6,379,083 5,844,012
------------- ------------- ------------- -------------
Gross Profit 1,646,779 1,428,265 4,901,577 4,378,838
------------- ------------- ------------- -------------
Operating Expenses
Selling, General and Administrative 972,535 935,290 2,878,850 2,735,956
Research and Development 61,889 59,541 184,229 193,270
------------- ------------- ------------- -------------
Operating Expenses 1,034,424 994,831 3,063,079 2,929,226
------------- ------------- ------------- -------------
Earnings from Operations 612,355 433,434 1,838,498 1,449,612
------------- ------------- ------------- -------------
Other Income (Expense)
Interest Expense 0 (75) 0 (1,170)
Interest Income 5,866 2,706 13,076 7,495
------------- ------------- ------------- -------------
Other Income (Expense) 5,866 2,631 13,076 6,325
------------- ------------- ------------- -------------
Net Earnings Before Tax 618,221 436,065 1,851,574 1,455,937
Provision for Income Taxes 263,885 38,548 768,213 128,705
------------- ------------- ------------- -------------
Net Earnings Available to
Common Stockholders $ 354,336 $ 397,517 $ 1,083,361 $ 1,327,232
============= ============= ============= =============
Basic and Diluted Earnings
Per Common Share (Note 2) $ 0.02 $ 0.03 $ 0.07 $ 0.09
============= ============= ============= =============
See Notes to Condensed Consolidated Financial Statements.
4
ALLERGY RESEARCH GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
September 30,
2004 2003
------------ ------------
Cash Flows From Operating Activities
Net Earnings $ 1,083,361 $ 1,327,232
------------ ------------
Adjustments to Reconcile Net Earnings to Net
Cash Provided by Operating Activities
Depreciation and Amortization 96,441 125,749
Changes in Assets and Liabilities
(Increase) Decrease in Accounts Receivable (9,774) (106,027)
(Increase) Decrease in Inventory (484,311) (80,204)
(Increase) Decrease in Prepaid Expenses
and Other Assets (170,469) (72,520)
(Increase) Decrease in Deferred Tax Assets 284,024 --
(Increase) Decrease in Deposits -- 11,711
Increase (Decrease) in Accounts Payable and
Accrued Liabilities 51,728 (79,165)
Increase (Decrease) in Income Taxes Payable (10,273) 2,929
------------ ------------
Total Adjustments (242,634) (197,527)
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Net Cash Flows Provided By Operating Activities 840,727 1,129,705
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Cash Flows From Investing Activities
Acquisition of Property and Equipment (8,906) (11,811)
Repayments From Officers 19,400 64,976
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Net Cash Flows Provided By Investing Activities 10,494 53,165
------------ ------------
Cash Flows From Financing Activities
Exercise of Employee Stock Options 9,800 4,000
Repayment on Capital Lease Obligations -- (48,771)
------------ ------------
Net Cash Flows Provided By (Used In)
Financing Activities 9,800 (44,771)
------------ ------------
Increase in Cash and Cash Equivalents 861,021 1,138,099
Cash and Cash Equivalents, Beginning of Period 1,704,529 340,002
------------ ------------
Cash and Cash Equivalents, End of Period $ 2,565,550 $ 1,478,101
============ ============
See Notes to Condensed Consolidated Financial Statements.
5
ALLERGY RESEARCH GROUP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 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, length
of product life cycles and property, and plant and equipment lives for
depreciation purposes. Actual results may differ from these estimates.
The results of operations for the period ended September 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 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 Nine Months Nine Months
Ended Ended Ended Ended
9/30/04 9/30/03 9/30/04 9/30/03
------------ ------------ ------------ ------------
Numerator-Net Earnings Available
to Common Stockholders $ 354,336 $ 397,517 $ 1,083,361 $ 1,327,232
============ ============ ============ ============
Denominator:
Weighted average shares used in computing basic EPS 14,516,605 14,725,292 14,506,386 14,723,179
Net effect of dilutive common shares 187,444 -- 210,087 --
------------ ------------ ------------ ------------
Weighted average shares used in computed diluted EPS 14,704,049 14,725,292 14,716,473 14,723,179
============ ============ ============ ============
Basic Earnings Per Share $ 0.02 $ 0.03 $ 0.07 $ 0.09
============ ============ ============ ============
Diluted Earnings Per Share $ 0.02 $ 0.03 $ 0.07 $ 0.09
============ ============ ============ ============
6
Note 3 - Accrued Expenses And Contingencies
- -------------------------------------------
----------------------------------------------------------------------------
Accrued expenses as of September 30, 2004 consist of the following:
----------------------------------------------------------------------------
Potential settlement $ 151,500
Operating expense 74,392
Vacation and bonus 289,879
Payroll 51,822
Sales Tax 6,675
---------
$ 574,268
=========
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 September 30, 2004 was 4.59%. 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 September 30, 2004 was 1.08%. The entire line was available for
use as of September 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 three and nine months ended
September 30, 2004 compared to the same periods in 2003. A
brief description is provided of transactions and events 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, 2004, including
related party transactions.
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.
The key factors that affect our operating results are as follows:
o the overall customer demand for our various products;
o the volume of products ordered;
o the mix of products purchased by our customers;
o the prices we obtain for our products;
o our ability to manage our cost structure for capital
expenditures and operating expenses such as salaries and
benefits, freight and royalties; and
o our ability to match operating costs to shifting volume
levels.
8
Other 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.
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.
9
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 September 30, 2004, we
experienced a concentration of approximately 62% of our manufacturing with five
separate vendors. Three of the vendors account for more than ten percent of the
total with the other two at eight percent each. 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 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, 2004 COMPARED TO SEPTEMBER 30, 2003
--------------------------------------------------------------
REVENUES. We had net sales of $3,723,401 for the third quarter and $11,280,660
for the nine months ended September 30, 2004, compared with $3,326,957 and
$10,222,850, respectively, for the same periods in 2003. The increase of
$396,444, or 12%, 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 $1,057,810, or 10%, for the nine-month period also reflects the
increased demand to new and existing customers.
COSTS OF SALES. Cost of sales increased $177,930 to $2,076,622 for the three
months ended September 30, 2004, compared to $1,898,692 for the three months
ended September 30, 2003. For the nine months ended September 30, 2004, cost of
sales increased $535,071 from $5,844,012 in 2003 to $6,379,083 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 44% at September 30, 2004.
OPERATING EXPENSES. Total operating expenses were $1,034,424 for the third
quarter and $3,063,079 for nine months ended September 30, 2004, compared with
$994,831 and $2,929,226, respectively, for the same periods in 2003, an increase
of $39,593 and $133,853, respectively. The increase was primarily due to an
increase in payroll expense associated with increased wages, workers'
compensation and medical insurance, 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 and
credit card processing fees, offset by a reduction in depreciation expense
associated with fully depreciated assets that are still in good working
condition, reduced legal fees associated with settlement of litigation, and
reduced equipment rental fees due to the purchase of the equipment.
INTEREST EXPENSE. Interest expense was zero for the third quarter and for nine
months ended September 30, 2004 compared to $75 and $1,170, 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.
10
PROVISION FOR INCOME TAXES. Provision for income taxes as of September 30, 2004
represents federal and state income taxes based on earnings. We estimate that we
have fully utilized our federal and state operating loss carryforwards available
from taxable year 2003 to offset 2004 taxable income to the extent available and
are subject to tax on the remaining earnings.
NET EARNINGS. During the quarter and nine-month period ended September 30, 2004,
we recorded net earnings of $354,336 and $1,083,361, respectively, compared to
net earnings of $397,517 and $1,327,232, respectively, for the same period in
2003. The decrease of $43,181 and $243,871, respectively, is primarily a result
of an increase in the provision for income taxes and change in deferred taxes.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Current Financial Condition
During the nine-month period ended September 30, 2004, we increased our working
capital by approximately $1,200,000 to $4,703,862, compared to a working capital
at December 31, 2003 of $3,503,764. Current assets mainly consist of
approximately $2.57 million in cash and $2.08 million in inventory. 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
$840,727 and $1,129,705 for the nine months ended September 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 decrease in cash flows
provided by operating activities from year to year is predominately explained by
our increase in inventory, which was necessary due to: (a) increased demand for
new products, (b) purchases of larger quantities of imported raw materials in
order to avoid delays in receiving the material, (c) stocking of finished goods
in anticipation of the down time associated with our move to a new location
anticipated in early 2005, and (c) purchases of larger amounts of inventory from
one of our vendors who accounts for more than ten percent of our purchases. This
particular vendor is experiencing financial difficulties. In order to avoid any
potential shortages, we increased our purchases from this vendor. It is our
current understanding that the vendor will continue in operation, but we are
researching alternate vendors. 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 comparative
period in order to take advantage of trade discounts available thus reducing our
cost of the product.
INVESTING ACTIVITIES. Net cash flows provided by investing activities for the
nine months ended September 30, 2004 was $10,494 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 nine months ended September 30, 2003 was $53,165, 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
nine months ended September 30, 2004 was $9,800 as a result of proceeds received
from the exercise of employee stock options. Net cash flows used in financing
activities was $44,771 for the nine months ended September 30, 2003,
representing repayments of capital lease obligations and proceeds received from
the exercise of employee stock options.
CONCENTRATION OF CREDIT RISK.
SALES. Approximately 12% of our total sales in 2003 were attributable to a
single distributor. In 2004, this distributor continued to account for
approximately 12% 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 you 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.
11
PURCHASES. We purchase raw materials and use outside vendors for the manufacture
of our products. For the nine months ended September 30, 2004, we had a
concentration of approximately 62% of our manufacturing with five separate
vendors. Three of these vendors individually account for more than ten percent
and two of the vendors account for eight percent each. 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. However,
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. One of our vendors who accounts for more than
ten percent of our purchases is experiencing financial difficulties. We have
increased our inventory of the products purchased from this vendor and we are
exploring possible alternate vendors.
PRODUCT. We have one product that individually accounts for more than 10% of our
sales dollars. One other product that has historically accounted for more than
10% of our sales dropped to 9% during the third quarter 2004.
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 (2) $73,741 $68,836 $4,905
- --------------------------------------------------------------------------------
Total Cash
Contractual
Obligations $73,741 $68,836 $4,905
- --------------------------------------------------------------------------------
(1) This represents the Company's borrowings under its line of
credit with Merrill Lynch, which had a zero balance throughout
the nine months ended September 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 September 30, 2004, the interest rate
on the line of credit was 4.59% 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.
(2) The company's building lease will expire on December 31, 2004,
with the option to renew for three additional months. We are
currently in negotiations with AriBen Corporation, a related
party, for the lease of a new location. See "Related Party
Transactions" below. It is anticipated that the monthly
obligation for the base rent on the lease will be $24,000. Our
current base rent is $17,299 for approximately 25,440 square
feet. The new building is built to our specifications and the
square footage is approximately 29,821. The space will be
better utilized to allow for expansion or sub-lease.
12
RELATED PARTY TRANSACTIONS. Stephen and Susan Levine, CEO and VP, respectively,
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 September 30, 2004, the
outstanding balance was $36,330. During the nine months ended September 30,
2004, the Levine's repaid $19,400.
Our building lease will expire on December 31, 2004, with the option to renew
for three additional months. In order to provide a more geographically
beneficial location and facilities that can accommodate internal manufacturing
and greater quality control, we plan to relocate to new facilities following
expiration of the lease. We are currently in negotiations with AriBen
Corporation, a related party 100% owned by Susan and Stephen Levine, for
approximately 29,821 square feet of office and industrial space. If signed, the
lease would be for a ten-year term with the option to renew for an additional
fifteen years. It is anticipated that the monthly obligation for the base rent
on the lease will be $24,000. The cost of moving, including leasehold
improvements, will be between five and six hundred thousand dollars. Due to our
strong cash position, we do not anticipate an increase in long-term liabilities
associated with the move.
LIQUIDITY RESOURCES. We have $2.57 million in cash and cash equivalents as of
September 30, 2004, which is sufficient to satisfy our cash requirements over
the next twelve months. 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.
13
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 our financial
statements or tax returns. Variations in the actual outcome of these future tax
consequences could materially impact our financial position or our results of
operations.
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
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.
CONTINGENCIES
Currently, there are no outstanding legal proceedings or claims, other
than that disclosed in Note 3 of the Consolidated Financial Statements. The
outcomes of potential legal proceedings and claims brought against us are
subject to significant uncertainty. SFAS 5, ACCOUNTING FOR CONTINGENCIES,
requires that an estimated loss from a loss contingency such as a legal
proceeding or claim should be accrued by a charge to income if it is probable
that an asset has been impaired or a liability has been incurred and the amount
of the loss can be reasonably estimated. Disclosure of a contingency is required
14
if there is at least a reasonable possibility that a loss has been incurred. In
determining whether a loss should be accrued we evaluate, among other factors,
the degree of probability of an unfavorable outcome and the ability to make a
reasonable estimate of the amount of loss. Changes in these factors could
materially impact our financial position or our results of operations.
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 corrective action with regard to significant
deficiencies and material weaknesses.
15
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
On August 23, 2004, 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, 2004. The voting totals were as follows:
For Against Abstain
--- ------- -------
(1) Directors - Stephen Levine 14,149,456 - 7,000
(1) Directors - Susan Levine 14,148,716 740 7,000
(1) Directors - Edward Kane 14,149,356 100 7,000
(2) Independent Auditors 14,140,656 6,550 9,250
Item 5. OTHER INFORMATION
Not Applicable.
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).
16
** 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: November 15, 2004
By: /s/ Stephen A. Levine
-------------------------------
Stephen A. Levine
Chief Executive Officer and
Chief Financial Officer
17