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, 2005
[ ] 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.)
2300 North Loop Road, Alameda, California 94502
(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 October 28, 2005.
1
ALLERGY RESEARCH GROUP, INC.
INDEX TO QUARTERLY REPORT
ON FORM 10-QSB
SEPTEMBER 30, 2005
================================================================================
PART I. FINANCIAL INFORMATION PAGE
ITEM 1. Condensed Consolidated Financial Statements (Unaudited):
Consolidated Balance Sheets................................... 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............................. 9
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.........................................................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 SHEETS
September 30, December 31,
2005 2004
(Unaudited) (Audited)
----------------------------
ASSETS
- ------
Current Assets
Cash and Cash Equivalents $2,237,727 $2,145,638
Accounts Receivable 948,422 758,068
Inventories 2,809,089 2,550,315
Prepaid Income Taxes 21,890 61,858
Prepaid Expenses and Other Current Assets 287,961 197,275
----------------------------
Total Current Assets 6,305,089 5,713,154
----------------------------
Property and Equipment, Net 594,084 120,583
----------------------------
Other Assets
Due From Officer 7,770 28,818
Intangible Assets 13,180 13,180
----------------------------
Total Other Assets 20,950 41,998
----------------------------
Total Assets $6,920,123 $5,875,735
============================
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current Liabilities
Accounts Payable $316,132 $340,215
Accrued Expenses (Note 4) 574,035 307,702
Income Taxes Payable 18,580 104,960
----------------------------
Total Current Liabilities 908,747 752,877
----------------------------
Commitments and Contingencies (Notes 5 & 9)
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 15,105
Additional Paid In Capital 1,149,705 1,149,705
Retained Earnings 5,126,167 4,237,649
Less: Treasury Stock, at cost (588,750 shares) (279,601) (279,601)
----------------------------
Total Stockholders' Equity 6,011,376 5,122,858
----------------------------
Total Liabilities and Stockholders' Equity $6,920,123 $5,875,735
============================
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,
2005 2004 2005 2004
----------- ----------- ----------- -----------
Revenues $3,835,014 $3,723,401 $11,927,863 $11,280,660
Cost of Sales 2,345,898 2,076,622 7,148,907 6,379,083
----------- ----------- ----------- -----------
Gross Profit 1,489,116 1,646,779 4,778,956 4,901,577
----------- ----------- ----------- -----------
Operating Expenses
Selling, General and Administrative 1,042,475 972,535 3,169,317 2,878,850
Research and Development 74,378 61,889 222,678 184,229
----------- ----------- ----------- -----------
Operating Expenses 1,116,853 1,034,424 3,391,995 3,063,079
----------- ----------- ----------- -----------
Earnings from Operations 372,263 612,355 1,386,961 1,838,498
----------- ----------- ----------- -----------
Other Income
Interest Income 14,211 5,866 31,557 13,076
----------- ----------- ----------- -----------
Net Earnings Before Tax 386,474 618,221 1,418,518 1,851,574
Provision for Income Taxes 142,200 263,885 530,000 768,213
----------- ----------- ----------- -----------
Net Earnings Available to Common Stockholders $244,274 $354,336 $888,518 $1,083,361
=========== =========== =========== ===========
Basic and Diluted Earnings Per Common Share (Note 2) $0.02 $0.02 $0.06 $0.07
=========== =========== =========== ===========
See Notes to Condensed Consolidated Financial Statements.
4
ALLERGY RESEARCH GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended
September 30,
2005 2004
----------- -----------
Cash Flows From Operating Activities
Net Earnings $ 888,518 $ 1,083,361
----------- -----------
Adjustments to Reconcile Net Earnings to Net Cash Provided
by Operating Activities
Depreciation and Amortization 68,345 96,441
Changes in Assets and Liabilities
(Increase) Decrease in Accounts Receivable (190,354) (9,774)
(Increase) Decrease in Inventory (258,774) (484,311)
(Increase) Decrease in Prepaid Expenses and Other Assets (50,718) (170,469)
(Increase) Decrease in Deferred Tax Assets - 284,024
Increase (Decrease) in Accounts Payable and Accrued Liabilities 242,250 51,728
Increase (Decrease) in Income Taxes Payable (86,380) (10,273)
----------- -----------
Net Cash Flows Provided By Operating Activities 612,887 840,727
----------- -----------
Cash Flows From Investing Activities
Acquisition of Property and Equipment (541,846) (8,906)
Repayments From Officers 21,048 19,400
----------- -----------
Net Cash Flows Provided by (Used In) Investing Activities (520,798) 10,494
----------- -----------
Cash Flows From Financing Activities
Exercise of Employee Stock Options - 9,800
----------- -----------
Net Cash Flows Provided By Financing Activities - 9,800
----------- -----------
Increase in Cash and Cash Equivalents 92,089 861,021
Cash and Cash Equivalents, Beginning of Period 2,145,638 1,704,529
----------- -----------
Cash and Cash Equivalents, End of Period $ 2,237,727 $ 2,565,550
=========== ===========
See Notes to Condensed Consolidated Financial Statements.
5
ALLERGY RESEARCH GROUP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2005
(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, 2005 are not necessarily indicative of
the operating results that may be expected for the entire year ending
December 31, 2005. 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, 2004, filed with the Company's
Annual Report on Form 10-KSB.
Note 2 - Recent Accounting Pronouncements
- -----------------------------------------
In December 2004, the FASB issued SFAS No. 123 (Revised 2004)
"Share-Based Payment" ("SFAS No. 123R"). SFAS No. 123R addresses all
forms of share-based payment ("SBP") awards, including shares issued
under employee stock purchase plans, stock options, restricted stock
and stock appreciation rights. SFAS No. 123R will require the Company
to expense SBP awards with compensation cost for SBP transactions
measured at fair value. On March 29, 2005, the SEC issued Staff
Accounting Bulletin (SAB) 107 which expresses the views of the SEC
regarding the interaction between SFAS No. 123R and certain SEC rules
and regulations and provides the SEC's views regarding the valuation
of share-based payment arrangements for public companies. In April
2005, the SEC issued a release which amends the compliance dates for
SFAS No. 123R. We do not expect the adoption of SFAS No. 123R and SAB
107 to have a material impact on the Company's financial statements.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections." SFAS No. 154 replaces APB Opinion No. 20
"Accounting Changes" and SFAS No. 3, "Reporting Accounting Changes in
Interim Financial Statements." SFAS No. 154 requires retrospective
application to prior periods' financial statements of changes in
accounting principle, unless it is impracticable to determine either
the period-specific effects or the cumulative effect of the change.
The adoption of SFAS No. 154 does not have any impact on the Company's
financial statements.
Note 3 - Earnings Per Share
- ---------------------------
Basic earnings per share ("EPS") is based on the weighted average
number of common shares outstanding. Diluted EPS is based on the
weighted average number of common shares outstanding and dilutive
common stock equivalents. Total potential common shares not included
in the computation of dilutive EPS for the nine-month period ended
September 30, 2004, was 150,000 options to purchase common shares,
which expired in January 2004, because their impact would be
antidilutive based on the prevailing market price during that period.
6
The computation of basic and diluted earnings per share is as follows:
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
9/30/05 9/30/04 9/30/05 9/30/04
------------ ------------ ------------ ------------
Numerator-Net Earnings Available to Common Stockholders $ 244,274 $ 354,336 $ 888,518 $ 1,083,361
============ ============ ============ ============
Denominator:
Weighted average shares used in computing basic EPS 14,516,605 14,516,605 14,516,605 14,506,386
Net effect of dilutive common shares 193,552 187,444 193,552 210,087
------------ ------------ ------------ ------------
Weighted average shares used in computing diluted EPS 14,710,157 14,704,049 14,710,157 14,716,473
Basic Earnings Per Share $ 0.02 $ 0.02 $ 0.06 $ 0.07
============ ============ ============ ============
Diluted Earnings Per Share $ 0.02 $ 0.02 $ 0.06 $ 0.07
============ ============ ============ ============
Note 4 - Accrued Expenses
- -------------------------
Accrued expenses consist of the following:
Operating expenses 110,664
Vacation and bonus 393,131
Payroll 63,445
Sales tax 6,795
----------
$ 574,035
==========
Note 5 - 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, 2005 was 6.61%. 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, 2005 was 3.01%. The entire line was available for
use as of September 30, 2005.
Note 6 - Concentration of Credit Risk
- -------------------------------------
The Company is subject to a wide variety of risks in the ordinary
course of its business as follows:
SALES. Approximately 11% of the Company's total sales in 2004 and
2005 were attributable to the same single distributor. In the event
the Company were to lose that account, management anticipates that it
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, management does not believe the loss of the account would have
a material negative impact on sales. However, no assurance can be
given that, if the Company were to lose this distributor, all or any
of the customers would transfer directly to the Company or that
current sales from this group would be maintained.
PURCHASES. The Company purchases raw materials and uses outside
vendors for the manufacture of its products. For the nine months ended
September 30, 2005, the Company had a concentration of approximately
41% of manufacturing with three separate vendors, who individually
account for more than ten percent of our purchases. The Company does
not currently have written contracts with any of its manufacturers,
but relies on long-term personal and professional relationships.
Management believes that, due to the large number of businesses
performing this type of service in the industry, it would have little
difficulty in finding viable alternatives in the event any one of
these vendors became unable or determined not to continue
manufacturing the Company's products. However, there can be no
assurance that suitable, alternative manufacturers would be available
to the Company when needed or that such alternative manufacturers
would not result in an increase in costs.
7
PRODUCT. The Company has one product that individually accounts
for more than 10% of its sales dollars. One other product that has
historically accounted for more than 10% of its sales dropped to 9%
during the third quarter of 2004 and slipped to 8% during the second
quarter 2005, returning to nine percent for the nine months ended
September 30, 2005.
Note 7 - Related Party Transactions
- -----------------------------------
The following significant related party transactions occurred in 2005:
On January 4, 2005, the Company entered into a lease with AriBen
Corporation, a related party 100% owned by Susan and Stephen Levine,
the Company's Vice President and CEO/CFO and collectively, as husband
and wife, the majority stockholders of the Company, respectively, for
approximately 29,821 square feet of office and industrial space. The
lease, which has a term of ten years with options to renew for two
subsequent periods of ten and five years, respectively, has a base
monthly rent of $24,000 for the initial period, $30,000 for the first
option period and $35,000 for the second option period. Rent will be
adjusted annually during the second five years of each 10-year lease
period based on the consumer price index, with a minimum increase of
three percent. Over the course of the initial ten-year lease the
Company will be obligated to pay $2,880,000. During the first quarter
the Company reimbursed AriBen Corporation for some of the tenant
improvements that were built out to our specifications in the amount
of $350,000.
Note 8 - Stock-Based Compensation
- ---------------------------------
The Company has authorized 1,000,000 shares of common stock for
issuance to directors and key employees under the 1998 Stock Option
Plan (the "plan"). The objectives of the plan include attracting and
retaining the best personnel, providing for additional performance
incentives, and promoting the success of the Company by providing
directors and key employees the opportunity to acquire common stock.
Options outstanding and exercisable at September 30, 2005 were 338,750
exercisable at $0.40 per share. The weighted-average exercise price of
options outstanding and exercisable at September 30, 2005 was $0.40
per share and the weighted-average remaining contractual life was 2.6
years. The options vest immediately and expire five years after the
date issued. Since there were no options granted during any of the
periods presented, the pro forma disclosures as required by SFAS 123
are not required.
Note 9 - Asserted and Unasserted Claims
- ---------------------------------------
From time to time the Company is subject to certain asserted and
unasserted claims encountered in the normal course of business. It is
the Company's belief that the resolution of these matters will not
have a material adverse effect on our financial position or results of
operations, however, we cannot provide assurance that damages that
result in a material adverse effect on our financial position or
results of operations will not be imposed in these matters. The
Company accounts for contingent liabilities when it is probable that
future expenditures will be made and such expenditures can be
reasonably estimated.
On July 28, 2005, the Company was served with a 60-day Notice of
Violation of the California Safe Drinking Water and Toxic Enforcement
Act of 1986 (the "Enforcement Act"), claiming that certain of its
products were required to bear California-specific labels regarding
the health risks of certain ingredients. The California Women's Law
Center of Los Angeles, California ("CWLC") served the notice. Notice
was also served on the California Attorney General's Office, the
attorney generals of the various California counties, the district
attorneys and the city attorneys of various cities, which could bring
a civil action to enjoin the further distribution of any product found
to be in violation of the Enforcement Act and to request that a civil
penalty of up to $2,500 per day for each violation be levied against
the Company. Since no civil action was brought by any of these
government authorities within the 60-day period following the notice,
a civil action may now be brought by a private party. We are currently
involved in discussions with the CWLC and estimate that the loss that
may be incurred as a result of the notice of violation is between
approximately $9,000 and $44,000. No loss provision has been recorded
in the financial statements as the amount is deemed to be immaterial
to the financial statements taken as a whole. We have ceased all sales
of the products and will no longer offer the products associated with
the notice. We will offer refunds to all California purchasers of such
products.
8
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-month and nine-month periods ended
September 30, 2005 compared to the same periods in 2004. 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, 2005, 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 that affect our business, included in this section and elsewhere in this
report.
The manufacturing, processing, formulation, packaging, labeling and advertising
of vitamins and other nutritional products are subject to regulation by one or
more federal agencies, including but not limited to the Food and Drug
Administration, the Federal Trade Commission, the United States Environmental
Protection Agency and the Occupational Safety and Health Administration. In July
2005, the international Codex Alimentarius Commission approved guidelines for
the trade of dietary supplements that are more restrictive than U.S. law. We are
unlikely to see any immediate major effect on our domestic supply of vitamins,
herbs, and minerals; however, these restrictions are expected to lower the
dosage of U.S.-manufactured products to standards set by foreign jurisdictions,
enabling foreign manufacturers to better compete with U.S. companies in those
jurisdictions. We are unable to predict the impact of the proposed or any final
Codex guidelines on our sales to foreign markets. In addition, we are unable to
predict how guidelines adopted by Codex would affect the United States market.
Although the FDA has stated that the Codex guidelines will not affect the
availability of supplement products to U.S. consumers, the United States is a
member of the World Trade Organization ("WTO") and a refusal to harmonize U.S.
laws to the guidelines could result in a finding by the WTO dispute resolution
panel that the U.S. is engaging in unfair trade practices. In the event of such
a finding, the United States could become subject to sanctions in the form of
tariffs and pressure will be on Congress to harmonize U.S. standards with those
adopted by the WTO. We are also subject to governmental regulation in the
jurisdictions in which we operate, including certain foreign jurisdictions, such
as New Zealand and the European Economic Community, both of which have recently
adopted more restrictive regulations on nutritional supplements. These
activities are also regulated by various agencies of the states and localities
in which our products may be sold. We may incur significant costs in complying
with these regulations. In the event we cannot comply with government
regulations affecting our business and products, we may be forced to curtail or
cease our business operations.
9
We face an inherent risk of exposure to product liability claims in the event
that the use of our products results in injury. Such claims may include, among
others, that our products contain contaminants or include inadequate
instructions as to use or inadequate warnings concerning side effects and
interactions with other substances. We do not anticipate obtaining contractual
indemnification from parties supplying raw materials or marketing our products.
In any event, any such indemnification if obtained would be limited by our terms
and, as a practical matter, to the creditworthiness of the indemnifying party.
In the event that we do not have adequate insurance or contractual
indemnification, product liabilities relating to defective products could have a
material adverse effect on our operations and financial conditions.
Because of our dependence upon consumer perceptions, adverse publicity
associated with illness or other adverse effects resulting from the consumption
of our products or any similar products distributed by other companies could
have a material adverse effect on our operations. Such adverse publicity could
arise even if the adverse effects associated with such products resulted from
consumers' failure to consume such products as directed. In addition, we may not
be able to counter the effects of negative publicity concerning the efficacy of
our products. Any such occurrence could have a negative effect on our
operations.
Other key factors that affect our operating results are as follows:
o Overall customer demand for our various products.
o Volume of products ordered.
o Mix of products purchased by our customers.
o Prices at which we sell our products.
o Our ability to manage our cost structure for capital expenditures and
operating expenses such as salaries and benefits, freight and
royalties.
o Our ability to match operating costs to shifting volume levels.
o Increases in the cost of raw materials and other supplies.
o The impact of competitive products.
o Adequacy and availability of insurance coverage.
o Limitations on future financing.
o Increases in the cost of borrowings and unavailability of debt or
equity capital.
o Our inability to gain and/or hold market share.
o Exposure to and expense of resolving and defending product liability
claims and other litigation.
o Consumer acceptance of our products.
o Managing and maintaining growth.
o Customer demands.
o Market and industry conditions including pricing, demand for products,
levels of trade inventories and raw materials availability.
o The success of product development and new product introductions into
the marketplace.
o Slow or negative growth in the nutritional supplement industry.
o The departure of key members of management.
o Our ability to efficiently manufacture our products.
o Unexpected customer bankruptcy.
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
currently 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(R) and Allergy Research Group(R)
labels. Our products are sold both through distributors and directly to medical
and professional accounts, to retailers, and directly to the consumer. We offer
two separate lines 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 2300
North Loop Road, Alameda, California 94502 and our telephone number is (800)
545-9960.
10
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 will 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 nine-month period ending September 30,
2005, we experienced a concentration of approximately 41% of manufacturing with
three separate vendors, who individually account for more than ten percent of
our purchases. We do not currently have written contracts with any of our
manufacturers, but rely on long-term personal and professional relationships
with our vendors. 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. 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.
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, 2005 COMPARED TO SEPTEMBER 30, 2004
--------------------------------------------------------------
REVENUES. Our revenues have continued to grow at a moderate rate during the
third quarter of 2005. We had net sales of $3,835,014 for the third quarter and
$11,927,863 for the nine months ended September 30, 2005, compared with
$3,723,401 and $11,280,660, respectively, for the same periods in 2004. The
increase of $111,613, or 3%, in the third quarter was driven by increased sales
to our distributors and professional accounts, whereas sales to our retail
customers, who account for approximately 12% (2004: 15%) of our total sales,
decreased. The increase of $647,203, or 6%, for the nine-month period was driven
by the same factors as those driving the third quarter. We expect to continue to
benefit from increased consumer awareness of the importance of nutritional
supplements in one's diet.
COSTS OF SALES. Cost of sales increased $269,276 to $2,345,898 for the three
months ended September 30, 2005, compared to $2,076,622 for the three months
ended September 30, 2004. For the nine months ended September 30, 2005, cost of
sales increased $769,824 from $6,379,083 in 2004 to $7,148,907 in 2005. The
increase in cost of sales corresponds with the increase in sales compounded by
increased cost of materials, which we experienced due to the demand of certain
raw ingredients exceeding the supply in the market place and because of the
weakening U.S. dollar. In addition, we have incurred approximately $31,000 in
product testing cost for the nine months ending September 30, 2005 compared to
approximately $13,000 for the same period last year. We are making a concerted
effort to determine that our manufacturers are maintaining the high standards we
and our customers expect. Gross profit margins decreased from approximately 44%
for the nine months ended September 30, 2004 to 40% for the same period in 2005.
The decrease of 4% for the period over period comparison is a result of
increased cost of materials that have not been passed on to our customers in
order to preserve our customer base and to respond to pricing pressures from
competitors. Based on these market pressures, we have concluded that we will
forestall any significant price increases until 2006,, however, our gross
margins by product line are evaluated periodically and there may be a
possibility that prices may increase sooner depending on the situation.
OPERATING EXPENSES. Total operating expenses were $1,116,853 for the third
quarter and $3,391,995 for the nine months ended September 30, 2005, compared
with $1,034,424 and $3,063,079, respectively, for the same periods in 2004. We
expensed approximately $100,000 as a result of the relocation of our corporate
office in mid-February 2005. We paid approximately $21,000 for liability and
earthquake insurance for the building, of which approximately $13,000 has been
expensed. Property tax associated with the building is estimated to be
approximately $45,000 from the beginning of the lease through September 30, 2005
and is included in accrued liabilities. We also incurred higher expenses due to
increases in wages, workers' compensation and medical insurance, employer
11
matching contributions to the 401(k) plan, accruals associated with anticipated
year-end bonuses, rent for our new facility and the associated insurance and
property tax, and increased mailings of promotional materials. We paid
approximately $21,000 for liability and earthquake insurance for the building,
of which approximately $13,000 has been expensed. Property tax associated with
the building is estimated to be approximately $45,000 from the beginning of the
lease through September 30, 2005 and is included in accrued liabilities.
Offsetting these increases in expenses was the reversal of a loss provision
associated with a lawsuit that was settled during 2003. We were awarded a
$250,000 settlement and a Florida lawyer asserted a lien claim for 35% of the
proceeds, plus costs of $64,000. The Florida lawyer did not prevail in his
assertion regarding the lien and the accrual for the settlement of $151,500 was
reversed during the second quarter ending June 30, 2005. Legal fees associated
with this case and fees associated with the threatened litigation associated
with the Notice of Violation of the California Safe Drinking Water and Toxic
Enforcement Act of 1986 discussed in the Legal Proceedings section below, caused
an increase in legal fees.
PROVISION FOR INCOME TAXES. Provision for income taxes as of September 30, 2005
represents federal and state income taxes based on earnings.
NET EARNINGS. During the quarter and nine-month period ended September 30, 2005,
we recorded net earnings of $244,274 and $888,518, respectively, compared to net
earnings of $354,336 and $1,083,361, respectively, for the same periods in 2004.
Although we showed increased sales of 3% for the quarter and 6% for the
nine-month period, net income slipped due to the decrease in profit margins and
increased operating expenses.
SEASONALITY. Historically, we have experienced little seasonal fluctuation in
revenues; however, during the spring and fall we traditionally attend two trade
shows geared toward the retail market. Show discounts are offered and the retail
distributors tend to purchase higher quantities due to the discounts. We attend
trade shows geared toward the professional market throughout the year, but the
shows are smaller and tend to not have an immediate effect on sales. These shows
are useful because they provide personal contact with the professional market
and potentially increase sales in the long run.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Current Financial Condition
During the nine-month period ended September 30, 2005, our working capital
increased by approximately $436,065 to $5,396,342, compared to a working capital
at December 31, 2004 of $4,960,277. Current assets mainly consist of
approximately $2.24 million in cash, $.90 million in accounts receivable, and
$2.81 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 cash equivalents, and borrowing
capacity under committed bank credit agreements, is sufficient to fund its
capital and liquidity needs for the next twelve months.
We currently do not utilize any off-balance sheet financing arrangements.
Cash Flows
OPERATING ACTIVITIES. Net cash flows provided by operating activities were
$612,887 and $840,727 for the nine months ended September 30, 2005 and 2004,
respectively. Net cash provided by operating activities for both periods
primarily reflects net income and net changes in operating assets and
liabilities such as accounts receivable, inventory and accounts payable. Cash
generated by operating activities for 2005 is explained by (i) an increase in
accounts receivable of $190,354 due to increased sales and (ii) an increase in
inventory levels of $258,774 due to rising prices and a modest increase in new
products available for sale. Increases in these asset accounts were offset
primarily by an increase in accounts payable and accrued liabilities of $242,250
because accrued bonuses had been paid by year-end 2004. Cash generated by
operating activities for 2004 is predominately explained by increases in
inventory levels as we built up inventories to respond to forecasted demand for
our products from the prior year's fourth quarter.
INVESTING ACTIVITIES. Net cash flows used in investing activities for the nine
months ended September 30, 2005 was $520,798 and primarily resulted from
payments for leasehold improvements for our new facility, office furniture and
computer equipment. Net cash flows for the comparative prior period were
immaterial.
FINANCING ACTIVITIES. Net cash flows provided by financing activities for the
nine months ended September 30, 2004 was $9,800 as a result of the exercise of
employee stock options. There were no corresponding cash flows from financing
activities for the same period in 2005.
CONCENTRATION OF RISK
The Company is subject to a wide variety of risks in the ordinary course of its
business. Some of the more significant of these risks include heavy
concentrations of sales with a few key customers; heavy concentrations of raw
material purchases with a few key suppliers; regulation by various federal,
state and local agencies with regards to the manufacture, handling, storage and
safety of products; and regulation by various agencies with regards to the
labeling and certification of products. The Company is also subject to
competition from other nutritional supplement companies and is dependant on the
continued demand for nutritional supplements by consumers.
SALES. Approximately 11% of our total sales in 2004 and 2005 were
attributable to the same single distributor. 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.
12
PURCHASES. We purchase raw materials and use outside vendors for the
manufacture of our products. For the nine months ended September 30, 2005, we
had a concentration of approximately 41% of our manufacturing with three
separate vendors who individually account for more than ten percent of our
purchases. 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.
PRODUCT. We have one product that individually accounts for more than ten
percent of our sales dollars. Another product that has historically accounted
for more than ten percent of our sales dropped to nine percent during the third
quarter of 2004 and slipped to eight percent during the second quarter 2005,
returning to nine percent in the third quarter 2005.
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) $2,700,000 $288,000 $864,000 $576,000 $972,000
- --------------------------------------------------------------------------------------------
Total Cash Contractual
Obligations $2,700,000 $288,000 $864,000 $576,000 $972,000
- --------------------------------------------------------------------------------------------
(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, 2005 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,
2005, the interest rate on the line of credit was 6.61% 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) Represents our building lease with AriBen Corporation, a related
party. See "Related Party Transactions" below. The monthly obligation
for the base rent on the lease is $24,000 for approximately 29,821
square feet.
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, 2005, the
outstanding balance was $7,770. During the nine months ended September 30, 2005,
the Levine's repaid $21,048.
On January 4, 2005, we entered into a lease with AriBen Corporation, a related
party 100% owned by Susan and Stephen Levine, for approximately 29,821 square
feet of office and industrial space. The lease, which has a term of ten years
with options to renew for two subsequent periods of ten and five years,
respectively, has a base monthly rent of $24,000 for the initial period, $30,000
for the first option period and $35,000 for the second option period. Rent will
be adjusted annually during the second five years of each 10-year lease period
based on the consumer price index, with a minimum increase of three percent.
During the first quarter we reimbursed AriBen Corporation for some of the tenant
improvements that were built out to our specifications in the amount of
$350,000.
LIQUIDITY RESOURCES. We have $2.24 million in cash and cash equivalents as of
September 30, 2005, which we believe to be 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. Cash flow from operations is expected to
provide us with our capital resources and liquidity needs.
13
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 that
may affect our business and financial results.
CRITICAL ACCOUNTING POLICIES
- ----------------------------
Our discussion and analysis is 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.
An accounting policy is deemed to be critical if it requires an accounting
estimate to be made based on assumptions about matters that are highly uncertain
at the time the estimate is made, and if different estimates that reasonably
could have been used or changes in the accounting estimate that are reasonably
likely to occur could materially change the financial statements.
We believe the following critical accounting policies reflect our more
significant estimates and assumptions used in the preparation of our
consolidated financial statements; however, management does not consider any of
the estimates and assumptions to be highly uncertain.
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. In the
event that our trade receivables become uncollectible, we would be forced to
record additional adjustments to receivables to reflect the amounts at net
realizable value. The accounting effect of this entry would be a charge to
income, thereby reducing our net earnings. Although we consider the likelihood
of this occurrence to be remote based on past history and the current status of
our accounts, there is a possibility of this occurrence.
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.
In the event we were unable to sell our products, the demand for our products
diminished, other competitors offered similar or better products, and/or the
product life cycles deteriorated causing quality issues, we would be forced to
record an adjustment to inventory for impairment or obsolescence to reflect
inventory at net realizable value. The effect of this entry would be a charge to
income, thereby reducing our net earnings. Although we consider the likelihood
of this occurrence to be remote based on our forecasted demand for our products,
there is a possibility of this occurrence
14
CONTINGENCIES
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
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.
During 2003, we were awarded a $250,000 settlement and a Florida lawyer asserted
a lien claim for 35% of the proceeds, plus costs of $64,000. The Florida lawyer
did not prevail in his assertion regarding the lien and the accrual for the
settlement of $151,500 was reversed during the second quarter ending June 30,
2005. Net of attorney's fees associated with the case that were recognized as
expense during the second quarter, the reversal's impact increased net income by
$130,135.
On July 28, 2005, we were served with a 60-day Notice of Violation of the
California Safe Drinking Water and Toxic Enforcement Act of 1986 (the
"Enforcement Act"), claiming that certain of our products were required to bear
California-specific labels regarding the health risks of certain ingredients.
The California Women's Law Center of Los Angeles, California ("CWLC") served the
notice. Notice was also served on the California Attorney General's Office, the
attorney generals of the various California counties, the district attorneys and
the city attorneys of various cities, which may bring a civil action to enjoin
the further distribution of any product found to be in violation of the
Enforcement Act and to request that a civil penalty of up to $2,500 per day for
each violation be levied against the Company. Since no civil action was brought
by one of these government authorities within the 60-day period following the
notice, a civil action may now be brought by a private party. We are currently
involved in discussions with the CWLC and estimate that the loss which may be
incurred as a result of the notice of violation is between approximately $9,000
and $44,000. No loss provision has been recorded in the financial statements as
the amount is deemed to be immaterial to the financial statements taken as a
whole. We have ceased all sales of the products and will no longer offer the
products associated with the notice. We will offer refunds to all California
purchasers of such products.
ITEM 3. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, the Company carried out an
evaluation of the effectiveness of the design and operation of its disclosure
controls and procedures pursuant to the Exchange Act Rule 13a-15. This
evaluation was done under the supervision and with the participation of the
Company's Chief Executive Officer and Chief Financial Officer, Stephen A.
Levine. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures were
effective as of the period covered by this report to ensure that information
required to be disclosed by us in the reports that we file 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.
There were no changes in the Company's internal controls over financial
reporting that occurred during the quarter ended September 30, 2005, that have
materially affected, or are reasonably likely to materially affect, our internal
controls over financial reporting.
15
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On July 28, 2005, we were served with a 60-day Notice of Violation of the
California Safe Drinking Water and Toxic Enforcement Act of 1986 (the
"Enforcement Act"), claiming that certain of our products were required to bear
California-specific labels regarding the health risks of certain ingredients.
The California Women's Law Center of Los Angeles, California ("CWLC") served the
notice. Notice was also served on the California Attorney General's Office, the
attorney generals of the various California counties, the district attorneys and
the city attorneys of various cities, which may bring a civil action to enjoin
the further distribution of any product found to be in violation of the
Enforcement Act and to request that a civil penalty of up to $2,500 per day for
each violation be levied against the Company. Since no civil action was brought
by any of these government authorities within the 60-days following notice, a
private party may bring a civil action. We are currently involved in discussions
with the CWLC and estimate that the loss that may be incurred as a result of the
notice of violation is between approximately $9,000 and $44,000. No loss
provision has been recorded in the financial statements as the amount is deemed
to be immaterial to the financial statements taken as a whole. We have ceased
all sales of the products and will no longer offer the products associated with
the notice. We will offer refunds to all California purchasers of such products.
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.
Item 6. EXHIBITS
(a) Exhibits
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
(b) Reports on Form 8-K
None
16
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 10, 2005 By: /s/ Stephen A. Levine
--------------------------------
Chief Executive Officer and
Chief Financial Officer
17