U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For Quarter Ended: SEPTEMBER 30, 2007
Commission File Number: 0-23100
HEALTHSPORT, INC.
(Exact name of small business issuer as specified in its charter)
DELAWARE 22-2649848
(State of Incorporation) (IRS Employer ID No)
7633 EAST 63RD PLACE, SUITE 220, TULSA, OKLAHOMA 74133
(Address of principal executive office)
(716) 691-6763
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ].
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X].
The number of shares outstanding of registrant's common stock, par value $.0001
per share, as of September 30, 2007, was 41,766,897.
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X].
HEALTHSPORT, INC. AND SUBSIDIARIES
INDEX
Page
----
PART I FINANCIAL INFORMATION (Unaudited)
Item 1: Condensed Consolidated Balance Sheet as of September 30, 2007 3
Condensed Consolidated Statements of Operations for the three
months ended September 30, 2007 and 2006 4
Condensed Consolidated Statements of Operations for the nine
months ended September 30, 2007 and 2006 5
Condensed Consolidated Statements of Cash Flows for the nine
months ended September 30, 2007 and 2006 6-7
Notes to Condensed Consolidated Financial Statements 8-18
Item 2: Management's Discussion and Analysis or Plan of Operation 19-22
Item 3: Controls and Procedures 23
PART II OTHER INFORMATION
Item 6: Exhibits 24
Signatures 25
2
HEALTHSPORT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 2007
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 876,947
Accounts receivable 190,252
Inventory 1,009,098
Prepaid expenses 948,314
-------------------------
Total current assets 3,024,611
Property and equipment, net 659,948
Goodwill 10,326,948
Patent costs and other intangible assets, net 20,615,539
Other assets 100,933
-------------------------
Total assets $ 34,727,979
=========================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 981,229
Accrued expenses 190,496
Current portion of capital lease obligation 212,700
Deferred revenue 555,442
-------------------------
Total current liabilities 1,939,867
-------------------------
Capital lease obligation, less current portion 126,368
-------------------------
Total liabilities 2,066,235
-------------------------
Commitments and contingencies
Stockholders' equity:
Preferred stock: $2.75 par value; authorized 2,000,000 shares;
no shares issued and outstanding -
Common stock: $.0001 par value; authorized 500,000,000 shares;
41,766,897 shares issued and outstanding 4,177
Additional paid-in capital 66,749,307
Intrinsic value of common stock options (3,383,423)
Stock subscriptions receivable (87,508)
Accumulated deficit (30,620,809)
-------------------------
Total stockholders' equity 32,661,744
-------------------------
Total liabilities and stockholders' equity $ 34,727,979
=========================
See accompanying notes to condensed consolidated financial statements.
3
HEALTHSPORT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
(UNAUDITED)
2007 2006
-------------------- --------------------
Revenue
Product sales $ 110,473 $ -
License fees, royalties and services 45,134 -
-------------------- --------------------
Total revenues 155,607 -
-------------------- --------------------
Costs and expenses
Cost of product sold 53,774 -
General and administrative expense 1,373,358 176,922
Marketing and selling expense 670,264 -
Non-cash compensation expense 600,789 -
Manufacturing costs 303,096 -
Research and development costs 130,614 -
-------------------- --------------------
Total costs and expenses 3,131,895 176,922
-------------------- --------------------
Net loss from operations (2,976,288) (176,922)
-------------------- --------------------
Other income (expense):
Interest income 21,968 3,669
Interest expense (6,618) (142,638)
-------------------- --------------------
Other income (expense) 15,350 (138,969)
-------------------- --------------------
Net loss before income taxes and minority interest (2,960,938) (315,891)
Provision for income taxes - -
-------------------- --------------------
Net loss before minority interest (2,960,938) (315,891)
Minority interest - 19,820
-------------------- --------------------
Net loss $ (2,960,938) $ (296,071)
==================== ====================
NET LOSS PER SHARE, BASIC AND DILUTED $ (0.07) $ (0.25)
==================== ====================
WEIGHTED AVERAGE SHARES OUTSTANDING,
BASIC AND DILUTED 41,766,897 1,198,864
==================== ====================
See accompanying notes to condensed consolidated financial statements.
4
HEALTHSPORT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
(UNAUDITED)
2007 2006
-------------------- --------------------
Revenue
Product sales $ 135,058 $ -
License fees, royalties and services 109,156 -
-------------------- --------------------
Total revenues 244,214 -
-------------------- --------------------
Costs and expenses
Cost of product sold 83,542 -
General and administrative expense 2,472,485 392,982
Marketing and selling expense 1,652,489 -
Non-cash compensation expense 1,546,380 -
Manufacturing costs 433,594 -
Research and development costs 1,020,672 -
-------------------- --------------------
Total costs and expenses 7,209,162 392,982
-------------------- --------------------
Net loss from operations (6,964,948) (392,982)
-------------------- --------------------
Other income (expense):
Interest income 65,589 5,633
Abandoned asset - (1,491)
Interest expense (11,725) (776,287)
-------------------- --------------------
Other income (expense) 53,864 (772,145)
-------------------- --------------------
Net loss before income taxes and minority interest (6,911,084) (1,165,127)
Provision for income taxes - -
-------------------- --------------------
Net loss before minority interest (6,911,084) (1,165,127)
Minority interest - 19,820
-------------------- --------------------
Net loss $ (6,911,084) $ (1,145,307)
==================== ====================
NET LOSS PER SHARE, BASIC AND DILUTED $ (0.22) $ (1.13)
==================== ====================
WEIGHTED AVERAGE SHARES OUTSTANDING,
BASIC AND DILUTED 31,964,819 1,010,127
==================== ====================
See accompanying notes to condensed consolidated financial statements.
5
HEALTHSPORT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
(UNAUDITED)
2007 2006
------------------------- ----------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (6,911,084) $ (1,145,307)
Adjustment to reconcile net loss to net cash used
in operating activities:
Minority interest - (19,820)
Amortization of non-cash stock compensation 1,546,380 4,084
Intrinsic value of beneficial conversion feature of
convertible promissory note - 358,880
Depreciation and amortization 616,928 16,605
Common stock issued for services - 58,500
Acquired research and development cost 847,336 -
Abandoned asset - 1,491
Change in other assets and liabilities:
Accounts receivable (103,594) -
Inventory (562,004) (3,500)
Prepaid expenses and other assets (368,354) (78,457)
Accounts payable 584,630 164,539
Accrued expenses 85,826 437,380
------------------------- ----------------------
Net cash used in operating activities (4,263,936) (205,605)
------------------------- ----------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Cash received in excess of cash paid in acquisition of InnoZen 16,832 -
Legal fees associated with acquisition of Neutracuticals (15,811) -
Loans to InnoZen prior to acquisition (500,000) -
Acquisition of property and equipment (187,477) -
------------------------- ----------------------
Net cash used in investing activities (686,456) -
------------------------- ----------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Loan proceeds - 448,600
Collect stock subscription receivable 250,000 -
Loan repayment to related party (108,285) -
Capital lease payments (79,494) -
Sale of common stock 5,446,974 -
------------------------- ----------------------
Net cash provided by financing activities 5,509,195 448,600
------------------------- ----------------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 558,803 242,995
CASH AND CASH EQUIVALENTS, beginning of period 318,144 1,348
------------------------- ----------------------
CASH AND CASH EQUIVALENTS, end of period $ 876,947 $ 244,343
========================= ======================
(Continued)
See accompanying notes to condensed consolidated financial statements.
6
HEALTHSPORT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
(UNAUDITED)
2007 2006
------------------------- ----------------------
SUPPLEMENTAL CASH FLOW INFORMATION
CASH PAID FOR INTEREST AND INCOME TAXES:
Interest $ 11,725 $ -
Income taxes - -
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Issuance of common stock for:
Investment in Health Strip Solutions, LLC $ - $ 900,000
Investment in InnoZen, Inc.:
Current assets, excluding cash 584,993 -
Property and equipment 471,188 -
Goodwill and other intangible assets 27,643,918 -
Research and development 847,336 -
Other assets 10,583 -
-------------------------
Total assets 29,558,018 -
Liabilities assumed (1,449,922) -
Liabilities to HealthSport, Inc. (750,000) -
-------------------------
Purchase price (net assets acquired) 27,358,096 -
Common stock issued (27,374,928) -
-------------------------
Cash acquired in excess of cash paid 16,832 -
=========================
Trade names and web site 74,000 -
Stock subscriptions receivable 172,754 -
Prepaid royalties 204,000 -
Accrued expense 15,000 -
Conversion of convertible notes and accrued interest - 5,006,281
Accounts payable - 161,507
Accounts payable and Idea Management Group, Inc. - 295,840
Property and equipment acquired with a capital lease 99,172 -
See accompanying notes to condensed consolidated financial statements.
7
HEALTHSPORT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following notes to the condensed consolidated financial statements and
management's discussion and analysis or plan of operation contain
"forward-looking" statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. Such forward-looking statements may include projections or
expectations of future financial or economic performance of the Company, and
statements of the Company's plans and objectives for future operations. Words
such as "expects", "anticipates", "approximates", "believes", "estimates",
"hopes", "intends", "plans", and variations of such words and similar
expressions are intended to identify such forward-looking statements. No
assurance can be given that actual results or events will not differ materially
from those projected, estimated, assumed or anticipated in any such
forward-looking statements. Important factors that could result in such
differences, in addition to other factors noted with such forward-looking
statements, include those discussed in Exhibit 99.1 filed with the Securities
and Exchange Commission as an exhibit to the Company's Annual Report on Form
10-KSB for fiscal year 2002.
NOTE 1: ORGANIZATION AND NATURE OF BUSINESS
-------------------------------------------
ORGANIZATION AND BASIS OF PRESENTATION
The condensed consolidated financial statements include the accounts of
HealthSport, Inc. ("HealthSport") and its wholly owned subsidiaries, Enlyten,
Inc. ("Enlyten"), InnoZen, Inc. ("InnoZen"), Health Strip Solutions, LLC
("Health Strip"), Cooley Nutraceuticals, Inc. ("Nutraceuticals"), and the
following inactive subsidiaries, World Championship Poker, Inc. ("Poker"),
Strategic Gaming Consultants, LLC ("Gaming") and Maxx Motorsports, Inc.
("Maxx"), and its wholly owned subsidiary, Team Racing Auto Circuit, LLC
("TRAC") (collectively, the "Company" or the "Companies"). All significant
intercompany balances and transactions have been eliminated in consolidation.
On April 24, 2006, the Company filed a Definitive Information Statement pursuant
to Section 14C which provided that effective May 15, 2006: 1) the name of the
Company would be changed to HealthSport, Inc.; 2) the Company's issued and
outstanding shares would be reverse-split one share for each 200 shares; and 3)
the Company's Certificate of Incorporation would be restated to reflect these
amendments. These amendments were approved by the Company's Board of Directors
and in writing by 52.33% of the Company's shareholders on March 31, 2006.
Accordingly, effective May 15, 2006, the Company's name was changed from Idea
Sports Entertainment Group, Inc. to HealthSport, Inc., the shares were
reverse-split one for 200 and the Company's Certificate of Incorporation was
restated to reflect these amendments. The Company has made the change in
outstanding shares and all references to shares retroactive for all periods
presented in the financial statements.
8
The condensed consolidated financial statements included in this report have
been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission for interim reporting and include all
adjustments (consisting only of normal recurring adjustments) that are, in the
opinion of management, necessary for a fair presentation. These condensed
consolidated financial statements have not been audited.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States have been condensed or omitted pursuant to such rules and
regulations for interim reporting. The Company believes that the disclosures
contained herein are adequate to make the information presented not misleading.
However, these condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's Annual Report for the year ended December 31, 2006,
which is included in the Company's Form 10-KSB for the year ended December 31,
2006. The financial data for the interim periods presented may not necessarily
reflect the results to be anticipated for the complete year.
Certain reclassifications of the amounts presented for the comparative period
have been made to conform to the current presentation.
NATURE OF BUSINESS
HealthSport is a holding company with the following active wholly owned
subsidiaries.
Enlyten was formed to market and sell the Company's ENLYTEN(TM) edible film
strip products.
InnoZen is the preeminent formulator, developer and manufacturer of edible thin
film strips that deliver drug actives and was the first company to deliver a
drug active ingredient in a thin film strip. InnoZen completed the development
of Chloraseptic(R) Sore Throat Relief Strips in June 2003 and launched two new
film strip products under its own Suppress(R) brand (http://www.suppress.com) in
September 2004.
All patent applications for the Companies are processed by InnoZen.
Health Strip, in conjunction with InnoZen, holds the proprietary technology for
the formulation of a thin film electrolyte strip and has filed a provisional
patent for this process. Along with water, electrolytes such as those found in
Health Strip's ENLYTEN(TM) SPORTSTRIPS, can be used in oral rehydration therapy
to replenish the body's electrolyte levels after dehydration caused by exercise,
diarrhea or vomiting. Health Strip and InnoZen also hold the proprietary
technology for ENLYTEN(TM) SURVIVAL STRIPS which are formulated with
antioxidants, non-cavity causing sweeteners, vitamins, herbal extracts,
electrolytes, caffeine and other proven beneficial compounds as a remedy to
fatigue, drowsiness and dehydration.
9
Nutraceuticals holds the proprietary technology for the formulation of a
nutritional supplement that quickly and effectively provides natural energy
enhancers, caffeine, electrolytes, antioxidants and other essential vitamins and
minerals. In conjunction with InnoZen, Nutraceuticals has designed the FIX
STRIPS(TM), as a formulation to supply the body with a healthy boost in energy,
while replenishing and maintaining the essential vitamins and minerals lost
during activity, after a long flight, bad night of sleep or over indulgence of
alcohol.
NEW ACCOUNTING POLICIES
The following accounting policies have been established and adopted by the
Company due to the recent acquisition of InnoZen and the Company's increasing
level of operations.
RESEARCH AND DEVELOPMENT COSTS - Research and development costs are charged to
operations when incurred.
REVENUE RECOGNITION - Revenue is recognized on the sale of licensed products
when title has transferred.
License fees received in advance in exchange for the right to use assets are
recognized over the term of the licensing agreement. Royalties are based on
actual sales of licensed product which are recognized when reported as earned.
Royalty agreements currently provide for rates ranging from 5% to 8%.
Deferred revenue is comprised of advance payments received under various
licensing, royalty and manufacturing agreements, the terms of which range from
five to fifteen years. The payments are not creditable against royalties and are
generally not refundable.
CUSTOMER REBATES AND INCENTIVES - The Company offers various rebates and
incentives to its customers based on customer sales volumes and advertising
plans. The amounts incurred are subject to changes in market conditions,
customer marketing strategies and changes in the profitability or sale of the
related merchandise. These rebates and incentives are offered at the later of
the date at which the related revenue is recognized or the date at which the
rebate or incentive is offered and are recorded as reductions of sales in
accordance with EITF 1-09.
NOTE 2: ACQUISITIONS
--------------------
INNOZEN, INC.
On May 4, 2007, the Company completed the acquisition of InnoZen through a
merger of InnoZen with InnoZen Acquisition Sub, Inc. ("Acquisition Sub"), the
Company's wholly owned subsidiary, all Delaware corporations, in exchange for
18,249,952 shares of the Company's common stock. In accordance with Delaware
General Corporate Law and pursuant to the terms and conditions of the Merger
Agreement, Acquisition Sub was merged with and into InnoZen, after which,
InnoZen became the Company's wholly owned subsidiary and continues as the
surviving corporation and the separate existence of Acquisition Sub ceased.
10
InnoZen is the preeminent formulator, developer and manufacturer of edible thin
film strips that deliver drug actives and was the first company to deliver a
drug active ingredient in a thin film strip when it completed the development of
Chloraseptic(R) Sore Throat Relief Strips in June 2003. With Chloraseptic Relief
Strips, InnoZen established a new process which prevented irritants and
incorporated additional compounds to make the strips more suitable for various
drug delivery needs. Relying on its expertise in the development of edible film
strips that deliver drug actives, InnoZen moved forward with its proprietary
technology to develop two new thin film strip products for cough. InnoZen
launched its two new film strip products under its own Suppress(R) brand
(http://www.suppress.com) in September 2004.
The acquisition was accounted for using the purchase method of accounting and,
accordingly, the consolidated statements of operations include the results of
InnoZen beginning May 4, 2007. The assets acquired and the liabilities assumed
were recorded at estimated fair values as determined by the Company's management
based on information currently available and on current assumptions as to future
operations. A summary of the estimated fair value of assets acquired and
liabilities assumed in the acquisition follows:
Current assets, excluding cash and cash equivalents $ 584,993
Property and equipment 471,188
Other assets 10,583
Intangible assets 19,102,968
Goodwill 8,540,950
Research and development cost 847,336
---------------
Total assets 29,558,018
Liabilities assumed (1,449,922)
Liabilities to HealthSport (750,000)
---------------
Purchase price (net assets acquired) 27,358,096
Common stock issued (27,374,928)
---------------
Cash acquired in excess of cash paid $ 16,832
===============
Unaudited pro forma results of operations for the three and nine-month periods
ended September 30, 2007 and 2006, as if the Company and InnoZen had been
combined as of the beginning of the periods follows. The pro forma results
include estimates and assumptions which management believes are reasonable.
However, pro forma results are not necessarily indicative of the results that
would have occurred if the business combination had been in effect on the dates
indicated, or which may result in the future.
THREE MONTHS ENDED SEPTEMBER 30,
2007 2006
------------ ------------
Net revenues $ 155,607 $ 366,794
Net loss 2,960,938 1,109,686
Net loss per share, basic and diluted $ (0.07) $ (0.06)
11
NINE MONTHS ENDED SEPTEMBER 30,
2007 2006
------------ ------------
Net revenues $ 654,509 $ 526,638
Net loss 7,464,949 2,951,565
Net loss per share, basic and diluted $ (0.19) $ (0.15)
HEALTH STRIP
On March 29, 2006, the Company entered into a Unit Purchase Agreement with the
majority of the unit holders of Health Strip to acquire 80% of Health Strip in
exchange for 500,000 shares of the Company's common stock. Health Strip, in
conjunction with InnoZen, holds certain proprietary technology for the
formulation of a film strip product containing electrolytes to replenish the
body while under physical stress (the "electrolyte strip"), which is the subject
of a provisional patent filed in the U.S. Patent and Trademark office on June
14, 2006. In addition, Health Strip reached an agreement for InnoZen to
manufacture and distribute the electrolyte strips through its California based
manufacturing facility. Through the use of InnoZen's patented manufacturing
process, the electrolyte strips have now been produced. Product names and
packaging were finalized and initial sales began at the end of 2006.
At the time it was acquired, Health Strip did not have any tangible assets or
liabilities, but it did have certain proprietary technology for an electrolyte
replenishment system and the rights to file for a patent of this process.
Accordingly, Health Strip recorded $1,125,000 as an intangible asset for patent
technology rights, 80% of which is equal to the value of the Company's common
stock issued on the date of the transaction. The Company commenced amortization
of its total patent costs in July 2006 over seventeen years. The Company will
periodically evaluate the unamortized balance of the patent and technology costs
and record an impairment loss if warranted.
During December 2006, the Company issued 925,000 shares of its common stock to
acquire the remaining 20% of Health Strip, which was valued at $1,871,250, based
upon the trading price of the Company's stock on the acquisition date. This
amount was reduced by the book value of the associated minority interest of
$135,252 and the resulting $1,735,998 was recorded as goodwill.
NUTRACEUTICALS
On December 6, 2006, the Company issued 375,000 shares of its common stock to
acquire 100% of Nutraceuticals. At the time it was acquired, Nutraceuticals had
a receivable for $3,750 and did not have any liabilities, but it did have
certain proprietary technology for the formulation of a nutritional supplement
that quickly and effectively provides natural energy enhancers, caffeine,
electrolytes, antioxidants and other essential vitamins and minerals. In
conjunction with InnoZen, Nutraceuticals has designed the Company's formulation
to supply the body with a healthy boost in energy, while replenishing and
maintaining the essential vitamins and minerals lost during activity, after a
long flight, bad night of sleep or over indulgence of alcohol. This transaction
was recorded based upon the trading price of the Company's common stock on the
date of the purchase and the resulting $806,250 was allocated $3,750 to accounts
receivable and $802,500 to an intangible asset for patent technology rights. The
Company commenced amortization of the patent costs over seventeen years, the
life of the expected patent in January 2007. The Company will periodically
evaluate the unamortized balance of the patent and technology costs and record
an impairment loss if warranted.
12
In June 2007, the Company issued 50,000 shares of its common stock, valued at
$74,000, and a warrant to acquire 50,000 shares of its common stock at $2.25 per
share to acquire the trade name for HANGOVER FIX(R), FIX STRIPS(TM) and the
website and related domain names.
NOTE 3: INVENTORY
-----------------
Inventory at September 30, 2007, consists of the following:
Raw materials $ 246,506
Work in progress 312,200
Finished goods 450,392
---------------
Total $ 1,009,098
===============
NOTE 4: INTANGIBLE ASSETS
-------------------------
The Company accounts for goodwill and intangible assets in accordance with SFAS
142. Goodwill and other intangible assets are tested annually, at a minimum, for
impairment. Patent costs are amortized over their life of seventeen years from
the date the patent application is filed. Patent costs include the costs
allocated to the proprietary technology for the formulation of thin film
electrolyte strip products and associated legal costs. Trade secrets include
costs allocated to InnoZen's formulations and are being amortized over seventeen
years. Trademarks represent the cost of acquired trademarks, which are not being
amortized. Client lists represents the cost of acquired client lists which are
being amortized over five years.
The Company's intangible assets consist of the following at September 30, 2007:
Goodwill $ 10,326,948
===============
Patent costs and other intangible assets:
Patent and trade secret costs $ 19,122,283
Trademarks 1,188,365
Client lists 846,000
Web site costs in progress 65,675
---------------
Total 21,222,323
Accumulated amortization (606,784)
---------------
Net $ 20,615,539
===============
13
NOTE 5: SHARE-BASED PAYMENTS
----------------------------
STOCK OPTIONS
In December 2004, the FASB issued SFAS 123 (revised 2004), "Share-Based Payment"
(SFAS 123R). Among other things, SFAS 123R requires expensing the fair value of
stock options, previously optional accounting. For transition, upon adoption on
January 1, 2006, SFAS 123R required expensing any unvested options and also
required the Company to change the classification of certain tax benefits from
option deductions to financing rather than operating cash flows.
Prior to January 1, 2006, the Company accounted for options granted under its
employee compensation plan using the intrinsic value method prescribed in
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees" ("APB 25") and related interpretations including Financial
Accounting Standards Board ("FASB") Interpretation No. 44, "Accounting for
Certain Transactions involving Stock Compensation, an interpretation of APB
Opinion No. 25." Under APB 25, compensation expense was recognized for the
difference between the market price of the Company's common stock on the date of
grant and the exercise price. As permitted by Statement of Financial Accounting
Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"), stock-based compensation was included as a pro forma disclosure in the
notes to the consolidated financial statements.
Effective January 1, 2006, the Company adopted the provisions of SFAS 123R using
the modified prospective transition method for all stock options issued. SFAS
123R required measurement of compensation cost for all options granted based on
fair value on the date of grant and recognition of compensation over the service
period for those options expected to vest. The Company had no unvested options
outstanding prior to July 1, 2006. Stock-based compensation expense recorded for
the nine months ended September 30, 2007, includes the estimated expense for
stock options granted on or subsequent to January 1, 2006, based on the grant
date fair value estimated in accordance with the provisions of SFAS 123R. The
Company recorded the cost of stock options by increasing additional paid-in
capital and increasing intrinsic value of common stock options. The deferred
intrinsic value of common stock options is being amortized over the period which
the awards are expected to be exercised. As prescribed under the modified
prospective and prospective transition methods, results for the prior period
have not been restated.
The Company currently fully reserves all of its tax benefits. Accordingly, the
adoption of SFAS 123R, which requires the benefits of tax deduction in excess of
the compensation cost recognized for those options to be classified as financing
cash inflows rather than operating cash inflows, on a prospective basis, will
have no current impact on the Company.
14
The fair value of each option on the date of grant is estimated using the Black
Scholes option valuation model. The following weighted-average assumptions were
used for options granted during the nine months ended September 30, 2007 (none
in the corresponding 2006 period):
Expected term 2-5 years
Expected volatility 95.77 to 102.91%
Expected dividend yield 0%
Risk-free interest rate 4.75%
Expected annual forfeiture rate 0%
A summary of option activity as of September 30, 2007, and changes during the
nine months then ended is presented below:
WEIGHTED
WEIGHTED AVERAGE AGGREGATE
AVERAGE REMAINING INTRINSIC
EXERCISE CONTRACTUAL VALUE
OPTIONS SHARES PRICE TERM (YRS) ($000)
------- ------ ----- ---------- ------
Outstanding, December 31, 2006 425,000
Granted 3,540,390
Exercised -
Forfeited or expired -
-------------------
Outstanding, September 30, 2007 3,965,390 $ 1.60 2.49 $ 4,289
=================== ================ ================= ================
Exercisable at September 30, 2007 3,945,390 $ 1.60 2.48 $ 4,247
=================== ================ ================= ================
The weighted-average grant date fair value of options granted during the nine
months ended September 30, 2007, was $1.07 and $1.18 during the 2006 period. No
options have been exercised.
As of September 30, 2007, there was $3,383,423 of total unrecognized
compensation cost related to share-based option compensation arrangements. The
cost is expected to be recognized over a weighted-average period of 27.75
months.
As of September 30, 2007, there were 3,750 warrants with an exercise price of
$20 per share which expire in November 2007.
Options granted include 2,825,390 which were granted to employees and
consultants of InnoZen to replace its outstanding options on the date of
acquisition of InnoZen.
STOCK GRANTS
In addition to stock options awarded to employees, consultants and
spokespersons, the Company has made stock grants to these parties. These stock
grants are for future services over terms of one to two years, are being
amortized over the period the services are being provided and are summarized
below.
15
NON-CASH STOCK COMPENSATION
The intrinsic value of stock option grants and the value of stock grants are
being amortized as non-cash stock compensation on a straight-line basis over the
relevant period. A summary of the activity follows:
OPTIONS GRANTS TOTAL
------------------- ----------------- -------------------
Balance, December 31, 2006 $ 457,190 $ 694,521 $ 1,151,711
Grants 3,785,845 545,750 4,331,595
Forfeiture - (236,250) (236,250)
Amortization (859,612) (686,768) (1,546,380)
------------------- ----------------- -------------------
Balance, September 30, 2007 $ 3,383,423 $ 317,253 $ 3,700,676
=================== ================= ===================
NOTE 6: CAPITAL LEASE OBLIGATION
--------------------------------
During the year ended December 31, 2005, InnoZen entered into a sale-leaseback
agreement, under which it sold certain manufacturing equipment and leased it
back for a period of three years. The leaseback was accounted for as a capital
lease and no gain was recognized on the transaction. The following is a schedule
by years of future minimum lease payments under capital leases together with the
present value of the net minimum lease payments as of September 30, 2007.
Total minimum lease payments:
Three months ended December 31, 2007 $ 59,193
Year ended December 31, 2008 236,772
Year ended December 31, 2009 23,352
Year ended December 31, 2010 23,352
Year ended December 31, 2011 23,352
Year ended December 31, 2012 13,622
---------------
379,643
Amount representing interest (40,575)
---------------
Present value of minimum lease payments 339,068
Less current obligations (212,700)
---------------
Non-current obligations under capital lease $ 126,368
===============
The lease covers equipment with a cost of $617,618 and accumulated depreciation
of $129,612 at September 30, 2007.
NOTE 7: COMMITMENTS AND CONTINGENCIES
-------------------------------------
The Company maintains its corporate office in the office of its accountant at no
cost to the Company.
16
In January 2007, the Company executed a three-year non-cancelable lease
agreement for the Enlyten office in Amherst, New York. The lease requires
monthly payments of $2,364 for the year ending January 31, 2008, $2,409 for the
year ending January 31, 2009 and $2,455 for the year ending January 31, 2010.
InnoZen leases its facility in Woodland Hills, California pursuant to a
non-cancelable agreement which expires on January 1, 2010. InnoZen has the
option to extend the term for one additional year. Minimum lease commitments at
September 30, 2007 are as follows: 2007 - $31,893; 2008 - $143,700; and 2009 -
$158,828.
The Company has the following royalty obligations:
1. Royalty agreement for 2 years of .5% of sales of the ENLYTEN(TM)
SPORTSTRIPS. Annual minimum royalty of $18,000 and maximum of
$75,000;
2. Royalty agreement for 2 years of .5% of sales of the ENLYTEN(TM)
SPORTSTRIPS. Annual minimum royalty of $15,000 and maximum of
$50,000;
3. Royalty agreement for an indefinite period of .5% of sales of the
ENLYTEN(TM) SPORTSTRIPS. Annual minimum royalty of $36,000 and
maximum of $100,000;
4. Royalty agreement for an indefinite period of 1.0% of the first
$100,000,000 in sales of the ENLYTEN(TM) SPORTSTRIPS and .5% of the
next $150,000,000 in sales;
5. Royalty agreement for an indefinite period of 1.0% of the first
$20,000,000 in sales of the FIX STRIPS(TM) and ENLYTEN(TM) Energy
strips and .5% of the next $80,000,000 in sales; and
6. Royalty agreement for 2 years of 1.5% of sales of the ENLYTEN(TM)
SURVIVAL STRIP with annual minimum royalty payments of $4,200.
The Company is a party to a number of endorsement contracts requiring minimum
payments which average approximately $44,000 per month.
During 2006, InnoZen entered into a distribution contract with Schering-Plough
PTY Limited ("Schering") whereby InnoZen granted to Schering an exclusive,
royalty-free license to distribute, market, offer to sell and import InnoZen's
film strip products in Australia, New Zealand, Singapore, Indonesia, Pakistan,
Hong Kong, Taiwan, Vietnam, Malaysia, Thailand, Korea, Philippines, India and
China ("territories"). Schering appointed InnoZen as the exclusive supplier of
film strip products in the cough and cold market to Schering for distribution in
the territories. With respect to all purchase orders submitted by Schering to
InnoZen, Schering shall pay InnoZen 50% of the invoice amount upon submitting
the purchase order and the remaining 50% of the invoice amount when Schering
receives shipping notification of the order. The contract expires in May 2011.
NOTE 8: RELATED PARTIES
-----------------------
The Company's acting CFO was paid consulting fees of $4,500 and $13,500 during
the three and nine months ended September 30, 2007, respectively, and none
during 2006.
InnoZen repaid a loan from a principal shareholder of the Company in the amount
of $108,285 after it was acquired by the Company.
17
NOTE 9: GOING CONCERN
---------------------
The Company has not established sources of revenue sufficient to fund the
development of business, projected operating expenses and commitments for the
next twelve months. During 2006, the Company acquired Health Strip and
Nutraceuticals to obtain the technology for the formulation of certain film
strip products. Initially the Company contracted with InnoZen to manufacture the
film strip products and acquired InnoZen in early May 2007. Management believes
the electrolyte strip products will be a business capable of generating revenues
sufficient to fund projected operating expenses and commitments. Since September
30, 2007, the Company has collected $1,126,000 from private placement sales of
its common stock and plans to borrow additional funds and also to sell
additional common stock in private placement transactions to raise the
additional capital required to complete its business plan. However, there can be
no assurance that the planned loans, sales of common stock or anticipated sales
will provide sufficient funding to develop the Company's current business plan.
As of September 30, 2007, the Company had working capital of $1,084,744 and had
incurred losses of $2,960,938 and $6,911,084 (pro forma $7,464,949) during the
three and nine months ended September 30, 2007, respectively. In addition, the
Company had revenues of $155,607 and $244,214 (pro forma $654,509) during the
three and nine months ended September 30, 2007, respectively. The Company began
sales of two new products in the fourth quarter, FIX STRIPS(TM) and a lower dose
electrolyte strip for children. However, while the Company expects substantial
sales growth from these and its other products, it is unlikely sales will
generate sufficient cash flow to fund the development of business, projected
operating expenses and commitments before 2008.
These conditions raise substantial doubt about the Company's ability to continue
as a going concern. The condensed consolidated financial statements do not
include any adjustments that may result from the outcome of these uncertainties.
NOTE 10: SUBSEQUENT EVENT
-------------------------
On October 30, 2007, HealthSport, Inc.'s wholly-owned subsidiary, Enlyten, Inc.,
filed a lawsuit against The Gatorade Company and PepsiCo, Inc. (collectively
referred to as Gatorade) in the State of New York Supreme Court, County of Erie.
The Complaint alleges that Gatorade has tortiously interfered with Enlyten's
contractual agreement with the Buffalo Bills and with Enlyten's business
relationships with various third parties including other NFL teams, in an
attempt to wrongfully restrain trade. Enlyten is represented by Michael B.
Powers of the law firm of Phillips Lytle, LLP in Buffalo, New York.
On November 16, 2007, the Company completed a non-binding letter of intent
("LOI") with Migami, Inc. ("MIGA") for a potential joint venture to construct
two new film strip manufacturing facilities in California and Japan. Terms of
the joint venture have not been finalized and those terms outlined in the LOI
may be subject to change.
18
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
>From time to time, we may publish forward-looking statements relative to such
matters as anticipated financial results, business prospects, technological
developments and similar matters. The Private Securities Litigation Reform Act
of 1995 provides a safe harbor for forward-looking statements. The following
discussion and analysis should be read in conjunction with the Consolidated
Financial Statements and the accompanying Notes to Consolidated Financial
Statements appearing earlier in this report. All statements other than
statements of historical fact included in this report are, or may be deemed to
be, forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Exchange Act of 1934,
as amended. Important factors that could cause actual results to differ
materially from those discussed in such forward-looking statements include, but
are not limited to, the following: our current liquidity needs, as described in
our periodic reports; changes in the economy; our inability to raise additional
capital; our involvement in potential litigation; volatility of our stock price;
the variability and timing of business opportunities; changes in accounting
policies and practices; the effect of internal organizational changes; adverse
state and federal regulation and legislation; and the occurrence of
extraordinary or catastrophic events and terrorist acts. These factors and
others involve certain risks and uncertainties that could cause actual results
or events to differ materially from management's views and expectations.
Inclusion of any information or statement in this report does not necessarily
imply that such information or statement is material. We do not undertake any
obligation to release publicly revised or updated forward-looking information,
and such information included in this report is based on information currently
available and may not be reliable after this date.
PLAN OF OPERATION
During the quarter ended June 30, 2007, we completed our sales and marketing
materials for the ENLYTEN(TM) SPORTSTRIPS allowing our sales staff to begin
marketing the product to retailers nationwide beginning June 15, 2007. In
addition, marketing and packaging materials were completed early in the fourth
quarter introducing our two newest products, FIX STRIPS(TM) and a lower dose
electrolyte strip for children. Marketing efforts for the saLE of these two
products began in August 2007 with deliveries expected to start in the fourth
quarter. Due to the seasonal nature of our suppress products, we expect to begin
making deliveries to our retailers at the beginning of the fourth quarter of
2007.
GOING CONCERN
We have not established sources of revenue sufficient to fund the development of
business, projected operating expenses and commitments for the next twelve
months. During 2006, we acquired Health Strip and Nutraceuticals to obtain the
technology for the formulation of certain film strip products. Initially we
contracted with InnoZen to manufacture the film strip products and acquired
InnoZen in early May 2007. Management believes the electrolyte strip products
business will become a business capable of generating revenues sufficient to
fund projected operating expenses and commitments. Since September 30, 2007, we
have collected $1,126,000 from private placement sales of our common stock and
plan to borrow additional funds and also to sell additional common stock in
private placement transactions to raise the additional capital required to
complete our business plan. However, there can be no assurance that the planned
loans, sales of common stock or anticipated sales will provide sufficient
funding to develop our current business plan.
19
As of September 30, 2007, we had working capital of $1,084,744 and had incurred
losses of $2,960,938 and $6,911,084 (pro forma $7,464,949) during the three and
nine months ended September 30, 2007, respectively. In addition, we had revenues
of $155,607 and $244,214 (pro forma $654,509) during the three and nine months
ended September 30, 2007, respectively. We began sales of two new products in
the fourth quarter, FIX STRIPS(TM) and a lower dose electrolyte strip for
children. However, while we expect substantial sales growth from these and our
other products, it is unlikely sales will generate sufficient cash flow to fund
the development of business, projected operating expenses and commitments before
2008.
These conditions raise substantial doubt about our ability to continue as a
going concern. The condensed consolidated financial statements do not include
any adjustments that may result from the outcome of these uncertainties.
ACQUISITION OF INNOZEN
On May 4, 2007, we issued 18,249,952 shares of our common stock to the
shareholders of InnoZen and completed the acquisition of InnoZen through a
merger of InnoZen with our wholly owned subsidiary, Acquisition Sub.
LAWSUIT
On October 30, 2007, our wholly-owned subsidiary, Enlyten, Inc., filed a lawsuit
against The Gatorade Company and PepsiCo, Inc. (collectively referred to as
Gatorade) in the State of New York Supreme Court, County of Erie. The Complaint
alleges that Gatorade has tortiously interfered with Enlyten's contractual
agreement with the Buffalo Bills and with Enlyten's business relationships with
various third parties including other NFL teams, in an attempt to wrongfully
restrain trade. Enlyten is represented by Michael B. Powers of the law firm of
Phillips Lytle, LLP in Buffalo, New York. The alleged interference has severely
limited our ability to market and sell the ENLYTEN(TM) SPORT STRIP.
20
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
REVENUES
During the three months ended September 30, 2007, we had product sales of
$110,473 and revenues from license fees, royalties and services of $45,134, a
total of $155,607. There were no sales in the corresponding 2006 period.
COSTS AND EXPENSES
Cost of product sold includes the direct cost of product sold plus distribution
center costs, freight and shipping supplies.
General and administrative expenses ("G&A") increased to $1,373,358 in the three
months ended September 30, 2007, from $176,922 in the 2006 period. We had
minimal operations in 2006 until completing the acquisition of Health Strip at
the end of March 2006. The major component of the increase is the $979,361 in
G&A for the three months InnoZen was included in the consolidated financial
statements.
Selling and marketing costs are $670,264 in the three months ended September 30,
2007, as compared to none in the 2006 period. Selling and marketing costs did
not commence until the end of 2006. The major components of the 2007 selling and
marketing costs include payments on endorsement contracts, minimum royalty
payments, research fees and sponsorship fees of $208,394, staff payroll of
$164,421, advertising and package development costs of $117,406 and costs
associated with initial trade shows, conferences and events of $84,785.
Non-cash compensation expense of $670,264 includes the amortization of stock
grants and amortization of the intrinsic value of stock options to employees,
consultants and spokespersons over the relevant service periods to both
employees and as a part of endorsement contracts. These agreements were not in
place during the 2006 period.
Manufacturing costs represent the costs incurred during the manufacturing
process that are not capitalized into inventory based on current production
volume for InnoZen in the three months it was included in the consolidated
financial statements.
Research and development ("R&D") costs include $130,614 in R&D was contract
services, supplies, materials and analytical testing costs incurred by InnoZen
during the three months it was included in the consolidated financial
statements.
21
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
REVENUES
During the nine months ended September 30, 2007, we had product sales of
$135,058 and revenues from license fees, royalties and services of $109,156, a
total of $244,214. There were no sales in the corresponding 2006 period.
COSTS AND EXPENSES
Cost of product sold includes the direct cost of product sold plus distribution
center costs, freight and shipping supplies.
General and administrative expenses ("G&A") increased to $2,472,485 in the nine
months ended September 30, 2007, from $392,982 in the 2006 period. We had
minimal operations in 2006 until completing the acquisition of Health Strip at
the end of March 2006. The major components of the increase include $1,553,078
in G&A for the five months InnoZen was included in the consolidated financial
statements, salaries and wages of $248,295, depreciation and amortization of
$87,818, legal and professional fees of $340,154 and travel and entertainment of
$91,578.
Selling and marketing costs are $1,652,489 in the nine months ended September
30, 2007, as compared to none in the 2006 period. Selling and marketing costs
did not commence until the end of 2006. The major components of the 2007 selling
and marketing costs include payments on endorsement contracts, minimum royalty
payments, research fees and sponsorship fees of $532,297, staff payroll of
$414,385, advertising and package development costs of $270,289 and costs
associated with initial trade shows, conferences and events of $201,301.
Non-cash compensation expense of $1,546,380 includes both the amortization of
stock grants to employees and stock grants as part of endorsement contracts over
the relevant service periods and amortization of the intrinsic value of stock
options to both employees and as a part of endorsement contracts.
Manufacturing costs represent the costs incurred during the manufacturing
process that are not capitalized into inventory based on current production
volume for InnoZen in the five months it was included in the consolidated
financial statements.
Research and development ("R&D") costs include $847,336 in R&D which was
capitalized as a part of the purchase of InnoZen and expensed pursuant to the
required method of accounting for R&D. The remaining $173,336 in R&D was
contract services, supplies, materials and analytical testing costs incurred by
InnoZen during the five months it was included in the consolidated financial
statements.
22
ITEM 3: CONTROLS AND PROCEDURES
A third-party consultant has been retained to communicate to management the
disclosures required by reports that are filed under the Exchange Act.
(a) Evaluation of Disclosure Controls and Procedures
Disclosure controls and procedures are controls and other procedures that are
designed to ensure that information required to be disclosed in the reports that
are filed or submitted under the Exchange Act is recorded, processed, summarized
and reported, within the time periods specified in the Securities and Exchange
Commission's rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed in the reports that are filed under the Exchange Act is
accumulated and communicated to management, including the principal executive
officer and principal financial officer, as appropriate to allow timely
decisions regarding required disclosure. Under the supervision of and with the
participation of management, including the principal executive officer and the
principal financial officer, the Company has evaluated the effectiveness of the
design and operation of its disclosure controls and procedures as of September
30, 2007, and, based on its evaluation, our principal executive officer and
principal financial officer have concluded that these controls and procedures
are effective.
(b) Changes in Internal Controls
There have been no significant changes in internal controls or in other factors
that could significantly affect these controls subsequent to the date of the
evaluation described above, including any corrective actions with regard to
significant deficiencies and material weaknesses.
23
PART II - OTHER INFORMATION
ITEM 6: EXHIBITS
(a) Exhibits
Exhibit 31 Certification pursuant to 18 U.S.C. Section 1350
Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32 Certification pursuant to 18 U.S.C. Section 1350
Section 906 of the Sarbanes-Oxley Act of 2002
24
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
HEALTHSPORT, INC.
November 19, 2007 By: /s/ Daniel J. Kelly
-------------------
Daniel J. Kelly, Chief Executive Officer
(Principal Executive Officer)
25