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| FIT > SEC Filings for FIT > Form 10-K on 25-Mar-2009 | All Recent SEC Filings |
25-Mar-2009
Annual Report
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 215 corporate fitness center sites, 166
corporate health management sites and 99 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.
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 - 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. 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 depends 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, which began to happen in the fourth
quarter of 2008; (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 in the Health Management
segment; (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.
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 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 have
determined that our goodwill relates to two reporting units for purposes of
impairment testing.
In the fourth quarter of 2006, we decided to begin reporting our business in two
reportable segments; Fitness Management and Health Management. These segments
also represent reporting units under SFAS 142, Goodwill and Other Intangibles
(SFAS 142). Consistent with the guidance provided in paragraphs 34 and 35 of
SFAS 142, we allocated our total goodwill of $14,546,250 to our Fitness
Management 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 $3,546,009 of
our total goodwill was allocated to our Fitness Management segment, and 75.6%,
or $11,000,241 was allocated to our Health Management segment. This initial
allocation of goodwill to each reporting unit will be the base amount that is
subject to write-down should we determine that impairment exists in future
years.
In connection with goodwill impairment testing as of December 31, 2008 and 2007,
and consistent with the guidance provided in paragraphs 32 and 33 of SFAS 142,
we allocated the assets and liabilities of our Fitness Management and Health
Management business segments based upon the respective benefit received from
each segment. Assets were allocated based on the percentage of revenue generated
as substantially all the assets consisted of accounts receivable. Liabilities
were allocated based on a percentage of cost of sales reported by each segment
as we determined our liabilities are closely linked to our segment cost of
sales. The net asset allocation that resulted for each segment was then compared
to an estimate of market value for each segment.
The accounting principles regarding goodwill acknowledge that the observed
market prices of individual trades of a company's stock (and thus its computed
market capitalization) may not be representative of the fair value of the
company as a whole. At December 31, 2008, the Company's shareholders' equity
exceeded its market capitalization by approximately $7,000,000. Consequently, we
performed a detailed analysis of our goodwill using the assistance of a third
party valuation specialist. Management assumes responsibility of the goodwill
impairment test that was performed. The impairment analysis utilized three
approaches: an income approach based on discounted cash flow and terminal value
using a 20% discount rate, and two market approaches, one looking at guideline
company values, and the second looking at recent comparable transactions for
others in our industry to determine if observable market data supports the
reasonableness of our estimates. The analysis utilized a range of assumptions
and multiples that allowed the Company to evaluate its results across a range of
potential values. Based on the analysis, we determined there was no impairment
of goodwill at the reporting unit level.
In addition, we reconciled our market capitalization to the estimated fair value
of the segments on a combined basis to determine if goodwill impairment exists
at the entity level. In performing this analysis, we started with a base market
capitalization, and then increased this amount to give consideration to the
trading illiquidity of our shares and a controlling equity interest. We
determined our base market capitalization by multiplying the 9,647,404
common shares outstanding at December 31, 2008, by a share price of $2.43, which
is an average share price for the twenty-two trading days in December 2008.
Since daily trading in our shares during the fourth quarter was approximately
one-tenth of one percent of outstanding shares, we determined it was reasonable
to assume our shares were undervalued due to illiquidity. To arrive at a
marketable, non-controlling value for our shares, we added an illiquidity
premium of 15% to our base market capitalization. Regarding a controlling equity
interest, we considered that, for publicly-traded companies, substantial value
may arise from the ability to take advantage of synergies and other benefits
that flow from control over another entity. Consequently, measuring the fair
value of a collection of assets and liabilities that operate together in a
controlled entity is different from measuring the fair value of that entity's
individual common shares. In most industries, including ours, an acquiring
entity typically is willing to pay more for equity securities that give it a
controlling interest than an investor would pay for a fractional, noncontrolling
ownership interest. For purposes of this analysis, we used a control premium of
30%. To determine the applicable control premium, we observed data derived from
acquisitions and trading multiples of companies in our industry, in addition to
data for companies operating in the overall services industry. We have 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.
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, forfeitures, 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.
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 general release. 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, in
accordance with Financial Accounting Standards No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, when circumstances indicate that 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, 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.
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 claims expense, including incurred but not reported losses, is
estimated using historical claims experience and reflected in the balance sheet
as accrued self-funded insurance.
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. We do not record a tax liability or benefit in connection with the
change in fair value of certain of our warrants. Income taxes are calculated
based on management's estimate of the Company's effective tax rate, which takes
into consideration a federal tax rate of 34% and an effective state tax rate of
approximately 7%. This normal effective tax rate of 41% is less than the tax
rate resulting from income tax expense we recognized during the year ended
December 31, 2008 due to the tax rate effects of compensation expense for
incentive stock options.
RESULTS OF OPERATIONS
offset by a potential annualized revenue loss of $4.5 million from contract
cancellations, of which $2.7 million is attributed to fitness management and
$1.8 million is attributed to health management. These cancellations reflect the
continuing weakness in the economy and the challenges companies expect to face
during 2009.
Gross Profit. Gross profit increased $4,099,000, or 20.9%, to $23,740,000 for
2008, from $19,641,000 for 2007. Total gross margin increased to 30.6%, from
28.1% 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 both Health and Fitness staffing services.
Fitness Management
Fitness Management gross profit decreased $26,000, which includes an increase of
$201,000 from staffing services and a decline of $227,000 from program services.
Gross margin for our Fitness Management segment increased in 2008 to 23.7%, from
23.1% for 2007. This result is primarily due to a gross margin increase in
staffing services, which increased to 22.9%, from 21.7% for last year. Gross
profit for program services decreased from 43.1% to 37.7%. The margin increase
for staffing services is primarily due to lower costs for employee paid time off
and medical benefits, in addition to expense savings for group classes and
liability insurance. The margin decrease for program services is primarily due
to higher costs to deliver site-based personal training and massage therapy
services.
Health Management
Health Management gross profit grew $4,125,000, which includes growth of
$814,000 from staffing services and growth of $3,310,000 from program services.
Gross margin for our Health Management segment increased from 35.8% to 38.2%.
This result is due to a gross margin increase for staffing services, which
increased to 26.4%, from 25.1% last year, and a gross margin decrease for
program services, which declined to 49.9%, from 50.1% last year. The gross
margin increase for staffing services is primarily due to revenue growth and
operating expense savings. The gross margin decrease in program services is
primarily due to the higher sales growth of lower margin program services, such
as biometric screenings and flu shots.
The anticipated negative impact of the economic recession discussed above may
challenge our ability to improve gross profit and margins in 2009 on a basis
consistent with past growth.
Operating Expenses and Operating Income. Operating expenses increased
$1,174,000, or 6.6%, to $18,955,000 for 2008, from $17,781,000 for 2007.
This increase is due to a $1,084,000, or 10.1% increase in salaries, and a
$97,000, or 1.4% increase in other selling, general and administrative expenses.
These increases are primarily due to staff additions in certain operating areas
that were impacted by our 2008 revenue growth, including Research, Development
and Outcomes, Information Technology, Business Development and Operations. For
2008 operating expense, as a percent of revenue, were 24.4%, compared to 25.4%
for 2007.
Operating margin increased to 6.2% for 2008, from 2.7% for 2007. This increase
is primarily due to sales growth in our Health Management segment, cost
efficiencies related to staffing services and a lower ratio of operating
expenses to revenue as discussed above. 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.
If we continue to experience profitable operations resulting in increased
shareholders' equity value, and if our market price per share does not increase
accordingly, it is possible this may trigger an impairment of goodwill in future
periods. In addition, our earnings might not maintain or increase at the rate
the market expects, or in parity with our competition, which could contribute to
a decline in our share price when compared to others in our industry. As a
result of these and other factors, we could experience a partial or complete
goodwill impairment of one or both of our segments or our company as a whole. An
impairment would have a negative impact on our profitability.
Other Income and Expense. Interest expense decreased $15,000 to $21,000 for
2008, from $36,000 for 2007. This decrease was due to lower use of our credit
line to temporarily fund working capital needs during 2008.
Income Taxes. Income tax expense increased $1,136,000 to $2,042,000 for 2008,
from $906,000 for 2007. The increase is primarily due to increased operating
income in 2008 compared to 2007.
Our effective tax rate was 42.9% of earnings before income taxes for 2008,
compared to 49.9% for 2007. Compared to our normal effective tax rate of 41%,
our current effective tax rate is higher due primarily to the non-deductibility
of compensation expense for incentive stock options, which added approximately
2.9% to our effective tax rate for 2008 and 4.0% for 2007.
. . .
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