ITEM 1.
BUSINESS.
1(a)
Business Development
PacificHealth Laboratories (hereinafter referred to as the “Company”, “us”, or “we”) is a leading nutrition company that was incorporated in the State of Delaware in April 1995. We focus on the development, marketing, and selling of patented premium nutrition tools that enable our consumers to enhance their health and improve their performance. Our principal areas of focus are sports performance and recovery, including optimal weight management. Our products can be marketed without prior Food and Drug Administration (“FDA”) approval under current regulatory guidelines. Going forward, we expect to become a more commercially-oriented consumer driven company that derives performance from its brands and science-based nutrition technology.
1(b)
Business of the Issuer
We are a pioneer in the development of patented protein-based nutritional products that activate biochemical pathways to enhance muscle endurance and additionally the specific peptides involved in appetite regulation. We employ multiple strategies for the commercialization of our technologies including: 1) launching a brand via highly targeted consumer channels, 2) licensing the technology to a major food or drug company, or 3) a combination of both 1 and 2.
During the quarter ended December 31, 2009, we made the decision to forgo marketing our FORZE GPS™ weight management product line in 2010. Our marketing efforts in 2009 did not result in sufficient sales of Forze GPS to be able to project that this product line would be financially viable in the short term. As a result of this decision, we recorded a restructuring charge in the amount of $81,050 in the fourth quarter of 2009 consisting of writing-off property and equipment specific to the marketing efforts of FORZE GPS less any realizable salvage values. We also recorded a $477,140 reserve for inventory associated with this decision as the value of this inventory may never be realized.
Sports Performance
Our research into factors influencing exercise performance, muscle endurance, and recovery has led to the development and commercialization of a new generation of sports and recovery drinks. The key to our technology is the specific ratio in which protein is combined with carbohydrates. We have received two patents on this technology and over 18 studies have been published demonstrating that products based on this technology can extend endurance, reduce muscle damage, improve rehydration, and accelerate muscle recovery. Our research in exercise performance has led to the introduction and commercialization of a number of products for the aerobic athlete including:
· ENDUROX R4® Recovery Drink - Introduced in February 1999
· ACCELERADETM Sports Drink - Introduced in May 2001
· ACCELERADETM HYDROTM Sports Drink with 30% less calories and 55% less sugar - Introduced in June 2008
· ACCEL GEL® - Introduced in February 2004
· ENDUROX® EXCEL® - Introduced in March 1997
Weight Regulation
Satiety peptides have been shown to suppress appetite and reduce food intake. Our research has specifically focused on developing nutritional formulations that can stimulate cholecystokin (CCK), one of the body’s primary satiety peptides. CCK is normally released after a meal, particularly one high in fat and protein. CCK is often called the “feel full” protein because when it is released it gives a feeling of fullness and signals the brain to terminate the meal. The objective of our research is to develop a nutritional composition that stimulates and extends the duration of action of CCK in a calorically efficient way, i.e. to cause a release of CCK with 45-50 calories of specific nutrients rather than 1,000 calories.
We have continued research in this area in order to develop a more effective composition that could be incorporated into different forms (ready-to-drink beverage, powder beverage, bars, chewable tablet). Starting in the third quarter of 2003, the Company funded a number of clinical studies on a further improved ready to drink formulation. The new formulation was shown to be significantly better than the previous product in reducing caloric intake, slowing gastric emptying, and extending a feeling of satiation following a meal. We have seven patents on our appetite suppressant technology. We launched an exclusively on-line brand, SATIATRIM®, in June 2007. Due to insignificant sales since inception from this product line, we discontinued it in 2008.
In the first quarter of 2009, we launched FORZE GPS™ in our sports specialty channel. FORZE GPS was the first appetite management nutrition tool designed specifically for athletes. We were not successful in 2009 in achieving adequate sales for this product line and have therefore decided not to continue to market this product in 2010. As a result, we recorded a reserve for our FORZE GPS inventory as of December 31, 2009 and wrote-off certain marketing assets associated with FORZE GPS as detailed above in section 1(b), Business of the Issuer.
All of our existing and proposed products are expected to be manufactured in the United States or Canada by third parties. See item 1(b)(i) below.
1(b)(i)
Principal Products and Markets
(a)
ENDUROX R4 Recovery Drink
We launched ENDUROX R4 Recovery Drink in February 1999. Clinical trials funded by us during 1998 at the University of North Texas Health Science Center in Fort Worth, Texas and the Human Performance Lab at St. Cloud University in St. Cloud, Minnesota showed that when tested against the nation’s leading sports drink, ENDUROX R4 delivered equal hydration effectiveness while enhancing performance and extending endurance by 55%, decreasing post-exercise muscle stress by 36%, reducing free radical build-up by 69%, and increasing the replenishment of muscle glycogen following exercise. These results have been published in a peer-reviewed journal. In April 2000, we were issued United States Patent No. 6,051,236 for ENDUROX R4. Patent office acceptance of specific claims does not necessarily permit us to make any specific claims to the public regarding this product. Our ability to make those claims is governed by the Food and Drug Administration (“FDA”), Federal Trade Commission, and other federal government agency regulations and guidelines.
(b)
ACCELERADE Sports Drink
In May 2001, we introduced ACCELERADE Sports Drink. ACCELERADE Sports Drink is the first sports drink that contains protein. Studies sponsored by the Company and done independently by university researchers and published in peer-reviewed journals have demonstrated that, compared to a conventional sports drink such as Gatorade, ACCELERADE improves endurance by 29%, decreases muscle damage by 83%, improves muscle recovery by 46%, and improves rehydration by 15%. To date, there are over 18 published studies on ACCELERADE. In January 2006, we received a specific patent on this formula.
(c)
ACCEL GEL Energy Gel
In February 2004, we introduced ACCEL GEL. ACCEL GEL is an energy gel that contains the patented 4:1 ratio found in ENDUROX R4 and ACCELERADE. ACCEL GEL is designed to provide athletes in all sports with a quick and rapid source of carbohydrate energy. Studies sponsored by the Company and published in a peer-reviewed journal have shown that ACCEL GEL, compared to the leading carbohydrate gel, improves endurance performance by 13%.
(d)
ENDUROX EXCEL Dietary Supplement
ENDUROX EXCEL is a dietary supplement of which the principal ingredient is the herb ciwujia. Laboratory studies funded by us during 1995 at the University of North Texas Health Science Center in Fort Worth, Texas and the Institute of Nutrition and Food in China, have demonstrated that ENDUROX EXCEL can have a beneficial effect on exercise performance. In December 1996, we were issued United States Patent No. 5,585,101 for our ENDUROX product.
ENDUROX R4, ACCELERADE, and ACCEL GEL are distributed in health foods chains (GNC, Vitamin Shoppe, Vitamin World), sporting goods retailers (REI), cycling stores and catalogs (Performance Bike), running stores and catalogs (Road Runner Sports), and sports specialty stores.
1(b)(ii)
Distribution Methods
We have pursued a “multi-channel” distribution strategy in marketing our endurance products. At the present time, these products are being sold in over 9,000 retail outlets including GNC, sports specialty stores, independent health food retailers, independent bike retailers, health clubs, catalogs, and Internet sites. We now sell all of our products in various foreign countries through independent distributors.
To support our marketing efforts, we may use a variety of marketing methods including advertising in trade and consumer sports and health food magazines that are intended to reach our targeted consumer. In addition, we may attend trade shows and exhibitions, sponsor promotional programs/events and in-store promotions, and engage in public relations efforts that have resulted and may continue to result in articles in numerous sports, health, fitness, trade and natural product publications, newspaper coverage, radio, and television spots.
In the years ended December 31, 2010 and 2009, our expenditures for product advertising and promotion were approximately $213,000 and $309,000, respectively.
1(b)(iii)
Status of Publicly Announced New Products
The status of all products that have been the subject of or mentioned in public announcements by us in the past year are discussed above under the caption “1(b)(i) - Principal Products and Markets”.
1(b)(iv)
Competition
In the sports performance market we only manufacture and distribute powder versions of ACCELERADE and ENDUROX R4 as well as ACCEL GEL. Our primary marketing focus will be the serious endurance athlete (cyclist, runner, triathlete and swimmer), as well as team sports. There are a number of companies that currently market products that compete with ACCELERADE and ENDUROX R4. The major companies include Hammer Nutrition, Cytosport, PowerBar, EAS, and Clif Bar. Increased competitive activity from such companies could make it more difficult for us to establish market share since such companies have greater financial and other resources available to them and possess far more extensive manufacturing, distribution and marketing capabilities than we do.
We believe that long-term success in the marketplace for any of our products will be dependent on the proprietary nature of our formulas, as well as such factors as distribution and marketing capabilities.
1(b)(v)
Suppliers of Raw Materials
We do not have manufacturing facilities and have no present intention to manufacture any products ourselves. We fulfill product needs through relationships with independent manufacturers. We presently do not have long-term contracts with any of these manufacturers but intend to enter into agreements where appropriate. Competitors that do their own manufacturing may have an advantage over us with respect to pricing, availability of product, and in other areas because of their control of the manufacturing process.
Generally, our contract manufacturers obtain raw materials necessary for the manufacture of our products from numerous sources. We generally do not have contracts with suppliers of materials required for the production of our products. All raw materials used in our existing products are available from multiple sources.
There is no assurance that suppliers will provide the raw materials needed by us in the quantities requested or at a price we are willing to pay. Because we do not control the source of these raw materials, we are also subject to delays caused by interruption in production of materials based on conditions outside of our control.
1(b)(vi)
Dependence on Major Customers
GNC, Performance Inc., and The Vitamin Shoppe accounted for approximately 18%, 12%, and 10%, respectively, of net sales in 2010 and 37%, 7%, and 13%, respectively, of net accounts receivable at December 31, 2010. Deferred revenue for consigned inventory at GNC was $60,836 as of December 31, 2010. The loss of these customers, a significant reduction in purchase volume by these customers, or the financial difficulty of such customers, for any reason, could significantly reduce our revenues. We have no agreement with or commitment from either of these customers with respect to future purchases.
1(b)(vii)
Patents and Trademarks
The following describes the patents and trademarks we have obtained related to our sports nutrition products and our weight loss technology. On February 22, 2006, we sold the patents and trademarks related to our ACCELERADE and ENDUROX line of sports nutrition products to Mott’s, subject to an exclusive royalty-free license back to us to continue to market the powder, gel and pill form of these products.
We received a use patent, United States Patent No. 5,585,101, in December 1996 covering the use of ciwujia, the principal active herb in ENDUROX and ENDUROX EXCEL caplets, entitled Method to Improve Performance During Exercise Using the Ciwujia Plant. This patent expires in December 2013.
We received a composition of matter patent, United States Patent No. 6,051,236, in April 2000 entitled Composition for Optimizing Muscle Performance During Exercise (see Item 1(b)(i)(a)). This patent expires in April 2017.
We received a composition of matter patent, United States Patent No. 6,207,638, in March 2001 entitled Nutritional Intervention Composition for Enhancing and Extending Satiety. This patent expires in March 2018.
We received a use patent, United States Patent No. 6,429,190, in August 2002 entitled Method For Extending The Satiety Of Food By Adding A Nutritional Composition Designed To Stimulate Cholecystokinin (CCK). This patent expires in August 2019.
We received a composition of matter patent, United States Patent No. 6,436,899, in August 2002 entitled Nutritional Intervention Composition for Enhancing and Extending Satiety. This patent expires in August 2019.
We received a composition of matter patent, United States Patent No. 6,468,962, in October 2002 entitled Nutritional Intervention Composition for Enhancing and Extending Satiety. This patent expires in October 2019.
We received a composition of matter patent, United States Patent No. 6,558,690, in May 2003 entitled Nutritional Intervention Composition for Improving Efficacy of a Lipase Inhibitor. This patent expires in May 2020.
We received a composition of matter patent, United States Patent No. 6,716,815, in April 2004 entitled Nutritional Intervention Composition for Enhancing and Extending Satiety. This patent expires in April 2021.
We received a composition of matter patent, United States Patent No. 6,838,431, in January 2005 entitled Nutritional Intervention Composition Containing Protease Inhibitor Extending Post Meal Satiety. This patent expires in January 2022.
We received a composition of matter patent, United States Patent No. 6,989,171, in January 2006 entitled Sports Drink Composition For Enhancing Glucose Uptake and Extending Endurance During Physical Exercise. This patent expires in January 2023.
We also have several patents pending on our technology. To the extent these are improvements on our existing sports drink patents, Mott’s will own these patents, but we will have an exclusive license to use them in powder, gel and pill products.
The patent holder for all patents is our former CEO, Dr. Robert Portman. Our policy is to have all patents assigned to us upon filing. Patent Nos. 6,051,236 and 6,989,171 above have been assigned to Mott’s. To the extent we do not have patents on our products, there can be no assurance that another company will not replicate one or more of our products nor is there any assurance that existing or future patents will provide meaningful protection or significant competitive advantages over competing products. For example, our use patent on ciwujia would not prevent the sale of a product containing that herb with a claim or for a use that was not covered by our patent. The expense to enforce any patent against an infringer could be prohibitive.
We also obtained federal trademark registrations for ENDUROX EXCEL, ENDUROX R4, ACCELERADE, ACCEL GEL, FORZE GPS among others. We have filed our trademarks in most Western European countries, Canada, Mexico and Japan. Our policy is to pursue registrations for all of the trademarks associated with our key products, and to protect our legal rights concerning the use of our trademarks. We rely on common law trademark rights to protect our unregistered trademarks.
1(b)(viii) and (ix) Governmental Regulation
We have determined that all of our existing and proposed products, as described above, are nutritional or dietary supplements as defined under federal statutes and regulations of the FDA. Neither nutritional supplements nor dietary supplements require FDA or other governmental approval prior to their marketing in the United States. No governmental agency or other third party makes a determination as to whether our products qualify as nutritional supplements, dietary supplements, or neither. We make this determination based on the ingredients contained in the products and the claims made for the products. The processing, formulation, packaging, labeling and advertising of such products, however, are subject to regulation by one or more federal agencies, including the FDA, the Federal Trade Commission, the Consumer Products Safety Commission, the Department of Agriculture and the Environmental Protection Agency. Our activities also are subject to regulation by various agencies of the states and localities in which our products are sold.
We market products that are covered under two types of FDA regulations, Nutritional Supplements and Dietary Supplements. Nutritional Supplements contain food and GRAS (Generally Regarded as Safe) ingredients and do not require FDA approval or notification. Such products must follow labeling guidelines outlined by the FDA.
Dietary Supplements is a classification of products resulting from the enactment of the Dietary Supplement Health and Education Act of 1994 (the "DSHEA") in October 1994. The DSHEA amended and modified the application of certain provisions of the Federal Food, Drug and Cosmetics Act (the "FFDC Act") as they relate to dietary supplements, and required the FDA to promulgate regulations consistent with the DSHEA.
The DSHEA defines a dietary supplement to include (i) any product intended to supplement the diet that bears or contains a vitamin, mineral, herb or other botanical, an amino acid, a substance to supplement the diet by increasing the total dietary intake, or any concentrate, constituent, extract, or combination of any such ingredient, provided that such product is either intended for ingestion in tablet, capsule, powder, softgel, gelcap, or liquid droplet form, (ii) or, if not intended to be ingested in such form, is not represented for use as a conventional food or as a sole item of a meal or the diet, and (iii) is labeled as a dietary supplement. The practical effect of such an expansive definition is to ensure that the new protections and requirements of the DSHEA will apply to a wide class of products.
Under the DSHEA, companies that manufacture and distribute dietary supplements are allowed to make any of the following four types of statements with regard to nutritional support on labeling without FDA approval: (i) a statement that claims a benefit related to a classical nutrient deficiency disease and discloses the prevalence of such disease in the United States; (ii) a statement that describes the role of a nutrient or dietary ingredient intended to affect structure or function in humans; (iii) a statement that characterizes the documented mechanism by which a nutrient or dietary ingredient acts to maintain or function; or (iv) a statement that "describes general well-being" from consumption of a nutrient or dietary ingredient. In addition to making sure that a statement meets one of these four criteria, a manufacturer of the dietary supplement must have substantiation that such statement is truthful and not misleading, must not claim to diagnose, mitigate, treat, cure, or prevent a specific disease or class of diseases, and must contain the following disclaimer, prominently displayed in boldface type: "This statement has not been evaluated by the Food and Drug Administration. This product is not intended to diagnose, treat, cure, or prevent any disease."
In 2000, the FDA issued new guidelines concerning statements made for dietary supplements. These regulations have important implications for the marketing of weight loss products. Previously, the regulations made it clear that a product that made a claim for obesity must be treated as a drug. Under the regulations issued in 2000, the FDA makes a distinction between obesity and overweight. Overweight is no longer considered a disease but rather a natural life process. Overweight is considered a condition that affects the structure and function of the body. As now defined, dietary supplements can make a claim for ordinary weight loss rather than as a treatment for obesity. Furthermore, these regulations also permit the use of appetite suppressant as a structure/function claim under DSHEA. The issuance of these regulations will give us greater latitude in the types of claims that we can make for weight loss products as long as we can substantiate such claims by the necessary studies.
1(b)(x)
Expenditures for Research and Development
Our research and development (“R & D”) expenditures in the past two fiscal years, exclusive of market research and marketing related expenditures, were approximately as follows: 2010 - $4,000; 2009 - $0. R & D expenses are expected to increase in 2011 as we go back to being science-driven and launch new products.
1(b)(xi)
Compliance with Environmental Laws
Except as described above under Item 1(b)(viii) and (ix), we are not aware of any administrative or other costs that we may incur which are directly related to compliance with environmental laws, and we have not experienced any other significant effect from the impact of environmental laws.
1(b)(xii)
Employees
At the present time, we have nine (9) full time employees and one (1) part time employee. Of these, two employees are executive, six are in sales and marketing, and two are in accounting, operations and administration. We may employ a number of consultants who devote limited portions of their time to our business. None of our employees are represented by a union and we believe that our employee relations are good.
ITEM 1A.
ITEM 1A.
RISK FACTORS
As a smaller reporting company, we have elected scaled disclosure reporting and therefore are not required to provide information required by this Item1A.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2.
PROPERTIES
We have an amended lease agreement for office space in Matawan, NJ for the rental of 3,200 square feet expiring December 2013. Rent, including utilities, will be $78,000 annually.
We do not intend to develop our own manufacturing capabilities, because management believes that the availability of manufacturing services from third parties on a contract basis is more than adequate to meet our needs in the foreseeable future.
We do not own any real property nor do we have any real estate investments.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
None.
ITEM 4.
ITEM 4.
REMOVED AND RESERVED
PART II
ITEM 5.
ITEM 5.
MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES.
5(a)
Market Information.
Our common stock is currently traded on the over-the-counter market on the OTC Bulletin Board, under the symbol "PHLI".
The following table sets forth the high and low sales prices of our common stock since January 1, 2009, as reported by the OTC Bulletin Board. These quotations reflect inter-dealer prices, without retail mark up, mark down or commissions and may not represent actual transactions.
On March 4, 2011, the closing price of our common stock as reported by the OTC Bulletin Board was $0.28 per share.
5(b)
Holders
As of March 4, 2011, there were 96 holders of record of our common stock. However, we believe that there are significantly more beneficial holders of our stock as many beneficial holders have their stock in “street name”.
5(c)
Dividends
We have never paid or declared dividends upon our common stock, and we do not contemplate or anticipate paying any dividends on our common stock in the foreseeable future.
5(d)
Recent Sales of Unregistered Securities
5(d)(i)
Recent Sales of Unregistered Securities
There were no sales of unregistered securities other than as reported in prior reports on Forms 10-K, 10-Q, or 8-K.
Company Repurchases
We did not repurchase any shares of our common stock in the fourth quarter of 2010.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
As a smaller reporting company, we have elected scaled disclosure reporting and therefore are not required to provide information required by this Item 6.
ITEM 7.
ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with our financial statements, including the notes thereto, appearing elsewhere in this Report.
7(a)
Introduction
We were incorporated in April 1995 to discover, develop and commercialize nutritional products that are patentable and substantiated by well-controlled clinical trials conducted at leading university research centers. Our current principal area of focus is sports performance. Prior to 2008, other areas of focus included weight management and Type 2 diabetes. Such endeavors have been discontinued. We introduced our first product, ENDUROX, in March 1996. We extended our exercise performance products with the introduction of ENDUROX R4 Recovery Drink in February 1999, ACCELERADE Sports Drink in May 2001, and ACCEL GEL in February 2004. These products are based on our patented technology that involves the combination of carbohydrate and protein in a specific ratio. A number of studies both funded by our Company and also conducted independently, demonstrate that this technology can extend endurance, decrease post-exercise muscle damage, speed recovery and improve rehydration.
In April 2000, we introduced our first product for weight loss that was based upon a novel mode of action - the stimulation of one of the body’s principal satiety peptides, cholecystokinin (CCK). This technology was launched under the brand name SATIETROL. In June 2001, we licensed this product to GlaxoSmithKline and discontinued promotion of our brand. In September 2002, the license was returned to us and we initiated a program to improve both the efficacy and form versatility of the technology. We introduced a new ready-to-drink beverage based on this enhanced technology under the brand name SATIATRIM exclusively on-line in January 2007. We officially launched SATIATRIM in June 2007. We did not generate significant sales from this product line, and we discontinued this product in September 2008. We launched FORZE GPS based on the same technology in early 2009, but also did not generate significant sales from this product line. We decided not to invest marketing support for this product in 2010.
7(b)
Results of Operations - Years Ended December 31, 2010 and 2009
Revenues decreased 10% for the year ended December 31, 2010 to $7,200,960 from $7,995,194 for the year ended December 31, 2009. The decrease in revenues in 2010 as compared to 2009 is the result of a reduction in promotional sales-through to one of our major customers and a change in 2009 in the way we reported certain product sales to another major customer. A major customer’s gross sales were down approximately $233,000 for 2010 as compared to 2009. One of the key changes we will be implementing in 2011 is an increase in consumer messaging and new product support to drive consumer awareness versus a heavy reliance on trade promotion to drive revenue. Also, in 2009, we changed the way we reported certain product sales to another major customer. Effective April 1, 2009, we commenced recognizing revenue for certain products not under a pay on scan (consignment) model upon shipment as we determined that we have met the criteria established in ASC 605, specifically as it relates to the ability to estimate future returns. This change in estimate for these product shipments was based primarily on our determination that we could, based upon historical secular analysis, estimate our returns of such product shipments with such historical data covering a five-year period. This resulted in additional revenues in 2009 of approximately $279,000.
For the year ended December 31, 2010, gross profit margin on product sales was 43.9% compared to 46.4% for the year ended December 31, 2009. The lower gross profit margin on product sales in 2010 as compared to 2009 is due primarily to promotional allowances given to major accounts in order to facilitate sales of our products.
During the quarter ended December 31, 2009, we reserved $477,140 of FORZE GPS inventory and $14,032 of other finished goods inventory. Our marketing efforts in 2009 did not result in sufficient sales of FORZE GPS to be able to project that this product line would be financially viable and the decision was made to cease marketing this product in 2010.
Sales and marketing (“S & M”) expenses decreased by 38% to $1,166,471 for the year ended December 31, 2010 from $1,880,102 for the year ended December 31, 2009. S & M expenses decreased as a percentage of product sales to approximately 16% in 2010 compared to approximately 24% in the 2009. The decrease in S & M expenses is due to the 2009 public relations and marketing campaign (including sample expense) associated with the launch of FORZE GPS as well as initial costs incurred for rolling out a national sales representation organization. We have assessed our return on investment in the third party outside sales group and decided to replace them with three dedicated Regional Sales Managers employed by us. These new regional managers will be spending 100% of their time supporting our new consumer efforts across triathlon, bicycle, and running stores in the U.S.
General and administrative (“G & A”) expenses decreased 14% to $2,753,512 for the year ended December 31, 2010 from $3,200,680 for the year ended December 31, 2009. The decrease is due primarily to lower CEO severance payments (see below), investor relations, travel and entertainment, and options expenses. Included in G & A in 2010 is approximately $336,000 paid to a former CEO in consideration of a non-compete clause pursuant to his Separation Agreement and for transition expenses. These payments will continue under the terms of the Separation Agreement until January 27, 2011. Also included in 2010 is an additional $126,000 in severance costs paid to other former employees. Included in G & A in 2009 is $172,000 paid to a different former CEO in consideration of a non-compete clause pursuant to his Separation Agreement. These payments ended under the terms of the Separation Agreement effective as of July 31, 2009.
Research and development (“R & D”) expenses were $4,000 in the year ended December 31, 2010 compared to $0 for the year ended December 31, 2009. We expect R & D expenses to increase as we invest in the latest science to produce products that address current athlete needs.
In December 2009, we made the decision to forgo marketing our FORZE GPS weight management product line as we were unable to generate enough sales in 2009 to make this product line viable in the foreseeable future. As a result of this decision, we recorded a restructuring charge in the amount of $81,050 consisting of writing-off property and equipment specific to the marketing efforts of FORZE GPS less any realizable salvage values.
Interest expense was $6,122 for the year ended December 31, 2010 compared to $5,320 for the year ended December 31, 2009.
In 2009, we recorded a net benefit from income taxes of $261,851. On February 8, 2010, we received $303,931 of net proceeds related to the sale of a portion of our unused net operating loss carryovers for the State of New Jersey to a third party through the 2009 NJEDA Technology Business Tax Certificate Transfer Program.
As a result of the foregoing, we recorded a net loss of $761,422, or ($0.05) per share basic and diluted, for the year ended December 31, 2010, compared to a net loss of $1,676,124, or ($0.11) per share basic and diluted, for the year ended December 31, 2009.
7(c)
Liquidity and Capital Resources
At December 31, 2010, our current assets exceeded our current liabilities by approximately $492,000 with a ratio of current assets to current liabilities of approximately 1.6 to 1. At December 31, 2010, cash on hand was $134,165, a decrease of $146,994 from December 31, 2009, primarily as the result of a decrease in other short-term investments of $25,000, a decrease in accounts receivable (net of reserves) of $346,566, a decrease in inventory of $209,895 (net of reserves), a decrease in prepaid expenses of $27,922, a decrease in tax loss receivable of $303,931, net borrowings under a line of credit of $75,000, issuances of notes payable of $70,293, repayments of notes payable of $61,805, a decrease in accounts payable and accrued expenses of $328,867, and a decrease in deferred revenue of $245,403 from December 31, 2009. Accounts receivable decreased due to lower sales in the 4th quarter of 2010 versus the same period in 2009 combined with offering payment discounts to our major customers in 2010. Inventories decreased due to better inventory management. Tax loss receivable decreased as we received the net proceeds related to the sale of a portion of our unused net operating loss carryovers for the State of New Jersey (see below). Accounts payable and accrued expenses decreased primarily due to aggressive inventory control. The line of credit increased as we drew down the maximum amount allowed under our auction rate securities line of credit (see below) and subsequently repaid a portion of this line. Deferred revenue decreased primarily as a result of a major customer discontinuing selling a number of products previously recorded as deferred revenue. Inventory associated with this deferred revenue previously recorded as consignment inventory has been returned to us in salable condition and recorded as finished goods.
On February 8, 2010, we received $303,931 of net proceeds related to the sale of a portion of our unused net operating loss carryovers for the State of New Jersey to a third party through the 2009 NJEDA Technology Business Tax Certificate Transfer Program. We used these proceeds for working capital purposes.
Net cash used in operating activities for 2010 was $214,263 compared to net cash used in operating activities for 2009 of $646,107. The net cash used in operations in 2010 as compared to the net cash used in operations in 2009 is primarily due to a decrease in accounts receivable in 2010 as compared to an increase in accounts receivable in 2009, a much bigger decrease in inventory in 2010 as compared to 2009, the receipt of the net proceeds from the tax loss sale in 2010 (see above) offset by a decrease in accounts payable and accrued expenses in 2010 compared to an increase in accounts payable and accrued expenses in 2009. Accounts receivable decreased in 2010 compared to an increase in 2009 due to lower sales in the 4th quarter of 2010 as compared to the same period in 2009 as well as less day’s sales outstanding in 2010 as we offered payment discounts to our major customers in 2010. Inventory decreased more in 2010 as compared to 2009 due to more aggressive inventory management. Accounts payable and accrued expenses decreased in 2010 compared to an increase in 2009 as we better managed inventory levels in 2010 as well as used the proceeds from the tax loss sale to increase payments to our vendors. Historically, we have funded inventory purchases through trade credit and we expect that to continue.
At December 31, 2010, we have $150,000 invested in auction rate securities that are presented as short-term investments on the balance sheet. During 2010, we were able to redeem $25,000 of these investments with no gain or loss. Redemptions of these securities are currently difficult to complete due to difficult credit market conditions. We have obtained a revolving line of credit with a financial institution with a maturity of May 2011 that will accept these securities as collateral. The maximum amount that we may borrow is limited to 50% of the value of these auction rate securities. On February 22, 2010, we drew down the $87,500 maximum amount allowed under this line of credit and on May 20, 2010 we paid down $12,500 on this line from the proceeds of the redeemed securities. On January 5, 2011, we redeemed $25,000 of these investments and paid down $12,500 on the line from the proceeds of the redeemed securities.
In 2010, capital expenditures amounted to $41,219 consisting mostly of office equipment. We have no material commitments for capital expenditures.
7(d)
Impact of Inflation
We expect to be able to pass inflationary increases for raw materials and other costs on to our customers through price increases, as required, and do not expect inflation to be a significant factor in our business. However, this expectation is based more on observations of our competitors' historic operations than our own experience.
7(e)
Seasonality
Sports nutrition products tend to be seasonal, especially in the colder climates. Lower sales are typically realized during the first and fourth quarters and higher sales are typically realized during the second and third quarters. We also plan our advertising and promotional campaigns for the ENDUROX R4, ACCELERADE, ACCEL GEL and new products around these seasonal demands. Weight loss products also have seasonality with greater sales seen in the first and second quarters as a result of consumers’ New Year’s resolutions and desire to “get into shape” for the summer. We believe that the impact of new product introductions and marketing promotions associated with the introduction of new products will have a far greater impact on our operations than industry and product seasonality.
7(f)
Impact of Recently Issued Financial Accounting Standards
There were no recently issued but not yet effective accounting pronouncements that would have a material impact on our financial statements.
7(g)
Off-Balance Sheet Arrangements
There are no off-balance sheet arrangements between us and any other entity that have, or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources that is material to investors.
7(h)
Critical Accounting Policies
Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. Certain accounting policies have a significant impact on amounts reported in financial statements. A summary of those significant accounting policies can be found in Note A to our financial statements. The more significant accounting policies involving estimates are described below.
In preparing financial statements in conformity with generally accepted accounting principles in the United States of America, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses for the reporting period covered thereby. Actual results could differ from those estimates.
Among such estimates made by management in the preparation of our financial statements are the determinations of the allowance for doubtful accounts, inventory valuation, revenue recognition as it relates to customer returns, and valuation allowance for deferred tax assets. The allowance for doubtful accounts is determined by assessing the realizability of accounts receivable by taking into consideration the value of past due accounts and collectability based on credit worthiness of such customers. Historically, we have not had to reserve significant amounts for doubtful accounts. We assess the realizability of inventories by reviewing all inventory to determine the value of items that are slow moving, any lack of marketability, and by analysis of the shelf life of products. Estimates are made for sales returns based on historical experience with actual returns. Certain of our products are subject to minimum sales thresholds by a significant retail customer. These sales thresholds are based on quantities sold-through at the retail level. We record revenue with respect to these products at the time the goods are sold-through to the end user as reported to us by the customer. We analyze retail sell-through data provided by the customer and our expectations of future customer sell-through trends. Based upon this information, we determine if any reserves for returns are necessary. We analyze the valuation allowance for deferred tax assets to determine any tax benefits that are not expected to be realized. Our financial statements have been prepared in accordance with U.S. generally accepted accounting principles.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a smaller reporting company, the Company has elected scaled disclosure reporting obligations and therefore is not required to provide the information requested by this Item 7A.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial information required in response to this Item of Form 10-K is set forth at pages through of this Report.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A(T)
ITEM 9A(T)
CONTROLS AND PROCEDURES
(a)
Evaluation of Disclosure Controls and Procedures
Prior to the filing of this Report on Form 10-K, an evaluation was performed under the supervision of and with the participation of the our management, including our President and Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Based on the evaluation, the President and CFO have concluded that, as of December 31, 2010, our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and is accumulated and communicated to our management, as appropriate, to allow timely decisions regarding required disclosure. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
(b)
Changes in Internal Controls Over Financial Reporting
During the quarter ended December 31, 2010, there were no changes in our internal control over financial reporting (as defined in Section 240.13a-15(f) or 240.15d-15(f) of the Exchange Act) that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that:
(i)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect our transactions and dispositions of our assets;
(ii)
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and
(iii)
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2010. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on management’s assessment and those criteria, management has concluded that our internal control over financial reporting was effective as of December 31, 2010.
ITEM 9B
ITEM 9B
OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
10(a)
Directors and Executive Officers
Our directors and executive officers as of the date of this Report are as follows:
Name
Position
Frederick Duffner 1
CEO, President and Director
Stephen P. Kuchen
Chief Financial Officer, Treasurer, and Secretary
Robert Portman, Ph.D.
Director
Michael Cahr
Director 2,3
Marc Particelli
Director 2,3
1 On January 27, 2010, Frederick Duffner, formerly the Senior Vice President of Sales, was promoted to President and was elected as a Director, following the mutual separation from employment with the Company of former CEO Jason Ash. On August 30, 2010, Mr. Duffner was promoted to Chief Executive Officer as well.
2 Member of Audit Committee
3 Member of Compensation Committee
Former Directors Adam Mizell and David Portman resigned effective June 30, 2010.
MANAGEMENT AND DIRECTORS
FREDERICK DUFFNER, age 54, was named President and a Director in January 2010 and promoted to Chief Executive Officer on August 30, 2010. Mr. Duffner served as our Senior Vice President of Sales since August 2008. Before joining PacificHealth, Mr. Duffner directed his own sales and marketing company, Duffner & Associates, servicing several clients including NutriSystem Inc. Prior to founding Duffner & Associates in 2004, Mr. Duffner was Senior Vice President of Customer Management at Atkins Nutritionals for 4 years, responsible for the expansion into the food, drug, and mass channels and growing their sales volume 10 times to over $500 million. Prior to Atkins, Mr. Duffner was responsible for total sales of the Revlon Beauty Business where he had spent 13 years.
STEPHEN P. KUCHEN, age 50, has served as Vice President of Finance, Chief Financial Officer, Treasurer and Secretary since June 2000. Mr. Kuchen also served as a Director from June 2000 until May 2008 and Chief Operating Officer from September 2004 until January 1, 2008. Mr. Kuchen initially joined us in February of 2000 as Controller. Prior to joining us, Mr. Kuchen was employed from 1996 to 1999 as the Controller of Able Laboratories, a public company located in South Plainfield, New Jersey that manufactured and sold generic pharmaceuticals. Prior to his employment by Able Laboratories, Mr. Kuchen was the Controller of Jerhel Plastics, a privately owned manufacturer of women's compact cases from 1993 to 1996. Mr. Kuchen is a graduate of Seton Hall University in South Orange, NJ, and is a Certified Management Accountant.
DR. ROBERT PORTMAN, age 66, currently serves as a Director. Since August 1, 2008, Dr. Portman has been Managing Principal of Signal Nutrition, a research and development company. He served as our Chief Executive Officer and Chief Scientific Officer from June 2005 through July 2008 and Chairman of the Board of Directors and Chief Scientific Officer since September 2004. He served as President from June 2005 through the end of calendar year 2007. From our inception to September 2004, Dr. Portman served as our President, Chief Executive Officer, and Chairman of the Board of Directors. Dr. Portman has a Ph.D. in Biochemistry and worked as a senior scientist at Schering Laboratories before co-founding M.E.D. Communications in 1974. In 1987, Dr. Portman started a consumer agency and, in 1993, he merged both agencies to form C&M Advertising with billings in excess of $100 million. Dr. Portman is coauthor of two books, Nutrient Timing and The Performance Zone. He has authored hundreds of articles on the role of nutrition in improving sports performance. He is a frequent guest on TV and radio and has been a keynote speaker at national coaches meetings on how nutritional intervention during and after exercise can improve athletic performance and speed muscle recovery. As the former Chief Scientific Officer of PacificHealth Laboratories, he obtained 12 patents for nutritional inventions to improve sports performance as well as to control appetite and help in the management of Type II diabetes.
MICHAEL CAHR, age 71, was appointed to the Board of Directors in April 2002. Since September 2004, Mr. Cahr has been a General Partner at Focus Equity Partners, a private equity investment and management firm that acquires middle market companies and assists them in reaching their performance potential. Prior to Focus, he was President of Saxony Consultants, a company that provides financial and marketing expertise to organizations in the United States and abroad. From February 2000 to March 2002, Mr. Cahr served as President and Chief Executive Officer of Ikadega, Inc., a Northbrook, Illinois server technology company developing products and services for the healthcare, data storage and hospitality fields. Mr. Cahr was Chairman of Allscripts, Inc., the leading developer of hand-held devices that provide physicians with real-time access to health, drug and other critical information from September 1997 through March 1999 and President, CEO and Chairman from June 1994 to September 1997. Prior to Allscripts, Mr. Cahr was Venture Group Manager for Allstate Venture Capital where he oversaw investments in technology, healthcare services, biotech and medical services from October 1987 to June 1994.
MARC PARTICELLI, age 65, was appointed to the Board of Directors in February 2007. Since July 2006, Mr. Particelli has been Chairman of the Board of Coactive Marketing Group (NASDAQ: CMKG), an integrated marketing communications agency. Mr. Particelli served as interim President and Chief Executive Officer of Coactive from July 2006 through October 2006. From August 2005 until March 2006, Mr. Particelli was the Chief Executive Officer of TSM Corporation, a telecommunications company serving the Hispanic market. Mr. Particelli was Chairman of the Board, President and Chief Executive Officer of Modem Media, an interactive marketing services firm, from January 1991 until its acquisition by Digitas Inc. in October 2004. Earlier, Mr. Particelli was a partner at Oak Hill Capital Management, a private equity investment firm, and managing director at Odyssey Partners L.P., a hedge fund. Prior to entering the private equity business, Mr. Particelli spent 20 years with Booz Allen where he helped create the Marketing Industries Practice and led its expansion across Europe, Asia and South America. Mr. Particelli also currently serves as a director of and investor in, several private companies and as an advisor to several private equity firms.
All directors hold office until the next annual meeting of stockholders and until their successors have been elected and qualified. Officers serve at the discretion of the Board of Directors.
10(b)
Scientific Advisory Boards
We do not have a formal established Scientific Advisory Board but as the need arises, we consult with individual scientists on a non-scheduled basis.
10(c)
Family Relationships
There are no family relationships among our directors, executive officers or persons nominated or chosen to become directors or executive officers of ours.
10(d)
Involvement in Certain Legal Proceedings
No events have occurred during the past five years that are required to be disclosed pursuant to Item 401(f) of Regulation S-K.
CORPORATE GOVERNANCE
10(e)
Procedures for Nomination of Directors by Security Holders
There were no material changes to the procedures for nomination of directors by the Company’s security holders during the year ended December 31, 2010.
10(f)
Audit Committee
The Board of Directors has established a separately designated, standing Audit Committee that performs the role described in section 3(a)(58)(A) of the Exchange Act. During the fiscal year ended December 31, 2010, the Audit Committee consisted of Michael Cahr and Adam Mizel through June 30, 2010 when Mr. Mizel resigned from the Board. He was subsequently replaced on the Audit Committee by Marc Particelli. Messrs. Cahr, Mizel, and Particelli met the criteria for independence set forth in Rule 10A-3(b)(1) of the Exchange Act.
10(g)
Audit Committee Financial Expert
Michael Cahr, a member of the Audit Committee of our Board of Directors, is the Audit Committee Financial Expert, as that term is defined in Item 407 of Regulation S-K. Mr. Cahr is “independent” as that term is defined in Item 7(d)(3)(iv) of Schedule 14A under the Exchange Act.
10(h)
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires that our directors and executive officers, and any persons who own more than ten percent of our common stock, file with the Securities and Exchange Commission, or SEC, initial reports of ownership and reports of changes in ownership of our common stock and other equity securities. Such persons are required by SEC regulations to furnish us with copies of all such reports that they file. To our knowledge, based upon our review of these reports, all Section 16 reports required to be filed by our directors, executive officers and beneficial owners during the fiscal year ended December 31, 2010 were filed on a timely basis.
10(i)
Code of Ethics
Our Board of Directors has adopted a code of ethics, which applies to all our directors, officers and employees. Our code of ethics is intended to comply with the requirements of Item 406 of Regulation S-K.
Our code of ethics is posted on our Internet website at www.pacifichealthlabs.com. We will provide our code of ethics in print without charge to any stockholder who makes a written request to: Corporate Secretary, PacificHealth Laboratories, Inc., 100 Matawan Road, Suite 150, Matawan, NJ 07747. Any waivers of the application and any amendments to our code of ethics that applies to our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions must be made by our Board of Directors. Any waivers of, and any amendments to, our code of ethics will be disclosed promptly on our Internet website, www.pacifichealthlabs.com .
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
As a “smaller reporting company,” the Company has elected to follow scaled disclosure requirements for smaller reporting companies with respect to Part III, Item 11 - Executive Compensation. Under the scaled disclosure obligations, the Company is not required to provide Compensation Discussion and Analysis and certain other tabular and narrative disclosures relating to executive compensation. Nor is the Company required to quantify payments due to the named executives upon termination of employment.
The table below sets forth information concerning compensation paid to executive officers Frederick Duffner, Jason Ash, Dr. Robert Portman and Stephen Kuchen in 2010 and 2009 as well as one other highly compensated non-executive employees. As set forth below, our compensation program for our named executive officers and other highly compensated employees consists of base salary and discretionary option awards.
Summary Compensation Table
(1) The amounts in column (f) reflect the dollar amount recognized for financial statement reporting purposes for the fiscal years ended December 31, 2010 and 2009, in accordance with ASC 718-10-05, “Compensation - Stock Compensation” of awards of stock options and thus include amounts from awards granted in and prior to 2010. Assumptions used in the calculation of this amount are included in Note A[10] of our audited financial statements for the fiscal year ended December 31, 2010 included in Part II - Item 8, Financial Statements of this Annual Report on Form 10-K and in Note A[10] of our audited financial statements for the year ended December 31, 2009 included in our Annual Report on Form 10-K filed with the SEC on March 30, 2010.
(2) On January 27, 2010, Frederick Duffner, formerly the Senior Vice President of Sales, was promoted to President and appointed a Director, following the mutual separation from employment with the Company of former CEO Jason Ash. Mr. Duffner was subsequently also named Chief Executive Officer on August 31, 2010. Mr. Duffner’s salary is set at $230,000 for 2011.
(3) Perquisites and other personal benefits in the aggregate were less than $10,000.
(4) Under the terms of his separation agreement of January 27, 2010, Mr. Ash is to receive $295,000 in the form of consulting expense for three months and the balance in severance over nine months. As part of this severance agreement, Mr. Ash also received $50,000 for transition costs.
(5) Under the terms of his employment agreement in effect during 2009, Mr. Ash received an annual base salary of $295,000 and an all-inclusive relocation/travel/car stipend of $40,000.
(6) Under the terms of his Separation Agreement effective August 1, 2008, Dr. Portman received non-compete payments of $24,583 per month through July 31, 2009.
(7) Mr. Kuchen’s salary is set at $165,000 for 2011.
(8) On January 15, 2010, Matt Spolar was terminated without cause and, under the terms of his employment agreement, we will pay him an amount equal to four months of his base salary.
Employment Agreements
We do not have written or unwritten employment agreements with Mr. Duffner or Mr. Kuchen. Their annual base salaries are determined by our Compensation Committee and are adjusted periodically.
We entered into an employment agreement with Mr. Ash with an initial term beginning January 3, 2008 and ending December 31, 2009. Under the terms of the employment agreement, the agreement automatically extended for a one-year period.
We entered into a Separation and Release Agreement (the “Separation Agreement”) with Mr. Ash on January 27, 2010. Under the terms of the Separation Agreement, Mr. Ash has agreed to provide consulting services for a period of 90 days following the date of the Separation Agreement, and Mr. Ash is entitled to the sum of $5,673.08 per week for such consulting services. During the one-year period commencing on January 11, 2010, Mr. Ash is entitled to the sum of $295,000, less the sum of consulting fees paid during such period and less any income, wages and/or salary received by Mr. Ash during such period in respect of full-time or substantially full-time employment. We also agreed to pay Mr. Ash up to $50,000 for relocation costs under certain circumstances, the cost of life insurance premiums during the period in which he provides consulting services and the cost of health insurance coverage for a period of six months. The Separation Agreement also provides that vesting of all options previously granted to Mr. Ash ceased as of January 11, 2010. All unvested options are terminated and, with respect to options that had vested as of that date, such options are only exercisable during the 90-day period following the expiration of Mr. Ash’s consulting services.
We employed Dr. Portman under an employment agreement effective January 1, 2007. Under the employment agreement, Dr. Portman received a salary of $295,000 per year, as well as a car allowance in the amount of $975 per month. In addition, Dr. Portman was entitled to an annual bonus not to exceed 100% of his base salary. The term of Dr. Portman’s employment agreement would have terminated on December 31, 2008, unless terminated earlier by either Dr. Portman or by us. On August 5, 2008, we entered into a Separation Agreement with Dr. Portman whereby we continued to pay the $295,000 salary for twelve months in exchange for a twelve-month non-compete provision. Also, all previously unvested options vested on August 5, 2008.
We entered into an employment agreement on January 3, 2008, with Matt Spolar, Vice President, Product Development and Supply Chain, that provides for minimum annual compensation of $190,000. Mr. Spolar was terminated without cause on January 15, 2010, and, under the terms of his employment agreement, we paid him an amount equal to four months of his base salary.
Equity Awards in 2010
During 2010, our Compensation Committee recommended, and our full Board of Directors approved, stock option awards to our executive officers as follows:
The options listed above vested over a three-year period in equal, annual installments beginning on the first anniversary of the date of grant.
Outstanding Equity Awards at Fiscal Year-End
The following table and its notes set forth information with respect to the value of all unexercised options previously awarded to each of the executive officers at the fiscal year end, December 31, 2010:
(1) These options vest in four equal annual installments beginning on July 14, 2009.
(2) These options vest in three equal annual installments beginning on January 25, 2011.
(3) These options vest in three equal annual installments beginning on August 30, 2011.
(4) These options vested in three equal annual installments beginning on February 10, 2007.
(5) These options vested in three equal annual installments beginning on December 13, 2007.
(6) These options vest in four equal annual installments beginning on September 17, 2009.
(7) These options vest in three equal annual installments beginning on December 7, 2011.
Post-Termination or Change-In-Control Payments
Under our arrangement with Mr. Kuchen, in the event of a sale, merger or change in control of the Company, Mr. Kuchen will receive one-half of his annual salary and all of his options would become immediately vested. If Mr. Kuchen were terminated, Mr. Kuchen would receive one-half of his annual salary as severance.
DIRECTOR COMPENSATION
In 2010, we compensated our non-employee Directors with stock grants equal to $6,000 for each quarter of service through the third quarter of 2010. The number of shares granted was calculated by dividing the value of the grant by the closing price of our common stock on the Over-the-Counter Bulletin Board on the last date of the quarter being compensated. For the 4th quarter of 2010, we accrued $6,000 for each non-employee director which will be paid in cash in 2011. Additionally, on March 10, 2010, a stock grant equal to $3,363 was issued to Dr. Portman as payment for advisory services. For 2011, the non-employee Directors will continue to be paid $6,000 per quarter in cash at such times as our cash flow permits such payment to be made.
Frederick Duffner, our Chief Executive Officer receives no compensation for his service as a Director because he is an employee of the Company. The compensation received by Mr. Duffner as an employee of the Company is shown in the Summary Compensation Table on page 21.
Director Compensation Table
The table below summarizes the compensation that we paid to non-employee Directors for the fiscal year ended December 31, 2010.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
As of March 4, 2011, we had 16,485,257 shares of common stock outstanding. The following table sets forth information concerning the present ownership of our common stock by our directors, executive officers and each person known to us to be the beneficial owner of more than five percent of the outstanding shares of our common stock.
*
Less than one percent
(1)
Except as otherwise indicated, the address of each person named in the above table is c/o PacificHealth Laboratories, Inc., 100 Matawan Road, Suite 150, Matawan, NJ 07747.
(2)
Common Stock includes shares issuable upon the exercise of a stock option which is presently exercisable or which becomes exercisable within sixty days is considered outstanding for the purpose of computing the percentage ownership (x) of persons holding such options, and (y) of officers and directors as a group with respect to all options held by officers and directors.
(3)
Includes 83,333 shares issuable upon the exercise of options granted under our 2010 Plan and 100,000 shares issuable upon the exercise of options not under any Incentive Stock plan (“NON-ISO”).
(4)
Includes 50,000 shares issuable upon the exercise of options granted under our 1995 Plan and 12,500 shares issuable upon the exercise of options granted not covered under any Plan (“NON-ISO”).
(5)
Includes 275,000 shares issuable upon the exercise of options not under any Incentive Stock plan (“NON-ISO”). Does not include 449,693 shares of Common Stock owned by Jennifer Portman, Dr. Portman's wife, individually and as Trustee for his and her children, as to which Dr. Portman disclaims beneficial ownership.
(6)
Includes 40,000 shares issuable upon the exercise of options granted under our 1995 Plan and 20,000 shares issuable upon the exercise of options granted under our 2000 Plan.
(7)
Includes 40,000 shares issuable upon the exercise of options granted under our 2000 Plan.
Securities Authorized For Issuance Under Equity Compensation Plans
The following table sets forth information as of the end of 2010 regarding our existing compensation plans and individual compensation arrangements pursuant to which our equity securities are authorized for issuance to employees or non-employees (such as directors, consultants and advisors) in exchange for consideration in the form of services:
Each of our named executive officers holds some options to purchase shares of our common stock that have not been approved by our stockholders. Specifically, Mr. Duffner holds options to purchase an aggregate of 200,000 shares of our common stock, and Mr. Kuchen holds options to purchase 50,000 shares of our common stock that have not been approved by our shareholders. The terms of the non-qualified options granted to Mr. Duffner and Mr. Kuchen are similar to those of our 2000 Incentive Stock Option Plan. The material terms of the 2000 Incentive Stock Option Plan are described in Note I to our audited financial statements for the fiscal year ended December 31, 2010 included in “Part II - Item 8, Financial Statements” of this Annual Report on Form 10-K. For information about the vesting schedule and exercise prices of these options, see the footnotes in the above table captioned “Outstanding Equity Awards at Fiscal Year-End” and the description under “Equity Awards in 2010” under “Item 10, Executive Compensation” above.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
Related Transactions
During the last two fiscal years, we have not entered into any material transactions or series of transactions which, in the aggregate, would be considered material in which any officer, director or beneficial owner of 5% or more of any class of our capital stock, or any immediate family member of any of the preceding persons, had a direct or indirect material interest, nor are any such transactions presently proposed, except as follows:
(a)
On June 24, 2009, our Board of Directors approved the sale of an aggregate of 535,714 shares of our common stock to Jason Ash, our then Chief Executive Officer and Frederick Duffner, current President and then Senior Vice President of Sales, for an aggregate purchase price of $150,000. The Board, including all independent directors, determined the purchase price of $0.28 per share represented fair market value. On the date the stock was purchased, the closing price was $0.28 per share.
(b)
On July 27, 2010, the Company entered into a consulting agreement with Signal Nutrition LLC (“Signal”), a company controlled by a director of the Company. Under terms of the Agreement, Signal will work with outside researchers, assist in developing new products, and formulate sales and marketing plans for the Company. The Agreement has an initial term of six months, with options by either party to renew for an additional six months, subject, however, to the right of either party to terminate on 15 days notice. The Company will pay Signal a fee of $11,000 per month, commencing September 1, 2010, during the term of the Agreement. Expense for 2010 is $55,000. Included in accounts payable and accrued expenses as of December 31, 2010 is $11,000 relating to this agreement.
(c)
On February 4, 2011, the Company extended this consulting agreement with Signal. Under terms of the Agreement, Signal will continue to work with outside researchers, assist in developing new products, and formulate sales and marketing plans for the Company. The Agreement has an indefinite term with an option by either party to terminate the agreement on thirty (30) days notice. The Company will pay Signal a fee of $16,000 per month, commencing March 1, 2011, during the term of the Agreement.
Director Independence
During 2010, the following members of our Board of Directors were independent under the relevant Marketplace Rules of The NASDAQ Stock Market LLC: Michael Cahr and Marc Particelli. During 2010, Mr. Cahr served on the Audit Committee, the Compensation Committee, and the Nominating Committee. During 2010, Mr. Particelli served on the Audit Committee, Compensation Committee and the Nominating Committee. Messrs. Cahr, and Particelli satisfied the criteria set forth under the Marketplace Rules of The NASDAQ Stock Market LLC relating to the independence standards for members of the Audit Committee. The Board of Directors did not consider any transaction, relationship or arrangement not otherwise disclosed above in this Item 12 under the heading Related Transactions in determining the independence of Messrs. Cahr or Particelli.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
WeiserMazars LLP (formerly Weiser LLP) served as our independent auditors for the years ended December 31, 2010 and December 31, 2009. We have been billed the fees set forth below in connection with services rendered by the independent auditors to us:
¹Audit fees consisted of fees for the audit of our annual financial statements and review of quarterly financial statements as well as services normally provided in connection with statutory and regulatory filings or engagements, comfort letters, consents and assistance with and review of company documents filed with the SEC.
2Audit-related fees consisted of fees for assurance and related services, including primarily employee benefit plan audits, due diligence related to acquisitions, accounting consultations in connection with acquisitions, consultation concerning financial accounting and reporting standards and consultation concerning matters related to Section 404 of the Sarbanes Oxley Act of 2002.
3Tax fees consisted primarily of fees for tax compliance, tax advice and tax planning services.
4Other fees consisted of our auditors consents in conjunction with 1933 Act filings.
Policy for Pre-Approval of Audit and Non-Audit Services
The Audit Committee's policy is to pre-approve all audit services and all non-audit services that our independent auditor is permitted to perform for us under applicable federal securities regulations. As permitted by the applicable regulations, the Audit Committee's policy utilizes a combination of specific pre-approval on a case-by-case basis of individual engagements of the independent auditor and general pre-approval of certain categories of engagements up to predetermined dollar thresholds that are reviewed annually by the Audit Committee. Specific pre-approval is mandatory for the annual financial statement audit engagement, among others.
The pre-approval policy was implemented effective as of March 16, 2004. All engagements of the independent auditor to perform any audit services and non-audit services since that date have been pre-approved by the Audit Committee in accordance with the pre-approval policy. The policy has not been waived in any instance. All engagements of the independent auditor to perform any audit services and non-audit services prior to the date the pre-approval policy was implemented were approved by the Audit Committee in accordance with its normal functions.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS
(a) A list of the exhibits filed as a part of this report is set forth in the Exhibit Index starting after page 30 hereof.
SUPPLEMENTAL INFORMATION
We have not sent an annual report or proxy statement to security holders in respect of the fiscal year ending December 31, 2010. Such report and proxy statement will be furnished to security holders in connection with any Annual Meeting held in 2011. Copies of such material will be furnished to the Commission when it is sent to security holders.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PacificHealth Laboratories, Inc.
By:
/s/Frederick Duffner
Frederick Duffner, CEO and President
Date: March 4, 2011
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/s/Frederick Duffner
Director, Chief Executive Officer
Frederick Duffner
and President
March 4, 2011
(Principal Executive Officer)
/s/Stephen P. Kuchen
Chief Financial Officer (Principal
March 4, 2011
Stephen P. Kuchen
Financial and Accounting Officer),
Treasurer and Secretary
/s/Robert Portman
Director
March 4, 2011
Robert Portman
/s/Michael Cahr
Director
March 4, 2011
Michael Cahr
s/ Marc Particelli
Director
March 4, 2011
Marc Particelli
EXHIBIT INDEX
10.13
Form of Stock Purchase Agreement entered into among the Company, Aquifer Opportunity Fund, L.P. and Marc C. Particelli.
N
10.14†
Form of Grant Instrument under PacificHealth Laboratories, Inc. 2000 Incentive Stock Option Plan for Adam M. Mizel.
N
10.15
Form of Grant Instrument under PacificHealth Laboratories, Inc. 2000 Incentive Stock Option Plan for Marc C. Particelli
N
10.16†
Employment Agreement, effective January 3, 2008, by and between PacificHealth Laboratories, Inc. and Jason Ash
O
10.17
Business Loan Agreement, dated April 21, 2008, by and between PacificHealth Laboratories, Inc. and Grand Bank, N.A.
P
10.18
Promissory Note, in the original principal amount of $675,000, issued on April 21, 2008 by PacificHealth Laboratories, Inc. in favor of Grand Bank, N.A.
P
10.19
Commercial Pledge Agreement, dated April 21, 2008, by and between PacificHealth Laboratories, Inc. and Grand Bank, N.A.
P
10.20
Subordination Agreement, dated April 21, 2008, by and among PacificHealth Laboratories, Inc., Robert Portman, Stephen Kuchen and Grand Bank, N.A.
P
10.21
Separation and Release Agreement, effective August 1, 2008, by and between PacificHealth Laboratories, Inc. and Robert Portman
Q
10.22†
Amendment No. 1 to Employment Agreement, by And between PacificHealth Laboratories, Inc. and Jason Ash, effective August 1, 2008
Q
10.23†
Amendment No. 2 to Employment Agreement, by And between PacificHealth Laboratories, Inc. and Jason Ash, effective June 24, 2009
R
10.24
Separation and Release Agreement, effective January 27, 2010, by and between PacificHealth Laboratories, Inc. and Jason Ash
S
10.25†
Summary of Compensation for Executive Officers of PacificHealth Laboratories, Inc.
*
23.1
-
Consent of WeiserMazars LLP
*
31.1
-
Rule 13a-14(a) Certification of Chief Executive Officer
*
31.2
-
Rule 13a-14(a) Certification of Chief Financial Officer
*
-
Certifications of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
*
*
Filed herewith
†
Management contract or management compensatory plan or arrangement.
A
Filed with Registration Statement on Form SB-2 (Registration No. 333-36379) (the “1997 SB-2”) on September 25, 1997.
B
Filed with Amendment No. 1 to the 1997 SB-2 on October 23, 1997.
C
Filed with Amendment No. 3 to the 1997 SB-2 on December 17, 1997.
D
Filed with Definitive Proxy Statement (Schedule 14A) for annual meeting held on August 16, 2000, filed on July 11, 2000.
E
Filed with Current Report on Form 8-K dated June 1, 2001, filed on June 14, 2001.
F
Filed with Annual Report on Form 10-KSB for the year ended December 31, 2001.
G
Filed with Amendment to Current Report on Form 8-K dated June 1, 2001, filed July 5, 2001.
H
Filed with Annual Report on Form 10-KSB for the year ended December 31, 2002.
I
Filed as Exhibit 3.1 to Current Report on Form 8-K, dated January 24, 2005, filed on January 28, 2005.
J
Filed as Exhibit 10.1 to Current Report on Form 8-K, dated and filed on September 9, 2004.
K
Filed with Annual Report on Form 10-KSB for the year ended December 31, 2004.
L
Filed with Annual Report on Form 10-KSB for the year ended December 31, 2005.
M
Filed as Exhibit to Current Report on Form 8-K, dated December 13, 2006 and filed on December 19, 2006.
N
Filed as Exhibit to Current Report on Form 8-K, dated February 22, 2007 and filed February 27, 2007.
O
Filed as Exhibit to Current Report on Form 8-K, dated November 28, 2007 and filed December 3, 2007.
P
Filed as Exhibit to the Annual report on Form 8-K dated April 29, 2008 and filed on May 2, 2008.
Q
Filed as Exhibit to the Annual report on Form 8-K dated August 8, 2008 and filed on August 11, 2008.
R
Filed as Exhibit to Current Report on Form 8-K dated June 24, 2009 and filed July 1, 2009.
S
Filed as Exhibit to Current Report on Form 8-K, dated January 27, 2010 and filed January 29, 2010.
Note: In the case of incorporation by reference to documents filed by the Registrant under the Exchange Act, the Registrant’s file number under the Exchange Act is 0-23495.
PACIFICHEALTH LABORATORIES, INC.
FINANCIAL STATEMENTS
DECEMBER 31, 2010 and 2009
PACIFICHEALTH LABORATORIES, INC.
Contents
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and
Stockholders of PacificHealth Laboratories, Inc.
WeiserMazars LLP (formerly Weiser LLP) has audited the accompanying balance sheets of PacificHealth Laboratories, Inc. (the “Company”) as of December 31, 2010 and 2009 and the related statements of operations, changes in stockholders' equity and cash flows for the years then ended. The Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of PacificHealth Laboratories, Inc. as of December 31, 2010 and 2009, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note B to the financial statements, the Company has incurred significant recurring operating losses and negative cash flows from operations. These factors raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note B. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ WeiserMazars LLP
New York, New York
March 7, 2011
PACIFICHEALTH LABORATORIES, INC.
Balance Sheets
The accompanying notes should be read in conjunction with the financial statements
PACIFICHEALTH LABORATORIES, INC.
Statements of Operations
The accompanying notes should be read in conjunction with the financial statements
PACIFICHEALTH LABORATORIES, INC.
Statements of Changes in Stockholders' Equity
Years Ended December 31, 2010 and 2009
The accompanying notes should be read in conjunction with the financial statements
PACIFICHEALTH LABORATORIES, INC.
Statements of Cash Flows
The accompanying notes should be read in conjunction with the financial statements
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2010 and 2009
Note A - The Company and Significant Accounting Policies
[1]
The Company:
The Company was incorporated in April 1995 to discover, develop, and commercialize nutritional products. The Company focuses on the development, marketing, and selling of patented premium nutrition tools that enable consumers to enhance their health and improve their performance. The Company’s principal areas of focus are sports performance and recovery, including optimal weight management. The Company utilizes third-party contractors to manufacture all products.
During the quarter ended December 31, 2009, the Company made the decision to forego marketing its FORZE GPS™ weight management product line as the Company was unable to generate enough sales in 2009 to make this product line viable in the foreseeable future. As a result of this decision, the Company recorded a restructuring charge in the amount of $81,050 in the fourth quarter of 2009 consisting of writing- off property and equipment specific to the marketing efforts of FORZE GPS less any realizable salvage values. The Company also recorded a $491,172 reserve for inventory associated with this decision as the value of this inventory may never be realized.
[2]
Cash and cash equivalents:
The Company considers all highly liquid investments with original maturities of three months or less at the date of purchase to be cash equivalents.
[3]
Accounts receivable:
Accounts receivable consist of trade receivables recorded at original invoice amount, less an estimated allowance for uncollectible accounts. Trade credit is generally extended on a short-term basis; thus trade receivables do not bear interest. Trade receivables are periodically evaluated for collectibility by considering a number of factors including the length of time an invoice is past due, the customers' credit worthiness and historical bad debt experience. Changes in the estimated collectibility of trade receivables are recorded in the results of operations for the period in which the estimate is revised. Trade receivables that are deemed uncollectible are offset against the allowance for uncollectible accounts. The Company generally does not require collateral for trade receivables.
[4]
Inventories:
Inventories are recorded at the lower of cost or market using the first-in, first-out ("FIFO") method. The Company determines its reserve for obsolete inventory by considering a number of factors, including product shelf life, marketability, and obsolescence. The Company determines the need to write down inventories by analyzing product expiration, market conditions, and salability of its products.
[5]
Property and equipment:
Property and equipment are stated at cost and is depreciated using the straight-line method over their estimated useful lives ranging from 2 to 5 years.
[6]
Loss per share:
Basic loss per common share is computed by dividing net loss applicable to common shareholders by the weighted average number of common shares outstanding during the year. The dilutive effect of the outstanding stock warrants and options is computed using the treasury stock method. For the year ended December 31, 2010, diluted loss per share did not include the effect of 2,368,500 options outstanding and 322,500 warrants outstanding, respectively, as their effect would be anti-dilutive. For the year ended December 31, 2009, diluted loss per share did not include the effect of 2,462,750 options outstanding and 402,500 warrants outstanding, respectively, as their effect would be anti-dilutive.
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2010 and 2009
[7]
Revenue recognition:
Sales are recognized when all of the following criteria are met: (1) persuasive evidence that an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the seller’s price to the buyer is fixed and determinable; and, (4) collectibility is reasonably assured. Sales are recorded net of incentives paid and discounts offered to customers.
The Company has a purchasing agreement with a significant customer for certain products that are sold on a “pay on scan” basis. The Company recognizes revenue for these products when its major customer sells through these products to the consumer. As of December 31, 2010 and 2009, shipments to this customer amounting to $60,836 and $306,239, respectively, have been reflected as deferred revenue in the Company’s balance sheet.
[8]
Research and development:
Costs of research and development activities are expensed as incurred.
[9]
Advertising costs:
Advertising costs are expensed as incurred. During 2010 and 2009, the Company recorded advertising expense of $213,132 and $309,130, respectively.
[10]
Stock-based compensation:
The Company accounts for equity instrument issuances (including common stock, options, and warrants) in accordance with ASC Topic 718-10-05. Such equity issuances encompass transactions in which an entity exchanges its equity instruments for goods or services including such transactions in which an entity obtains employee and/or director services in share-based payment transactions and issuances of stock options to employees. The Company recorded a charge of $124,934 in the year ended December 31, 2010, representing the effect on loss from operations, loss before income taxes, and net loss. The Company recorded a charge of $299,875 in the year ended December 31, 2009, representing the effect on loss from operations, loss before income taxes, and net loss.
The fair value of the options and warrants granted during the years ended December 31, 2010 and 2009 are determined using the Black-Scholes pricing model with the following assumptions:
The weighted average fair values of options granted during the years ended December 31, 2010 and 2009 were $0.15 and $0.28, respectively. Also see Note J.
[11]
Segment information:
The Company operates in one business segment: the design, development and marketing of dietary and nutritional supplements that enhance health and well-being. Segment disclosures relate to sales data for geographic reasons only.
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2010 and 2009
[12]
Income taxes:
The Company recognizes deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined on the basis of the differences between the tax basis of assets and liabilities and their respective financial reporting amounts ("temporary differences") at enacted tax rates in effect for the years in which the differences are expected to reverse. Any resulting deferred tax asset is reduced, if necessary, by a valuation allowance for any tax benefits that are not expected to be realized.
ASC Topic 740, “Income Taxes”, clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. It prescribes a threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. ASC Topic 740 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure, and transition.
The Company recorded a liability related to uncertain tax positions in the amount of approximately $22,853 and $40,000 at December 31, 2010 and 2009, respectively, relating to certain states in which the Company is required to file state tax returns as they have effectively established nexus in these states. These amounts have been recorded as a component of accounts payable and accrued expenses on the balance sheet and part of income taxes on the statement of operations. The reconciliation of these uncertain tax positions is as follows:
The Company’s 2007, 2008 and 2009 Federal and state income tax returns remain open for examination.
[13]
Impairment of long-lived assets:
Long-lived assets, to be held and used, are reviewed for impairment whenever events or changes in circumstances indicate that the related carrying amounts may not be recoverable using expected future undiscounted cash flows. When required, impairment losses on assets to be held and used are recognized based on the excess of the assets' carrying amount over their fair values as determined by selling prices for similar assets or application of other appropriate valuation techniques. Long-lived assets to be disposed of are reported at the lower of their carrying amounts or fair values less disposal costs.
[14]
Recent accounting pronouncements:
There were no recently issued but not yet effective accounting pronouncements that would have a material impact on the financial statements.
[15]
Use of estimates:
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make certain estimates and assumptions that affect the reported amounts of assets, liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenue and expenses during the reporting period. Actual results may differ from these estimates.
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2010 and 2009
[16] Shipping and handling fees and costs:
Shipping and handling costs are included in cost of sales.
Note B - Basis of Presentation
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. The Company has incurred significant operating losses, negative cash flows from operations, and has an accumulated deficit of $19,648,462 as of December 31, 2010. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. The Company is currently exploring strategic alternatives including, but not limited to, negotiating extended payment terms with its major vendors and raising additional capital.
Note C - Other Short-Term Investments
Excess cash is invested in auction rate securities with long-term maturities, the interest rates of which are reset periodically (typically between 7 and 35 days) through a competitive bidding process often referred to as a "Dutch auction". Despite the underlying long-term maturity of these securities, such securities were typically priced and accounted for as cash equivalents because of the Dutch auction process which has historically provided a liquid market for auction rate securities, as this mechanism generally allows existing investors to rollover their holdings and continue to own their respective securities at the then existing market interest rate or to liquidate their holdings by selling their securities at par value. In 2008, however, primarily due to liquidity issues experienced in global credit and capital markets, many auctions for auction rate securities have failed and the sellers of such securities have been unable to liquidate their securities. A seller must then wait until the next successful auction to attempt to sell its auction rate securities, unless there is a secondary market for the particular securities. As a result of a failed auction, however, the auction rate securities will generally pay interest to the holder at a maximum or default rate defined by the securities' governing documents.
The Company measures fair value utilizing a hierarchy that prioritizes into three levels the components of valuation techniques that are used to measure fair value. The fair value hierarchy gives the highest priority to quoted market prices (unadjusted) in active markets for identical assets or liabilities (Level 1); lower priority to inputs other than quoted prices that are observable for assets or liabilities, either directly or indirectly (Level 2); and the lowest priority to unobservable inputs (Level 3).
The Company has measured these investments as Level 2 inputs.
Accordingly, at December 31, 2010 and 2009, the Company has classified such investments from cash and cash equivalents to other short-term investments. During 2010, the Company redeemed $25,000 of these investments with no gain or loss.
Note D - Inventories
Inventories, which are held at third-party warehouses and on consignment with customers, consist of the following and include reserves of $37,121 at December 31, 2010 and $387,971 at December 31, 2009 which is netted against finished goods at third party warehouse:
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2010 and 2009
Note E - Property and Equipment
Property and equipment consist of the following:
Depreciation expense aggregated $99,591 and $198,089 for the years ended December 31, 2010 and 2009, respectively.
In connection with the restructuring in 2009 (see Note A[1]), the Company wrote-off assets with a cost of $143,709 and accumulated depreciation of $25,883, settled accounts payable with the vendor in the amount of $36,776, and recorded this loss on disposition as restructuring expense for the year ended December 31, 2009.
Note F - Accounts payable and accrued expenses
Accounts payable and accrued expenses consist of the following:
Note G - Notes Payable
The Company has notes payable as follows:
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2010 and 2009
Note H - Stockholders' Equity
The total number of shares of all classes of stock which the Company has authority to issue is 51,000,000 shares, consisting of (a) fifty million (50,000,000) shares of common stock, par value $0.0025 per share, and (b) one million (1,000,000) shares of preferred stock, par value $0.01 per share. The preferred stock may be issued in one or more series, and may have such voting powers, full or limited, or no voting powers, and such designations and preferences as shall be stated in the resolution or resolutions provided for the issue thereof adopted by the Board of Directors of the Company, from time to time.
Note I - Commitments
[1]
Employment agreements:
The Company entered into a Separation and Release Agreement (the “Separation Agreement”) with a former CEO, Mr. Jason Ash, on January 27, 2010. Under the terms of the Separation Agreement, Mr. Ash agreed to provide consulting services for a period of 90 days following the date of the Separation Agreement, and Mr. Ash was entitled to the sum of $5,673 per week for such consulting services. During the one-year period commencing on January 11, 2010, Mr. Ash was entitled to the sum of $295,000, less the sum of consulting fees paid during such period and less any income, wages and/or salary received by Mr. Ash during such period in respect of full-time or substantially full-time employment. The Company also agreed to pay Mr. Ash up to $50,000 for relocation costs under certain circumstances, the cost of life insurance premiums during the period in which he provided consulting services, and the cost of health insurance coverage for a period of six months.
The Separation Agreement also provided that the vesting of all options previously granted to Mr. Ash ceased as of January 11, 2010. All unvested options were terminated and, with respect to options that had vested as of that date, such options are only exercisable during the 90-day period following the expiration of Mr. Ash’s consulting services.
The Company employed Dr. Portman under an employment agreement effective January 1, 2007. Under the employment agreement, Dr. Portman received a salary of $295,000 per year, as well as a car allowance in the amount of $975 per month. In addition, Dr. Portman was entitled to an annual bonus not to exceed 100% of his base salary. The term of Dr. Portman’s employment agreement would have terminated on December 31, 2008, unless terminated earlier by either Dr. Portman or by the Company. On August 5, 2008, the Company entered into a Separation Agreement with Dr. Portman whereby the Company continued to pay the $295,000 salary for twelve months in exchange for a twelve-month non-compete provision. Also, all previously unvested options vested on August 5, 2008.
The Company entered into an employment agreement on January 3, 2008, with Matt Spolar, Vice President, Product Development and Supply Chain, that provided for minimum annual compensation of $190,000. Mr. Spolar was terminated without cause on January 15, 2010, and, under the terms of his employment agreement, the Company will pay him an amount equal to four months of his base salary.
[2]
Lease:
The Company has a lease agreement, as amended, for office space for the rental of 3,200 square feet expiring December 2013.
The future minimum lease payments due under the lease is as follows:
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2010 and 2009
Rent expense amounted to $100,588 and $135,620 in 2010 and 2009, respectively.
[3] Contracts:
The Company signed an agreement with an outside party to provide athletes marketing services. The agreement covers the period from January 1, 2011 through December 31, 2011 and totals $45,000. The Company is required to make payments of $5,000 per month commencing January 2011 through October 2011.
Note J - Stock Option Plans and Warrants
The Company has three stock option plans (the "Plans") under which 1,500,000 shares of common stock are available for issuance.
Stock options may be granted as either incentive stock options intended to qualify under Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), or as options not qualified under Section 422 of the Code. All options are issued with an exercise price at or above 100% of the fair market value of the common stock on the date of grant. Incentive stock option plan awards of restricted stock are intended to qualify as deductible performance-based compensation under Section 162(m) of the Code. Incentive stock option awards of unrestricted stock are not designed to be deductible by the Company under Section 162(m). The Board of Directors determines the option price (not to be less than fair market value for incentive options) at the date of grant. The options have a maximum term of 5 years and outstanding options expire at various times through December 2015. Vesting ranges from immediate to over five years.
Stock option transactions for employees during 2010 and 2009 were as follows:
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2010 and 2009
The market value of the Company’s common stock as of December 31, 2010 was $0.15 per share.
Information with respect to employee stock options outstanding and employee stock options exercisable at December 31, 2010 is as follows:
A summary of the non-vested stock options for employees during 2010 and 2009 were as follows:
As of December 31, 2010, the total fair value of non-vested employee options amounted to $141,177. The weighted average remaining period over which such options are expected to be recognized is 2.39 years.
Per Mr. Ash’s Separation Agreement (see Note I [1] above), 300,000 options at $0.65 with a remaining life of approximately 3 years and 175,000 options at $0.28 with a remaining life of approximately 4.5 years were canceled on January 11, 2010.
The Company recognized an expense of $75,363 and $102,000 for issuance of stock in 2010 and 2009, respectively, for director compensation.
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2010 and 2009
The Company did not grant any stock options to non-employees for the years 2010 and 2009.
Stock option transactions for non-employees during 2010 and 2009 were as follows:
The Company granted 10,000 warrants to non-employee athlete endorsers during 2010 with an exercise price of $0.12 per share. Of these warrants, 5,000 warrants vest in the fourth quarter of 2010 and 5,000 of these warrants vest in the fourth quarter of 2011. These warrants were determined to have a total fair value of $460. Compensation expense recognized during 2010 for these warrants amounted to $232. These amounts were charged to operations and added to additional paid-in capital in accordance with ASC Topic 718. The Company granted 402,500 warrants to non-employee athlete endorsers during 2009 with an exercise price of $0.14 per share. Of these warrants, 109,167 warrants vest in the fourth quarter of 2009; 4,167 warrants vest in the first quarter of 2010; 109,167 of these warrants vest in the fourth quarter of 2010 (of which 30,000 were canceled in 2010); 4,167 warrants vest in the first quarter of 2011; 109,166 of these warrants vest in the fourth quarter of 2011 (of which 30,000 were canceled in 2010); 4,166 warrants vest in the first quarter of 2012; and 62,500 of these warrants vest in the fourth quarter of 2012. These warrants were determined to have a total fair value of $38,713. Compensation expense recognized during 2009 for these warrants amounted to $10,743. This amount was charged to operations and added to additional paid-in capital in accordance with ASC Topic 718-10-05. No warrants were exercised during 2010.
Stock warrant transactions during 2010 and 2009 were as follows:
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2010 and 2009
A summary of the non-vested stock warrants during 2010 and 2009 were as follows:
As of December 31, 2010, the total fair value of non-vested warrants amounted to $14,890. The weighted average remaining period over which such warrants are expected to be recognized is 1.63 years.
Note K - Income Taxes
In December 2009, the Company was approved by the New Jersey Economic Development Authority (the “NJEDA”) to participate in the 2009 NJEDA Technology Business Tax Certificate Transfer Program. This program enables approved, unprofitable technology companies based in the State of New Jersey to sell their unused net operating loss carryovers to unaffiliated, profitable corporate taxpayers in the State of New Jersey for at least 75% of the value of the tax benefits. On February 8, 2010, the Company received $303,931 of net proceeds ($328,669 gross proceeds less $24,738 of expenses incurred) from a third party related to the sale of approximately $3,927,000 of our unused net operating loss carryovers for the State of New Jersey. The Company will use these proceeds for working capital purposes.
The difference between the statutory federal income tax rate on the Company's pre-tax loss and the Company's effective income tax rate is summarized as follows:
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2010 and 2009
At December 31, 2010, the Company has approximately $17,135,000 in federal and $3,767,000 in state net operating loss carryovers that can be used to offset future taxable income. The net operating loss carryforwards begin to expire in the year 2016 through the year 2030.
The components of the Company's deferred tax assets are as follows:
Note L - Concentrations of Credit Risks, Major Customers, and Major Vendors
[1]
Concentrations of credit risk:
Financial instruments, which potentially subject the Company to concentrations of credit risk, consist primarily of cash, cash equivalents and trade accounts receivable.
The Company has concentrated its credit risk for cash by maintaining substantially all of its depository accounts in two financial institutions. Amounts at one of the institutions are insured by the Federal Deposit Insurance Corporation up to $250,000 and amounts at the other institution are insured by the Securities Investor Protection Corporation up to $500,000. These financial institutions have a strong credit rating, and management believes that credit risk relating to these deposits is minimal.
The Company does not require collateral on its trade accounts receivable. Historically, the Company has not suffered significant losses with respect to trade accounts receivable.
[2]
Fair value of financial instruments:
Cash, cash equivalents, accounts receivable, accounts payable and notes payable approximate their fair values due to the short-term maturity of these instruments.
[3]
Major customers:
Three customers accounted for approximately 18%, 12% and 10%, respectively, of net product sales for the year ended December 31, 2010 and two customers accounted for 20% and 14%, respectively, of net product sales for the year ended December 31, 2009. Accounts receivable outstanding related to these three customers at December 31, 2010 were 37%, 13%, and 7%, respectively, of net accounts receivable. Accounts receivable outstanding related to these two customers at December 31, 2009 were 52% and 1%, respectively, of net accounts receivable. Deferred revenue from one of these customers was $60,836 as of December 31, 2010 and $306,239 as of December 31, 2009. Such amounts are included in the accompanying balance sheet. The loss of these customers, a significant reduction in purchase volume by these customers, or the financial difficulty of such customers, for any reason, could significantly reduce our revenues. We have no agreement with or commitment from either of these customers with respect to future purchases.
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2010 and 2009
[4]
Major vendors:
Two suppliers accounted for approximately 76% and 17%, respectively, of total inventory purchases for the year ended December 31, 2010 and two suppliers accounted for 65% and 13%, respectively, of total inventory purchases for the year ended December 31, 2009. At December 31, 2010, amounts due to these two vendors represented approximately 41% and 7%, respectively, of accounts payable and accrued expenses. At December 31, 2009, amounts due to these two vendors represented approximately 42% and 2%, respectively, of accounts payable and accrued expenses.
Note M - Segment and Related Information
In 2010 and 2009, the Company has one reportable segment:
Dietary and nutritional supplements.
The following table presents revenues by region:
Product sales for the years ended December 31, 2010 and 2009 are net of credits of $618,103 and $374,033, respectively, for marketing promotions, customer rebates, and returns of certain products. These credits primarily relate to the sports performance product line.
Note N - Line of Credit
In April 2008, the Company obtained a one-year revolving line of credit with a financial institution with an interest rate equal to the Wall Street Journal Prime Rate (3.25% as of December 31, 2010) with a floor of 5.00%. This line is collateralized by the short-term investments that are deemed auction rate securities. The maximum amount that the Company may borrow is limited to 50% of the value of these auction rate securities. The Company renewed this one-year revolving line of credit that now matures in May 2011 in the amount of $87,500. On February 22, 2010, the Company drew down $87,500, the maximum amount allowed under this line of credit at that time. The Company paid back $12,500 of this line in May 2010.
Note O - CEO Separation Agreement
The Company entered into a Separation Agreement with former CEO Robert Portman effective August 1, 2008. The terms of the agreement consisted of twelve equal monthly payments that aggregated $295,000 and included a non-compete clause. In the twelve months ended December 31, 2009, the Company recognized $172,083 of expense under this Agreement.
The Company entered into a Separation Agreement with former CEO Jason Ash effective January 27, 2010, see Note I [1] above. In the twelve months ended December 31, 2010, the Company recognized $335,618 of expense under this Agreement.
PACIFICHEALTH LABORATORIES, INC.
Notes to Financial Statements
December 31, 2010 and 2009
Note P - Related Party Transaction
On July 27, 2010, the Company entered into a consulting agreement with Signal Nutrition LLC (“Signal”), a company controlled by a director of the Company. Under terms of the Agreement, Signal will work with outside researchers, assist in developing new products, and formulate sales and marketing plans for the Company. The Agreement has an initial term of six months, with options by either party to renew for an additional six months, subject, however, to the right of either party to terminate on 15 days notice. The Company will pay Signal a fee of $11,000 per month, commencing September 1, 2010, during the term of the Agreement. Expense for 2010 is $55,000. Included in accounts payable and accrued expenses as of December 31, 2010 is $11,000 relating to this agreement.
Note Q - Valuation Allowances
The Company’s activity in its allowance for doubtful accounts for the years ended December 31, 2010 and 2009 is summarized as follows:
The Company’s activity in its reserve for obsolete inventory for the years ended December 31, 2010 and 2009 is summarized as follows:
Note R - Subsequent Events
On January 5, 2011, the Company redeemed $25,000 of its auction rate securities and paid down $12,500 on its line of credit from these proceeds.
On February 4, 2011, the Company entered into another consulting agreement with Signal Nutrition LLC (“Signal”), a company controlled by a director of the Company. Under terms of the Agreement, Signal will work with outside researchers, assist in developing new products, and formulate sales and marketing plans for the Company. The Agreement has an indefinite term with an option by either party to terminate the agreement on thirty (30) days notice. The Company will pay Signal a fee of $16,000 per month, commencing March 1, 2011, during the term of the Agreement.
On February 9, 2011, the Company entered into an agreement with its largest vendor whereby extended payment terms were granted to the Company up to 90 days from invoice date up to a maximum credit limit of $750,000. Unpaid invoices under this agreement will bear simple interest at an annual rate of 5%, calculated on a per diem basis, during the period commencing 31 days following the invoice date until paid, payable monthly. Additionally, the vendor has a secured interest in the Company’s accounts receivable.