Item 1. BUSINESS
OVERVIEW
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 231 corporate fitness center sites, 170 corporate health
management sites and 97 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 82nd Street, Suite 1100,
Minneapolis, Minnesota 55431, telephone number (952) 831-6830. We maintain an internet website at
www.hfit.com.
BUSINESS MODEL
Major corporations, hospitals and universities invest in fitness centers and health improvement
programs for several reasons. First, it is widely understood that healthier employees are more
productive, experience reduced levels of stress and are absent from work less often due to illness.
At the same time, companies are struggling to deal with the rising cost of employee healthcare,
which has historically increased at double-digit rates. According to a recent government report,
U.S. spending on prescription drugs, hospital care and other health services is expected to double
to $4.1 trillion over the next decade, up from $2.1 trillion in 2006. This dramatic increase in
expected healthcare costs is primarily attributed to an aging population and poor lifestyle choices
relating to diet and exercise. Many companies realize that they may be able to decrease the
financial burden of employee healthcare and lost productivity by making health improvement programs
a strategic business priority. We believe the services we offer will help employees make better
lifestyle behavior choices, thus improving their health, in addition to helping companies decrease
the rate of spending on employee healthcare costs.
To capitalize on the growth opportunities within the employer marketplace, we organized our
business into two segments: Fitness Management Services and Health Management Services. Within
each of these business segments, we provide two types of service: (i) Staffing Services, and (ii)
Program and Consulting Services. Our decision to move to segment reporting was based on (i) the
evolution of our Health Management segment, and management’s belief that the future growth of our
Company may depend on our Health Management segment; (ii) management’s belief that total revenue
and gross profit from our Health Management segment may outpace the total revenue and gross profit
from our legacy Fitness Management segment; (iii) management has invested significant resources to
hire additional service and account management staff to handle the growth we have experienced, and
expect to experience in the future; (iv) management has invested, and expects to continue investing
resources to enhance the functionality of our web-based software system to appeal to a wider range
of current and new customers for both of our operating segments, and (v) on a monthly, quarterly
and annual basis, we manage the performance of our business by reviewing internally-generated
financial reports that detail revenue and gross profit results for each segment.
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Following is a description of the services we offer within each segment:
Fitness Management Services
The Fitness Management segment of our business involves the management of fitness centers that have
been developed and equipped by corporations and other organizations for their employees.
Historically, corporations developed these fitness centers as a way to attract and retain
productive employees. More recently, these same corporations have come to realize that a fitness
center can play an integral role in modifying unhealthy lifestyle behaviors and improving work
productivity.
In terms of size, we believe we are the largest provider of corporate fitness center management
services in the United States. Currently, we manage 231 corporate sites, including two sites
located in Canada, all of which accounted for approximately 61% and 66% of our 2007 and 2006
revenue, respectively. From a sales perspective, we generally obtain new corporate customers by
submitting a proposal, which answers specific questions regarding our management philosophies and
pricing structures.
Our Fitness Management segment derives its revenue from the following services:
Staffing Services. We have agreements with corporations and other organizations to staff and
manage fitness centers they have developed for use by their employees. We derive revenue from
these services through the reimbursement of staff costs, including wages, taxes and benefits, and
reimbursement of our costs to provide liability insurance to protect our customers against injury
claims. We also receive a management fee to cover the cost of regional and corporate support
services. Costs of revenue are comprised of staff wages, employer taxes and employee benefits, in
addition to fitness center operating expenses we may contractually agree to pay.
In 2007, 2006 and 2005, revenue from our Fitness Management staffing services accounted for 56.8%,
62.4% and 69.6%, respectively, of total consolidated revenue.
Program and Consulting Services. At many of our managed fitness centers, we generate additional
revenue from members through the delivery of fee-for-service fitness and wellness program services.
These services primarily include personal training, weight loss programs, seminars, special
classes and massage therapy. Costs of revenue are comprised of commissions we pay our staff for
selling and delivering these program services, in addition to the cost of inventory when products
are sold in connection with a service.
Within our fitness management consulting practice, companies that are planning new fitness centers
may employ us to develop floor plans and interior design plans, select and source fitness equipment
and design fitness programs. For companies that desire to develop a commercial fitness center, we
can perform a comprehensive analysis of market potential for the center. Services can include
demographic analysis, market analysis, and multiple-year financial business plan development.
In 2007, 2006 and 2005, revenue from our Fitness Management program and consulting services
accounted for 3.8%, 4.0% and 4.4%, respectively, of total consolidated revenue.
Health Management Services
The Health Management segment of our business involves the delivery of services to help
corporations and other organizations assess the health characteristics of their employees. We also
provide health education services to employees dealing with multiple health risks to improve their
lifestyle behaviors.
This segment of our business has experienced the fastest rate of growth, with 2007 revenue growing
approximately 29% over 2006, and 2006 revenue growing approximately 49% over 2005. This growth is
attributed to our past and recent investments to strategically enhance this segment, which has
improved our ability to meet the increasing
market demand for health improvement services, as well as meet the increasing needs of our
customers. Currently,
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we manage 170 corporate health management sites and 97 unstaffed health
management programs, which accounted for approximately 39% and 34% of our 2007 and 2006 revenue,
respectively. In this segment, we generally obtain new corporate customers by submitting a
proposal, which answers specific questions regarding our management philosophies and pricing
structures.
Our Health Management segment derives its revenue from the following services:
Staffing Services. We have agreements with corporations and other organizations to staff and
manage the delivery of health promotion programs, lifestyle coaching services, and injury
prevention and treatment services. These relationships may or may not involve the management of an
on-site fitness center. We derive revenue from these services through the reimbursement of staff
costs, including wages, taxes and benefits, and reimbursement of our cost to provide liability
insurance to protect our customers against injury claims. We also receive a management fee to
cover the cost of regional and corporate support services. Costs of revenue are comprised of staff
wages, employer taxes and employee benefits, in addition to operating expenses we may contractually
agree to pay.
In 2007, 2006 and 2005, revenue from our Health Management staffing services accounted for 22.6%,
21.5% and 22.3%, respectively, of total consolidated revenue.
Program and Consulting Services. We offer a comprehensive menu of products and services to assess
the health risks of our customer’s employees, and manage specific health risks by delivering
programs to educate and coach participants to improve lifestyle behaviors. We derive program
revenue from participant fees we charge for our e-Health platform; paper and web-based health risk
assessments; biometric screenings to assess blood profiles and body composition; and face-to-face,
web-based and telephonic health coaching services. We also derive revenue from data collection and
reporting services as it relates to the demonstration of program effectiveness. Revenue from these
program services are generally paid by our corporate customer, although they may ask their
employees to share in the cost. Our costs of revenue for these services are mainly comprised of
supply expenses and the direct cost of staff wages, taxes and benefits.
Within our health management consulting practice, we provide corporations and other organizations
with a comprehensive analysis of the effectiveness of employee health improvement programs, with a
focus on demonstrating a return on investment. We also provide a suite of occupational health
consulting services, including injury prevention program design, work-hardening programs, injury
treatment, return-to-work programs and regulatory compliance consulting.
In 2007, 2006 and 2005, revenue from our Health Management program and consulting services
accounted for 16.7%, 12.1% and 3.7%, respectively, of total consolidated revenue.
CONTRACT DURATION
In each of our business segments, the duration of staffing and program service agreements may
widely vary, from those that are month-to-month, to those that have a term of five years. A
typical staffing services contract carries a term of three years, with revenue recognized upon
delivery of service. Contract duration for program and consulting services generally ranges from
month-to-month up to three years, depending on the scope of services to be delivered. Revenues for
these services are recognized upon delivery of service.
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SEGMENT FINANCIAL INFORMATION
We assess and manage the performance of each business segment by reviewing internally-generated
reports that detail revenue and gross profit results for each of our customer sites. This
information is used to formulate plans regarding the future prospects of our business, and aids in
our determination of how we will invest our resources to ensure we achieve our future revenue and
profitability targets.
The following table provides an analysis of business segment revenue and gross profit for each of
the years ended December 31, 2007, 2006 and 2005:
| 2007 | 2006 | 2005 | ||||||||||
Revenue |
||||||||||||
Fitness Management Services |
||||||||||||
Staffing Services |
$ | 39,747,239 | $ | 39,670,546 | $ | 38,226,444 | ||||||
Program and Consulting Services |
2,679,881 | 2,574,463 | 2,392,272 | |||||||||
| 42,427,120 | 42,245,009 | 40,618,716 | ||||||||||
Health Management Services |
||||||||||||
Staffing Services |
15,819,481 | 13,669,201 | 12,267,973 | |||||||||
Program and Consulting Services |
11,711,450 | 7,664,330 | 2,055,516 | |||||||||
| 27,530,931 | 21,333,531 | 14,323,489 | ||||||||||
Total Revenue |
||||||||||||
Staffing Services |
55,566,720 | 53,339,747 | 50,494,417 | |||||||||
Program and Consulting Services |
14,391,331 | 10,238,793 | 4,447,788 | |||||||||
| $ | 69,958,051 | $ | 63,578,540 | $ | 54,942,205 | |||||||
Gross Profit |
||||||||||||
Fitness Management Services |
||||||||||||
Staffing Services |
$ | 8,643,280 | $ | 8,861,829 | $ | 8,772,194 | ||||||
Program and Consulting Services |
1,155,217 | 1,129,585 | 810,401 | |||||||||
| 9,798,497 | 9,991,414 | 9,582,595 | ||||||||||
Health Management Services |
||||||||||||
Staffing Services |
3,974,348 | 3,399,875 | 3,499,117 | |||||||||
Program and Consulting Services |
5,868,032 | 4,239,295 | 735,462 | |||||||||
| 9,842,380 | 7,639,170 | 4,234,579 | ||||||||||
Total Gross Profit |
||||||||||||
Staffing Services |
12,617,628 | 12,261,704 | 12,271,311 | |||||||||
Program and Consulting Services |
7,023,249 | 5,368,880 | 1,545,863 | |||||||||
| $ | 19,640,877 | $ | 17,630,584 | $ | 13,817,174 | |||||||
With respect to segment asset allocation in accordance with SFAS 131, management believes the
Company does not have assets that are related solely to each segment, except for the
segmentation of goodwill for annual impairment testing, and thus has not allocated assets to our
reportable segments for the following reasons:
| a. | The Company is a service business that depends heavily on the joint efforts of our staff to operate and grow each segment of our business. | ||
| b. | We do not maintain a large asset infrastructure. The tangible and intangible assets we do own, including the web-based software system we acquired from HealthCalc, are deployed across both segments of our business to generate segment revenue and gross profit results. | ||
| c. | Our future growth plans involve a tighter integration between our Fitness and Health Management segments, resulting in opportunities to cross-sell our fitness and health management services to existing customers within each segment. It is difficult to ascertain which assets are responsible for segment results. | ||
| d. | We do not separate assets into our reportable segments for internal accounting and reporting purposes. Management believes an arbitrary allocation of assets to each reportable segment would not result in meaningful information about our business. |
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GROWTH STRATEGY
In the long-term, we believe that we can enhance our position as the leading integrator of fitness
and health management services for corporations and other large organizations. Key elements of our
growth strategy include:
| • | Pursue both aggressive organic growth and strategic opportunities in our Health Management business segment. We believe the market for population health management programs will continue to grow. | ||
| • | Pursue new customers in our Fitness Management business segment to expand market share. As the largest provider of corporate fitness management services, we believe we can continue to add new customers, and sell additional fitness services to our current customers. However, this segment operates in a mature market, and price competition is common. | ||
| • | Maximize opportunities to sell our Fitness Management customers on adopting the services we offer in our integrated Health Management model. | ||
| • | Pursue strategic opportunities that provide operational capabilities and long-term financial value. |
We intend to continue investing in our Health Management business segment commensurate with the
addition of new business, including investments in people, systems and infrastructure in order to
enhance our ability to scale, gain greater cost efficiencies and provide a broader base of
services.
OPERATIONS
In our Fitness Management segment, we have one Vice President of Account Services, who has
management responsibility for all of our geographical regions in the United States. Each region is
managed by a Regional Vice President, who is responsible for fitness center and wellness program
staffing, service quality, financial performance, client relationships and the introduction of new
service capabilities to our customers.
In our Health Management segment, we have one Vice President of Account Services, who manages all
activities related to our health management customers. We also have Regional Vice Presidents who
are directly responsible for program implementation, service delivery, financial performance and
client relationships.
The Vice President of each segment reports to a Senior Vice President of Account Services, who in
turn reports directly to our Chief Operations Officer. These two positions have primary
operational management responsibility for our entire business.
Our corporate office provides centralized administrative support, including accounting and finance,
human resources and payroll, information technology systems, sales and marketing, and executive
management functions, including the offices of the Chief Financial Officer and Chief Executive
Officer, who also retains responsibility as our head of sales.
All expenses related to the operating areas noted above are contained in the Operating Expenses
section of our Statements of Operations contained in Item 8 of this Form 10-K.
SALES AND MARKETING
We market our services to corporations, members of the fitness centers we manage and to individuals
eligible to participate in their corporate health improvement program. Our sales force actively
pursues new corporate customers for each segment of our business, which spans a wide variety of
industries. Our sales force is primarily responsible for identifying potential corporate customers
and sales lead partners, and managing the overall sales
process. Our corporate marketing department supports the marketing needs of our sales function, in
addition to
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developing point of sale materials for fitness center programs and collateral materials
designed to solicit participation in a health improvement program.
SEASONALITY
In our Fitness Management segment, we do not experience any seasonal fluctuations in the
realization of new business, or recognition of revenue. In our Health Management business segment,
we may experience seasonal fluctuations in the realization of new business, which will generally be
timed with the start of a client’s benefit plan year. We have also found that the early stage of
certain health management engagements result in a higher rate of revenue recognition due to the
delivery of on-site biometric screening services. Thereafter, revenue will decrease to a lower
level until we deliver a second phase of biometric screening services to assess health improvement,
which is generally one year after the initial phase of screenings.
RESEARCH AND DEVELOPMENT
All research and development activities pertaining to the maintenance of our e-Health technology
platform, as well as activities leading up to establishing technological feasibility for
significant e-Health platform enhancements, are expensed as incurred.
SIGNIFICANT CUSTOMER RELATIONSHIP
We had one customer that provided 9.8%, 10.3% and 11.9% of our total revenue in 2007, 2006 and
2005, respectively. For this customer, we provide fitness center management and employee wellness
administration services for approximately 50 locations. The agreement with this customer was
recently renewed and expires on December 31, 2009, and will automatically renew for successive one
year periods unless either party delivers written notice at least 90 days prior to termination. We
believe that our relationship with this customer is good.
COMPETITION
Within the business-to-business fitness management services industry, there are relatively few
national competitors. However, virtually all markets are home to regional providers that manage
several sites within their geographic areas. The principal method of competition among fitness
management service providers is price, and our target client base has generally been
price-sensitive. With our national presence and almost 30 years of history, management believes
that we are recognized as a leading provider of corporate fitness management services, that we have
a cost-effective business model, and that we are well positioned to compete in this industry.
Within the business-to-business health management services industry, there has been a trend toward
consolidation as companies establish a better position to compete for the growth that is expected
in this industry. Disease management and managed care companies have made acquisitions of health
management companies within the past twenty-four months. To effectively compete with these
organizations, which are larger and have access to more resources, we have made considerable
investments into the development of our corporate health management business model. Our December
2005 acquisition of HealthCalc.Net, Inc. and the development of our web-based and telephonic health
coaching services have enabled us to more effectively compete with these larger companies. With
additional strategic investments to augment our current capabilities, we believe we can build a
sustainable competitive advantage in order to compete for new business opportunities against these
larger competitors.
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PROPRIETARY RIGHTS
We have three registered trademarks, “Insight”®, “It Pays To Be Healthy”® and “Live For Life”® that
are used in connection with the sale and delivery of our fitness and health management services.
We do not have any other significant proprietary rights.
GOVERNMENT REGULATION
Management believes there is no significant government regulation which materially limits our
ability to provide fitness and health management services to our corporate, hospital, community and
university-based clients. Although our occupational health, health risk assessment and health
coaching services, in addition to the group health plan we sponsor for our employees, are subject
to the requirements of the Health Insurance Portability and Accountability Act of 1996, or HIPAA,
we do not believe that these regulations have a material impact on our activities.
FOREIGN OPERATIONS
We provide services to companies located in Canada through our wholly-owned subsidiary Health
Fitness Corporation of Canada, Inc. Revenue recognized from our Canadian customers totaled
approximately $241,000, $259,300 and $277,600 for the years ended December 31, 2007, 2006 and 2005,
respectively. 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.
EMPLOYEES
At December 31, 2007, we had 878 full-time and 2,931 part-time and on-call employees, of which 117
were employed at our corporate, divisional and regional offices. The remainder is primarily
engaged in providing our staffing and programs services to our Fitness and Health Management
customers. Management believes our relationship with employees is good.
AVAILABLE INFORMATION
We file reports with the Securities and Exchange Commission, or as referred to herein as the SEC,
including annual reports on Form 10-K, quarterly reports on Form 10-Q and other reports from time
to time. We are an electronic filer and the SEC maintains an Internet site at www.sec.gov that
contains the reports, proxy, information statements and other information filed electronically.
The public may read and copy any materials filed by us with the SEC at the SEC’s Public Reference
Room at 100 F Street, NE, Washington, DC 20549. The public may also obtain information from the
Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, we maintain at our
website (www.hfit.com), and make available free of charge, our annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as
soon as reasonably practicable after such information is filed electronically with the SEC. The
information provided on our website is not a part of this report, and is therefore not incorporated
by reference unless such information is otherwise specifically referenced elsewhere in this report.
OUTLOOK AND TRENDS
Within our Health Management business segment, the high cost of employee health care and lost
employee productivity has become a key concern for many corporations. According to published
reports, annual health care costs are expected to continue to increase at double digit rates for
the next several years due to a number of factors, including an aging workforce, unhealthy
populations entering the workforce and obesity-related medical conditions due to poor nutrition and
a lack of exercise. We believe that, as part of a broader strategy to reduce health care costs and
lost productivity, many companies will be interested in addressing the health needs of employees,
and
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their dependents and retirees, and will also desire to implement specific strategies to help
“at-risk” individuals. We believe that we can provide the products, services, expertise and
personnel to effectively meet this need.
Within our Fitness Management segment, recessionary pressures in recent years have negatively
affected the corporate landscape, which has negatively affected the prices we offer to induce
renewal of customer agreements, and to obtain new customers. Although we believe that price
competition will not materially affect results of operations, we believe that price competition
will continue for the foreseeable future. In addition, we have customers that operate in
industries that are experiencing negative financial and competitive pressures. Specifically, in
2007 we experienced the termination of fitness management services at a large automotive company.
Although we believe that the loss of this business will not materially affect our results of
operations, additional large contract terminations from customers operating in a troubled industry
may have a material adverse effect on our results of operation.
ITEM 1A. RISK FACTORS
The foregoing discussion in this Item 1 and the discussion contained in Item 7 of this Form 10-K
contain various “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.
Forward-looking statements are based on current expectations or beliefs concerning future events.
Such statements can be identified by the use of terminology such as “anticipate,” “believe,”
“estimate,” “expect,” “intend,” “may,” “could,” “possible,” “plan,” “project,” “will,” “forecast”
and similar words or expressions. Our forward-looking statements generally relate to growth
strategies, demand for our services, financial results, marketing efforts, competitive conditions
and cash requirements. Although it is not possible to foresee all of the factors that may cause
actual results to differ from our forward-looking statements, such factors include, among others,
the risk factors that follow. However, investors are cautioned that all forward-looking statements
involve risks and uncertainties.
We may not be able to implement our growth strategy successfully. Our growth strategy is based on
becoming the leading integrator of fitness and health management services for corporations and
other large organizations. The key elements of our strategy are to pursue growth in our Health
Management business segment, pursue new customers in our Fitness Management business segment, sell
our Fitness Management customers on adopting the services we offer in our integrated Health
Management model, and pursue strategic opportunities that provide operational and financial value.
Our ability to implement each of these elements depends largely upon our ability to make strategic
investments in our Health Management business segment to fund this growth, and the success of those
investments. If we do not have sufficient resources to make the necessary investments, or do not
successfully make these investments, our growth strategy will be adversely affected and we may not
be able to increase our revenues or profitability. Similarly, if we are unable to implement any of
the elements of our growth strategy, our growth may be adversely affected.
We may experience difficulty managing growth, including attracting qualified staff. We have
experienced substantial growth during the past few years, both organically and by acquisition. Our
ability to grow in the future will depend on a number of factors, including the ability to obtain
new customers, expand existing customer relationships, develop additional fitness and health
improvement programs and services and hire and train qualified staff. We may experience difficulty
in attracting and retaining qualified staff in various markets to meet growth opportunities.
Further, in order to attract qualified staff, we may be required to pay higher salaries and enhance
benefits in more competitive markets, which may result in a material adverse effect on our results
of operation and financial condition. Sustaining growth may require us to sell our services at
lower prices to remain competitive, which may result in a material adverse effect on our results of
operation and financial condition. There can be no assurance that we will be able to manage
expanding operations effectively or that we will be able to maintain or accelerate our growth, and
any failure to do so may result in a material adverse effect on our results of operation and
financial condition.
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We may not be able to successfully cross-sell our health management programs to our fitness
management customers. A part of our growth strategy involves continuing and expanding our efforts
to sell health management services to our fitness management customers. Our cross-selling efforts
may not be successful since our experience indicates that some current customers have different
internal departments involved with procuring fitness management services, on the one hand, and
health management services, on the other hand. As a result, we may be required to establish new
relationships with personnel within our customers, which will limit the potential benefit of
established relationships we have developed. We may also be required to overcome different
purchasing requirements and standards to the extent they vary within internal departments of our
customers. We may experience similar difficulties in cross-selling all of our services to foreign
operations of our domestic customers. If we experience significant limitations as a result of the
foregoing circumstances, or any other circumstances, we may not be able to increase our revenues or
profitability to the extent we anticipate.
The timing of new and lost staffing service contracts may not be indicative of trends in our
business or of future quarterly financial results. We evaluate our business, in part, by reviewing
trends in our financial performance. We believe an important indicator of our outlook is revenue
to be derived from fitness and health management service contracts we secure with customers.
Fitness and health management service contracts are often long-term contracts (i.e., 3 to 5 years),
automatically renew on an annual basis and generally require 30 to 60 days notice to terminate in
order to avoid the automatic renewal provision. Revenue from new contracts often is not recognized
for a period of 90 to 180 days after proposal acceptance due to lead times necessary to execute a
contract and hire staff to begin providing services. Since termination notice periods are
considerably less than the time it takes to begin servicing new contracts, the revenue lost in a
reporting period may significantly exceed the revenue gained from new contracts.
Because of these timing differences, management generally does not view changes in quarterly
revenue, whether sequential or as compared to prior quarter changes, to be indicative of its
outlook or trends in our business or to be reflective of revenue expected in succeeding quarters.
Rather, management generally evaluates revenue trends in our fitness and health management services
business based upon 12 to 18-month periods since we believe this helps to minimize the timing
impact from new and terminated contracts. Management cautions investors not to place undue
reliance upon fluctuations in quarterly revenue viewed in isolation from revenue information over
longer periods of time (e.g., comparative trailing 12-month information), and to not view quarterly
revenue as necessarily being indicative of our outlook or results to be expected in future
quarters.
We are dependent on maintaining our relationships with third party partners to provide programs and
services. Our growth strategy depends in part upon continuous development and improvement of
attractive and effective fitness and health management programs and services. Our failure to
anticipate trends or to successfully develop, improve or implement such programs or services may
have a material adverse effect on our results of operation and financial condition. We currently
contract with certain third party partners to provide a portion of such programs and services and
anticipate that this will continue to be the case. If any of such third party partners no longer
makes these programs and services available to us, there is no assurance that we would be able to
replace such third-party partner programs and services, and if we could not do so, our ability to
pursue our growth strategies would be seriously compromised.
Failure to renew existing customer contracts could have a negative effect on our financial
condition and results of operations. The majority of our contracts are with large corporations for
the management of on-site fitness centers and corporate wellness programs. While the specific
terms of such agreements vary, some contracts are subject to early termination by the corporate
customer without cause. Although we have a history of consistent contract renewals, there can be
no assurance that future renewals will be secured. The early termination or non-renewal of
corporate contracts may have a material adverse effect on our results of operation and financial
condition.
Our financial results are subject to discretionary spending of our customers. Our revenue,
expenses and net income are subject to general economic conditions. A significant portion of our
revenue is derived from
companies who historically have reduced their expenditures for on-site fitness management services
during economic
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downturns. Should the economy weaken, or experience more significant recessionary
pressures, corporate customers may reduce or eliminate their expenditures for on-site fitness
center management services, and prospective customers may not commit resources to such services.
Also, should the size of a customer’s workforce be reduced, we may have to reduce the number of
staff assigned to manage a customer’s fitness center. These factors may have a material adverse
effect on our results of operation and financial condition.
We operate within a highly competitive market against formidable companies. We compete for new and
existing corporate customers in a highly fragmented and competitive market. Management believes
that our ability to compete successfully depends on a number of factors, including quality and
depth of service, locational convenience and cost. The market for on-site fitness center
management services is price-sensitive, and the health management market is dominated by
competitors that are larger and have more resources and experience. From time to time, our
competitors in either or both of the fitness management and health management markets may put us at
a disadvantage by proposing a substantially lower price than us. There can be no assurance that we
will be able to compete successfully against current and future competitors, or that competitive
pressures faced by us will not have a material adverse effect on our results of operation and
financial condition.
We have implemented, on a limited basis, a business model for managing corporate fitness centers on
a cost-neutral or for-profit basis. We have, on a limited basis, implemented a model of managing
corporate fitness centers on a cost-neutral or for-profit basis. In connection with this business
model, we have complete responsibility to generate and account for all fitness center revenues,
which are recognized as we provide services. From the revenue we recognize and collect, we pay for
all expenses to operate the fitness center. We derive our management fee revenue from the profits
of the fitness center. The application of this business model may require us to fund operating
losses until enough memberships are sold, and other revenue sources are generated in order to
achieve profitability. We believe it may be necessary to fund operating losses from this type of
business model for up to twenty-four months before the fitness center achieves profitability.
Currently, existing contracts representing this business model do not present a material risk or
represent a material contribution to our results of operation. However, there is no assurance that
the number and scope of such contracts will not become material in the future or that we will be
able to manage such centers profitably or to fund losses for these centers until profitability is
achieved.
Failure to identify acquisition opportunities may limit our growth. An important part of our
growth has been the acquisition of complementary businesses. We may choose to continue this
strategy in the future. Management’s identification of suitable acquisition candidates involves
risks inherent in assessing the value, strengths, weaknesses, overall risks and profitability of
acquisition candidates. Management may be unable to identify suitable acquisition candidates. If
we do not make suitable acquisitions, we may find it more difficult to realize growth objectives
and to enhance shareholder value.
Future acquisitions may be dilutive to shareholders, cause us to incur additional indebtedness and
large one-time expenses or create intangible assets that could result in significant amortization
expense. If we spend significant funds or incur additional debt, our ability to obtain necessary
financing may decline and we may become more vulnerable to economic downturns and competitive
pressures. Management cannot guarantee that we will be able to successfully complete any future
acquisitions, that we will be able to finance acquisitions or that we will realize any anticipated
benefits from completed acquisitions.
We may not realize the anticipated benefits of acquisitions we complete. On December 23, 2005, we
acquired HealthCalc.Net, Inc. In the future, we may acquire other businesses. The process of
integrating new businesses into our operations poses numerous risks, including:
| • | an inability to assimilate acquired operations, information systems and technology platforms, and internal control systems and products; | ||
| • | diversion of management’s attention; |
12
| • | difficulties and uncertainties in transitioning business relationships from the acquired entity to us; and | ||
| • | the loss of key employees of acquired companies. |
If we are unsuccessful in integrating other future acquisitions into our operations, we might not
realize all of the anticipated benefits of such acquisitions. In such instances, our acquisitions
might not be accretive to our earnings, the costs of such acquisitions may otherwise outweigh the
benefits and the market price of our common stock might decline.
The loss of any of our key employees could have a material adverse effect on our performance and
results of operations. Our success is highly dependent on the efforts, abilities and continued
services of its executive officers, including Gregg Lehman, Ph.D., our President and Chief
Executive Officer, Wesley Winnekins, our Chief Financial Officer, and other key employees. The
loss of any of the executive officers or key employees may have a material adverse effect on our
results of operation and financial condition. We also believe that our future success will depend
on our ability to attract, motivate and retain highly-skilled corporate, regional and site-based
personnel. Although historically we have been successful in retaining the services of our senior
management, there can be no assurance that we will be able to do so in the future.
Our results of operations could be adversely impacted by litigation. Because of the nature of our
business, we may be subject to claims and litigation alleging negligence or other grounds for
liability arising from injuries or other harm alleged by our clients’ employees. We have
occasionally been named a defendant in claims relating to accidents that occurred in the fitness
centers we manage. There can be no assurance that additional claims will not be filed, and that
our insurance will be adequate to cover liabilities resulting from any claim.
The indemnification provisions in our management agreements with customers may obligate us to pay
claims that arise from our acts or omissions. A majority of our management agreements include a
provision that obligates us to indemnify and hold harmless the customer and their employees,
officers and directors from any and all claims, actions and/or suits (including attorneys’ fees)
arising directly or indirectly from any act or omission of the Company or its employees, officers
or directors in connection with the operation of our business. A majority of these management
contracts also include a provision that obligates the customer to indemnify and hold us harmless
against all liabilities arising out of the acts or omissions of the customer, their employees and
agents. We can make no assurance that claims by our customers, or their employees, officers or
directors, will not be made in the course of operating our business.
Our insurance policies may not provide adequate coverage. We maintain the following types of
insurance policies: commercial general liability, professional liability, automobile liability,
commercial property, employee dishonesty, employment practices, directors and officers liability,
workers compensation and excess umbrella liability. The policies provide for a variety of
coverages and are subject to various limitations, exclusions and deductibles. While we believe our
insurance policies are sufficient in amount and coverage for our current operations, there can be
no assurance that coverage will continue to be available in adequate amounts or at a reasonable
cost, and there can be no assurance that the insurance proceeds, if any, will cover the full extent
of loss resulting from any claims.
We could experience a potential depressive effect on the price of our common stock following the
exercise and sale of existing convertible securities. At December 31, 2007, the Company had
outstanding stock options and warrants to purchase an aggregate of 4,032,731 shares of common
stock. The exercise of such outstanding stock options and warrants, and the sale of the common
stock acquired thereby, may have a material adverse effect on the price of our common stock. In
addition, the exercise of such outstanding stock options and warrants and sale of such
shares of our common stock could occur at a time when we might otherwise be able to obtain
additional equity capital on terms and conditions more favorable to us.
13
Our common stock is thinly traded, and subject to volatility. Our common stock is traded on the
Over the Counter Bulletin Board. Investing in OTC securities is speculative and carries a high
degree of risk. Many OTC securities are relatively illiquid, or “thinly traded,” which can enhance
volatility in the share price and make it difficult for investors to buy or sell without
dramatically affecting the quoted price or may be unable to sell a position at a later date. As a
result, an investor may find it more difficult to dispose of or obtain accurate quotations as to
the price of a share of our common stock. If limited trading in our stock continues, it may be
difficult for investors to sell their shares in the public market at any given time at prevailing
prices.
Our share repurchase plan could affect our stock price and add volatility. On March 24, 2008, we
announced that our Board of Directors authorized the repurchase of up to $2.5 million of the
Company’s outstanding common stock. Any repurchases pursuant to this repurchase plan could affect
our stock price and add volatility. The repurchase plan is at our discretion, and thus there can be
no assurance that any repurchases will actually be made under the plan, nor is there any assurance
that a sufficient number of shares of our common stock will be repurchased to satisfy any market
expectations. Furthermore, there can be no assurance that any repurchases conducted under the plan
will be made at the best possible price. The announcement and existence of the share repurchase
plan could also cause our stock price to be higher than it would be in the absence of such a plan
and could potentially reduce the market liquidity for our stock. Additionally, we are permitted to
and could discontinue our share repurchase plan at any time and any such discontinuation could
cause the market price of our stock to decline.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
We lease approximately 28,000 square feet of commercial office space for our corporate headquarters
in Bloomington, Minnesota, mostly under a lease that expires in December 2012. Our monthly base
rent for this office space is approximately $31,000, plus taxes, insurance and other related
operating costs. We also assumed a lease in connection with our 2005 acquisition of HealthCalc for
approximately 8,200 square feet of office space in Dallas, Texas, which expires in December 2012.
Our minimum monthly base rent for this space is approximately $14,000.
ITEM 3. LEGAL PROCEEDINGS
We are, from time to time, subject to claims and suits arising in the ordinary course of business.
Such claims have, in the past, generally been covered by insurance. Management believes the
resolution of other legal matters will not have a material effect on our financial condition or
results of operation, although no assurance can be given with respect to the ultimate outcome of
any such actions. Furthermore, there can be no assurance that our insurance will be adequate to
cover all liabilities that may arise out of claims brought against us.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
14
EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by Item 10 relating to directors, our code of ethics, procedures for
shareholder recommendations of director nominees, the audit committee and compliance with Section
16 of the Exchange Act is incorporated herein by reference to the sections entitled “Election of
Directors”, “Corporate Governance” and “Section 16(a) Beneficial Ownership Reporting Compliance,”
which appear in the Company’s definitive proxy statement for its 2008 Annual Meeting.
The names, ages and positions of our executive officers are as follows:
| Name | Age | Position | ||
Gregg O. Lehman, Ph.D.
|
60 | President, Chief Executive Officer and Director | ||
John E. Griffin
|
51 | Chief Operations Officer | ||
Wesley W. Winnekins
|
46 | Chief Financial Officer and Treasurer | ||
Jeanne C. Crawford
|
50 | Chief Human Resources Officer and Secretary | ||
David T. Hurt
|
42 | Vice President Account Services-Fitness Management | ||
Katherine M. Hamlin
|
41 | Vice President Account Services-Health Management | ||
Brian J. Gagne
|
45 | Senior Vice President-Account Services | ||
John F. Ellis
|
48 | Chief Information Officer | ||
James O. Reynolds, M.D.
|
60 | Chief Medical Officer | ||
Gregg O. Lehman, Ph.D. has been the President and Chief Executive Officer of the Company since
January 1, 2007. From March 2006 through December 2006 Mr. Lehman served as Chairman, President and
Chief Executive Officer of INSPIRIS Inc., a Nashville-based specialty care management company that
provides care to frail Medicare Advantage members in long-term care facilities. From 2003 to 2006,
Mr. Lehman was President and Chief Executive Officer of Gordian Health Solutions, Inc., a Nashville
company dedicated to improving the health of employees and dependents for employers and health
plans. From 1998 to 2003, Mr. Lehman served as President and Chief Executive Officer of the
National Business Coalition on Health, a Washington D.C.-based movement of ninety employer-led
coalitions seeking better quality and more cost-effective healthcare for employees. Mr. Lehman,
who has a Ph.D. and an M.S. from Purdue University in Higher Education Administration, has been a
director of the Company since September 22, 2006.
John E. Griffin has been the Company’s Chief Operations Officer since February 1, 2008.
Mr. Griffin is responsible for overseeing the Company’s information technology, account services
functions and operations, excluding sales and marketing, finance, human resources and research,
development and outcomes. Mr. Griffin has served as President of The Meridian Group, a consulting
company he founded that focused on health case financial forecasting, budgeting, strategic planning
and operational management, since August 2006 and from September 1995 to April 2003. From July 2007
through January 31, 2008, the Company engaged Mr. Griffin as an operations consultant. From April
2003 to July 2006, Mr. Griffin served as Chief Operating Officer of Gordian Health Solutions, a
Nashville-headquartered population health management organization. Mr. Griffin has also served as
Chief Operating Officer of eClickMD, Inc. and Computer Sentry Software, Inc. Mr. Griffin holds a
Doctor of Jurisprudence from the University of Tennessee College of Law and a Bachelor of Science
in Business Administration with a major in accounting. He is a member of the Health Law Section of
the Tennessee Bar Association.
Wesley W. Winnekins has been Chief Financial Officer and Treasurer of the Company since February
2001. Prior to joining the Company, Mr. Winnekins served as CFO (from January 2000 to February
2001) of University.com, Inc., a privately held provider of on line learning solutions for
corporations. From June 1995 to April 1999 he served as CFO and vice president of operations for
Reality Interactive, a publicly held developer of CD-ROMs and online training for the corporate
market. From June 1993 to May 1995 he served as controller and director of operations for The
Marsh, a Minneapolis-based health club, and was controller of the Greenwood Athletic Club in Denver
from October 1987 to January 1989. From May 1985 to October 1987, he served in the audit practice
at
15
Arthur Andersen. Mr. Winnekins received a Bachelor’s in Business Administration with a major in
Accounting from Iowa State University. He has passed the CPA exam.
Jeanne C. Crawford has been the Company’s Chief Human Resources Officer (formerly titled Vice
President — Human Resources) since July 1998 and Secretary of the Company since February 2001.
From July 1996 through July 1998, Ms. Crawford served as a Human Resource consultant to the
Company. From October 1991 through September 1993, Ms. Crawford served as Vice President of Human
Resources for RehabClinics, Inc. a publicly held outpatient rehabilitation company. From May 1989
through October 1991, Ms. Crawford served as Director of Human Resources for Greater Atlantic
Health Service, an HMO and physicians medical group. From 1979 through 1989, Ms. Crawford served
in various human resources management positions in both the retail and publishing industries. Ms.
Crawford graduated cum laude from Temple University with a bachelor’s degree in business
administration, and is a member of the Society for Human Resources Management.
David T. Hurt has served as Vice President Account Services-Fitness Management, where he is
responsible for the operation of accounts within the Company’s Fitness Management business segment,
since April 2001. He directs the overall development and management of Corporate, Hospital,
Community and University fitness center operations. Mr. Hurt has been active in the industry for
more than 16 years. His experience in health and fitness management began in 1988 with the Valley
Wellness Center in Harrisonburg, Virginia. In recent years, he has been involved in the successful
development and management of several start-up fitness center projects ranging in size from 45,000
– 150,000 square feet. Mr. Hurt is a graduate of James Madison University, where he received a
bachelor’s degree in sports management.
Katherine M. Hamlin was appointed as the Company’s Vice President Account Services-Health
Management, in March 2005. In this role, she directs the implementation and management of the
Company’s Health Management accounts. From December 2003 to March 2005, she served as the
Company’s Vice President of Marketing. Previously, Ms. Hamlin spent 15 years with the Health &
Fitness Division of Johnson & Johnson Health Care Systems Inc., a subsidiary of Johnson & Johnson,
a business acquired by the Company. Ms. Hamlin was the Director of Marketing Services and National
Sales leading business expansion in the United States and internationally, while exploring new
markets. Ms. Hamlin serves on the board for International Council on Active Aging (ICAA). She is
a member of the Alliance for Work Life Progress (AWLP), National Business Group on Health (NBGH),
American Marketing Association (AMA) and Wellness Councils of America (WELCOA). Ms. Hamlin has a
bachelor’s degree in business with an emphasis in exercise science and sports management from the
University of Tennessee and a Master of Business Administration from East Tennessee State
University. Additionally, Katherine has completed advanced studies in organizational theory from
Pepperdine University.
Brian J. Gagne has served as the Company’s Senior Vice President-Account Services since January
2008 and served as National Vice President-Health Management from August 2006 to December 2007, and
as Vice President of Programs and Partnerships from December 2003 to August 2006. In his current
role, he oversees the Company’s Fitness and Health Management account services function. Mr. Gagne
brings more than 16 years of health, fitness and wellness experience in the corporate, commercial
and medical fitness markets. Mr. Gagne joined the Company after the acquisition of Johnson &
Johnson Health Care Systems in December 2003. Prior to Health Fitness, he was the Director of
Integrated Behavioral Solutions and was responsible for the strategic design and development of
patient education programs and tools for the Johnson & Johnson Family of Companies. Mr. Gagne
started his career in 1987 as an Exercise Physiologist at Gottlieb Health & Fitness Center (GHFC).
Mr. Gagne has a master’s degree in exercise physiology and a bachelor’s degree in exercise science
from the University of Illinois-Chicago.
John F. Ellis serves as the Company’s Chief Information Officer. Mr. Ellis is formerly a Founder
and Chief Executive Officer of HealthCalc.Net, Inc., a company we acquired in December 2005. From
January 1995 to August 1999, Mr. Ellis held a position of Senior Specialist with Perot Systems, an
information technology consulting group. From November 1989 to January 1995, Mr. Ellis held a
position of Vice President of
Information Technology at People Karch International, a health and fitness software development
services firm. Mr. Ellis holds a B.S. in Physical Education from The Citadel.
16
James O. Reynolds, M.D., has been the Company’s Chief Medical Officer since February 1, 2008.
Dr. Reynolds has oversight of all clinical aspects of the Company’s programs and services and the
Company’s Research, Development and Outcomes division. Dr. Reynolds served from October 2005 to
January 2008 as Principal and Senior Healthcare Consultant for Mercer Human Resource Consulting, a
global provider of consulting, outsourcing and investment services, where he served as a senior
clinical consultant on Mercer’s Health and Productivity Management specialty practice. From
September 2003 to October 2005, Dr. Reynolds served as Vice President and Medical Director,
Integrated Care Solutions, for CorSolutions Medical, Inc., a provider of disease management and
related services to employers, health plans and government-sponsored healthcare programs that was
acquired by Matria Healthcare, Inc. in 2005. From January 2001 to September 2003, Dr. Reynolds
served as Co-Founder, Chief Operating Officer and Executive Vice President of Health and
Productivity Corporation of America, which was acquired by CorSolutions in 2003. Prior to these
positions, Dr. Reynolds served in various positions in the healthcare industry, was in private
practice as an internal medicine physician, and served as an Associate Professor of Medicine at the
University of Missouri Hospital and Clinics. Dr. Reynolds has Bachelor’s of Science from Drury
College, an M.D. degree from the University of Missouri and is board certified in internal
medicine. He is an active member of the American College of Physicians, American Medical
Association, and the American College of Environmental and Occupational Medicine.
PART II
| ITEM 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
Trading of the Company’s common stock is conducted in the over-the-counter markets (often referred
to as “pink sheets”) or on the OTC Bulletin Board under the symbol “HFIT.”
The following table sets forth, for the periods indicated, the range of low and high closing prices
for the Company’s common stock as reported by the OTC Bulletin Board.
| Fiscal Year 2007: | Low | High | ||||||
Fourth quarter |
$ | 2.27 | $ | 3.20 | ||||
Third quarter |
2.80 | 3.20 | ||||||
Second quarter |
2.42 | 3.16 | ||||||
First quarter |
2.45 | 2.98 | ||||||
| Fiscal Year 2006: | Low | High | ||||||
Fourth quarter |
$ | 1.52 | $ | 2.65 | ||||
Third quarter |
1.48 | 1.90 | ||||||
Second quarter |
1.78 | 2.40 | ||||||
First quarter |
2.18 | 2.75 | ||||||
The trading volume for the Company’s common shares has historically been relatively limited and a
consistently active trading market for our common stock may not occur on the OTC Bulletin Board or
in the “pink sheets.”
On March 24, 2008, the published high and low sale prices for the Company’s common stock were $2.30
and $2.00 per share, respectively. On March 24, 2008, there were issued and outstanding 20,255,834
shares of common stock of the Company held by 609 shareholders of record (not including shares held
in street name).
17
DIVIDENDS
We have never declared or paid any cash dividends on our common stock and do not intend to pay cash
dividends on our common stock in the foreseeable future. However, we have paid dividends to our
preferred shareholders as disclosed herein, but we currently have no preferred stock outstanding.
The Company presently expects to retain any earnings to finance the development and expansion of
its business. The payment of dividends, if any, is subject to the discretion of the Board of
Directors, and will depend on the Company’s earnings, financial condition, capital requirements and
other relevant factors.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
For information on our equity compensation plans, refer to Item 12, “Security Ownership of Certain
Beneficial Owners and Management and Related Stockholder Matters.”
REPURCHASES
We did not engage in any repurchases of our Common Stock during the fourth quarter of 2007.
On March 24, 2008, we announced that our Board of Directors authorized the repurchase of up to
$2.5 million of the Company’s outstanding common stock. Under the plan, the Company may repurchase
shares on the open market in amounts and at times deemed appropriate by management and in
accordance with Rule 10b-18 and other pertinent rules and regulations. Share repurchases will be
funded by the Company’s available working capital. The timing and amount of any such repurchases
under the plan will depend on share price, economic and market conditions and applicable corporate
and regulatory requirements. The share repurchase plan is effective on April 1, 2008 and will
continue for a period of six months, subject to the Company’s right to announce earlier termination
or an extension of the plan. The Company’s insiders will be prohibited from trading in the
company’s stock throughout the duration of the plan. The plan does not require the Company to
repurchase a specific number of shares, and may be modified, suspended, or discontinued at any
time.
SALES OF UNREGISTERED SECURITIES
There were no unregistered sales of the Company’s equity securities during the fourth quarter or
year ended December 31, 2007 that were not previously disclosed on a Form 8-K.
18
| ITEM 6. | SELECTED FINANCIAL DATA |
The data given below as of and for each of the five years in the period ended December 31, 2007,
has been derived from the Company’s Audited Consolidated Financial Statements. In order to
understand the effect of accounting policies and material uncertainties that could affect our
presentation of financial information, such data should be read in conjunction with the Company’s
Consolidated Financial Statements and Notes thereto included under Item 8 to this Form 10-K and in
conjunction with Management’s Discussion and Analysis of Financial Condition and Results of
Operation included under Item 7 to this Form 10-K.
| Years Ended December 31, | ||||||||||||||||||||
| 2007 | 2006 | 2005 | 2004 | 2003 | ||||||||||||||||
STATEMENT OF OPERATIONS DATA (in
thousands except per share
amounts): |
||||||||||||||||||||
REVENUE |
$ | 69,958 | $ | 63,579 | $ | 54,942 | $ | 52,455 | $ | 31,479 | ||||||||||
NET EARNINGS |
910 | 3,025 | 1,345 | 1,674 | 633 | |||||||||||||||
NET EARNINGS (LOSS) APPLICABLE TO
COMMON SHAREHOLDERS |
910 | 1,352 | 1,204 | 1,588 | (27 | ) | ||||||||||||||
NET EARNINGS PER COMMON SHARE: |
||||||||||||||||||||
Basic |
$ | 0.05 | $ | 0.07 | $ | 0.09 | $ | 0.13 | $ | 0.00 | ||||||||||
Diluted |
$ | 0.04 | $ | 0.03 | $ | 0.08 | $ | 0.10 | $ | 0.00 | ||||||||||
BALANCE SHEET DATA (in thousands): |
||||||||||||||||||||
TOTAL ASSETS |
$ | 35,962 | $ | 32,318 | $ | 27,585 | $ | 20,934 | $ | 19,808 | ||||||||||
LONG-TERM DEBT |
— | — | — | $ | 1,613 | $ | 4,350 | |||||||||||||
SHAREHOLDERS’ EQUITY |
$ | 26,478 | $ | 23,798 | $ | 10,488 | $ | 11,484 | $ | 9,732 | ||||||||||
| ITEM 7. | 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 8.
Some of the information contained in this discussion and analysis or set forth elsewhere in this
annual 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 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.
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 231 corporate fitness center sites, 170 corporate health management sites and 97 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,
19
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.
In December 2005, we acquired all of the capital stock of HealthCalc.Net, Inc. (“HealthCalc”), a
leading provider of web-based fitness, health management and wellness programs to corporations,
health care organizations, physicians and athletic/fitness centers. We spent most of 2006
integrating HealthCalc’s capabilities into the service offerings we provide in our two business
segments. The discussion of HealthCalc’s financial contribution to our results of operation for
2006, compared to 2005, is limited to HealthCalc’s 2006 contribution to our revenue and expense
growth. In 2006, the revenue and gross profit derived from HealthCalc’s customers was classified
as Health Management segment activity, as the revenue and gross profit derived from Fitness
Management segment customers of HealthCalc was immaterial.
CRITICAL ACCOUNTING POLICIES
The following discussion and analysis of our financial condition and results of operations is based
upon our consolidated financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States. Preparation of the consolidated financial
statements requires management to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues, expenses and related disclosures. On an ongoing basis, management
evaluates its estimates and judgments. By their nature, these estimates and judgments are subject
to an inherent degree of uncertainty. Management bases its estimates and judgments on historical
experience, observation of trends in the industry, information provided by customers and other
outside sources and on various other factors that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about the carrying value of
assets and liabilities that are not readily apparent from other sources. Actual results may differ
from these estimates under different assumptions or conditions.
Our significant accounting policies are described in Note 1 of the Consolidated Financial
Statements. Critical accounting policies are those that we believe are both important to the
portrayal of our financial condition and results and are based on estimates that are reasonably
likely to change or require our most difficult, subjective or complex judgments, often as a result
of the need to make estimates about the effect of matters that are inherently uncertain.
Management believes the following critical accounting policies affect its more significant
judgments and estimates used in the preparation of our consolidated financial statements:
Segment Reporting – Effective with the fourth quarter of 2006, we made a decision to move to
segment reporting based upon (i) the evolution of our Health Management segment, and management’s
belief that the future growth of our Company may depend on our Health Management segment; (ii)
management’s belief that total revenue and gross profit from our Health Management segment may
outpace the total revenue and gross profit from our legacy Fitness Management segment; (iii)
management has invested significant resources to hire additional service and account management
staff to handle the growth we have experienced, and expect to experience in the future; (iv)
management has invested, and expects to continue investing resources to enhance the functionality
of our web-based software system to appeal to a wider range of current and new customers for both
of our operating segments, and (v) on a monthly, quarterly and annual basis, we manage the
performance of our business by reviewing internally-generated financial reports that detail revenue
and gross profit results for each segment. As a result of these factors, we follow FASB Statement
No. 131, Disclosure about Segments of an Enterprise and Related Information (“SFAS 131”), for the
two segments of our business: Fitness Management and Health Management. We do not believe that
our decision to follow FASB Statement No. 131 will impact the presentation of our financial
information or the ability to compare our financial results to prior periods.
Revenue Recognition – Revenue is recognized at the time the service is provided to the customer.
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. The revenues relating to
these services are estimated in the month that the service is performed. Amounts received from, or
billed to customers in advance of providing services are treated
as deferred revenue and recognized when the services are provided. We have contracts with
third-parties to provide
20
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 the ultimate customer. We do not recognize revenues
related to such transactions as the ultimate 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.
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. We generally do not require collateral or any other security to
support amounts due. Management performs ongoing credit evaluations of customers. We maintain
allowances for potential credit losses which, when realized, have been within management’s
expectations. 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.
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 December 31 of each year and
determined that our goodwill relates to two reporting units for purposes of impairment testing.
In connection with goodwill impairment testing as of December 31, 2006, and consistent with the
guidance provided in paragraphs 34 and 35 of SFAS 142, Accounting for Goodwill, we allocated our
total goodwill of $14,546,250 to our Fitness and Health Management business segments based upon the
ratio of the estimated market value for each segment to the total estimated market value for the
entire company. In connection with this allocation, 24.4%, or $3,549,285 of our total goodwill was
allocated to our Fitness Management segment, and 75.6%, or $10,996,965 was allocated to our Health
Management segment. This allocation of goodwill to each segment will be the base amount that is
subject to write-down should we determine that impairment exists in future years.
Stock-Based Compensation – We maintain a stock option plan for the benefit of certain eligible
employees and directors of the Company. Commencing January 1, 2006, we adopted Statement of
Financial Accounting Standard No. 123R, “Share Based Payment” (“SFAS 123R”), using the modified
prospective method of adoption, which requires 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. Further information on our share-based payments can be
found in Note 8 in the Notes to the Consolidated Financial Statements under Item 8 in this Form
10-K.
Valuation of Derivative Instruments – In accordance with the interpretive guidance in EITF Issue
No. 05-4, “The Effect of a Liquidated Damages Clause on a Freestanding Financial Instrument Subject
to EITF Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company’s Own Stock”, we originally valued warrants we issued in November
2005 in our financing transaction as a derivative liability. We had to make certain periodic
assumptions and estimates to value the derivative liability. Factors affecting the amount of this
liability included changes in our stock price, the computed volatility of our stock price and other
assumptions. The change in value is reflected in our statements of operations as non-cash income
or expense.
Further information regarding our warrant valuation can be found in the section titled “Liquidity
and Capital Resources” and in our Note 2 to the Consolidated Financial Statements under Item 8 in
this Form 10-K.
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Software Development Costs - We expense all costs of software development that we incur to
establish technological feasibility of an enhancement, including activities related to i