UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2009
Commission File No. 000-25064
HEALTH FITNESS CORPORATION
(Exact name of registrant as specified in its charter)
| Minnesota | No. 41-1580506 | |
| (State or Other Jurisdiction of Incorporation or Organization) | (IRS Employer Identification No.) | |
1650 West 82 nd Street, Bloomington, MN 55431
(Address of Principal Executive Offices)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES ☑ NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES o NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer", "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
| Large accelerated filer o | Accelerated filer o | Non-accelerated filer o | Smaller reporting company ☑ | |||
| (Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO ☑
The number of shares outstanding of the registrant's common stock as of November 11, 2009 was: Common Stock, $0.01 par value, 10,136,550 shares.
Health Fitness Corporation
Consolidated Financial Statements
Table of Contents
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PART I. FINANCIAL INFORMATION | ||||||||
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ITEM 1. Consolidated Financial Statements (unaudited) | ||||||||
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Consolidated Balance Sheets as of September 30, 2009 and December 31, 2008 | 3 | |||||||
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Consolidated Statements of Operations for the three and nine months ended September 30, 2009 and 2008 | 4 | |||||||
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Consolidated Statements of Cash Flows for the three and nine months ended September 30, 2009 and 2008 | 5 | |||||||
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Notes to Consolidated Financial Statements | 6 | |||||||
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ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations | 15 | |||||||
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ITEM 3. Quantitative and Qualitative Disclosures About Market Risk | 22 | |||||||
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ITEM 4. Controls and Procedures | 22 | |||||||
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PART II. OTHER INFORMATION | 23 | |||||||
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ITEM 1. Legal Proceedings | 23 | |||||||
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ITEM 1A. Risk Factors | 23 | |||||||
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ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds | 23 | |||||||
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ITEM 3. Defaults Upon Senior Securities | 23 | |||||||
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ITEM 4. Submission of Matters to a Vote of Security Holders | 23 | |||||||
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ITEM 5. Other Information | 23 | |||||||
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ITEM 6. Exhibits | 23 | |||||||
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Signatures | 24 | |||||||
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Exhibit Index | 25 | |||||||
| EX-11.0 | ||||||||
| EX-31.1 | ||||||||
| EX-31.2 | ||||||||
| EX-32.1 | ||||||||
| EX-32.2 | ||||||||
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PART I. - FINANCIAL INFORMATION
| ITEM 1. | CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) |
HEALTH FITNESS CORPORATION
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
SEPTEMBER 30, 2009 AND DECEMBER 31, 2008
| September 30, | December 31, | |||||||
| 2009 | 2008 | |||||||
ASSETS | ||||||||
CURRENT ASSETS | ||||||||
Cash | $ | 5,194,454 | $ | 1,300,620 | ||||
Trade and other accounts receivable, less allowances of $285,000 and $317,600 | 15,558,692 | 16,306,197 | ||||||
Inventory | 300,757 | 347,510 | ||||||
Prepaid expenses and other | 750,135 | 354,257 | ||||||
Deferred tax assets | 324,831 | 288,626 | ||||||
| ||||||||
Total current assets | 22,128,869 | 18,597,210 | ||||||
PROPERTY AND EQUIPMENT, net | 1,378,396 | 1,243,413 | ||||||
OTHER ASSETS | ||||||||
Goodwill | 14,546,250 | 14,546,250 | ||||||
Software technology, less accumulated amortization of $1,789,200 and $1,301,300 | 2,173,204 | 1,977,071 | ||||||
Trademark, less accumulated amortization of $459,000 and $438,700 | 34,000 | 54,400 | ||||||
Other intangible assets, less accumulated amortization of $367,500 and $313,600 | 161,625 | 215,500 | ||||||
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| $ | 40,422,344 | $ | 36,633,844 | ||||
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LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||
CURRENT LIABILITIES | ||||||||
Trade accounts payable | $ | 1,563,775 | $ | 1,470,440 | ||||
Accrued salaries, wages, and payroll taxes | 3,881,585 | 2,632,329 | ||||||
Other accrued liabilities | 1,138,652 | 1,664,710 | ||||||
Accrued self funded insurance | 217,620 | 310,511 | ||||||
Deferred revenue | 1,708,619 | 1,820,960 | ||||||
| ||||||||
Total current liabilities | 8,510,251 | 7,898,950 | ||||||
DEFERRED TAX LIABILITY | 769,607 | 751,769 | ||||||
LONG-TERM OBLIGATIONS | - | - | ||||||
COMMITMENTS AND CONTINGENCIES | ||||||||
STOCKHOLDERS' EQUITY | ||||||||
| ||||||||
Common stock, $0.01 par value; 25,000,000 shares authorized; 10,136,550 and 9,647,404 shares issued and outstanding at September 30, 2009 and December 31, 2008, respectively | 101,366 | 96,474 | ||||||
Additional paid-in capital | 29,129,448 | 28,263,803 | ||||||
Accumulated comprehensive loss from foreign currency translation | (66,548 | ) | (83,835 | ) | ||||
Retained earnings (accumulated deficit) | 1,978,220 | (293,317 | ) | |||||
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| 31,142,486 | 27,983,125 | ||||||
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| $ | 40,422,344 | $ | 36,633,844 | ||||
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See notes to consolidated financial statements
3
HEALTH FITNESS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
| Three Months Ended | Nine Months Ended | |||||||||||||||
| September 30, | September 30, | |||||||||||||||
| 2009 | 2008 | 2009 | 2008 | |||||||||||||
REVENUE | $ | 19,775,972 | $ | 18,497,423 | $ | 57,764,111 | $ | 56,015,548 | ||||||||
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COSTS OF REVENUE | 13,335,335 | 12,510,045 | 39,419,619 | 39,149,412 | ||||||||||||
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GROSS PROFIT | 6,440,637 | 5,987,378 | 18,344,492 | 16,866,136 | ||||||||||||
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OPERATING EXPENSES | ||||||||||||||||
Salaries | 3,143,231 | 2,950,618 | 9,259,634 | 8,949,305 | ||||||||||||
Other selling, general and administrative | 1,783,897 | 1,485,206 | 5,188,745 | 5,080,973 | ||||||||||||
Amortization of trademarks and other intangible assets | 24,758 | 42,771 | 74,275 | 128,311 | ||||||||||||
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Total operating expenses | 4,951,886 | 4,478,595 | 14,522,654 | 14,158,589 | ||||||||||||
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OPERATING INCOME | 1,488,751 | 1,508,783 | 3,821,838 | 2,707,547 | ||||||||||||
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OTHER INCOME (EXPENSE) | ||||||||||||||||
Interest expense | - | (16,252 | ) | - | (20,383 | ) | ||||||||||
Other, net | 19 | (662 | ) | 1,546 | 412 | |||||||||||
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EARNINGS BEFORE INCOME TAX EXPENSE | 1,488,770 | 1,491,869 | 3,823,384 | 2,687,576 | ||||||||||||
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INCOME TAX EXPENSE | 576,872 | 650,519 | 1,551,847 | 1,158,814 | ||||||||||||
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NET EARNINGS | $ | 911,898 | $ | 841,350 | $ | 2,271,537 | $ | 1,528,762 | ||||||||
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NET EARNINGS PER COMMON SHARE: | ||||||||||||||||
Basic | $ | 0.09 | $ | 0.09 | $ | 0.23 | $ | 0.16 | ||||||||
Diluted | 0.09 | 0.09 | 0.22 | 0.15 | ||||||||||||
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WEIGHTED AVERAGE COMMON SHARES OUTSTANDING: | ||||||||||||||||
Basic | 9,781,522 | 9,610,238 | 9,724,247 | 9,837,994 | ||||||||||||
Diluted | 10,438,155 | 9,688,941 | 10,138,651 | 9,982,990 | ||||||||||||
See notes to consolidated financial statements
4
HEALTH FITNESS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
| Nine Months Ended | ||||||||
| September 30, | ||||||||
| 2009 | 2008 | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||
Net earnings | $ | 2,271,537 | $ | 1,528,762 | ||||
Adjustment to reconcile net earnings to net cash provided by operating activities: | ||||||||
Common stock issued for Board of Directors compensation | 8,636 | - | ||||||
Stock-based compensation | 486,194 | 592,115 | ||||||
Deferred taxes | (18,367 | ) | 233,323 | |||||
Depreciation and amortization | 866,669 | 844,052 | ||||||
Change in assets and liabilities: | ||||||||
Trade and other accounts receivable | 747,505 | 1,249,004 | ||||||
Inventory | 46,753 | 47,664 | ||||||
Prepaid expenses and other | (395,878 | ) | (250,052 | ) | ||||
Other assets | - | 9,807 | ||||||
Trade accounts payable | 110,622 | (757,007 | ) | |||||
Accrued liabilities and other | 630,307 | (1,694,654 | ) | |||||
Deferred revenue | (112,341 | ) | (615,883 | ) | ||||
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Net cash provided by operating activities | 4,641,637 | 1,187,131 | ||||||
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CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||
Purchases of property and equipment | (439,443 | ) | (160,686 | ) | ||||
Capitalized software development costs | (684,067 | ) | (551,582 | ) | ||||
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Net cash used in investing activities | (1,123,510 | ) | (712,268 | ) | ||||
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CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||
Borrowings under line of credit | - | 13,549,495 | ||||||
Repayments under line of credit | - | (13,549,495 | ) | |||||
Repurchase of common stock | - | (2,354,923 | ) | |||||
Proceeds from the issuance of common stock | 186,944 | 189,322 | ||||||
Proceeds from the exercise of stock options | 188,763 | 197,429 | ||||||
| ||||||||
Net cash provided by (used in) financing activities | 375,707 | (1,968,172 | ) | |||||
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NET INCREASE (DECREASE) IN CASH | 3,893,834 | (1,493,309 | ) | |||||
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CASH AT BEGINNING OF PERIOD | 1,300,620 | 1,946,028 | ||||||
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CASH AT END OF PERIOD | $ | 5,194,454 | $ | 452,719 | ||||
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SUPPLEMENTAL CASH FLOW DISCLOSURES | ||||||||
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Supplemental cash flow information: | ||||||||
Cash paid for interest | $ | - | $ | 13,667 | ||||
Cash paid for taxes | 1,124,563 | 719,735 | ||||||
See notes to consolidated financial statements.
5
HEALTH FITNESS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1. ORGANIZATION
Health Fitness Corporation, a Minnesota corporation (also referred to as "we," "us," "our," the "Company," or "Health Fitness"), is a leading provider of population health improvement services and programs to corporations, hospitals, communities and universities located in the United States and Canada. We currently manage 202 corporate fitness center sites, 171 corporate health management sites and 82 unstaffed health management programs.
We provide staffing services as well as a comprehensive menu of programs, products and consulting services within our Health Management and Fitness Management business segments. Our broad suite of services enables our clients' employees to live healthier lives, and our clients to control rising healthcare costs, through participation in our assessment, education, coaching, physical activity, weight management and wellness program services, which can be offered as follows: (i) through on-site fitness centers we manage; (ii) remotely via the web and; (iii) through telephonic health coaching.
You may contact us at our executive offices at 1650 West 82 nd Street, Suite 1100, Bloomington, Minnesota 55431, telephone number (952) 831-6830. We maintain an internet website at www.hfit.com .
NOTE 2. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements for the three and nine months ended September 30, 2009 have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. Financial information as of December 31, 2008 has been derived from our audited consolidated financial statements. In accordance with the rules and regulations of the United States Securities and Exchange Commission, the Company has omitted footnote disclosures that would substantially duplicate the disclosures contained in the audited financial statements of the Company. The unaudited consolidated financial statements should be read together with the financial statements for the year ended December 31, 2008, and the footnotes thereto included in the Company's Form 10-K as filed with the United States Securities and Exchange Commission on March 25, 2009.
In the opinion of management, the interim consolidated financial statements include all adjustments (consisting of normal recurring accruals) necessary for the fair presentation of the results for interim periods presented. These financial statements include some amounts that are based on management's best estimates and judgments. These estimates may be adjusted as more information becomes available, and any adjustment could be significant. The impact of any change in estimates is included in the determination of earnings in the period in which the change in estimate is identified. Operating results for the three and nine months ended September 30, 2009 are not necessarily indicative of the operating results that may be expected for the year ending December 31, 2009.
NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidation - The consolidated financial statements include the accounts of our Company and our wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Cash - We maintain cash balances at several financial institutions, and at times, such balances exceed insured limits. We have not experienced any losses in such accounts and we believe we are not exposed to any significant credit risk on cash. At September 30, 2009 and December 31, 2008, we had cash of approximately $160,400 and $111,800 (U.S. Dollars), respectively, in a Canadian bank account.
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Trade and Other Accounts Receivable - Trade and other accounts receivable represent amounts due from companies and individuals for services and products. We grant credit to customers in the ordinary course of business, but generally do not require collateral or any other security to support amounts due. Management performs ongoing credit evaluations of customers. Accounts receivable from sales of services are typically due from customers within 30 to 90 days. Accounts outstanding longer than contractual payment terms are considered past due. We determine our allowance for doubtful accounts by considering a number of factors, including the length of time trade accounts receivable are past due, our previous loss history, the customer's current ability to pay its obligation to us, and the condition of the general economy and the industry as a whole. We write off accounts receivable when they become uncollectible, and payments subsequently received on such receivable are credited to the allowance. Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers and their geographic dispersion.
Inventories - Inventories, which consist primarily of health management resource materials and supplies used in our biometric screenings services, are stated at the lower of cost or market. Cost is determined using average cost, which approximates the first-in, first-out method.
Property and Equipment - Property and equipment are stated at cost. Depreciation and amortization are computed using both straight-line and accelerated methods over the useful lives of the assets.
Software Development Costs - We expense all costs of software development that we incur to establish technological feasibility of an enhancement, including activities related to initial planning, functionality design, health content sourcing and organization, technical performance requirements and assessing integration issues with the overall software system. Accordingly, software development costs incurred subsequent to the determination of technological feasibility are capitalized. Capitalization of costs ceases and amortization of capitalized software development costs commences when the products are available for their intended purpose. We amortize our capitalized software development costs using the straight-line method over the estimated economic life of the product, which is generally three to five years.
Capitalized software development costs are evaluated for impairment when circumstances indicate an impairment has occurred. Circumstances which might indicate that an impairment has occurred include: (1) a realization that the internal-use software is not expected to provide substantive service potential; (2) a significant change in the extent or manner in which the software is used; (3) a significant change has been made or is being anticipated to the software program; or (4) the costs of developing or modifying the internal-use software significantly exceed the amount originally expected. Recoverability of these capitalized costs is determined by comparing the forecasted future revenues from the related products and services, based on management's best estimates using appropriate assumptions and projections at the time, to the carrying amount of the capitalized software development costs. If the carrying value is determined not to be recoverable from future cash flows, an impairment loss is recognized equal to the amount by which the carrying amount exceeds the future cash flows. We determined that no circumstances existed at September 30, 2009 that would trigger a recoverability evaluation.
During the three and nine months ended September 30, 2009, we capitalized $205,800 and $684,000 of software development costs related to enhancements we made to our eHealth platform. Such enhancements include the development of a program that will allow us to deliver our online health risk assessment services in multiple languages, a web-based point of sale system to electronically capture sales and inventory transactions and improvements to our platform data management infrastructure. These capitalized costs are reported within Software Technology, and will be amortized over the remaining economic life of the eHealth platform, or three to five years, once the programs are placed into service. We expect to recover our capitalized software development costs through the growth of our business, enhancements to our services, and cost efficiencies generated.
Goodwill - Goodwill represents the excess of the purchase price and related costs over the fair value of net assets of businesses acquired. The carrying value of goodwill is not amortized, but is tested for impairment on an annual basis or when factors indicating impairment are present. We elected to complete the annual impairment test of goodwill on
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December 31 of each year and have determined that our goodwill relates to two reporting units for purposes of impairment testing.
For the year ended December 31, 2008, our market capitalization was less than our stockholders' equity. We performed a detailed valuation and reconciliation process and based on this process we concluded that our reconciliation factors are reasonable and support the differential between market capitalization and the estimated aggregate fair value of our reporting segments.
At December 31, 2007 and 2006 our market capitalization exceeded our equity by a significant margin and the reconciliation process described above was not performed for those years. Based upon the results of our testing, we determined that no impairment of goodwill existed at December 31, 2008, 2007, and 2006.
Goodwill of a reporting unit shall be tested between annual impairment tests if events or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. Such events or circumstances include: (1) adverse legal, regulatory or business climate; (2) loss of key personnel; (3) a significant change in assets, liabilities or operating performance; or (4) other changes in the critical estimates outlined above in the testing of goodwill performed at the most recent year end.
At September 30, 2009 we observed no events or circumstances that in our judgment would cause our reporting units, individually or in the aggregate, to require an updated test for impairment and our market capitalization significantly exceeded our stockholders' equity.
Intangible Assets - Our intangible assets include trademarks and tradenames, software and other intangible assets, all of which are amortized on a straight-line basis. Trademarks and tradenames represent the value assigned to acquired trademarks and tradenames, and are amortized over a period of five years. Software technology represents the value assigned to an acquired web-based software program and is amortized over a period of five years. Other intangible assets include the value assigned to acquired customer lists, which is amortized over a period of six years.
Accrued Self-Funded Insurance - We are self-insured, up to certain limits, for employee group health claims. We expense the cost of claims reported and an estimate of claims incurred but not reported. A liability for unpaid claims and the associated claim expenses, including incurred but not reported losses, is estimated using historical claims experience and reflected in the balance sheet as accrued self-funded insurance. The Company has purchased stop-loss insurance in order to limit its exposure, which will reimburse the Company for a participant's claims in excess of $100,000 annually and a participant's aggregate lifetime claims in excess of $2,000,000.
Revenue Recognition - Revenue is recognized at the time the service is provided to the customer. We determine our allowance for discounts by considering historical discount history and current payment practices of our customers. For annual contracts, monthly amounts are recognized ratably over the term of the contract. Certain services provided to the customer may vary on a periodic basis and are invoiced to the customer in arrears. The revenues relating to these services are estimated and recorded in the month that the service is performed.
We also provide services to companies located in Canada. Although we invoice these customers in their local currency, we do not believe there is a risk of material loss due to foreign currency translation.
Amounts received from customers in advance of providing contracted services are treated as deferred revenue and recognized when the services are provided.
We have contracts with third-parties to provide ancillary services in connection with their fitness and wellness management services and programs. Under such arrangements, the third-parties invoice and receive payments from us based on transactions with our customer. We do not recognize revenues related to such transactions as our customer assumes the risk and rewards of the contract and the amounts billed to the customer are either at cost or with a fixed markup.
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Advertising - The Company expenses advertising costs as they are incurred, with the exception of direct response advertising. Direct response advertising is deferred and amortized over the period in which the future benefits are expected to be received.
Comprehensive Income - Comprehensive income is net earnings plus certain other items that are recorded directly to stockholders' equity. Our comprehensive income represents net earnings adjusted for foreign currency translation adjustments.
Net Earnings Per Common Share - Basic net earnings per common share is computed by dividing net earnings by the number of basic weighted average common shares outstanding. Diluted net earnings per share is computed by dividing net earnings by the number of diluted weighted average common shares outstanding, and common share equivalents relating to stock options, unearned restricted stock and stock warrants, if dilutive. Refer to Exhibit 11.0 attached hereto for a detailed computation of earnings per share.
Stock-Based Compensation - We maintain a stock option plan for the benefit of certain eligible employees and directors of the Company. Accounting rules require all share-based payments, including grants of stock options, to be recognized in the income statement as an operating expense, based on their fair values over the requisite service period. The compensation cost we record for these awards is based on their fair value on the date of grant. The Company continues to use the Black Scholes option-pricing model as its method for valuing stock options. The key assumptions for this valuation method include the expected term of the option, stock price volatility, risk-free interest rate and dividend yield. Many of these assumptions are judgmental and highly sensitive in the determination of compensation expense.
Fair Values of Financial Instruments - Due to their short-term nature, the carrying value of our current financial assets and liabilities approximates their fair values. The fair value of long-term obligations, if recalculated based on current interest rates, would not significantly differ from the recorded amounts.
Income Taxes - The Company records income taxes in accordance with the liability method of accounting. Deferred income taxes are provided for temporary differences between the financial reporting and tax basis of assets and liabilities and federal operating loss carryforwards. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of the enactment. Tax benefits are recognized when management believes the benefit is more likely than not to be sustained upon review from the relevant authorities. If the Company were to record a liability for unrecognized tax benefits, interest and penalties would be recorded as a component of income tax expense. Income taxes are calculated based on management's estimate of the Company's effective tax rate, which takes into consideration a federal statutory tax rate of 34% and an average state and local statutory tax rate of approximately 4.5%. The Company's annual estimated effective tax rate of 40.6% is higher than the combined federal and state statutory rate due primarily to the non-deductibility of compensation expense for incentive stock options.
Use of Estimates - Preparing consolidated 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 and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Subsequent Events - We evaluated our quarter ended September 30, 2009 financial statements for subsequent events through November 12, 2009, the date the financial statements were available to be issued. We are not aware of any subsequent events which would require recognition or disclosure in the financial statements.
NOTE 4. SEGMENT REPORTING
A reportable operating segment is a component of a company for which operating results are reviewed regularly by the chief operating decision-makers to determine resource allocation and assess performance. The Company has two
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reportable segments, Fitness Management and Health Management. Total assets are not allocated to the segments for internal reporting purposes. Financial information by segment is as follows:
| Three Months Ended | Nine Months Ended | |||||||||||||||
| September 30, | September 30, | |||||||||||||||
| Segment Data: | 2009 | 2008 | 2009 | 2008 | ||||||||||||
REVENUE: | ||||||||||||||||
Fitness Management | ||||||||||||||||
Staffing Services | $ | 9,174,940 | $ | 9,702,089 | $ | 27,649,173 | $ | 29,245,435 | ||||||||
Program Services | 550,725 | 618,839 | 1,787,251 | 1,888,318 | ||||||||||||
| ||||||||||||||||
| 9,725,665 | 10,320,928 | 29,436,424 | 31,133,753 | ||||||||||||
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Health Management | ||||||||||||||||
Staffing Services | 4,730,518 | 4,552,417 | 13,922,308 | 13,417,216 | ||||||||||||
Program Services | 5,319,789 | 3,624,078 | 14,405,379 | 11,464,579 | ||||||||||||
| ||||||||||||||||
| 10,050,307 | 8,176,495 | 28,327,687 | 24,881,795 | ||||||||||||
| ||||||||||||||||
Total Revenue | ||||||||||||||||
Staffing Services | 13,905,458 | 14,254,506 | 41,571,481 | 42,662,651 | ||||||||||||
Program Services | 5,870,514 | 4,242,917 | 16,192,630 | 13,352,897 | ||||||||||||
| ||||||||||||||||
| $ | 19,775,972 | $ | 18,497,423 | $ | 57,764,111 | $ | 56,015,548 | ||||||||
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GROSS PROFIT: | ||||||||||||||||
Fitness Management | ||||||||||||||||
Staffing Services | 2,174,433 | 2,356,310 | 6,429,704 | 6,822,420 | ||||||||||||
Program Services | 219,271 | 209,267 | 730,439 | 681,973 | ||||||||||||
| ||||||||||||||||
| 2,393,704 | 2,565,577 | 7,160,143 | 7,504,393 | ||||||||||||
| ||||||||||||||||
Health Management | ||||||||||||||||
Staffing Services | 1,233,368 | 1,279,853 | 3,396,659 | 3,456,656 | ||||||||||||
Program Services | 2,813,565 | 2,141,948 | 7,787,690 | 5,905,087 | ||||||||||||
| ||||||||||||||||
| 4,046,933 | 3,421,801 | 11,184,349 | 9,361,743 | ||||||||||||
| ||||||||||||||||
Total Gross Profit | ||||||||||||||||
Staffing Services | 3,407,801 | 3,636,163 | 9,826,363 | 10,279,076 | ||||||||||||
Program Services | 3,032,836 | 2,351,215 | 8,518,129 | 6,587,060 | ||||||||||||
| ||||||||||||||||
| $ | 6,440,637 | $ | 5,987,378 | $ | 18,344,492 | $ | 16,866,136 | ||||||||
| ||||||||||||||||
NOTE 5. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2009, the FASB issued Accounting Standards Update (ASU) No. 2009-01 , Generally Accepted Accounting Principles (ASC Topic 105) which establishes the FASB Accounting Standards Codification (the Codification or ASC) as the official single source of authoritative U.S. generally accepted accounting principles (GAAP). All existing accounting standards are superseded. All other accounting guidance not included in the Codification will be considered non-authoritative. The Codification also includes all relevant Securities and Exchange Commission (SEC) guidance organized using the same topical structure in separate sections within the Codification.
Following the Codification, the Board will not issue new standards in the form of Statements, FASB Staff's Positions or Emerging Issues Task Force Abstracts. Instead, it will issue Accounting Standards Updates (ASU) which will serve to update the Codification, provide background information about the guidance and provide the basis for conclusions on the changes of the Codification. This Topic is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The adoption of this Topic did not have a material effect on our consolidated financial statements.
In June 2009, the FASB issued Statement 167, Amendments to FASB Interpretation No. 46(R), to improve how enterprises account for and disclose their involvement with variable interest entities (VIE's), which are special-purpose entities, and other entities whose equity at risk is insufficient or lack certain characteristics. Among other things, Statement 167 changes how an entity determines whether it is primary beneficiary of a variable interest entity (VIE) and whether that VIE should be consolidated. The new Statement requires an entity to provide significantly more disclosures about its involvement with VIEs. We do not believe the adoption of Statement 167 will have a material effect on our consolidated financial statements.
In May 2009, the FASB issued Accounting Standards Codification (ASC) Topic 855, Subsequent Events , to incorporate the accounting and disclosure requirements for subsequent events into U.S. generally accepted accounting
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principles (GAAP). Topic 855 introduces new terminology, defines a date through which management must evaluate subsequent events, and lists the circumstances under which an entity must recognize and disclose events or transactions occurring after the balance-sheet date. The adoption of Topic 855 in the second quarter of 2009 did not have a material effect on our consolidated financial statements.
In August 2009, the FASB issued Accounting Standards Update (ASU) 2009-05, Fair Value Measurements and Disclosures (Topic 820): Measuring Liabilities at Fair Value. ASU-2009-05 provides guidance clarifying the measurement of liabilities at fair value when no observable data is available. It is effective for the first interim or annual reporting period beginning after August 28, 2009. We do not believe the adoption of ASU-2009-05 will have a material effect on our consolidated financial statements.
NOTE 6 . EQUITY
The following is a summary of the change in Stockholders' Equity for the nine month period ended September 30, 2009:
| Retained | ||||||||||||||||||||||||||||
| Additional | Accumulated | Earnings | Total | |||||||||||||||||||||||||
| Common Stock | Paid-In | Comprehensive | (Accumulated | Stockholders' | Comprehensive | |||||||||||||||||||||||
| Shares | Amount | Capital | (Loss)/Income | Deficit) | Equity | Income | ||||||||||||||||||||||
BALANCE AT DECEMBER 31, 2008 | 9,647,404 | $ | 96,474 | $ | 28,263,803 | $ | (83,835 | ) | $ | (293,317 | ) | $ | 27,983,125 | |||||||||||||||
Issuance of common stock through stock purchase plan | 60,687 | 607 | 186,338 | - | - | 186,945 | ||||||||||||||||||||||
Redemption of common stock for option exercises | (6,295 | ) | (63 | ) | (13,470 | ) | - | - | (13,533 | ) | ||||||||||||||||||
Issuance of common stock for option exercises | 102,150 | 1,022 | 201,274 | - | - | 202,296 | ||||||||||||||||||||||
Issuance of common stock for executive compensation | 35,914 | 359 | 40,180 | - | - | 40,539 | ||||||||||||||||||||||
Issuance of common stock for board of directors compensation | 10,000 | 100 | 8,536 | - | - | 8,636 | ||||||||||||||||||||||
Issuance of common stock for warrants | 5,259 | 53 | (53 | ) | - | - | - | |||||||||||||||||||||
Executive equity compensation program | 281,431 | 2,814 | 183,323 | - | - | 186,137 | ||||||||||||||||||||||
Stock option compensation | - | - | 259,517 | - | - | 259,517 | ||||||||||||||||||||||
Net earnings | - | - | - | - | 2,271,537 | 2,271,537 | $ | 2,271,537 | ||||||||||||||||||||
Foreign currency translation | - | - | - | 17,287 | - | 17,287 | 17,287 | |||||||||||||||||||||
| ||||||||||||||||||||||||||||
Comprehensive Income | $ | 2,288,824 | ||||||||||||||||||||||||||
| ||||||||||||||||||||||||||||
BALANCE AT SEPTEMBER 30, 2009 | 10,136,550 | $ | 101,366 | $ | 29,129,448 | $ | (66,548 | ) | $ | 1,978,220 | $ | 31,142,486 | ||||||||||||||||
| ||||||||||||||||||||||||||||
Stock Options - We maintain a stock option plan for the benefit of certain eligible employees and our directors. We have authorized 2,000,000 shares for grant under our Amended and Restated 2005 Stock Option Plan, and a total of 253,825 shares of common stock are reserved for additional grants of options at September 30, 2009. Generally, the options outstanding are granted at prices equal to the market value of our stock on the date of grant, generally vest over four years and expire over a period of six or ten years from the date of grant.
For the three and nine months ended September 30, 2009, we recorded stock option compensation expense of $73,400 and $259,500, respectively, compared to $96,800 and $334,400, respectively, for the three and nine months ended September 30, 2008. The compensation expense, net of tax effects, reduced diluted earnings per share by approximately $0.01 and $0.03 for the nine months ended September 30, 2009 and 2008, respectively.
As of September 30, 2009, approximately $451,000 of total unrecognized compensation costs related to non-vested awards is expected to be recognized over a weighted average period of approximately 2.11 years.
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The following table summarizes information about stock options at September 30, 2009:
| Options Outstanding | Options Exercisable | |||||||||||||||||||
| Weighted Average | Weighted | Weighted | ||||||||||||||||||
| Remaining | Average | Average | ||||||||||||||||||
| Range of | Number | Contractual Life | Exercise | Number | Exercise | |||||||||||||||
| Exercise Prices | Outstanding | In Years | Price | Exercisable | Price | |||||||||||||||
| $0.94 - $1.77 | 76,000 | 5.29 | $ | 0.28 | 17,500 | $ | 1.20 | |||||||||||||
| 1.90 - 2.50 | 83,850 | 2.35 | 3.67 | 58,850 | 2.41 | |||||||||||||||
| 2.52 - 4.54 | 278,050 | 4.30 | 3.97 | 266,800 | 3.97 | |||||||||||||||
| 4.56 - 6.10 | 637,750 | 3.78 | 5.37 | 360,688 | 5.42 | |||||||||||||||
| ||||||||||||||||||||
| 1,075,650 | 3.91 | $ | 4.52 | 703,838 | $ | 4.51 | |||||||||||||
| ||||||||||||||||||||
We use the Black-Scholes option pricing model using weighted average assumptions for options granted to determine the fair value of options. The fair value of options at date of grant and the assumptions utilized to determine such values are indicated in the following table:
| Three Months Ended | ||||||||
| September 30, | ||||||||
| 2009 | 2008 | |||||||
Risk-free interest rate | 1.75 | % | 2.99 | % | ||||
Expected volatility | 43.9 | % | 37.9 | % | ||||
Expected life (in years) | 3.58 | 3.53 | ||||||
Dividend yield | - | - | ||||||
Forfeitures | 13.0 | % | 0.0 | % | ||||
Option transactions under the 2005 Stock Option Plan during the nine months ended September 30, 2009 are summarized as follows:
| Weighted | Weighted | |||||||||||||||
| Average | Aggregate | Average | ||||||||||||||
| Exercise | Intrinsic | Remaining | ||||||||||||||
| Options | Price | Value | Term | |||||||||||||
Outstanding at December 31, 2008 | 1,055,550 | $ | 4.43 | |||||||||||||
Granted | 126,000 | 3.09 | ||||||||||||||
Exercised | (102,150 | ) | 1.98 | |||||||||||||
Canceled/Forfeited | (3,750 | ) | 1.90 | |||||||||||||
| ||||||||||||||||
Outstanding at September 30, 2009 | 1,075,650 | $ | 4.52 | $ | 1,201,279 | 3.41 | ||||||||||
| ||||||||||||||||
Exercisable at September 30, 2009 | 703,838 | $ | 4.51 | $ | 790,712 | 3.03 | ||||||||||
| ||||||||||||||||
Restricted Stock - In connection with our employment agreement dated as of December 1, 2006 with Gregg O. Lehman, Ph.D., our President and Chief Executive Officer, on January 1, 2007 we granted an award of 25,000 shares of restricted common stock to Mr. Lehman, which was valued at a price of $5.30 per share on the date of grant. This restricted common stock vested in three equal installments on the first of the year for each of 2007, 2008 and 2009. This restricted common stock has the same voting rights as common shares. For both the three and nine months ended September 30, 2009, we recorded stock-based compensation related to this grant of $0 compared to $5,500 and $16,500, respectively, for the three and nine months ended September 30, 2008.
On April 7, 2008, we granted an award of 10,000 shares of restricted stock to Wesley W. Winnekins, our Chief Financial Officer, under the Equity Incentive Plan (as defined below). This restricted common stock vests in two equal installments on December 31, 2008 and 2009. This restricted common stock has the same voting rights as common shares. For the three and nine months ended September 30, 2009, we recorded stock-based compensation related to this grant of $3,300 and $9,900, respectively, compared to $11,000 and $22,000, respectively, for the three and nine months ended September 30, 2008. This grant was valued using a price of $4.60 per share, which was the market value of our common stock on the date of the grant. As of September 30, 2009, $3,300 of unrecognized compensation costs related to the non-vested portion of this award will be recognized through December 31, 2009.
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On December 8, 2008, we granted an award of 10,000 shares of restricted stock to J. Mark McConnell, our Senior Vice President of Business Development under the Equity Incentive Plan (as defined below). This restricted common stock vests in three equal installments on December 8 for each of 2009, 2010 and 2011. This restricted common stock has the same voting rights as common shares. For the three and nine months ended September 30, 2009, we recorded stock-based compensation related to this grant of $3,800 and $11,400, respectively. This grant was valued using a price of $2.48 per share, which was the market value of our common stock on the date of grant. As of September 30, 2009, $12,100 of unrecognized compensation costs related to the non-vested portion of this award will be recognized through November 30, 2011.
On February 26, 2009, we granted 35,914 shares of restricted stock to our executives under the Equity Incentive Plan (as defined below). This restricted common stock vests in four equal installments on February 26 of 2010, 2011, 2012, and 2013. This restricted common stock has the same voting rights as common shares. For the three and nine months ended September 30, 2009, we recorded stock-based compensation related to this grant of $8,300 and $19,300, respectively. This grant was valued using a price of $1.77 per share, which was the market value of our common stock on the date of the grant. As of September 30, 2009, $44,200 of unrecognized compensation costs related to the non-vested portion of this award will be recognized through February 26, 2013.
On May 27, 2009, we granted 10,000 shares of restricted stock to Wendy D. Lynch, a board director. This restricted common stock vests in three equal installments on May 27 for each of 2010, 2011 and 2012. This restricted common stock has the same voting rights as common shares. For the three and nine months ended September 30, 2009, we recorded stock-based compensation related to this grant of $6,500 and $8,600, respectively. This grant was valued using a price of $4.24 per share, which was the market value of our common stock on the date of grant. As of September 30, 2009, $33,800 of unrecognized compensation costs related to the non-vested portion of this award will be recognized through May 30, 2012.
Employee Stock Purchase Plan - We maintain an Employee Stock Purchase Plan, which allows employees to purchase shares of our common stock at 95% of the fair market value. On May 27, 2009 we increased the total number of shares reserved for issuance under the Employee Stock Purchase Plan by 200,000 shares, thus increasing our total shares of common stock reserved for issuance to 700,000 of which 259,457 shares are unissued and remain available for issuance at September 30, 2009.
Equity Incentive Plan - At our Annual Meeting of Shareholders on May 21, 2007, our shareholders approved the implementation of our 2007 Equity Incentive Plan (the "Equity Plan"). The Equity Plan was developed to provide our executives with restricted stock incentives if certain financial targets are achieved for calendar years 2007 through 2009. In lieu of selecting restricted stock, and at the discretion of our Board of Directors, executives can choose to receive a cash bonus under our 2007 Cash Incentive Plan (the "Cash Plan"). The performance objectives, and monetary potential of grants under the Cash Plan would be the same as those under the Equity Plan and participants would receive their cash bonuses at the same time as the restricted stock vests under the Equity Plan. Restricted stock granted under the Equity Plan through September 30, 2009, other than the restricted stock granted to our Chief Financial Officer in April 2008 and our Senior Vice President of Business Development in December 2008 as described previously, is earned on an annual basis upon achievement of certain financial objectives for each of 2007, 2008 and 2009. All such shares earned during these years will vest upon completion of our 2009 annual audit. For the three and nine months ended September 30, 2009, we recorded $62,000 and $186,000, respectively, of stock-based compensation related to elections under the Equity Plan, which was valued using a price of $5.56 per share, the market value of our common stock on the grant date. We also accrued $7,100 and $21,300 of bonus expense related to elections under the Cash Plan for both the three and nine months ended September 30, 2009. As of September 30, 2009, $124,100 of unrecognized compensation costs related to the non-vested portion of this program will be recognized through March 2010.
Common Stock Repurchase Plan - During 2008, we repurchased 570,680 common shares at an aggregate cost of $2.3 million, including commissions of $34,000. All repurchased shares have been retired. These purchases concluded the common stock repurchase plan, announced on March 24, 2008, authorizing the Company to repurchase up to $2.5 million of its outstanding common stock.
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Reverse Stock Split - On October 6, 2008 we completed a one-for-two reverse stock split in order to qualify for listing on the American Stock Exchange, now known as the NYSE AMEX. Except where specifically indicated, all common share information (including information related to stock options and other equity awards) and all "per share" information related to our common stock in this report has been restated to reflect the one-for-two reverse split. Pursuant to provisions in our stock options agreements and equity plans, the number of common shares available for purchase and issuance under these agreements and plans, and the exercise prices, were automatically adjusted to give proportionate effect to this reverse split.
NOTE 7 . CONTINGENCIES
Legal Proceedings - We are involved in various claims and lawsuits incidental to the operation of our business. We believe that the outcome of such claims will not have a material adverse effect on our financial condition, results of operation, or cash flows.
Automotive Bankruptcies - On April 30, 2009, an automotive customer in our fitness management segment filed for bankruptcy protection under Chapter 11. Our outstanding receivable from this customer was approximately $34,000. The customer has paid the outstanding balance and continues to make timely payments on the continued monthly service billings. In addition, we collected receivable payments of approximately $137,000 from the customer during the 90 days before the bankruptcy filing. Such payments may constitute preferential payments recoverable under the Bankruptcy Code. We believe we have valid defenses to any potential claim for these payments and will not be required to repay the full amount. This customer has assumed our contract as of May 22, 2009. On June 1, 2009, another automotive customer in our fitness management segment filed for bankruptcy protection under Chapter 11. Our outstanding receivable from this customer was approximately $283,000. The customer has paid the outstanding balance and continues to make timely payments on the continued monthly service billings. In addition, we collected receivable payments of approximately $110,000 from the customer during the 90 days before bankruptcy. Such payments may constitute preferential payments recoverable under the Bankruptcy Code. We believe we also have valid defenses to any potential claim for these payments. This customer has assumed our contracts as of July 10, 2009. Our revenue from these customers was approximately $2,909,000 and $1,087,000 for the year ended December 31, 2008 and the nine months ended September 30, 2009, respectively.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis of our financial condition and results of operations together with our financial statements and the related notes appearing under Item 1 of Part 1. Some of the information contained in this discussion and analysis or set forth elsewhere in this quarterly report, including information with respect to our plans and strategy for our business and expected financial results, includes forward-looking statements that involve risks and uncertainties. You should review the "Risk Factors" under Item 1A of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2008 for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.
CRITICAL ACCOUNTING POLICIES
Our most critical accounting policies, which are those that require significant judgment, include: revenue recognition, trade and other accounts receivable, goodwill, stock-based compensation, income taxes, and self-funded insurance. A more in-depth description of these can be found in Note 3 to the interim consolidated financial statements included in this Quarterly Report and Note 1 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2008.
BUSINESS DESCRIPTION
As a leading provider of population health improvement services and programs to corporations, hospitals, communities and universities located in the United States and Canada, we currently manage 202 corporate fitness center sites, 171 corporate health management sites and 82 unstaffed health management programs.
We provide staffing services as well as a comprehensive menu of programs, products and consulting services within our Health Management and Fitness Management business segments. Our broad suite of services enables our clients' employees to live healthier lives, and our clients to control rising healthcare costs, through participation in our assessment, education, coaching, physical activity, weight management and wellness program services, which can be offered as follows: (i) through on-site fitness centers we manage; (ii) remotely via the web; and (iii) through telephonic health coaching.
RESULTS OF OPERATIONS
The following table sets forth our statement of operations data as a percentage of total revenues for the quarter ended September 30, 2009 and 2008:
| Three Months Ended | Nine Months Ended | |||||||||||||||
| September 30, | September 30, | |||||||||||||||
| 2009 | 2008 | 2009 | 2008 | |||||||||||||
REVENUE | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
COSTS OF REVENUE | 67.4 | % | 67.6 | % | 68.2 | % | 69.9 | % | ||||||||
| ||||||||||||||||
GROSS PROFIT | 32.6 | % | 32.4 | % | 31.8 | % | 30.1 | % | ||||||||
OPERATING EXPENSES | ||||||||||||||||
Salaries | 15.9 | % | 16.0 | % | 16.0 | % | 16.0 | % | ||||||||
Other selling, general and administrative | 9.0 | % | 8.0 | % | 9.0 | % | 9.1 | % | ||||||||
Amortization of acquired intangible assets | 0.1 | % | 0.2 | % | 0.1 | % | 0.2 | % | ||||||||
| ||||||||||||||||
Total operating expenses | 25.0 | % | 24.2 | % | 25.1 | % | 25.3 | % | ||||||||
| ||||||||||||||||
OPERATING INCOME | 7.6 | % | 8.2 | % | 6.7 | % | 4.8 | % | ||||||||
OTHER INCOME (EXPENSE) | 0.0 | % | -0.1 | % | 0.0 | % | 0.0 | % | ||||||||
| ||||||||||||||||
EARNINGS BEFORE INCOME TAXES | 7.6 | % | 8.1 | % | 6.7 | % | 4.8 | % | ||||||||
INCOME TAX EXPENSE | 2.9 | % | 3.5 | % | 2.7 | % | 2.1 | % | ||||||||
| ||||||||||||||||
NET EARNINGS | 4.7 | % | 4.6 | % | 4.0 | % | 2.7 | % | ||||||||
| ||||||||||||||||
15
Results of Operations for the quarter ended September 30, 2009 compared to the quarter ended September 30, 2008.
Revenue. Revenue increased $1,279,000 or 6.9%, to $19,776,000 for the three months ended September 30, 2009, from $18,497,000 for the three months ended September 30, 2008.
Fitness Management
Our Fitness Management segment declined 5.8%, or $595,000, which included a decline in staffing services of $527,000 or 5.4%, and a decline in program services of $68,000, or 11% . This overall revenue decline is primarily due to contract terminations we experienced in 2008 and 2009 related to customer reaction to the recessionary business climate. The decline in program services, as compared to last year, was primarily due to contract terminations and lower participation in personal training and specialty classes.
Health Management
Our Health Management segment contributed total revenue growth of 22.9%, or $1,874,000, which included growth from staffing services of $178,000, or 3.9%, and growth from program services of $1,696,000, or 46.8%. Overall, the growth in staffing revenue is attributable to new customers and the expansion of sales to existing customers. The increase in program services, compared to last year, was primarily driven by an increase in health coaching and advising services and biometric screening services.
2009 Customer Commitments and Cancellations
For the three months ended September 30, 2009, the Company received a total of four health management commitments and two fitness management commitments. This commitment activity for 2009 may realize annualized revenue of $5.2 million, to be partially offset by a potential annualized revenue loss of $0.4 million from fitness and health management contract cancellations. These cancellations reflect the continuing weakness in the economy and the financial challenges companies expect to face in the foreseeable future.
Gross Profit. Gross profit increased $453,000 or 7.6%, to $6,441,000 for the three months ended September 30, 2009, from $5,987,000 for the three months ended September 30, 2008. Total gross margin increased to 32.6%, from 32.4% for the same period last year, which is primarily due to Health Management revenue representing a larger percentage of our total revenue.
Fitness Management
Fitness Management gross profit decreased $172,000, which includes a decrease of $182,000 from staffing services, partially offset by an increase of $10,000 from program services. Gross margin for our Fitness Management segment decreased in the three months ended September 30, 2009 to 24.6%, from 24.9% for the same period of 2008. This result is primarily due to a gross margin decrease in staffing services, which decreased from 24.3% for the same period last year, to 23.7%, partially offset by a gross margin increase in program services, which increased from 33.8% for the same period last year, to 39.8%. The margin decrease for staffing services is primarily due to increased wage costs. The margin increase for program services is primarily due to labor efficiencies for personal training and massage services.
Health Management
Health Management gross profit increased $625,000, which includes an increase of $672,000 from program services, reduced by a decrease of $47,000 from staffing services. Gross margin for our Health Management segment decreased in the three months ended September 30, 2009 to 40.3%, from 41.8% for the same period of 2008. This result is
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primarily due to a gross margin decrease in program services, which decreased from 59.1% for the same period last year, to 52.9%, further reduced by a gross margin decrease in staffing services, which decreased from 28.1% for the same period last year, to 26.1%. The margin decrease for staffing services is primarily due to higher costs for employee paid time off and increased wage costs. The margin decrease in program services is primarily due to the mix of programs delivered, the addition of telephonic health coaches during the quarter and higher costs for our eHealth platform.
Operating Expenses and Operating Income. Operating expenses increased $473,000, or 10.6%, to $4,952,000 for the three months ended September 30, 2009, from $4,479,000 for the three months ended September 30, 2008.
The increase is primarily due to higher costs for management incentive programs and higher customer service costs that reflect the growth in health improvement programs. For the three months ended September 30, 2009, operating expenses, as a percent of revenue, were 25.0%, compared to 24.2% for the same period last year.
Operating margin decreased to 7.5% for the three months ended September 30, 2009, from 8.2% for the same period last year. This result reflects the higher operating expenses, as discussed above, reduced by sales growth in our Health Management segment.
Other Income and Expense. Interest expense was inconsequential during the quarters ended September 30, 2009 and 2008.
Income Taxes. Income tax expense decreased $74,000 to $577,000 for the three months ended September 30, 2009, from $651,000 for the three months ended September 30, 2008. The decrease is due primarily to a lower effective tax rate for the quarter ended September 30, 2009, compared to the same period of 2008.
Our effective tax rate was 38.7% of earnings before income taxes for the third quarter of 2009, compared to 43.6% for the same period last year. The lower effective tax rate as compared to the corresponding period of 2008 is primarily due to the lower non-deductible stock based compensation expense in proportion to earnings before income taxes.
Net Earnings. Net earnings increased $71,000 to $912,000 for the three months ended September 30, 2009, from $841,000 for the three months ended September 30, 2008. This increase is primarily due to the sales growth in our Health Management segment and lower income taxes, reduced by higher operating expenses, as discussed above.
Results of Operations for the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008.
Revenue. Revenue increased $1,749,000, or 3.1%, to $57,764,000 for the nine months ended September 30, 2009, from $56,015,000 for the nine months ended September 30, 2008.
Fitness Management
Our Fitness Management segment declined $1,697,000, which included a decline in staffing services of $1,596,000 and a decline in program services of $101,000 . This revenue decline is primarily due to contract terminations in 2008 and 2009, and lower participation in personal training and specialty classes.
If the economic recession continues for the remainder of 2009, it is possible we could continue to experience a higher level of staffing services revenue loss in our Fitness Management segment. Our most at risk contracts include those in the automotive industry, although we believe the current recession may have an adverse impact on many industries, which could affect our other customers and lead to further revenue loss from contract termination or service reduction. With respect to the automotive industry, we have lost approximately $1.4 million in revenue when comparing the nine month period ended September 30, 2009 to the corresponding period of 2008. During 2009, we expect to realize
17
approximately $1.4 million in revenue from our "at risk" automotive contracts, and if their financial difficulties continue, we may see additional revenue losses.
It is also possible we could experience further declines in Fitness Management program service revenue during 2009. Program service revenue is derived from fees we charge to members of our managed fitness centers for services such as personal training, massage therapy, weight loss programs and special fitness classes. The revenue decline we experienced in the first half of 2009 is attributed to the effects of the recessionary economy, employment reductions and our members decreasing their spending on discretionary services. We believe this trend will continue during 2009.
Because we are the largest provider of fitness management services in the United States, we believe the number of opportunities to bid on new business during 2009 should be consistent with past years. In order to increase our chances of winning new business in 2009 and reverse the historical decline of our fitness management revenue, we also believe that we will need to lower our pricing to be competitive in this market, which may result in lower profitability.
Health Management
Our Health Management segment contributed total growth of $3,446,000, which includes growth of $505,000 from staffing services and growth of $2,941,000 from program services. Overall, the growth in staffing revenue is attributable to new customers and the expansion of sales to existing customers. The increase in program services revenue is primarily due to an increase in our core health programs, including biometric screening services, health coaching and advising services and eHealth platform revenue.
For 2009, we anticipate that the economic recession may have a negative impact on revenue from existing customers. It is possible that many of our health management customers may reduce the scope of, or eliminate their programs during 2009 as a measure to conserve cash and improve profitability. Our health management revenue may also be negatively affected by lower participation rates at some customers due to employee layoffs. At the same time, the recessionary economy has also lengthened the sales cycle for new opportunities. The combination of these events, if they materialize, may challenge our ability to increase 2009 revenue on a basis consistent with past growth.
2009 Customer Commitments and Cancellations
For the nine months ended September 30, 2009, the Company received a total of eleven health management commitments, three expansions of health management services to existing clients, and seven fitness management commitments. This commitment activity for 2009 may realize annualized revenue of $11.2 million, to be partially offset by a projected annualized revenue loss of $2.2 million from fitness and health management contract cancellations. These cancellations reflect the continuing weakness in the economy and the financial challenges companies expect to face in the foreseeable future.
Gross Profit. Gross profit increased $1,478,000, or 8.8%, to $18,344,000 for the nine months ended September 30, 2009, from $16,866,000 for the nine months ended September 30, 2008. Total gross margin in the nine months ended September 30, 2009 increased to 31.8% from 30.1% for the same period last year, which is primarily due to Health Management revenue representing a larger percentage of our total revenue and improved margins for Health Management program services.
18
Fitness Management
Fitness Management gross profit decreased $344,000, which includes a decrease of $393,000 from staffing services, partially offset by an increase of $49,000 from program services. Gross margin for our Fitness Management segment increased in the nine months ended September 30, 2009 to 24.3%, from 24.1% for the same period of 2008. This result is primarily due to a gross margin increase in program services, which increased from 36.1% for the same period last year, to 40.9%. Gross margin in staffing services remained flat at 23.3%. The margin increase for program services is primarily due to the mix of programs delivered and labor efficiencies for personal training and massage services.
Health Management
Our Health Management segment contributed gross profit growth of $1,823,000, which includes growth of $1,883,000 from program services and a decline of $60,000 from staffing services. Gross margin for our Health Management segment increased in the nine months ended September 30, 2009 to 39.5%, from 37.6% for the same period of 2008. This result is primarily due to a gross margin increase in program services, which increased from 51.5% for the same period last year, to 54.1%, reduced by a gross margin decrease in staffing services, which decreased from 25.8% for the same period last year, to 24.4%. The margin decrease for staffing services is primarily due to higher costs for employee paid time off, medical benefits, workers compensation and increased wage costs. The margin increase in program services is primarily due to increased margins on health coaching and advising services and biometric screening services.
Operating Expenses and Operating Income. Operating expenses increased $364,000, or 2.6%, to $14,523,000 for the nine months ended September 30, 2009, from $14,159,000 for the nine months ended September 30, 2008.
The increase is primarily due to higher costs for management incentive programs and higher customer service costs that reflect the growth in health improvement programs. For the nine months ended September 30, 2009, operating expenses, as a percent of revenue, were 25.1%, compared to 25.3% for the same period last year.
Operating margin increased to 6.6% for the nine months ended September 30, 2009, from 4.8% for the same period in 2008. This result reflects the sales growth in our Health Management segment and cost efficiencies related to Health Management segment program services, reduced by the decrease in Fitness Management segment sales. Since 2009 revenue growth may be challenged by recessionary pressures, our strategies to maximize our operating profitability will focus on closely managing operating expenses and improving business processes.
Other Income and Expense. Interest expense was inconsequential for the nine months ended September 30, 2009 and 2008.
Income Taxes. Income tax expense increased $393,000 to $1,552,000 for the nine months ended September 30, 2009, from $1,159,000 for the nine months ended September 30, 2008. The increase is due to a higher operating income for the first nine months of 2009 as compared to the same period last year.
Our effective tax rate was 40.6% of earnings before income taxes for the nine months ended September 30, 2009, compared to 43.1% for the same period last year. The lower effective tax rate as compared to the corresponding period of 2008 is primarily due to the lower non-deductible stock based compensation expense in proportion to earnings before income taxes.
Net Earnings. Net earnings applicable to common shareholders increased $743,000 to $2,272,000 for the nine months ended September 30, 2009, from $1,529,000 for the nine months ended September 30, 2008. This increase is primarily due to sales growth in our Health Management segment and cost efficiencies related to Health Management segment program services, reduced by the decrease in Fitness Management segment sales.
LIQUIDITY AND CAPITAL RESOURCES
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Our working capital increased $2,921,000 to $13,619,000 for the nine months ended September 30, 2009, from $10,698,000 at December 31, 2008. This increase is largely attributable to our improved operating results and cash accumulation strategy given current economic conditions.
In addition to cash flows generated from operating activities, our other primary source of liquidity and working capital is provided by a $3,500,000 Credit Agreement with Wells Fargo Bank, N.A. (the "Wells Loan"). Effective with the renewal of the Wells Loan on March 24, 2009, interest will be computed using the daily three month LIBOR rate plus a markup of 2.75% (effective rate of 3.048% and 3.25% at September 30, 2009 and December 31, 2008, respectively). The Wells Loan matures on June 30, 2011, as amended. Working capital advances from the Wells Loan are based upon a percentage of our eligible accounts receivable, less any amounts drawn and outstanding. The facility provided maximum borrowing capacity of $3,250,000 at September 30, 2009 and December 31, 2008, respectively and no debt was outstanding on those dates. There were no borrowings under the line of credit during the nine months ended September 30, 2009. Although we do not anticipate borrowing from the Wells Loan in 2009, we have extended the agreement, as previously discussed, to provide an additional source of funding. All borrowings are collateralized by substantially all of our assets. At September 30, 2009, we were in compliance with all of our financial covenants and expect to remain in compliance with the covenants over the life of the credit agreement.
We believe our short and long-term capital needs will be met with cash flows generated by operations. We anticipate investment activities in 2009 will be near 2008 levels and will be funded through operating cash flows. Capitalized software development costs, as previously discussed, are primarily related to enhancements to our eHealth platform. These enhancements are made to improve efficiencies and/or generate additional revenues and are, thus, discretionary in nature.
We did not see a material change in the payment activities of our customers in 2008 and do not anticipate a material change in 2009. We do, however, expect to realize approximately $2.2 million in revenue from our existing automotive contracts in 2009, including $1.4 million from "at risk" automotive clients, and will continue to monitor their financial health as it relates to outstanding accounts receivable. On April 30, 2009, an automotive customer in our fitness management segment filed for bankruptcy protection under Chapter 11. Our outstanding receivable from this customer was approximately $34,000. The customer has paid the outstanding balance and continues to make timely payments on the continued monthly service billings. In addition, we collected receivable payments of approximately $137,000 from the customer during the 90 days before the bankruptcy filing. Such payments may constitute preferential payments recoverable under the Bankruptcy Code. We believe we have valid defenses to any potential claim for these payments and will not be required to repay the full amount. This customer has assumed our contract as of May 22, 2009. On June 1, 2009, another automotive customer in our fitness management segment filed for bankruptcy protection under Chapter 11. Our outstanding receivable from this customer was approximately $283,000. The customer has paid the outstanding balance and continues to make timely payments on the continued monthly service billings. In addition, we collected receivable payments of approximately $110,000 from the customer during the 90 days before bankruptcy. Such payments may constitute preferential payments recoverable under the Bankruptcy Code. We believe we also have valid defenses to any potential claim for these payments. This customer has assumed our contracts as of July 10, 2009. Our revenue from these customers was approximately $2,909,000 and $1,087,000 for the year ended December 31, 2008 and the nine months ended September 30, 2009, respectively.
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INFLATION
We do not believe that inflation has significantly impacted our results of operations in any of the last three completed fiscal years.
OFF-BALANCE SHEET ARRANGEMENTS
As of September 30, 2009, the Company had no off-balance sheet arrangements or transactions with unconsolidated, limited purpose entities.
PRIVATE SECURITIES LITIGATION REFORM ACT
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Such "forward-looking" information is included in this Form 10-K, including this Item 7, as well as in other materials filed or to be filed by the Company with the Securities and Exchange Commission (as well as information included in oral statements or other written statements made or to be made by the Company).
Forward-looking statements include all statements based on future expectations and specifically include, among other things, statements relating to revenue loss in our Fitness Management segment; our belief the current recession may have an adverse impact on many industries, which could affect our customers and lead to further revenue loss from contract termination or service reduction; our belief that revenue decline will continue during 2009 due to the effects of the recessionary economy, employment reductions and our members decreasing their spending on discretionary services; our belief that the number of opportunities to bid on new fitness management business during 2009 should be consistent with past years; our belief that we will need to lower our pricing to be competitive in the fitness management market, which may result lower profitability; our ability to increase 2009 revenue on a basis consistent with past growth; our expectation that we will not borrow from the Wells Loan in 2009 and that we will remain in compliance with all of our financial covenants over the life of the credit agreement; our belief that our short and long-term capital needs will be met with cash flows generated by operations; our anticipation that investment activities in 2009 will be at or below 2008 levels and will be funded through operating cash flows; our anticipation that we will not see a material change in the payment activities of our customers in 2009; statements regarding the potential effects of automotive company bankruptcies on our accounts receivable, contract continuation and prior payments and related claims and defenses regarding repayment of preferential payments, and our belief that inflation has not significantly impacted our results of operations in any of the last three completed fiscal years, as well as statements regarding projections and outlook relating to the industries in which we compete and the economy in general, increasing revenue, improving margins, marketing efforts, competitive conditions, the effect of price competition and changes to the economy, and the sufficiency of our liquidity and capital resources. In addition, the estimated annualized revenue value of our new, lost and existing contracts is a forward looking statement, which is based upon an estimate of the anticipated annualized revenue to be realized or lost. Such information should be used only as an indication of the activity we have recently experienced in our two business segments. These estimates, when considered together, should not be considered an indication of the total net, incremental revenue growth we expect to generate in any year, as actual net growth may differ from these estimates due to actual staffing levels, participation rates and contract duration, in addition to other revenue we may lose in the future due to contract termination. Any statements that are not based upon historical facts, including the outcome of events that have not yet occurred and our expectations for future performance, are forward-looking statements. The words "potential," "believe," "estimate," "expect," "intend," "may," "could," "will," "plan," "anticipate," and similar words and expressions are intended to identify forward-looking statements. Such statements are based upon the current beliefs and expectations of our management. Such forward-looking information involves important risks and uncertainties that could significantly affect anticipated results in the future and, accordingly, such results may differ from those expressed in any forward-looking statements made by or on behalf of the Company. These risks and uncertainties include, but are not limited to, our inability to deliver the health management services demanded by major corporations and other clients, our inability to successfully cross-sell health management services to our fitness management clients, our inability to successfully obtain new business opportunities, our failure to have sufficient resources to make investments, our ability to make investments and implement strategies successfully,
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continued delays in obtaining new commitments and implementing services, the continued deterioration of general economic conditions, the actions of automotive customers and bankruptcy courts, and those matters identified and discussed in Item 1A of the 2008 Form 10-K under "Risk Factors."
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks related to changes in U.S. and international interest rates. The Company's borrowings under the Wells Loan bear interest at a variable rate. There were no borrowings outstanding under the Wells Loan at September 30, 2009.
We have no history of, nor do we anticipate in the future, investing in derivative financial instruments, derivative commodity instruments or other such financial instruments. We invoice our Canadian customers in their local currency, and such transactions are considered immaterial in relation to our total billings. As a result, the exposure to foreign currency fluctuations and other market risks is not material.
ITEM 4. CONTROLS AND PROCEDURES
Our Chief Executive Officer and Chief Financial Officer, referred to collectively herein as the Certifying Officers, are responsible for establishing and maintaining our disclosure controls and procedures. The Certifying Officers have reviewed and evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 240.13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934) as of September 30, 2009. Based on that review and evaluation, which included inquiries made to certain other employees of the Company, the Certifying Officers have concluded that, as of the end of the period covered by this Report, the Company's disclosure controls and procedures, as designed and implemented, are effective in ensuring that information relating to the Company required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, including ensuring that such information is accumulated and communicated to the Company's management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
There were no changes in the Company's internal controls over financial reporting during the quarter ended September 30, 2009 that may have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
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PART II. - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Refer to Item 3 (Legal Proceedings) in the Company's Annual Report on Form 10-K for the year ended December 31, 2008.
ITEM 1A. RISK FACTORS
In addition to the other information set forth in this report, including the important information in "Private Securities Litigation Reform Act," you should carefully consider the "Risk Factors" discussed in our Annual Report on Form 10-K for the year ended December 31, 2008. Those factors, if they were to occur, could cause our actual results to differ materially from those expressed in our forward-looking statements in this report, and materially adversely affect our financial condition or future results. Although we are not aware of any other factors that we currently anticipate will cause our forward-looking statements to differ materially from our future actual results, or materially affect the Company's financial condition or future results, additional risks and uncertainties not currently known to us or that we currently deem to be immaterial might materially adversely affect our actual business, financial condition and/or operating results.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
| (a) | Exhibits - See Exhibit Index on page following signatures |
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
| Dated: November 12, 2009 | HEALTH FITNESS CORPORATION | |||
| By | /s/ Gregg O. Lehman | |||
| Gregg O. Lehman | ||||
| President and Chief Executive Officer (Principal Executive Officer) | ||||
| By | /s/ Wesley W. Winnekins | |||
| Wesley W. Winnekins | ||||
| Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer) | ||||
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HEALTH FITNESS CORPORATION
FORM 10-Q
| Exhibit No. | Description | |
| ||
**11.0 | Statement re: Computation of Earnings per Share | |
| ||
**31.1 | Certification of President and Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
| ||
**31.2 | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
| ||
**32.1 | Certification of President and Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
| ||
**32.2 | Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| ** | Filed herewith |
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