U.S. Securities and Exchange Commission
Washington, D.C. 20549
Form 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _______________ to ________________
Commission file no. 0-24921
Power3 Medical Products, Inc.
(Exact name of small business issuer as specified in its charter)
New York 65-0565144
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3400 Research Forest Drive, Suite B2-3
Woodlands, Texas 77381
(Address of principal executive offices)
(281) 466-1600
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [ ] No [X]
As of May 15, 2005, there were 65,345,121 shares of voting common stock of the
registrant issued and outstanding.
Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
1
INDEX
PART I. FINANCIAL INFORMATION.................................................3
Item 1. Financial Statements..................................................3
Condensed Balance Sheet (unaudited)...........................................3
Condensed Statements of Operations (unaudited)................................4
Condensed Statement of Cash Flows (unaudited).................................5
Notes to Condensed Financial Statements (unaudited)...........................6
Item 2. Management's Discussion and Analysis or Plan of Operation.....23
Item 3. Controls and Procedures.......................................34
Part II. Other Information....................................................36
Item 1. Legal Proceedings.............................................36
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds......................................................36
Item 3. Defaults upon Senior Securities...............................36
Item 4. Submission of Matters to a Vote of Security Holders...........37
Item 5. Other Information.............................................37
Item 6. Exhibits and Reports on Form 8-K..............................37
SIGNATURES....................................................................39
EXHIBIT INDEX.................................................................40
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
POWER3 MEDICAL PRODUCTS, INC.
(A Development Stage Enterprise)
CONDENSED BALANCE SHEET AS OF MARCH 31, 2005
(unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 38,358
Prepaid expenses and other current assets 7,201
Total current assets 45,559
FURNITURE, FIXTURES AND LAB EQUIPMENT (net of
accumulated depreciation of $243,024) 72,283
OTHER ASSETS:
Debt issuance costs - net 168,619
Other intangibles - net 169,601
Deposits 25,900
TOTAL $ 481,962
================
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Accounts payable and accrued and other liabilities $ 1,449,245
Notes payable 20,000
Convertible debentures (net of unamortized discounts of
$1,238,899) 161,111
Total current liabilities 1,630,356
COMMITMENTS AND CONTINGENCIES (see Notes (1) and (8))
STOCKHOLDERS' DEFICIT:
Common stock - $0.001 par value: 150,000,000 shares
authorized; 65,345,121 shares issued and outstanding 65,345
Additional paid-in capital 34,804,083
Common stock subscribed 70,000
Deferred compensation (15,794,030)
Deficit accumulated during the development stage (20,293,793)
Total stockholders' deficit (1,148,395)
TOTAL $ 481,962
================
See notes to condensed financial statements.
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POWER 3 MEDICAL PRODUCTS, INC.
(A Development Stage Enterprise )
CONDENSED STATEMENTS OF OPERATIONS
(unaudited)
___________________________________________________________________________________________________
For the Period Advanced BioChem
May 18, 2004 (the Predecessor)
For the Three (date of
Months Ended acquisition) to For the Three Months
March 31, 2005 March 31, 2005 Ended March 31, 2004
REVENUES $ - $ 4,000 $ 137,837
OPERATING EXPENSES:
Stock based compensation and consulting 3,609,438 17,509,067 -
Other operating expenses 720,896 2,543,066 167,727
Total operating expenses 4,330,334 20,052,133 167,727
LOSS FROM OPERATIONS 4,330,334 20,048,133 29,890
INTEREST AND FINANCING EXPENSE 189,787 245,660 51,942
NET LOSS $ (4,520,121) $(20,293,793) $ (81,832)
============= ============= ==============
NET LOSS PER SHARE - Basic and diluted $ (.07) $ (.01)
============= ==============
Weighted average number of shares
Outstanding 65,345,121 12,624,672
============= ==============
___________________________________________________________________________________________________
See notes to condensed financial statements.
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POWER 3 MEDICAL PRODUCTS, INC.
(A Development Stage Enterprise)
CONDENSED STATEMENTS OF CASH FLOWS
(unaudited)
______________________________________________________________________________________________________________
For the period
May 18, 2004 Advanced BioChem
For the (date of (the Predecessor)
Three Months acquisition)
Ended March to March 31, For the Three Months
31, 2005 2005 Ended March 31, 20045
NET CASH USED IN OPERATING ACTIVITIES $ (529,802) $(1,799,420) $ (269,535)
CASH USED IN INVESTING ACTIVITIES (25,622) (319,957) -
NET CASH PROVIDED BY FINANCING ACTIVITIES 435,000 2,157,735 271,491
NET CHANGE IN CASH AND CASH EQUIVALENTS (120,424) 38,358 1,956
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 158,782 - -
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 38,358 $ 38,358 $ 1,956
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of net liabilities in a
recapitalization - see Note A $ - $ (41,635) $ -
============ ============ ============
Issuance of common stock for net liabilities
of Advanced BioChem $ - $ (444,774) $ -
============ ============ ============
Liabilities converted to stock $ - $ 31,471 $ 25,477
============ ============ ============
______________________________________________________________________________________________________________
See notes to condensed financial statements.
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POWER 3 MEDICAL PRODUCTS, INC
(A Development Stage Enterprise)
NOTES TO CONDENSED FINANCIAL STATEMENTS
(unaudited)
(1) Nature of Operations and Background
Prior to May 18, 2004, Power 3 Medical Products, Inc. ("Power 3" or the
"Company"), formerly known as Surgical Safety Products, Inc., was engaged in
product development, sales and distribution and services for the healthcare
industry. The Company had limited business activity during 2003 and the period
January 1, 2004 to May 18, 2004 (date of acquisition). Subsequent to the
acquisition described below, the overall business strategy of Power 3 was
changed. Power 3 is currently engaged in the early detection, monitoring, and
targeting of diseases through the analysis of proteins. The Company's business
objective is to focus on disease diagnosis, protein and biomarkers
identification, and drug resistance in the areas of cancers, neurodegenerative
and neuromuscular diseases by utilizing protein identification for cancer
discovery and applying proteomics to the medical diagnostic market (principally
hospitals and other medical facilities). The Company's products are in the form
of diagnostic tests. Principal national markets include diagnostics and drug
discovery and development in the United States and Canada.
Because Power3 has been focusing most of its efforts on research and
development, and capital raising activities since May 18, 2004 and because it
has not generated significant revenues through March 31, 2005, it is considered
to be in the development stage as defined in Financial Accounting Standards
Board Statement No. 7. Accordingly, some of its accounting policies and
procedures have not yet been established.
Advanced BioChem Transaction
On May 18, 2004, Power 3 purchased all of the assets of Advanced BioChem, Inc.
(the "Predecessor" or "Advanced BioChem") and initially agreed to assume
approximately $260,000 of the Predecessor's liabilities (or approximately 8% of
the total of such liabilities) in exchange for the issuance of 15,000,000 shares
of its common stock pursuant to an Asset Purchase Agreement of even date
therewith. For financial statement purposes, the transaction has been accounted
for as a re-capitalization of the equity structure rather than a business
combination. Accordingly, no stock based compensation expenses were recorded as
a result of this transaction, and the assets and liabilities of Power3 and the
Predecessor were combined based on their historical costs. Also, the accumulated
deficits of Power3 and the Predecessor prior to the date of the transaction were
eliminated.
In May 2005, Advanced BioChem publicly announced that it was reviewing the terms
of the aforementioned acquisition, and has asserted that the Company, together
with Messrs. Rash and Goldknopf, are responsible for the Predecessor's
liabilities (with the exception of those specifically excluded). The amount of
such disputed liabilities is approximately $2,700,000. The terms of the Asset
Purchase Agreement are not clear and are subject to different interpretations.
While the Company believes that it has properly interpreted the provisions of
the agreement, fulfilled its obligations there under and reflected the terms of
the transaction in its financial statements and previous filings, in an effort
to avoid possible litigation and to settle the claims asserted by Advanced
BioChem, the Company has attempted to negotiate a settlement with Advanced
BioChem, which in part included an offer to assume additional liabilities of
$425,000. However, at this time, Advanced BioChem has ceased discussions with
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the Company indicating that it will delay any action for a period of thirty days
to allow the Company to become current in its filings with the SEC.
While it is not certain that the Company will ultimately be required to assume
the additional $425,000 of liabilities, in accordance with Financial Accounting
Standards Board Statement Number 5, "Accounting for Contingencies", the Company
has reflected this settlement offer as a purchase price adjustment in the
accompanying financial statements by recording the additional liabilities of
$425,000 and reducing additional paid in capital by such amount. In addition,
the Company remains contingently liable for the remaining liabilities of
$2,325,000. However the purchase price and related financial statements have not
been adjusted for these liabilities as the fair value of this contingency cannot
be reasonably estimated at this time.
At the time of the acquisition, the Company's Chief Executive Officer owned
approximately 3.92% of the common stock of Advanced BioChem, thus resulting in
indirect beneficial ownership at the time of the transaction of approximately
588,000 shares of the Company's common stock through the Predecessor.
Additionally, the Company's Chief Scientific Officer held approximately 8.23% of
the common stock of Advanced BioChem at the time of the transactions, thus
resulting in his indirect beneficial ownership at the time of the transaction of
approximately 1,234,500 shares of the Company's common stock through the
Predecessor.
Because of this transaction, and because the Company is in the development
stage, the accompanying statements of operations and cash flows include the
accounts and balances of the Advanced BioChem for the quarter ended March 31,
2004, and the accounts and balances of the Company for the quarter ended March
31, 2005 and for the period May 18, 2004 (date of acquisition) to March 31,
2005.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
certain estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements. The reported amounts of revenues and expenses during
the reporting period may be affected by the estimates and assumptions management
is required to make. Estimates that are critical to the accompanying financial
statements include assessing the impact of contingencies (see above and Note 7)
and the amortization periods for the debt issuance costs and debt discount on
the convertible debentures (see Note 8) as well as estimating depreciation and
amortization periods of tangible and intangible assets, and long-lived
impairments, among others. Estimates and assumptions are reviewed periodically
and the effects of revisions are reflected in the financial statements in the
period they are determined to be necessary.
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Furniture, Fixtures and Lab Equipment
Furniture, fixtures and lab equipment are stated at cost. Major additions are
capitalized, while minor additions and maintenance and repairs, which do not
extend the useful life of an asset, are expensed as incurred. Depreciation and
amortization are provided using the straight-line method over the assets'
estimated useful lives. At March 31, 2005, certain lab equipment having a net
book value of approximately $39,500 serves as security for certain liabilities.
Debt Acquisition Costs
Debt acquisition costs are being amortized over the maximum term of the
convertible debentures of three years using the straight line method.
Unamortized Discount
Unamortized discount resulting from the allocation of value to warrants and the
beneficial conversion feature embedded in the convertible debentures (see Note
8) is being amortized to interest expense over the contractual lives of the
debentures using the interest method.
Other Intangibles
Other intangibles consist primarily of patents which are recorded at cost and
arise from legal and filing fees. Patents and other intangibles are being
amortized over ten years on a straight-line basis.
Long-Lived Assets
Statement of Financial Accounting Standards (SFAS) 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" requires that long-lived assets,
including certain identifiable intangibles, be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying value of the
assets in question may not be recoverable. The Company evaluated its long-lived
assets at December 31, 2004 and determined that certain impairment losses were
necessary. As a result, operations were charged for $15,832 during the period
May 18, 2004 (date of acquisition) to December 31, 2004. Management believes
that the remaining balances of the Company's long-lived assets are recoverable
at March 31, 2005.
Net Loss Per Share
Net loss per share is computed in accordance with SFAS No. 128 "Earnings per
Share" ("SFAS No. 128") and SEC Staff Accounting Bulletin No. 98 ("SAB 98").
Under the provisions of SFAS No. 128 and SAB 98, basic net loss per share is
computed by dividing the net loss available to common stockholders for the
period by the weighted average number of common shares outstanding during the
period. Diluted net loss per share is computed by dividing the net loss for the
period by the number of common and common equivalent shares outstanding during
the period. In periods in which they would be anti-dilutive, common equivalent
shares are ignored in the loss per share calculations. As a result, basic and
diluted net loss per share are identical for each of the periods in the
accompanying financial statements.
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Stock - Based Compensation
The Company accounts for equity instruments issued to employees for services
based on the intrinsic value of the equity instruments issued and accounts for
equity instruments issued to those other than employees based on the fair value
of the consideration received or the fair value of the equity instruments,
whichever is more reliably measurable.
The Company has adopted Statement of Financial Accounting Standards No. 148
"Accounting for Stock-Based Compensation - Transition and Disclosure" (SFAS No.
148). This statement amends FASB Statement No. 123, "Accounting for Stock Based
Compensation". It provides alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for employee
stock based compensation. It also amends the disclosure provision of FASB
statement No. 123 to require prominent disclosure about the effects on reported
net income of an entity's accounting policy decisions with respect to
stock-based employee compensation. As permitted by SFAS No. 123 and amended by
SFAS No. 148, the Company continues to apply the intrinsic value method under
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees," to account for its stock-based employee compensation
arrangements.
Income Taxes
The Company and the Predecessor compute income taxes in accordance with
Financial Accounting Standards Statement No. 109 "Accounting for Income Taxes"
("SFAS 109"). The Company also prepares its income taxes in accordance with this
standard. Under SFAS 109, deferred taxes are recognized for the tax consequences
of temporary differences by applying enacted statutory rates applicable to
future years to differences between the financial statement carrying amounts and
the tax basis of existing assets and liabilities. Also, the effect on deferred
taxes of a change in tax rates is recognized in income in the period that
included the enactment date. There were no significant temporary differences at
March 31, 2005.
Research and Development
Research and development costs, which approximated $172,000 and $362,000 for the
three months ended March 31, 2005 and the period May 18, 2004 (date of
acquisition) to December 31, 2004, respectively, are expensed as incurred. There
were no research and development costs incurred during the three months ended
March 31, 2004.
Cash Equivalents
For purposes of the statements of cash flows, the Company considers all highly
liquid debt instruments purchased with a maturity of three months or less to be
cash equivalents.
Investments
The Company accounts for its interest in Power 3 Medical, Inc., a Nevada
corporation, now known as Tenthgate, Inc., using the cost method.
Basis of Presentation
The accompanying unaudited financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America
("GAAP") for interim financial information and with the instructions to Form
10-QSB and Item 310(b) of Regulation S-B. As such, they may not include all of
the information and footnotes required by GAAP for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
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recurring adjustments) considered necessary for a fair presentation have been
included. The results of operations for the quarter ended March 31, 2005 are not
necessarily indicative of the results to be expected for the full year ended
December 31, 2005.
(2) Going Concern
The Company's financial statements are presented on a going concern basis, which
contemplates the realization of assets and satisfaction of liabilities in the
normal course of business. The Company is in the development stage and has
primarily been involved in research and development and capital raising
activities; as such the Company has incurred significant losses from operations
and has a significant stockholders' deficit at March 31, 2005. As a result, the
Company has an immediate need for capital to continue its operations, and it
will need to raise significant additional funds to implement its business plan.
This cash will have to come from equity sales and/or borrowings as management
has projected that the Company will need significant additional capital for
development and other ongoing operational activities before it will have any
anticipated revenue generating products. The actual amount of funds that the
Company will need will be determined by many factors, some of which are beyond
the Company's control. These factors include:
|X| The extent to which the Company enters into licensing arrangements,
collaborations or joint ventures;
|X| The progress and results of research and product development;
|X| The costs and timing of obtaining new patent rights;
|X| The extent to which the Company requires or licenses other technologies;
and
|X| Regulatory changes and competition and technological developments in the
market.
A current focus of management is on raising the remaining funds of $1,600,000
potentially available to them pursuant to the Securities Purchase Agreement
dated October 28, 2004 (the "Agreement"). These funds will be immediately
reduced by the payment of certain delinquent payables of approximately $200,000
and $251,000 of certain bridge financing received in April 2005 that is to be
repaid upon the receipt of the $1,600,000. The Company is in immediate need for
capital to continue its operations and as such its ability to continue as a
going concern is subject to its ability to generate a profit or obtain necessary
funding from outside sources. Management believes that even though the Company
currently has limited cash resources and liquidity, assuming exercise of the
warrants and additional investment rights specified in the Agreement, that the
net funds available from the final closing under such Agreement will allow the
Company to continue operations through the first quarter of 2007. In the event the final
closing and sale of $1,600,000 in aggregate principal amount of debentures
occurs, but the warrants and additional investment rights are not exercised, the
Company anticipates that it will need to raise additional capital prior to
October 2005 to meet its operating costs. However, the Company is currently in
default under the conditions set forth in the Agreement as well as the
debentures and registration rights agreement and consequently, there is no
assurance that the Company will be successful in completing the sale and
issuance of the remaining $1,600,000 aggregate principal amount of debentures
and/or the additional investments rights pursuant to the Agreement. If the
Company is unsuccessful in the closing of the sale and issuance of the
$1,600,000 aggregate principal amount of debentures at the final closing, the
Company will be required to obtain alternative financing, sell or license some
of its technology, and/or to curtail or cease its operations. Any such funding
may significantly further dilute existing shareholders or may limit the
Company's rights to its technology. Moreover, the increase in the number of
shares available in the public marketplace may reduce the market price for the
Company's common stock, and consequently, the price investors may receive at the
time of sale. The financial statements do not include any adjustments to reflect
the possible future effects on the recoverability and classification of assets
or the amounts and classification of liabilities that may result from the
possible inability of the Company to continue as a going concern.
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(3) Loss Per Share
The following common equivalent shares have been excluded from the fully diluted
loss per share calculations because the effects would be anti-dilutive;
o 2,500,000 warrants, and additional investment rights having a value of
$2,500,000, which were issued to certain accredited investors on October
28, 2004 under the Agreement. In addition, pursuant to the Agreement, the
investors purchased certain convertible debentures that if exercised, will
result in the issuance of an indeterminate number of shares of common
stock.
o 333,333 warrants which were issued to certain accredited investors on
January 26, 2005 under the Agreement. In addition, pursuant to the
Agreement, the investors purchased certain convertible debentures that if
exercised, will result in the issuance of an indeterminate number of shares
of common stock
o 580,000 shares of warrants which were issued to members of the Company's
Scientific Advisory Board and various other consultants in 2004 (including
100,000 to the agent that placed the convertible debentures discussed
above). The warrants, which expire three to five years from the dates of
the respective grants and were issued at no cost to such personnel, may be
converted to a like number of shares of the Company's common stock at any
time prior to their expiration(s). As a result, during the period May 18,
2004 (date of acquisition) to December 31, 2004, the Company recorded
$626,100 of stock based compensation as a result of the issuance of these
warrants, which amounts represent the fair value of the warrants on the
dates they were granted.
(4) Income Taxes
The Company, and the Predecessor, recognized losses for both financial and tax
reporting purposes during each of the periods in the accompanying statements of
operations. Accordingly, no provisions for income taxes and/or deferred income
taxes payable have been provided for in the accompanying financial statements.
At March 31, 2005 the Company had net operating loss carryforwards for income
tax purposes of approximately $9,551,000 (the significant difference between
these net operating loss carryforwards and the Company's deficit, and previous
losses incurred by Power 3 before May 18, 2004 which were eliminated as of such
date) arises primarily from stock based expenses that are considered to be
permanent differences. These net operating loss carryforwards expire at various
times through the period ended March 31, 2005 however because the Company has
experienced changes in control and has incurred significant operating losses,
utilization of the income tax loss carryforwards are not assured. As a result,
the non-current deferred income tax asset arising from these net operating loss
carryforwards is not recorded in the accompanying balance sheet because the
Company established a valuation allowance to fully reserve such assets as their
realization did not meet the required asset recognition standard established by
SFAS 109.
(5) Related Party Transactions
In October 2004, the Company's chief financial officer loaned $75,000 to the
Company. The loan was repaid, without interest, in November 2004 with proceeds
from the Company's financing on October 28, 2004.
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During the three months ended March 31, 2005 this same officer advanced $35,000
to the Company. The advance, which is due on demand and unsecured, bears
interest at 6% per annum. At March 31, 2005, the balance of the advance is
included in accounts payable and accrued and other liabilities in the
accompanying condensed balance sheet.
(6) Notes Payable
Notes payable existing at March 31, 2005 bear interest at a fixed rate of 6% and
were scheduled to mature on December 31, 2004. However, the Company has entered
into agreements with the note holders to extend the maturity of the notes
through June 30, 2005. In addition, the Company has the option to convert 75% of
the notes into its common stock at a mutually agreeable conversion ratio.
(7) Other Commitments and Contingencies
Operating Lease
At March 31, 2005, the Company is obligated under a lease for its operating
facility which expires on August 31, 2009, has an initial term of sixty-three
months, and requires base monthly minimum lease payments ranging from
approximately $6,000 to $9,600 (plus utilities and operating expenses) over the
lease term. The lease contains a provision which allows the Company to extend
the lease for two additional terms of sixty months. Rent expense, including
utilities, approximated $18,000, $21,500 and $62,800, for the three months ended
March 31, 2005 and 2004, and the period May 18, 2004 (date of acquisition) to
March 31, 2005, respectively.
Employment Agreements
The Company is obligated under amended and restated employment agreements with
its Chief Executive Officer, Chief Scientific Officer and Chief Financial
Officer. The significant terms of the agreements are as follows:
Chief Executive Officer - The amended and restated employment agreement is
effective as of May 18, 2004 and has an initial term of five years, subject to
each party's termination rights. The agreement provides for a base salary of
$250,000 per year and the opportunity to receive cash bonuses based on
performance upon the discretion of the board of directors. The agreement also
includes participation in employee benefit plans offered to employees, as well
as a grant of 13,250,000 shares of restricted common stock and 1,500,000 shares
of restricted Series B preferred stock (the Series B preferred shares have not
yet been issued). Either party may terminate the Chief Executive Officer's
employment under the contract, either with or without cause upon giving the
other party at least thirty days notice. If the Company terminates the chief
executive officer's employment at any time during the initial term without
cause, he will be entitled to receive compensation provided under the agreement
for the remaining initial term of employment. In addition, in the event of a
change in control as defined in the agreement, the Company may waive, in whole
or in part, any and all remaining restrictions on the restricted shares of
common stock and Series B preferred stock granted to him.
Chief Scientific Officer - The amended and restated employment agreement is
effective as of May 18, 2004 and has an initial term of five years, subject to
each party's termination rights. The agreement provides for a current base
salary of $125,000 through December 18, 2004 and $100,000 thereafter and the
opportunity to receive cash bonuses based on performance upon the discretion of
the board of directors. The agreement also includes participation in employee
benefit plans offered to employees, as well as a grant of 13,250,000 shares of
restricted common stock and 1,500,000 shares of restricted Series B preferred
stock (the Series B preferred shares have not yet been issued). Either party may
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terminate the chief scientific officer's employment under the contract, either
with or without cause upon giving the other party at least thirty days notice.
If the Company terminates the Chief Scientific Officer's employment at any time
during the initial term without cause, he will be entitled to receive
compensation provided under the agreement for the remaining initial term of
employment. In addition, in the event of a change in control as defined in the
agreement, the Company may waive, in whole or in part, any and all remaining
restrictions on the restricted shares of common stock and Series B preferred
stock granted to him.
Chief Financial Officer - The amended and restated employment agreement is
effective as of July 2, 2004 and has an initial term of three years, subject to
each party's termination rights. The agreement provides for a base salary of
$120,000 per year and the opportunity to receive cash bonuses based on
performance upon the discretion of our board of directors. The agreement also
includes participation in employee benefit plans offered by us to our employees,
as well as a grant of 140,000 shares of restricted common stock. Either party
may terminate the Chief Financial Officer's employment under the contract,
either with or without cause upon giving the other party at least thirty days
notice. If the Company terminates the chief financial officer's employment at
any time during the initial term without cause, he will be entitled to receive
compensation provided under the agreement for the remaining initial term of
employment. In addition, in the event of a change in control as defined in the
agreement, the Company may waive, in whole or in part, any and all remaining
restrictions on the restricted shares of common stock granted to him.
In addition to the above common stock grants, during the period May 18, 2004
(date of acquisition) to March 31, 2005, the Company granted 1,305,000 shares of
its common stock to various other employees. Because all of the shares were
granted at no cost to the employees, and because the shares generally vest over
a period of two years, the Company recorded $25,150,500 of deferred compensation
upon the date of the grant (which amount was determined based on the total
number of shares granted times the trading values of the shares on the dates the
stock grants were made). This amount is being amortized to stock based
compensation expense over the vesting period.
As mentioned above, the Company has agreed to issue a total of 3,000,000 shares
of Series B Preferred Stock to two of its officers. However, for various
reasons, including certain restrictions required by the indebtedness (which
preclude the shares from being issued for at least 90 days after the effective
date of the registration statement that has been filed to cover the resale of
the shares of common stock that will be issued upon the conversion or exercise
of the securities issued by the Company for such indebtedness), the shares have
not yet been issued. The Company intends to issue such shares of the Series B
Preferred Stock at such time as it is permitted. The shares will be convertible
into a like number of common shares as vesting occurs over a period which is
expected to be two years. Because of this and because all of the shares were
granted at no cost to the officers, the Company recorded $2,700,000 of deferred
compensation upon the date of the respective employment contracts (which amount
was determined based on the 3,000,000 common shares that may ultimately be
issued as a result of the convertible feature times the trading values of the
shares on the dates the stock grants were made). This amount is being amortized
to stock based compensation expense over the anticipated vesting period.
Future required payments for base compensation under all of the employment
agreements discussed above are approximately as follows:
Periods Ending Amounts
December 31,
2005 (nine months) $ 352,500
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2006 470,000
2007 410,000
2008 350,000
2009 175,000
Total $1,757,500
==========
Contingencies
In the normal course of business, the Company is involved in certain litigation,
including one matter in which the plaintiff is seeking $1,522,000 in damages.
Management believes the claim is without merit, and intends to vigorously
contest such claim. This matter is currently in the discovery stage and
accordingly its ultimate resolution cannot presently be determined. As such, no
effect has been given to any loss that might result from the outcome of this
litigation in the accompanying financial statements.
In addition, an equipment vendor filed a complaint against the Predecessor in
April of 2002 in a California court alleging breach of contract and seeking
damages. The Predecessor reached a settlement agreement in April of 2003 under
which the Predecessor would pay the vendor $40,000 in installments through
August of 2003. The Predecessor recorded a settlement cost of $40,000 in 2002
general and administrative expenses. At December 31, 2003, the Predecessor had a
balance remaining of $20,000. In April 2005 the equipment vendor filed a lawsuit
against the Predecessor, certain former officers of the Predecessor, and the
Company in order to enforce its claim for the remaining balance which is past
due and may be assumed by the Company as part of the settlement of the dispute
with the Predecessor.
(8) Securities Purchase Agreement
Convertible Debentures
The Company entered into a Securities Purchase Agreement, dated October 28, 2004
(the "Agreement") with certain accredited investors, and an Amendment to such
Securities Purchase agreement on January 19, 2005 in which four investors
accelerated the purchase of debentures in exchange for additional warrants.
Pursuant to the Agreement, the purchasers agreed to purchase from the Company
convertible debentures due three (3) years from the date of issuance in the
aggregate principal amount of $3,000,000. The Agreement also provides for the
issuance to the purchasers, at no additional cost to the purchasers, warrants to
purchase shares of the Company's common stock and additional investment rights
to purchase additional convertible debentures. In connection with the Agreement,
the Company also entered into a registration rights agreement with the
purchasers, which requires that the Company file a registration statement with
the SEC registering on behalf of the purchasers the resale of the shares of
common stock issuable upon conversion of the debentures and the exercise of the
warrants. The Company will also file an additional registration statement for
the resale of the shares issuable upon conversion of the debentures issuable
upon exercise of the additional investment rights previously issued by the
Company.
Effective October 28, 2004, the Company issued and sold to the purchasers the
first $1,000,000 in aggregate principal amount of such debentures at the initial
closing under the Agreement. Effective January 26, 2005, the Company issued and
sold to certain investors $400,000 aggregate principal amount of debentures.
Subject to the conditions set forth in the Agreement, as amended, the purchasers
are required to purchase the remaining $1,600,000 in aggregate principal amount
of such debentures at the final closing, which is to occur on or before the
fifth trading day after the effective date of the registration statement. The
Company is currently in default under the Agreement and the previously issued
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debentures and related registration rights agreement, and therefore the
conditions of the Agreement will not be satisfied or otherwise met on a timely
basis. Consequently, there are no assurances that the investors will purchase
all or any portion of the remaining $1,600,000 aggregate principal amount of
debentures. Assuming they are not called because of the Company's default
(see below), the $1,000,000 aggregate principal amount of debentures issued in
the initial closing and the $400,000 aggregate principal amount of debentures
issued on January 26, 2005 are due and payable in accordance with their original
terms in full three years after the date of issuance and will not bear interest.
The debentures which may be issued at the final closing will be due and payable
in full three (3) years after the date of their issuance, and will not bear
interest. The aggregate cash purchase price for the debentures will be
$3,000,000, which is equal to the full face amount of the debentures. At any
time from the closing date until the maturity date of the debentures, the
purchasers have the right to convert the debentures, in whole or in part, into
common stock of the Company at the then effective conversion price. The
conversion price for the previously issued $1,400,000 aggregate principal amount
of debentures and the 1,600,000 aggregate principal amount of debentures
issuable at the final closing is equal to the lesser of (1) $0.90, (2) the 75%
average of the daily volume weighted average price of the common stock for the
five (5) consecutive days preceding the effective date of the registration
statement or (3) the daily volume weighted average price of the common stock on
the effective date of the registration statement. The conversion price shall be
subject to adjustment under circumstances set forth in the debentures.
Under the Agreement, the Purchasers also received at the first closing warrants
to purchase an aggregate of up to 2,500,000 shares of common stock and
additional investment rights to purchase up to an additional $2,500,000
principal amount of convertible debentures. Pursuant to the Amendment to the
Agreement, concurrent with the Company's issuance of the $400,000 aggregate
principal amount of debentures on January 26, 2005, the Company issued
additional warrants to purchase an aggregate of up to 333,333 shares of common
stock. The warrants are exercisable at a price of $1.44 per share (subject to
adjustment), for a period of five (5) years from October 28, 2004.
The additional investment rights are exercisable at a price equal to the
principal amount of the debentures to be purchased, for (1) a period of nine
months following the effective date of the registration statement to be filed
pursuant to the registration rights agreement, or (2) a period of 18 months from
the date of issuance of the additional investment rights, whichever is shorter.
The debentures to be purchased upon the exercise of the additional investment
rights will have the same terms as the debentures described above, except that
the conversion price will be equal to $1.08 (subject to adjustment).
The debentures contain covenants that will limit the Company's ability to, among
other things: incur or guarantee additional indebtedness; incur or create liens;
amend the Company's certificate of incorporation, bylaws or other charter
documents so as to adversely affect any rights of the holders of the debentures;
and repay or repurchase more than a de minimis number of shares of common stock
other than as permitted in the debentures and other documents executed with the
purchasers.
The debentures include customary default provisions and an event of default
includes, among other things, a change of control of the Company, the sale of
all or substantially all of the Company's assets, the failure to have the
registration statement declared effective on or before the 180th day after the
initial closing date, and the lapse of the effectiveness of the registration
statement for more than 30 consecutive trading days during any 12-month period
(with certain exceptions), the Company's failure to timely deliver certificates
to holders upon conversion and a default by the Company in any obligations under
any indebtedness of at least $150,000 which results in such indebtedness being
accelerated. Upon the occurrence of an event of default, each debenture may
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become immediately due and payable, either automatically or by declaration of
the holder of such debenture. The aggregate amount payable upon an acceleration
by reason of an event of default shall be equal to the greater of 130% of the
principal amount of the debentures to be prepaid or the principal amount of the
debentures to be prepaid, divided by the conversion price on the date specified
in the debenture, multiplied by the closing price on the date set forth in the
debenture.
As mentioned above, the Company is in default under the provisions of the
Agreement, registration rights agreement and previously issued debentures. The
events of default principally relate to the Company's inability to timely file
its Annual Report on Form 10-KSB and the Company's resulting inability to have
the registration statement declared effective within the time period required by
the agreements. As previously disclosed by the Company, the Company has been
unable to file its 2004 Annual Report on Form 10-KSB due to its inability to
include the audited financial statements of the Predecessor for fiscal year
2003. Fitts, Roberts & Co., P.C. ("Fitts, Roberts") audited the financial
statements of Advanced BioChem for the year ended December 31, 2003 and has
previously issued its audit opinion in Advanced BioChem's Annual Report on Form
10-KSB for 2003. Fitts, Roberts previously gave the Company its consent to the
inclusion of Fitts, Roberts' audit report in the Company's previous filings.
Fitts, Roberts has refused to give its consent to the inclusion, in the
Company's Annual Report on Form 10-KSB for 2004, of Fitts, Roberts' audit report
on the financial statements of Advanced BioChem for fiscal year 2003. The
Company has requested guidance from the SEC concerning the accounting treatment
of its transaction with Advanced BioChem which may resolve this issue.
Alternatively, the Company will request Advanced BioChem to engage an
independent auditor to re-audit the 2003 financial statements of Advanced
BioChem and issue a new audit opinion thereon to be included in the Company's
Form 10-KSB.
Although the Company intends to seek waivers or forbearance agreements from the
holders of its debentures, there is no assurance that the Company will receive
such concessions. As such, the indebtedness has been classified as a current
liability in the accompanying balance sheet. If the Company is unable to obtain
such concessions, the aggregate amount payable under the outstanding debentures
due to the acceleration thereof by reason of the default is equal to the
"Mandatory Prepayment Amount" as specified in the debentures. The Mandatory
Prepayment Amount equals the sum of (i) the greater of: (a) 130% of the
principal amount of the debentures to be prepaid, or (b) the principal amount of
the debentures to be prepaid, divided by the conversion price on (x) the date
the payment is demanded or otherwise due, or (y) the date the payment is paid in
full, whichever is less, multiplied by the closing price of the Company's common
stock on (x) the date the payment is demanded or otherwise due, or (y) the date
the payment is paid in full, whichever is greater, and (ii) all other amounts,
costs, expenses and liquidated damages due in respect of the debentures. In
addition to the foregoing, pursuant to the terms of the registration rights
agreement, the Company is required to pay each holder of the debentures
liquidated damages since the registration statement was not declared effective
on or before February 25, 2005. The amount of liquidated damages shall equal two
percent (2%) of the aggregate purchase price paid by the holders for the
debentures and shall be payable on each monthly anniversary of such date until
the registration statement is declared effective. As of March 31, 2005, the
Company has recorded $104,000 of expense and accrued liabilities as a result of
this provision.
The Company has received notice from one of the purchasers of the debentures
informing the Company that it is in default under the debentures and demanding
payment of the Mandatory Prepayment Amount, together with the liquidated
damages, to which it is entitled pursuant to the agreement.
Filing of the Company's Form 10-KSB will be made as soon as the issues
concerning the inclusion of the 2003 financial statements of Advanced BioChem
have been resolved. Promptly thereafter, the Company intends to file an
amendment to its previously filed registration statement and will endeavor to
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have it declared effective as soon as practicable. The Company is in discussion
with its debenture holders regarding a resolution of this matter.
In connection with such financing, the Company became obligated to issue to its
placement agent a warrant to purchase 100,000 shares of common stock at an
exercise price of $3.00. If any investor exercises their additional investment
rights and purchases additional debentures, the placement agent will be entitled
to receive additional warrants to purchase up to a number of shares of common
stock equal to ten percent (10%) of the exercise price paid upon exercise of the
additional investment rights divided by ninety percent (90%) of the market price
as of the initial closing.
In accordance with the provisions of Emerging Issues Task Force Issue 98-5
("EITF 98-5"), discounts have been recorded for the entire face amount of the
convertible debentures on the dates the debentures were sold (i.e. October 28,
2004 and January 25, 2005) to allocate value to the embedded beneficial
conversion feature and the 2,500,000 warrants.
Since there is no assurance that the Company will receive the remaining funds
due at the time of the final closing and/or through the exercise of additional
investment rights, no effect has been given to any value that may result from
the issuance of securities in the accompanying financial statements.
(9) Other Significant Equity Transactions
During the period May 18, 2004 (date of acquisition) to March 31, 2005, the
Company had other (i.e. not disclosed elsewhere in the notes to the financial
statements) significant equity transactions as follows:
At the date of Advanced BioChem transaction discussed at Note (1), the Company
recorded common stock subscribed of $70,000. This amount resulted when an
affiliate of the previous management and Series A preferred stockholders
advanced funds to pay certain liabilities. Because the amount is expected to be
settled through the issuance of the Company's common stock, it has been
reflected as common stock subscribed in the accompanying balance sheet.
As of May 18, 2004 (date of acquisition), the Company had 3,870,000 shares of
Series A preferred stock outstanding. These shares were converted into 3,000,024
common shares of the Company's common stock on November 17, 2004.
The Company entered into a securities purchase agreement with an institutional
investor covering the purchase of up to $1,500,000 of restricted common stock at
various prices. During the period May 18, 2004 (date of acquisition) to December
-17-
31, 2004, the investor purchased 242,157 shares for $722,735 from the Company.
The Company does not expect to issue additional shares under this agreement.
In April, 2004 the Company entered into a Strategic Alliance Agreement with UTEK
Corporation and agreed to issue 240,000 shares of common stock for consulting
services provided. Under the terms of the agreement, the shares were to vest at
a rate of 20,000 per month. The agreement was cancelled in August, 2004 and as a
result, 160,000 of the 240,000 shares were returned to the Company.
On June 22, 2004, the Company engaged a public relations firm to provide such
services for a period of one year. As consideration for these services, in July
2004, the Company issued 125,000 shares of its common stock to this entity. As a
result thereof, the Company recorded deferred compensation of $262,500 at June
30, 2004, which amount was based on the number of shares issued and the market
value of the Company's common stock on the date of the agreement. The deferred
compensation is being amortized to stock based expense over the term of the
consulting agreement.
In June 2004, Company entered a consulting agreement having an initial term of
one year with an investor relations consultant. As consideration for services to
be rendered under the agreement, the consultant received 125,000 shares of the
Company's common stock (which shares were issued in July 2004) and is receiving
a monthly retainer of $5,000. The agreement, which may be canceled upon sixty
days written notice, automatically renews on a month to month basis after the
initial term of the lease, if no such notice is provided. The Company recorded
deferred compensation of $250,000 at June 30, 2004, which amount was based on
the number of shares issued and the market value of the Company's common stock
on the date of the agreement. The deferred compensation is being amortized to
stock based expense over the term of the consulting agreement.
In July 2004, the Company issued 100,000 shares of its common stock to a related
entity for services provided by such entity prior to June 30, 2004. The common
shares had a value of $210,000 on the date of the agreement, and accordingly
such amount has been included in stock based compensation in the accompanying
statement of operations for the period May 18, 2004 (date of acquisition) to
December 31, 2004.
(10) Stock Option Plans
The Company has various stock option and warrant plans outstanding. Options
granted under the 1998 stock option plans are exercisable only after the
respective vesting period, which is determined by the Company's stock option
committee. Options expire seven years from the date of grant. Under the 1999
stock option plan, options granted to employees vest ratably over three years;
vesting is determined by the Company's stock option committee for options
granted to officers, directors, and consultants. Options expire ten years from
the date of grant.
On March 31, 2003, the Company approved the 2003 Stock Compensation Plan, which
provides for the granting of common stock, options and/or warrants to officers,
directors and employees of the Company, as well as consultants and attorneys who
provide services to the Company. Under this plan the Company is authorized to
issue up to 8,000,000 shares of common stock, options or warrants. The options
and warrants shall expire according to terms as determined by a committee on the
date of grant, which will not exceed ten years from the date of grant, or five
years in cases of a grantee who owns more than 10% of the total combined voting
power of all classes of stock (10% Stockholder). The exercise period of any
options or warrants granted will also be determined by this committee at the
date of grant. The exercise price shall be determined by the committee at the
time of grant except that in the case of incentive stock options, the exercise
price shall not be less than 100% of the fair market value of the shares on the
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date of grant, and in cases of a 10% Stockholder, for which the exercise price
shall not be less than 110% of fair market value on the date of grant. At March
31, 2005 no warrants or options are outstanding under this plan.
In addition to the above, in January 2004, the Company's Board of Directors
approved the 2004 Directors, Officers and Consultants Stock Option, Stock
Warrant, and Stock Award Plan (the 2004 Plan). Pursuant to the 2004 Plan,
initially 10,000,000 shares of common stock, warrants, options, preferred stock
or any combination thereof may be optioned. After the grant of any option,
warrant or share of preferred stock, the number of shares that may be optioned
under the 2004 Plan will be increased. The number of shares of such increase
shall be an amount such that immediately following such increase, the total
number of shares issuable under this plan and reserved for issuance upon
exercise of options, warrants, or conversion of shares of preferred stock will
equal 15% of the total number of issued and outstanding shares of the Company's
common stock. At December 31, 2004 no warrants or options are outstanding under
this plan.
Pro forma information regarding net income and earnings per share is required by
SFAS 123, and has been determined as if the Company had accounted for all of its
options and warrants (the "Warrants") under the fair value method of that
Statement. The fair value for the Warrants was estimated at the date of grant
using a Black-Scholes option pricing model with the following assumptions for
Warrants granted in 2000: risk-free interest rate of 6.03%; dividend yield of
0%; volatility factor of the expected market price of the Company's common stock
of .34; and a weighted-average expected life of the options of 2.7 years. The
following assumptions were used for Warrants granted in 2004: risk-free interest
rate of 5.0%; dividend yield of 0%; volatility factor of the expected market
price of the Company's common stock of 1.86 and a weighted-average expected life
of the options of -0- years (as all were immediately vested). The Black-Scholes
option valuation model was developed for use in estimating the fair value of
traded Warrants that have no vesting restrictions and are fully transferable. In
addition, option valuation models require the input of highly subjective
assumptions including the expected stock price volatility. Because the Company's
Warrants have characteristics significantly different from those of traded
Warrants, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of its
Warrants.
All of the Company's warrants were recorded at their fair values; accordingly
stock based compensation actually recorded and stock based compensation that
would be recorded using a fair value based method are identical.
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A summary of the Company's warrant activity and related information for the
period May 18, 2004 (date of acquisition to December 31, 2004) is as follows:
Weighted
Average
Exercise
Warrants Price
Outstanding at January 1, 2004 6,360 $ 12.50
========
Cancelled - $ -
========
Granted 3,080,000 $ 1.44
========
Exercised - $ -
========
Outstanding at December 31, 2004 3,086,360 $ 1.46
========= ========
Exercisable at the end of the year 3,086,360 $ 1.46
========= ========
The following table summarizes information about the Company's Warrants
outstanding at December 31, 2004:
Weighted Average Weighted
Number Remaining Contractual Average
Exercise Price Outstanding Life (in years) Exercise Price
$ .98 300,000 2.4 $ .98
$ 1.00 100,000 2.4 $ 1.00
$ 1.43 50,000 2.8 $ 1.43
$ 1.44 2,500,000 4.8 $ 1.44
$ 2.77 30,000 2.6 $ 2.77
$ 3.00 100,000 4.8 $ 3.00
$ 6.50 5,460 6.0 $ 6.50
$50.00 900 3.0 $50.00
3,086,360 $ 1.46
=========
In addition to the Warrants discussed above, during the 3 months ended March 31,
2005, the Company issued 333,333 warrants to certain holders of the convertible
debentures (see Note 8).
(11) Recent Pronouncements
FIN 46 - Consolidation of Variable Interest Entities
In January 2003, the FASB issued FIN 46, (revised in December 2003 as FIN46R)
"Consolidation of Variable Interest Entities," which clarifies the application
of Accounting Research Bulletin ("ARB") 51, Consolidated Financial Statements,
to certain entities (called variable interest entities) in which equity
investors do not have the characteristics of a controlling financial interest or
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do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. The
disclosure requirements of this Interpretation are effective for all financial
statements issued after January 31, 2003. The consolidation requirements apply
to all variable interest entities created after January 31, 2003. In addition,
public companies must apply the consolidation requirements to variable interest
entities that existed prior to February 1, 2003 and remain in existence as of
the beginning of annual or interim periods beginning after June 15, 2003. The
adoption of FIN 46R had no impact on the financial statements of either the
Company or the Predecessor as neither of such entities have any variable
interests in variable interest entities.
SFAS 150 - Accounting for Certain Financial Instruments with Characteristics of
Both Liabilities and Equity
In May 2003, SFAS No. 150 "Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity," was issued to establish new
standards for how an entity classifies and measures certain financial
instruments with characteristics of both liabilities and equity. It requires
that an entity classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). Many of these instruments were
previously classified as equity. This statement was effective when issued for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective for calendar year public companies for the third quarter of 2003.
The adoption of SFAS 150 had no impact on the financial statements of either the
Company or the Predecessor.
SFAS 132 - Employers' Disclosures about Pensions and Other Postretirement
Benefits
In December 2003, FASB Statement No. 132 (revised) was issued which prescribes
the required employers' disclosures about pension plans and other postretirement
benefit plans; but it does not change the measurement or recognition of those
plans. The Statement retains and revises the disclosure requirements contained
in the original Statement 132. It also requires additional disclosures about the
assets, obligations, cash flows, and net periodic benefit cost of defined
benefit pension plans and other postretirement benefit plans. The Statement
generally is effective for fiscal years ending after December 15, 2003. Since
the Company does not have any types of pension plans or other postretirement
benefits, the adoption of this Statement did not have an effect on the Company's
financial statements.
SFAS 123(R) `Share-Based Payments'
In December 2004, the Financial Accounting Standards Board issued Statement
Number 123 ("FAS 123 (R)"), Share-Based Payments. FAS 123 (R) requires all
entities to recognize compensation expense in an amount equal to the fair value
of shared-based payments such as stock options granted to employees. The Company
will be required to apply FAS 123 (R) on a modified prospective method. Under
this method, the Company is required to record compensation expense (as previous
awards continue to vest) for the unvested portion of previously granted awards
that remain outstanding at the date of adoption. In addition, the Company may
elect to adopt FAS 123 (R) by restating previously issued financial statements,
basing the amounts on the expense previously calculated and reported in the pro
forma disclosures that had been required by FAS 123. FAS 123 (R) is effective
for the first reporting period beginning after December 15, 2005. The Company
does not believe the impact of adopting this Statement will be material as there
are no unvested options and warrants at March 31, 2005.
SFAS 153 - Exchanges of Nonmonetary Assets an Amendment of APB Opinion No. 29
In December 2004, FASB Statement No. 153 was issued amending APB Opinion No. 29
to eliminate the exception allowing nonmonetary exchanges of similar productive
assets to be measured based on the carrying value of the assets exchanged as
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opposed to at their fair values. This exception was replaced with a general
exception for exchanges of nonmonetary assets that do not have commercial
substance. A nonmonetary exchange has commercial substance if the future cash
flows of the entity are expected to change significantly as a result of the
exchange. The provisions of this statement are effective for nonmonetary asset
exchanges occurring in fiscal periods beginning after the June 15, 2005. The
adoption of this statement did not have a material impact on the Company's
financial statements.
FIN- 45 Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of
Indebtedness of Others
In November 2002, the FASB issued FASB Interpretation ("FIN") 45 "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others," which elaborates on the disclosures to be
made by a guarantor in its interim and annual financial statements about its
obligations under certain guarantees that it has issued. It also clarifies that
a guarantor is required to recognize, at the inception of the guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The initial recognition and initial measurement provisions of this
Interpretation are applied prospectively to guarantees issued or modified after
December 31, 2002. The adoption of these recognition provisions will result in
recording liabilities associated with certain guarantees provided by us. The
disclosure requirements of this Interpretation are effective for financial
statements of interim or annual periods ending after December 15, 2002. FIN 45
has no impact on Advanced BioChem's financial statements
(12) Subsequent Event
On April 5, 2005, the Company received a bridge loan in the amount of $251,000.
This bridge loan is due and payable on the sooner of August 15, 2005 or one
business day following the closing of the Company's sale and issuance of the
$1,600,000 aggregate principal amount of debentures. The bridge loan bears
interest at a rate of 10% per annum which, at the holder's option, may be paid
in (a) cash, or (b) that number of shares of the Company's common stock
determined by dividing $251,000 by the common stock price on date of payment and
multiplying the quotient so obtained by 20%. If the holder elects to have the
indebtedness satisfied through the issuance of common stock, the Company will be
required to recognize non-cash interest expense for the fair value of the common
stock issued.
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Item 2. Management's Discussion and Analysis or Plan of Operation
Forward Looking Statements
This report contains certain forward-looking statements of the intentions,
hopes, beliefs, expectations, strategies, and predictions of the Company or its
management with respect to future activities or other future events or
conditions 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.
These statements are usually identified by the use of words such as "believes,"
"will," "anticipates," "estimates," "expects," "projects," "plans," "intends,"
"should," "could," or similar expressions. These statements are based on certain
assumptions and analyses made by the Company in light of its experience and its
perception of historical trends, current conditions, expected future
developments and other factors it believes are appropriate. Investors are
cautioned that all forward-looking statements involve risks and uncertainties,
including, without limitation:
o The Company's history of operating losses;
o The Company's need and ability to raise significant capital and obtain
adequate financing for its development efforts;
o The Company's ability to successfully develop and complete validation
studies for its products;
o The Company's dependence upon and the uncertainties associated with
obtaining and enforcing patents and intellectual property rights important
to its business;
o The uncertainties associated with the lengthy regulatory approval process,
including uncertainties associated with the United States Food and Drug
Administration ("FDA") decisions and timing of product development or
approval;
o Development by competitors of new or competitive products or services;
o The Company's ability to retain management, implement its business
strategy, assimilate and integrate any acquisitions;
o The Company's lack of operating experience and present commercial
production capabilities; and
o The increasing emphasis on controlling healthcare costs and potential
legislation or regulation of healthcare pricing.
Although the Company believes that the assumptions underlying the
forward-looking statements contained in this report are reasonable, any of the
assumptions could be inaccurate, and, therefore, there can be no assurance that
the forward-looking statements included in this report will prove to be
accurate. In light of the significant uncertainties inherent in the
forward-looking statements included in this report, the inclusion of such
information should not be regarded as a representation by the Company or any
other person that the objectives and plans of the Company will be achieved.
Except for its ongoing obligation to disclose material information as required
by the federal securities laws, the Company undertakes no obligation to release
publicly any revisions to any forward-looking statements to reflect events or
-23-
circumstances after the date of this report or to reflect the occurrence of
unanticipated events. Accordingly, the reader should not rely on forward-looking
statements, because they are subject to known and unknown risks, uncertainties,
and other factors that may cause our actual results to differ materially from
those contemplated by the forward-looking statements.
Delay in Filing Annual Report on Form 10-KSB
As previously reported, the Company was unable to file its 2004 Form 10-KSB
within the extended filing deadline ending April 15, 2005 and remains unable to
make the filing. As reported, the Company is required to include in its 2004
Form 10-KSB certain audited financial statements from Advanced BioChem, Inc.,
the entity from which the Company purchased certain assets during 2004. The
Company was unable to file its 2004 Form 10-KSB because Fitts, Roberts & Co.,
the former auditor of Advanced BioChem, refused to give its consent to the
inclusion, in the Company's 2004 Form 10-KSB, of Fitts Roberts' audit opinion on
the financial statements of Advanced BioChem for fiscal year 2003. As previously
reported by the Company, Fitts Roberts informed the Company that it has refused
to furnish its consent due to concerns with the accounting treatment of the May
18, 2004 transaction with Advanced BioChem. Advanced BioChem has recently
advised the Company that it is reviewing the terms of the May 2004 transaction
and has asserted that the Company did not assume all of the liabilities for
which it was obligated under the Securities Purchase Agreement. These disputed
liabilities relate to the concerns expressed by Fitts Roberts. The Company has
attempted to negotiate a settlement of their differences concerning the
liabilities retained by Advanced BioChem and assumed by the Company in the May
2004 transaction. (See "Recent Developments - Dispute with Advanced BioChem.")
While the audit of Advanced BioChem records associated with the period January
1, 2004 through May 17, 2004 is effectively complete as is the audit of the
Company for the period from May 18, 2004 (date of acquisition) to December 31,
2004, the Company anticipates that it will be necessary to determine the scope
of the disagreement with Advanced BioChem so that the Company may adequately
disclose its potential obligations with respect to the disputed liabilities.
Further, as previously reported, the Company must also incorporate Advanced
BioChem's audited 2003 historical statements and accompanying notes into its
audit and Form 10-KSB for fiscal year 2004, and this must be done with the
consent of the auditor of those financial statements, Fitts, Roberts & Co.
The Company previously requested Advanced BioChem to engage new auditors to
obtain a separate audit of the 2003 financial statements. Although the Company
continues to work with Advanced BioChem with respect to this request, the
Company has elected to pursue guidance from the SEC in an alternative effort to
resolve the accounting matters as expeditiously as possible. Pending a
resolution of these issues and the filing of the Company's 2004 Form 10-KSB, the
Company has elected to file this Quarterly Report on Form 10-QSB to make
available the Company's current financial information.
Overview
The Company is an early stage development company engaged in the early
detection, monitoring, and targeting of diseases through the analysis of
proteins. The Company's business objective is to focus on disease diagnosis,
protein and biomarkers identification, and drug resistance in the areas of
cancers, neurodegenerative and neuromuscular diseases. The Company has
established a scientific advisory board to assist in the research and
development of its products. The members of the scientific advisory board are
recognized leaders in their chosen fields, and the Company is working with them
in the development of effective early diagnosis and drug targets for early
treatment of cancers, neurodegenerative and neuromuscular diseases.
Prior to the Company's acquisition of the assets of Advanced BioChem, Inc. (the
Predecessor) on May 18, 2004, the Company was primarily engaged in the
production and distribution of surgical safety devices through the operations of
its subsidiary, Power3 Medical, Inc. On May 18, 2004, the Company completed its
acquisition of the assets of Advanced BioChem (the Predecessor). The Company
acquired all assets and intellectual properties of Advanced BioChem (the
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Predecessor) and assumed certain liabilities in exchange for the issuance of
15,000,000 shares of the Company's common stock. As a result of this
transaction, the Company established the new business direction described above.
The accounting for the transaction was treated as a capital transaction rather
than a business combination and the Company effectively became a new entity from
an accounting perspective on such date. The financial statements of Advanced
BioChem (the Predecessor), as an operating entity, provide the most relevant
financial information available for the Company's current operations for periods
prior to the asset purchase. Consequently, unless otherwise stated, all
financial information presented for periods prior to the consummation of the
asset purchase (May 18, 2004) is that of Advanced BioChem (the Predecessor) and
all information presented in this Quarterly Report for periods subsequent to the
asset purchase is that of the Company.
As a result of the Company's acquisition of the assets and certain liabilities
of Advanced BioChem (the Predecessor), the Company has transformed into an
advanced proteomics company applying existing proprietary methodologies to
discover and identify protein biomarkers associated with diseases. The Company
currently has no products for sale and is principally focused on research and
development activities and, to a certain extent, initiating the "proof of
concept" of its technologies.
The Company has had significant losses since the date of its transaction with
Advanced BioChem (the Predecessor) as well as from its inception. The Company
anticipates that it will continue to incur substantial operating losses in
future years as it progresses in its research and development activities as well
as the commercializing of its technologies. The Company does not expect to
produce revenues from operations in the near term and expects that its revenues
will be limited to research grants, collaboration agreements, and other
strategic alliances which the Company is able to obtain. The Company has an
immediate need for capital to continue its current operations. At March 31,
2005, the Company had an accumulated deficit of $1,148,395.
Recent Developments
Scientific Developments
The members of the Company's scientific team have developed a method for the
differential diagnosis of neurodegenerative diseases utilizing blood serum,
which was co-developed with neurologist, Dr. Stan Appel, Chairman of the
Department of Neurology and his team at The Methodist Hospital in Houston. Under
the trade name of NuroPro, the Company is continuing development of a group of
tests to differentiate individuals with no known neurological disorders from
those with Alzheimer's disease, Parkinson's disease, ALS, and other disorders
that have similar clinical symptoms as these diseases. Each test involves
monitoring the concentration of a group of differentially expressed proteins
selected from a panel of 34 biomarkers that have been identified as indicators
of the different disorders. Each test employs a different combination of 4 to 10
biomarkers to achieve the desired diagnostic capability for the specific disease
discrimination designed for any individual test.
At the end of the first quarter of 2005, the number of unique samples in our
collection used for constructing our NuroPro tests has increased from 435 to
over 526. During this time, the Company has determined the protein identities
for 30 of the 34 differentially expressed proteins in the pool of biomarkers
targeting neurodegenerative diseases and has focused its efforts on
commercializing the first 2 of the diagnostic tests in the NuroPro series. The
first test is a "General" test designed to aid the general practitioner in
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differentiating individuals with no known neurological disorders from those with
neuromuscular diseases including Parkinson's disease, ALS, and other disorders
with similar clinical symptoms. This test has demonstrated an ability to
correctly identify over 70% of the normal individuals and over 70% of those with
neuromuscular disorders. The second test is designed to aid the neurologist in
differentiating individuals with ALS from those disorders with similar clinical
symptoms as ALS. This second test has demonstrated an ability to correctly
identify over 70% of the individuals with ALS and over 60% of those with
neuromuscular disorders with similar symptoms.
During the first quarter ended March 31, 2005, the Company filed four utility
patent applications focusing on the Company's biomarker discovery technologies
and biomarkers for neurodegenerative diseases, and filed a provisional patent
application for the Company's first generic, blood based diagnostic test for
neuromuscular disorders on May 9, 2005. Following this provisional patent
application, the Company submitted a pre-market IDE application to the FDA for
the first diagnostic test in the NuroPro series. Currently, there are no other
diagnostic tests available to the physician to assist in the diagnosis of these
disorders and the Company believes the FDA is highly interested in evaluating
this technology.
The Company has entered into a collaborative research agreement with New
Horizons Diagnostic effective March 21, 2005 for the development of antibody
based diagnostic tests for neurodegenerative disease utilizing the Company's
identified biomarkers. The research agreement is based on groups of biomarkers
whose profiles are relatively sensitive and specific in distinguishing patients
with ALS, Alzheimer's disease and Parkinson's disease from each other, as well
as from normal patients and patients with other neuromuscular and neurological
disorders. The purpose of the agreement is to tailor monoclonal and polyclonal
antibodies to the biomarkers, which will be incorporated into immunoassays. Once
the assays are available, they will be developed to validate diagnostic tests
specifically designed to detect and discriminate among the neurodegenerative
diseases. The research agreement provides that the parties will develop an
agreed upon schedule and budget for the work contemplated there under within
sixty (60) days of the effective date. The agreement provides that in the event
the parties are able to achieve specified goals relating to the development of a
diagnostic kit as contemplated by the research agreement, New Horizons would be
compensated in any one of the following manners with respect to such diagnostic
kit: (i) a contract to manufacture at least one key component of such diagnostic
kit; (ii) royalties on the sale of such diagnostic kit; (iii) the opportunity to
form a joint venture with the Company for the commercialization of such
diagnostic kit; or (iv) a reasonable percentage of any cash consideration that
the Company receives from a third party for such diagnostic kit. Although the
form and amounts of any consideration to be paid have not been agreed upon, the
parties have agreed to be reasonable in negotiating such consideration.
Power3's Discovery Platform of patents pending and trade secrets for identifying
protein biomarkers, which signal early stages of breast cancer (pre-mammography)
have led to what the Company believes to be the first test of its type that
detects breast cancer earlier than current technology allows. These discoveries
establish the basis of a very sensitive, non-invasive, early detection breast
cancer-screening test. The Company's breast Cancer NAFTest(TM)Clinical
Validation Study continues with promising results. The current enrollment status
includes 122 patients, including all categories of normal, benign and cancer
samples. The three clinical sites include Mercy Women's Hospital in Oklahoma
City, OK, Obstetrical and Gynecology Associates in Houston, TX., and NYU School
of Medicine in NY, NY. It is anticipated that the enrollment will continue
without changes to the sites or Primary Investigators. The Company is pleased
with the continual progress of the validation study and the advice received from
the study's principal investigator.
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Dispute with Advanced BioChem
Advanced BioChem recently advised the Company, and publicly announced, that it
was reviewing the terms of the Company's acquisition of the assets and
assumption of certain liabilities of Advanced BioChem pursuant to the Asset
Purchase Agreement. Advanced BioChem has asserted that the Company, together
with Messrs. Rash and Goldknopf, are responsible for the Predecessor's
liabilities (with the exception of those specifically excluded). The amount of
such disputed liabilities is approximately $2,700,000. The terms of the Asset
Purchase Agreement are not clear and are subject to different interpretations.
While the Company believes that it has properly interpreted the provisions of
the agreement, fulfilled its obligations there under and reflected the terms of
the transaction in its financial statements and previous filings, the Company
has had discussions and negotiations with Advanced BioChem in an effort to
resolve this disagreement. At this time, Advanced BioChem has ceased discussions
with the Company indicating that it will delay any action for a period of thirty
days to allow the Company to become current in its filings with the SEC.
Notwithstanding this, because the Company offered to assume certain additional
liabilities of approximately $425,000 in connection with their efforts to
resolve the dispute, In accordance with Financial Accounting Standards Board
Statement Number 5, "Accounting for Contingencies", the Company has increased
the purchase price by $425,000 (which amount represents the minimum amount of
the range of additional liabilities that may ultimately be assumed upon the
resolution of this matter). In addition, the Company remains contingently liable
for the remaining liabilities of $2,325,000. However the purchase price and
related financial statements have not been adjusted for these liabilities as the
fair value of this contingency cannot be reasonably estimated at this time.
Results of Operations
Three Months Ended March 31, 2005 as Compared to Three Months Ended March 31,
2004
There were no revenues for the quarter ended March 31, 2005 compared to $137,837
for the prior year. Revenues of $137,837 received by the Predecessor related
primarily to contract services performed in the area of protein identification.
Due to the Company's focus on disease diagnosis, protein and biomarkers
identification, and drug resistance in the areas of cancer, neurodegenerative
and neuromuscular diseases, the Company has not continued to provide such
contract services after the date of the acquisition and it is unlikely that the
Company will continue to receive any such revenues in the future.
Operating expenses were $4,330,334 during the quarter ended March 31, 2005 as
compared to $167,727 for the quarter ended March 31, 2004, an increase of
$4,162.607 The increase in operating expenses was primarily attributable to an
increase of $3,609,438 in stock based compensation expense due to the issuance
of shares of common stock and warrants to management and other employees as well
as consultants and advisors. In addition, other operating expenses included
$720,896 in the first quarter of 2005 as compared to $167,727 during the first
quarter of 2004; an increase of $553,169. These fees increased substantially
primarily due to SEC compliance costs and other costs necessary to develop the
Company's business plan.
Interest expense in 2005 was $189,787 as compared to $51,942 during 2004. The
increase in interest expense is primarily attributable to the non-cash interest
expense recorded as a result of fair valuing certain warrants issued to
purchasers of convertible debentures.
The above matters result in net loss increasing from $81,832 in 2004 to
$4,520,121 in 2005.
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Liquidity and Capital Resources
The Company has financed its operations since the date of the Advanced BioChem
transaction primarily through the net proceeds generated from the sale of common
stock and convertible debentures. Since the date of the Advanced BioChem
transaction, the Company has raised $2,122,735. As described in
"Recent Financing" below, the Company may sell an additional $1,600,000 in
aggregate principal amount of convertible debentures following the effectiveness
of the Registration Statement on Form SB-2 filed by the Company for the resale
of certain shares of the Company's stock by the purchasers of the Company's
convertible debentures. The Company is in default under the terms of the
Securities Purchase Agreement, the previously issued debentures and related
registration rights agreement and there can be no assurance that the existing
investors will purchase all or any portion of the additional $1,600,000
aggregate principal amount of debentures. If additional debentures are issued
and sold by the Company, the Company will use a portion of the proceeds from the
sale and issuance of such debentures to pay the $251,000 principal balance owing
under the promissory note dated April 5, 2005 which is payable on the sooner of
August 15, 2005 or one business day following the sale and issuance of such
debentures and to pay certain delinquent liabilities.
The Company's liquidity and capital needs relate primarily to working capital,
development and other general corporate requirements. The Company has not
received any cash from operations. Under the terms of the license agreement with
M.D. Anderson, which the Company acquired from Advanced BioChem, the Company is
required to pay a nonrefundable license documentation fee of $40,000, payable in
two installments. The first $20,000 installment was previously paid following
the execution of the license agreement and the second installment was paid in
February 2005. A similar license documentation fee is payable under the terms of
the license agreement the Company entered into with M.D. Anderson and the
Company will be obligated to pay the second installment of $20,000 in August of
2005. The Company has an immediate need for capital to continue its current
operations. In addition to seeking additional capital, the Company will seek
revenues from research grants, collaboration agreements, and other strategic
alliances. If the Company is successful in completing the sale and issuance of
the remaining $1,600,000 aggregate principal amount of debentures, of which no
assurances can be given due to the Company's default under the Securities
Purchase Agreement and related documents, management believes that the net funds
available, after repayment of the bridge note of $251,000 and certain delinquent
liabilities, will provide adequate cash to satisfy this obligation to
M.D. Anderson and to allow the Company to meet its funding requirements through
the third quarter of 2005. In the event the sale and issuance of the $1,600,000
aggregate principal amount of debentures occurs and the investors exercise their
warrants and additional investment rights, the Company anticipates it will have
adequate cash to meet its funding requirements through the first quarter of
2007. The foregoing projections are based upon the Company's existing
obligations. Advanced BioChem has asserted that the Company has not assumed or
recognized all liabilities for which it is obligated under the terms of the
Securities Purchase Agreement. The resolution of this dispute, including a
possible settlement thereof, could result in an increase in the Company's
liabilities. If the Company's obligations are increased, the Company will
require additional funding sooner than is currently anticipated. (See
"Recent Developments - Dispute with Advanced BioChem.")
Net cash used in operating activities approximated $529,800 for the quarter
ended March 31, 2005, compared to $269,535 for the quarter ended March 31, 2004.
The increase in net cash used in operating activities during 2005 was primarily
due to an increase in the net loss, exclusive of stock based expenses.
Net cash provided by financing activities was $435,000 for the quarter
ended March 31, 2005, as compared to $271,491 for the quarter ended March 31,
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2004. The net cash provided by financing activities in 2005 is primarily due to
net proceeds received from the interim closing of the Company's October 2004
private offering described below.
As of March 31, 2005, the Company's principal source of liquidity was
$38,358 in cash. The Company received a bridge loan of $251,000 on
April 5, 2005. If the Company is successful in completing the sale and issuance
of the remaining $1,600,000 aggregate principal amount of debentures, of which
no assurances can be given due to the Company's default under the Securities
Purchase Agreement and related documents, management believes that the net funds
available, after repayment of the bridge note of $251,000 and certain delinquent
liabilities, will provide adequate cash to allow the Company to meet its current
funding requirements through the third quarter of 2005. However, the Company's
funding requirements will likely be affected by the claims asserted by Advanced
BioChem.
Recent Financing
The Company entered into a securities purchase agreement, dated as of October
28, 2004, with certain investors. Pursuant to the securities purchase agreement,
the investors agreed to purchase from the Company convertible debentures due
three (3) years from the date of issuance in the aggregate principal amount of
$3,000,000. Effective January 19, 2005, the Company entered into an amendment to
the securities purchase agreement with each of the investors. The securities
purchase agreement, as amended, also provides for the issuance to the investors
of warrants to purchase shares of the Company's common stock and additional
investment rights to purchase additional convertible debentures. In connection
with the securities purchase agreement, the Company entered into a registration
rights agreement which requires the Company to file a registration statement
registering on behalf of the investors the resale of the shares of common stock
issuable upon conversion of the debentures and the exercise of the warrants. The
Company will also file a registration statement registering on behalf of the
investors the resale of shares of common stock issuable upon conversion of the
debentures issued upon exercise of the additional investment rights previously
issued by the Company.
Effective October 28, 2004, the Company issued and sold to the investors the
first $1,000,000 in aggregate principal amount of such debentures at the initial
closing under the securities purchase agreement. Pursuant to the securities
purchase agreement, as amended, effective January 26, 2005 the Company issued
and sold to certain investors $400,000 aggregate principal amount of convertible
debentures. Subject to the Company's satisfaction of the conditions set forth in
the securities purchase agreement, as amended, the investors are required to
purchase the remaining $1,600,000 in aggregate principal amount of such
debentures at the final closing, which is to occur on or before the fifth
trading day after the effective date of the registration statement. The Company
is currently in default under the Securities Purchase Agreement, the previously
issued debentures and related registration rights agreement and therefore the
conditions of the Securities Purchase Agreement will not be satisfied or
otherwise met on a timely basis. Consequently, there are no assurances that the
investors will purchase all or any portion of the remaining $1,600,000 aggregate
principal amount of debentures. Assuming they are not called because of the
Company's default, the securities purchase agreement provides that
the $1,000,000 aggregate principal amount of debentures issued on October 28,
2004 and the $400,000 aggregate principal amount of debentures issued January
26, 2005 are due and payable in accordance with their original terms in full
three (3) years after issuance and do not bear interest. The $1,600,000
aggregate principal amount of debentures, or portion thereof, which may be
issued at the final closing will be due and payable in full three (3) years
after the date of their issuance, and will not bear interest. The aggregate cash
purchase price for the debentures will be $3,000,000, which is equal to the full
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face amount of the debentures. At any time from the closing date until the
maturity date of the debentures, the purchasers have the right to convert the
debentures, in whole or in part, into common stock at the then effective
conversion price. The conversion price for the previously issued $1,400,000
aggregate principal amount of debentures is $0.90 but is subject to adjustment
if either (1) 75% of the average of the daily volume weighted average price of
the Company's common stock for the five (5) consecutive trading days preceding
the date that the registration statement is declared effective by the SEC or (2)
the daily volume weighted average price of the common stock on such date is less
than $0.90 per share. In such event, the conversion price will be adjusted down
to equal the lower of (1) the 75% average of the daily volume weighted average
price of the common stock for the five (5) consecutive days preceding the
effective date of the registration statement or (2) the daily volume weighted
average price of the common stock on the effective date of the registration
statement. The $1,600,000 aggregate principal amount of debentures issuable at
the final closing will have a conversion price equal to the lesser of (1) $0.90,
(2) the 75% average of the daily volume weighted average price of the common
stock for the five (5) consecutive days preceding the effective date of the
registration statement of which this prospectus forms a part, or (3) the daily
volume weighted average price of the common stock on the effective date of the
registration statement. It is anticipated that the conversion price of the
previously issued $1,400,000 aggregate principal amount of debentures, as well
as the conversion price of any remaining debentures issued by the Company, will
be adjusted and reduced below the current adjustment price of $0.90.
The debentures contain covenants that will limit the Company's ability to, among
other things: incur or guarantee additional indebtedness; incur or create liens;
amend the Company's certificate of incorporation, bylaws or other charter
documents so as to adversely affect any rights of the holders of the debentures;
and repay or repurchase more than a de minimis number of shares of common stock
other than as permitted in the debentures and other documents executed with the
purchasers.
The debentures include customary default provisions and an event of default
includes, among other things, a change of control of the Company, the sale of
all or substantially all of the Company's assets, the failure to have the
registration statement declared effective on or before the 180th day after the
initial closing date, and the lapse of the effectiveness of the registration
statement for more than 30 consecutive trading days during any 12-month period
(with certain exceptions), the Company's failure to timely deliver certificates
to holders upon conversion and a default by the Company in any obligations under
any indebtedness of at least $150,000 which results in such indebtedness being
accelerated. Upon the occurrence of an event of default, each debenture may
become immediately due and payable, either automatically or by declaration of
the holder of such debenture. The aggregate amount payable upon an acceleration
by reason of an event of default shall be equal to the greater of 130% of the
principal amount of the debentures to be prepaid or the principal amount of the
debentures to be prepaid, divided by the conversion price on the date specified
in the debenture, multiplied by the closing price on the date set forth in the
debenture.
The Company is in default under the provisions of the Securities Purchase
Agreement, registration rights agreement and previously issued debentures. The
events of default principally relate to the Company's inability to timely file
its Annual Report on Form 10-KSB and the Company's resulting inability to have
the registration statement declared effective. Although the Company intends to
seek waivers or forbearance agreements from the holders of its debentures, there
is no assurance that the Company will receive such concessions. If the Company
is unable to obtain such concessions, the aggregate amount payable under the
outstanding debentures due to the acceleration thereof by reason of the default
is equal to the "Mandatory Prepayment Amount" as specified in the debentures.
The Mandatory Prepayment Amount equals the sum of (i) the greater of: (a) 130%
of the principal amount of the debentures to be prepaid, or (b) the principal
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amount of the debentures to be prepaid, divided by the conversion price on (x)
the date the payment is demanded or otherwise due, or (y) the date the payment
is paid in full, whichever is less, multiplied by the closing price of the
Company's common stock on (x) the date the payment is demanded or otherwise due,
or (y) the date the payment is paid in full, whichever is greater, and (ii) all
other amounts, costs, expenses and liquidated damages due in respect of the
debentures. In addition to the foregoing, pursuant to the terms of the
registration rights agreement, the Company is required to pay each holder of the
debentures liquidated damages since the registration statement was not declared
effective on or before February 25, 2005. The amount of liquidated damages shall
equal two percent (2%) of the aggregate purchase price paid by the holders for
the debentures and shall be payable on each monthly anniversary of such date
until the registration statement is declared effective.
Concurrent with the issuance of the initial $1,000,000 aggregate principal
amount of debentures dated October 28, 2004, the purchasers also received
warrants to purchase an aggregate of up to 2,500,000 shares of common stock and
additional investment rights to purchase up to an additional $2,500,000
principal amount of convertible debentures. Pursuant to the terms of the
amendment to the securities purchase agreement, concurrent with the issuance of
the $400,000 aggregate principal amount of convertible debentures, the Company
issued additional warrants to purchase an aggregate of up to 333,333 shares of
its common stock. The warrants are exercisable at a price of $1.44 per share
(subject to adjustment), for a period of five (5) years from October 28, 2004.
The additional investment rights are exercisable at a price equal to the
principal amount of the debentures to be purchased, for (1) a period of nine
months following the effective date of the registration statement, or (2) April
28, 2006.
The debentures to be purchased upon the exercise of the additional investment
rights will have the same terms as the debentures described above, except that
the conversion price will be equal to $1.08 (subject to adjustment).
Each selling shareholder has contractually agreed to restrict its ability to
convert the debentures, exercise the warrants and additional investment rights
and receive shares of the Company's common stock such that the number of shares
of common stock held by them and their affiliates after such conversion or
exercise does not exceed 4.99% of the number of shares of the Company's common
stock outstanding immediately after giving effect to such conversion or
exercise.
On April 5, 2005, the Company received a bridge loan in the amount of $251,000.
This bridge loan is due and payable on the sooner of August 15, 2005 or one
business day following the closing of the Company's sale and issuance of the
$1,600,000 aggregate principal amount of debentures. The Company expects to use
proceeds from the sale and issuance of such debentures to repay such bridge
loan. The bridge loan bears interest at a rate of 10% per annum which, at the
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holder's option, may be paid in (a) cash, or (b) that number of shares of the
Company's common stock determined by dividing $251,000 by the common stock price
on date of payment and multiplying the quotient so obtained by 20%.
Plan of Operations and Cash Requirements
The Company currently does not have operating revenues from product sales or the
performance of services and it continues to experience net operating losses. The
Company is actively pursuing third party licensing agreements, collaboration
agreements and similar business arrangements in order to establish a revenue
base utilizing its capabilities in disease diagnosis based on protein and
biomarker identification, and drug resistance in the areas of cancers,
neurodegenerative and neuromuscular diseases. The Company has undertaken
clinical validation studies to demonstrate the diagnostic capabilities of its
technologies. However, there can be no assurances that revenue-generating
agreements will be in place in the next twelve months.
Absent a source of revenues, the Company will require funding in order to carry
out its business plan until such time as it is able to generate sustained
revenues. The Company's current cash requirements are approximately $250,000 per
month and the Company anticipates that it will require approximately $3,500,000
(exclusive of payments necessary for the bridge financing and delinquent
payables) for the twelve months ended March 31, 2006 to continue its development
activities, undertake and perform clinical validation studies, continue its
marketing efforts and maintain its administrative infrastructure, broken down as
follows:
Estimated Expenditures Required
During Next Twelve Months
General and Administrative $ 2,550,000
Capital Expenditures $ 400,000
Patent filings and intellectual property $ 200,000
NAF clinical validation studies $ 350,000
Total $ 3,500,000
The foregoing is based upon the Company's current estimated cash requirements.
The resolution of the Company's current dispute with Advanced BioChem regarding
the liabilities assumed by the Company in the parties' transaction may result in
an increase in the Company's liabilities and cash requirements. The Company has
no significant capital expenditure requirements and does not plan to increase
its monthly expenditure rate absent an increase in revenues or additional
funding.
As noted in "Recent Financing" above, the Company entered into a securities
purchase agreement and an amendment to the securities purchase agreement
pursuant to which certain investors agreed to purchase, subject to the
satisfaction of certain conditions, convertible debentures in the aggregate
principal amount of $3,000,000.
The securities purchase agreement, as amended, also provides for the issuance of
warrants to purchase shares of the Company's common stock and additional
investment rights to purchase additional convertible debentures. On the initial
closing under the securities purchase agreement, which was effective as of
October 28, 2004, the investors purchased the first $1,000,000 in aggregate
principal amount of the convertible debentures of which the Company received
approximately $860,000 after payment of fees and expenses. Pursuant to the
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securities purchase agreement, as amended, certain investors have purchased an
additional $400,000 aggregate principal amount of convertible debentures on
January 26, 2005. Subject to the Company's satisfaction of the conditions set
forth in the securities purchase agreement (which includes the effectiveness of
the registration statement), the investors are required to purchase the
remaining $1,600,000 in aggregate principal amount of such convertible
debentures on or before the fifth trading day after the effective date of the
registration statement. The Company is currently in default under the Securities
Purchase Agreement, the previously issued debentures and related registration
rights agreement and therefore the conditions of the Securities Purchase
Agreement will not be satisfied or otherwise met on a timely basis.
Consequently, there are no assurances that the investors will purchase all or
any portion of the remaining $1,600,000 aggregate principal amount of
debentures.
Assuming the completion of the remaining closing and sale and issuance of the
remaining $1,600,000 in aggregate principal amount of the convertible
debentures, the Company estimates that, after repayment of the bridge note of
$251,000 and the certain delinquent payables immediately following the sale and
issuance of such debentures, the Company will have adequate cash to allow it to
meet its current funding requirements through the third quarter of 2005. In the
event the sale and issuance of such debentures occurs and the investors exercise
their warrants and additional investment rights, the Company anticipates it will
have adequate cash to meet its current funding requirements through the first
quarter of 2007. The foregoing is based upon current estimated cash requirements
and may be affected by the Company's current dispute with Advanced BioChem
regarding the liabilities assumed under the May 2004 transaction.
In addition to the convertible debentures, the Company also issued warrants to
purchase up to 2,500,000 shares of common stock, with an exercise price equal to
$1.44. The Company issued additional warrants to purchase up to 333,333 shares
of common stock concurrent with its issuance of the $400,000 aggregate principal
amount of debentures. Full exercise of the warrants would generate funds in
excess of $4,000,000. The Company also issued additional investment rights,
which give the investors the right to purchase up to an aggregate of $2,500,000
of convertible debentures with a conversion price of $1.08. However, the
exercise of these warrants and additional investment rights is at the discretion
of the purchasers and there are no assurances that the purchasers will exercise
their rights under such securities.
The Company will continue to require additional debt or equity financing for its
operations, which may not be readily available. The Company's ability to
continue as a going concern is subject to its ability to generate a profit or
obtain necessary funding from outside sources. If the Company is successful in
completing the sale and issuance of the remaining $1,600,000 aggregate principal
amount of debentures, of which no assurances can be given due to the Company's
default under the Securities Purchase Agreement and related documents,
management believes that the net funds available, after repayment of the bridge
note of $251,000 immediately following the sale and issuance of such debentures,
and certain delinquent payables, will provide adequate cash to allow the Company
to meet its funding requirements through the third quarter of 2005. The
foregoing projections are based upon current estimated cash requirements and may
be affected by the Company's current dispute with Advanced BioChem. In addition
to the uncertainties resulting from the Company's dispute with Advanced BioChem,
the Company's actual results may differ materially from these estimates, and no
assurance can be given that additional funding will not be required sooner than
anticipated or that such additional funding will be available when needed or on
terms acceptable to the Company. Insufficient funding will require the Company
to curtail or terminate operations.
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Off-Balance Sheet Arrangements
At March 31, 2005, with the exception of the lease for its operating
facility, and employment agreements entered with its three principal officers,
the Company did not have any significant off balance sheet commitments.
Critical Accounting Policies
In accordance with the Emerging Issues Task Force (EITF) Issue 98-5, the Company
allocates the proceeds received from convertible instruments to the instrument,
and to the intrinsic value, if any, of the imbedded conversion option. Under
this approach, the proceeds received in the financing transaction are allocated
to the convertible instrument and any detachable instruments on a fair value
basis. The Issue 98-5 model is then applied to the amount allocated to
convertible instrument and the intrinsic value of the embedded conversion option
is then measured.
The Company accounts for equity instruments issued to employees for services
based on the intrinsic value of the equity instruments issued. Equity
instruments issued to non-employees that are fully vested and non-forfeitable
are measured at fair value at the issuance date and expensed in the period over
which the benefit is expected to be received.
The Company has adopted Statement of Financial Accounting Standards No. 148
"Accounting for Stock-Based Compensation - Transition and Disclosure" (SFAS No.
148). This statement amends FASB statement No. 123, "Accounting for Stock Based
Compensation". It provides alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for employee
stock based compensation. It also amends the disclosure provision of FASB
statement No. 123 to require prominent disclosure about the effects on reported
net income of an entity's accounting policy decisions with respect to
stock-based employee compensation. As permitted by SFAS No. 123 and amended by
SFAS No. 148, the Company continues to apply the intrinsic value method under
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees," to account for its stock-based employee compensation
arrangements.
In December 2004, the Financial Accounting Standards Board issued Statement
Number 123 ("FAS 123 (R)"), Share-Based Payments. FAS 123 (R) requires all
entities to recognize compensation expense in an amount equal to the fair value
of share-based payments such as stock options granted to employees. The Company
will be required to apply FAS 123 (R) on a modified prospective method. Under
this method, the Company will be required to record compensation expense (as
previous awards continue to vest) for the unvested portion of previously granted
awards that remain outstanding at the date of adoption. In addition, the Company
may elect to adopt FAS 123 (R) by restating previously issued financial
statements, basing the amounts on the expense previously calculated and reported
in the pro forma disclosures that had been required by FAS 123, FAS 123 (R) is
effective for the first reporting period beginning after June 15, 2005. The
Company has not yet determined the impact that FAS 123 (R) will have on its
financial statements; however, it does not believe the impact of adopting this
Statement will be material as there are no unvested options and warrants at
December 31, 2004.
Item 3. Controls and Procedures
Under the supervision and with the participation of the Company's management,
including its Chief Executive Officer and Chief Financial Officer, the Company
conducted an evaluation of its disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) of the Exchange Act). Based on this evaluation and
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for the reasons set forth below, the Chief Executive Officer and Chief Financial
Officer concluded that the Company's disclosure controls and procedures were
ineffective as of March 31, 2005, the end of the period covered by this report.
Management has identified certain deficiencies which have caused it to conclude
that the Company's disclosure controls are ineffective. Many of these
deficiencies were previously reported in the Company's Quarterly Report on Form
10-QSB for the quarterly period ended September 30, 2004. The Company has
undertaken steps and implemented actions as disclosed in its previous Form
10-QSB in an effort to resolve these deficiencies. While the actions identified
in the previously filed Form 10-QSB and the actions identified below have
addressed many of these deficiencies, the Company continued to have deficiencies
with respect to its disclosure controls and procedures at March 31, 2005
including the following:
o As the Company has previously reported, the Company has been unable to file
its 2004 Annual Report on Form 10-KSB. As previously reported by the
Company and discussed in "Item 3. Defaults Upon Senior Securities" above,
the Company's inability to timely file its 2004 Form 10-KSB was caused by
its inability to include the audit report of Advanced BioChem's previous
auditor in the Company's 2004 Form 10-KSB. The Company has also encountered
deficiencies arising from a lack of supporting documentation and records
relating to periods prior to the Advanced BioChem transaction and a lack of
communication between the Company, its auditors and the previous auditors
of Advanced BioChem. The lack of this supporting documentation and failure
either to obtain the prior auditor's consent or make alternative
arrangements for the 2003 Advanced BioChem audit report have resulted in
the Company's inability to file its Annual Report on Form 10-KSB. These
deficiencies have also resulted in a delay by the Company in the filing of
this quarterly report on Form 10-QSB.
o Although the Company has hired accounting personnel as reported in its
previous Form 10-QSB, the Company's limited financing and available capital
have restricted the Company's ability to fully implement its procedures for
the improvement of its internal control over financial reporting and to
engage outside professionals and advisors to the extent the Company has
desired to support the Company's accounting personnel in the preparation
and/or audit of financial statements and reports to be filed with the SEC.
o The Company continues to face unexpected issues relating to the integration
of the Advanced BioChem transaction such as the dispute described in this
quarterly report and such issues have caused the Company's accounting
personnel to devote significant and unanticipated time and attention to
these matters.
The Company continues to believe that the deficiencies are attributable to many
factors including issues relating to the quality of the Company's disclosure
controls and procedures at the time of the Advanced BioChem transaction and the
transition following the transaction. Management is committed to a sound
disclosure control and internal control environment and is continuing its
efforts to improve the Company's infrastructure, personnel, processes and
controls to help ensure that the Company is able to produce accurate financial
statements on a timely basis.
Changes in Internal Control Over Financial Reporting
During the first quarter of 2005, the Company continued the implementation of
more rigorous policies with respect to its disclosure and financial reporting
review process including improvements of its infrastructure and processes to
improve its internal control over financial reporting. The Company also is
continuing its implementation of procedures to improve its review and processing
of non-accounting documentation and contracts. Other than the changes described
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above, there were no changes in the Company's internal control over financial
reporting that occurred during the three months ended March 31, 2005 that have
materially affected, or are reasonably likely to materially affect, the
Company's internal controls over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In November 2004, Chapman Spira & Carson, LLC ("Chapman Spira") filed a lawsuit
in the Supreme Court of the State of New York for the County of New York against
Advanced BioChem (the Predecessor), Power3 and Steven Rash. The suit alleges
that Advanced BioChem (the Predecessor) and Power3 are liable to Chapman Spira
for damages allegedly resulting from the breach of a letter agreement between
Chapman Spira and Advanced BioChem (the Predecessor) relating to the performance
of strategic and investment banking services. The suit further alleges that Mr.
Rash made false statements regarding the performance of services by Chapman
Spira. Chapman Spira is seeking damages in the amount of $1,522,000 plus
interest. The Company has filed an answer in the lawsuit. The Company believes
that Chapman Spira's claims are without merit; however, the Company does not
know if it will ultimately prevail or if the outcome of the action will
adversely affect the Company's business, financial position or results of
operations.
An equipment vendor filed a complaint against the Predecessor in April of 2002
in a California court alleging breach of contract and seeking damages. The
Predecessor reached a settlement agreement in April of 2003 under which the
Predecessor would pay the vendor $40,000 in installments through August of 2003.
The Predecessor recorded a settlement cost of $40,000 in 2002 general and
administrative expenses. At December 31, 2003, the Predecessor had a balance
remaining of $20,000. In April 2005 the equipment vendor filed a lawsuit against
the Predecessor, certain former officers of the Predecessor and the Company in
order to enforce its claim for the remaining balance which is past due and may
be assumed by the Company as part of the settlement of the dispute with the
Predecessor.
Item 2. Unregistered Sale of Equity Securities and use of Proceeds
(a) Not applicable.
(b) Under the terms of the $400,000 aggregate principal amount of convertible
debentures issued by the Company as of January 26, 2005, as well as the
terms of the $1,000,000 aggregate principal amount of convertible
debentures issued by the Company as of October 28, 2004, the Company is
prohibited from taking certain actions without the approval of the holders
of a two-thirds majority of the then-outstanding principal amount of the
debentures. Specifically, the Company has agreed not to, and not to permit
its subsidiary to, so long as any portion of the debentures are
outstanding, (1) amend it certificate of incorporation, bylaws or other
charter documents so as to adversely affect any rights of the holders of
the debentures, or (2) repurchase more than a de minimis number of shares
of its common stock or other equity securities other than as to the shares
of common stock issuable upon conversion of the debentures described above.
(c) Not applicable.
(d) Not applicable.
Item 3. Defaults Upon Senior Securities
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The Company is in default under the provisions of the Securities Purchase
Agreement, registration rights agreement and previously issued debentures. The
events of default principally relate to the Company's inability to timely file
its Annual Report on Form 10-KSB and the Company's resulting inability to have
the registration statement declared effective within the time period required by
the agreements. As previously disclosed by the Company, the Company has been
unable to file its 2004 Annual Report on Form 10-KSB due to its inability to
include the audited financial statements of the Predecessor for fiscal year
2003. Fitts, Roberts & Co., P.C. ("Fitts, Roberts") audited the financial
statements of Advanced BioChem for the year ended December 31, 2003 and has
previously issued its audit opinion in Advanced BioChem's Annual Report on Form
10-KSB for 2003. Fitts, Roberts previously gave the Company its consent to the
inclusion of Fitts, Roberts' audit report in the Company's previous filings.
Fitts, Roberts has refused to give its consent to the inclusion, in the
Company's Annual Report on Form 10-KSB for 2004, of Fitts, Roberts' audit report
on the financial statements of Advanced BioChem for fiscal year 2003. The
Company has requested guidance from the SEC concerning the accounting treatment
of its transaction with Advanced BioChem, which may resolve this issue.
Alternatively, the Company will request Advanced BioChem to engage an
independent auditor to re-audit the 2003 financial statements of Advanced
BioChem and issue a new audit opinion thereon to be included in the Company's
Form 10-KSB.
Although the Company intends to seek waivers or forbearance agreements from the
holders of its debentures, there is no assurance that the Company will receive
such concessions. If the Company is unable to obtain such concessions, the
aggregate amount payable under the outstanding debentures due to the
acceleration thereof by reason of the default is equal to the "Mandatory
Prepayment Amount" as specified in the debentures. The Mandatory Prepayment
Amount equals the sum of (i) the greater of: (a) 130% of the principal amount of
the debentures to be prepaid, or (b) the principal amount of the debentures to
be prepaid, divided by the conversion price on (x) the date the payment is
demanded or otherwise due, or (y) the date the payment is paid in full,
whichever is less, multiplied by the closing price of the Company's common stock
on (x) the date the payment is demanded or otherwise due, or (y) the date the
payment is paid in full, whichever is greater, and (ii) all other amounts,
costs, expenses and liquidated damages due in respect of the debentures. In
addition to the foregoing, pursuant to the terms of the registration rights
agreement, the Company is required to pay each holder of the debentures
liquidated damages since the registration statement was not declared effective
on or before February 25, 2005. The amount of liquidated damages shall equal two
percent (2%) of the aggregate purchase price paid by the holders for the
debentures and shall be payable on each monthly anniversary of such date until
the registration statement is declared effective. The Company has received
notice from one of the purchasers of the debentures informing the Company that
it is in default under the debentures and demanding payment of the Mandatory
Prepayment Amount, together with the liquidated damages, to which it is entitled
pursuant to the agreement.
Filing of the Company's Form 10-KSB will be made as soon as the issues
concerning the inclusion of the 2003 financial statements of Advanced BioChem
have been resolved. Promptly thereafter, the Company intends to file an
amendment to its previously filed registration statement and will endeavor to
have it declared effective as soon as practicable. The Company is in discussion
with its debenture holders regarding a resolution of this matter.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to the security holders for a vote during the quarter
ended March 31, 2004.
Item 5. Other Information
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None
Item 6. Exhibits and Reports on Form 8-K
EXHIBIT NO. DESCRIPTION
4.1 Form of Convertible Debenture due January 26, 2008 (Incorporated by
reference to Exhibit 4.1 of the Company's Current Report on Form 8-K filed February 1, 2005.)
4.2 Form of Common Stock Purchase Warrant. (Incorporated by
reference to Exhibit 4.2 of the Company's Current Report on Form 8-K filed February 1, 2005.)
10.1 Amendment to Securities Purchase Agreement dated as of January 19, 2005 by among the Company and
each purchaser identified therein. (Incorporated by
reference to Exhibit 10.2 of the Company's Registration Statement on Form SB-2 filed January 21, 2005
(file No. 333-122227))
10.2 Collaborative Research Agreement effective as of March 21, 2005, between Horizons Diagnostic and
Power3 Medical Products, Inc. (Incorporated by reference to Exhibit 10.1 to Company's current
report on Form 8-K filed March 28, 2005).
31.1* Certification
31.2* Certification
32.1** Certification Pursuant to Section 906
32.2** Certification Pursuant to Section 906
*Filed with this report.
**Furnished with this report.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Power3 Medical Products, Inc. (Registrant)
Date: May 23, 2005 By: /s/ Steven B. Rash
Steven B. Rash
Chairman and Chief Executive Officer
Pursuant to the requirements of the Exchange Act, this report has been
signed by the following persons in the capacities and on the dates indicated.
Signature Title Date
/s/ Steven B. Rash Chairman and
Steven B. Rash Chief Executive Officer May 23, 2005
/s/ Michael J. Rosinski
Michael J. Rosinski Chief Financial Officer May 23, 2005
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EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
4.1 Form of Convertible Debenture due January 26, 2008 (Incorporated by
reference to Exhibit 4.1 of the Company's Current Report on Form 8-K filed February 1, 2005.)
4.2 Form of Common Stock Purchase Warrant. (Incorporated by
reference to Exhibit 4.2 of the Company's Current Report on Form 8-K filed February 1, 2005.)
10.1 Amendment to Securities Purchase Agreement dated as of January 19, 2005 by among the Company and
each purchaser identified therein. (Incorporated by
reference to Exhibit 10.2 of the Company's Registration Statement on Form SB-2 filed January 21, 2005
(file No. 333-122227))
10.2 Collaborative Research Agreement effective as of March 21, 2005, between Horizons Diagnostic and
Power3 Medical Products, Inc. (Incorporated by reference to Exhibit 10.1 to Company's current
report on Form 8-K filed March 28, 2005).
31.1* Certification
31.2* Certification
32.1** Certification Pursuant to Section 906
32.2** Certification Pursuant to Section 906
*Filed with this report.
**Furnished with this report.
-40-
