UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB/A
(Mark One)
[X] AMENDED QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2005
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE EXCHANGE ACT
for the transition period from ________________ to ______________
Commission File Number 000-29171
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MED GEN, INC.
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(Exact name of registrant as specified in its charter)
Nevada 65-0703559
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(State of incorporation) (IRS Employer Identification No.)
7284 W. Palmetto Park Road, Suite 207, Boca Raton, FL 33433
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(Address of principal executive offices)
(561) 750-1100
-------------------------
(Issuer's telephone number)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12B-2). Yes [ ] No [X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
As of June 30, 2005, 30,136,447 shares of common stock, .001 par value
per share, were outstanding.
The Company's stock trades on the OTCBB under the symbol "MDGN".
Transitional Small Business Disclosure Format (check one):
Yes [ ] No [X]
INDEX
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheet - June 30, 2005 (Unaudited)
Statements of Operations - Three months ended June 30, 2005
and 2004 and Nine Months ended
June 30, 2005 and 2004 (Unaudited)
Statements of Cash Flows - Nine months ended June 30,
2005 and 2004 (Unaudited).
Notes to Financial Statements (Unaudited).
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.
Item 3. Controls and Procedures
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
2
MED GEN, INC.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
3
Med Gen, Inc.
Balance Sheet
June 30, 2005
(Restated)
(Unaudited)
ASSETS
Current Assets
Cash and cash equivalents $ 514,805
Accounts receivable 82,209
Inventory 140,846
Other current assets 5,700
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Total Current Assets 743,560
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Property and Equipment, net 33,595
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Other Assets
Deferred loan costs 164,671
Deposits and other 37,950
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202,621
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$ 979,776
===========
LIABILITIES AND STOCKHOLDERS' (DEFICIT)
Current Liabilities
Accounts payable and accrued expenses $ 82,081
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Total Current Liabilities 82,081
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Derivative instruments 14,041,914
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Convertible debentures -
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Stockholders' (Deficit)
Preferred stock, $.001 par value, 5,000,000
shares authorized -
Series A 8% cumulative, convertible, 1,500,000
shares authorized -
Undesignated, 3,500,000 shares authorized -
Common stock, $.001 par value, 245,000,000
shares authorized, 31,136,447 shares
issued and outstanding 31,136
Paid in capital 15,098,308
Receivable for common stock (35,000)
Deferred compensation (19,024)
Accumulated (deficit) (28,219,639)
-----------
(13,144,219)
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$ 979,776
===========
See accompanying notes to financial statements.
4
Med Gen, Inc.
Statements of Operations
For the Three Months and Nine Months Ended June 30, 2004 and 2005
(Unaudited)
Three Months Nine Months
-------------------------- --------------------------
2004 2005 2004 2005
----------- ----------- ----------- -----------
(Restated) (Restated)
Net sales $ 232,087 $ 181,034 $ 744,288 $ 664,678
Cost of sales 98,460 99,658 346,649 270,747
----------- ----------- ----------- -----------
Gross profit 133,627 81,376 397,639 393,931
----------- ----------- ----------- -----------
Operating expenses:
Non cash stock compensation -
selling, general and administrative 279,350 60,000 415,100 365,640
Selling, general and administrative expenses 1,062,432 557,582 1,873,503 1,184,738
----------- ----------- ----------- -----------
1,341,782 617,582 2,288,603 1,550,378
----------- ----------- ----------- -----------
(Loss) from operations (1,208,155) (536,206) (1,890,964) (1,156,447)
----------- ----------- ----------- -----------
Other (income) expense:
Interest expense 39,850 47,111 111,185 56,171
Derivative instruments - 3,294,047 - 12,622,158
Non cash stock interest expense 37,500 - 50,000 180,000
----------- ----------- ----------- -----------
77,350 3,341,158 161,185 12,858,329
----------- ----------- ----------- -----------
(Loss) before income taxes (1,285,505) (3,877,364) (2,052,149) (14,014,776)
Income taxes - - - -
----------- ----------- ----------- -----------
Net (loss) $(1,285,505) $(3,877,364) $(2,052,149) $(14,014,776)
=========== =========== =========== ============
Per share information - basic and fully diluted:
Weighted average shares outstanding 15,328,609 30,806,777 8,098,809 29,065,385
=========== =========== =========== ============
Net (loss) per share $ (0.00) $ (0.13) $ (0.25) $ (0.48)
=========== =========== =========== ============
See accompanying notes to financial statements.
5
Med Gen, Inc.
Statements of Cash Flows
For the Nine Months Ended June 30, 2004 and 2005
(Unaudited)
2004 2005
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Cash flows from operating activities:
Net cash (used in) operating activities $ (1,460,329) $ (963,390)
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Cash flows from investing activities:
Net cash (used in) investing activities - -
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Cash flows from financing activities:
Borrowing (repayment) of related party notes (994,315) (175,000)
Proceeds from option exercise 1,059,173 101,987
Proceeds From convertible debentures 1,915,139 1,337,500
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Net cash provided by financing activities 1,979,997 1,264,487
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Net increase in cash 519,668 301,097
Beginning - cash and cash equivalents 90,791 213,708
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Ending - cash and cash equivalents $ 610,459 $ 514,805
============= =============
See accompanying notes to financial statements.
6
MED GEN, INC.
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2005
(UNAUDITED)
(1) Basis Of Presentation
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles (GAAP) for interim
financial information and Item 310(b) of Regulation S-B. They do not include
all of the information and footnotes required by GAAP for complete financial
statements. In the opinion of management, all adjustments (consisting only
of normal recurring adjustments) considered necessary for a fair presentation
have been included.
The results of operations for the periods presented are not necessarily
indicative of the results to be expected for the full year. For further
information, refer to the financial statements of the Company as of September
30, 2004, and for the two years then ended, including notes thereto included
in the Company's Form 10-KSB.
The financial statements for the 2005 peiods have been restated to reflect
the correction of an error as discussed in Note 9. No other changes have
been made.
(2) Earnings Per Share
The Company calculates net income (loss) per share as required by Statement
of Financial Accounting Standards (SFAS) 128, "Earnings per Share." Basic
earnings (loss) per share is calculated by dividing net income (loss) by
the weighted average number of common shares outstanding for the period.
Diluted earnings (loss) per share is calculated by dividing net income
(loss) by the weighted average number of common shares and dilutive common
stock equivalents outstanding. During periods when anti-dilutive commons
stock equivalents are not considered in the computation.
(3) Inventory
Inventory is stated at the lower of cost, determined on a first in, first
out basis, or market value. Inventory consists principally of finished
goods and packaging materials.
(4) Notes Payable - Related Parties
During the period ended March 31, 2005, the Company repaid $181,000 in
notes due to related parties and borrowed an additional $411,000 from
related parties with interest at 8% per annum. The balance due was
$405,000 at March 31, 2005. During April 2005 the Company repaid the
$405,000 balance from the proceeds of the notes described in Note 9.
(5) Income Taxes
The Company accounts for income taxes under SFAS 109, "Accounting for
Income Taxes", which requires use of the liability method. SFAS 109 provides
that deferred tax assets and liabilities are recorded based on the
differences between the tax bases of assets and liabilities and their
carrying amounts for financial reporting purposes, referred to as temporary
differences. Deferred tax assets and liabilities at the end of each period
are determined using the currently enacted tax rates applied to taxable
income in the periods in which the deferred tax assets and liabilities are
expected to be settled, or realized.
7
The Company's deferred tax asset of approximately $2,300,000 resulting from
net operating loss carryforwards aggregating approximately $6,700,000 is
fully offset by a valuation allowance. The Company has recorded a valuation
allowance to state its deferred tax assets at estimated net realizable
value due to the uncertainty related to realization of these assets through
future taxable income.
The provision for income taxes differs from the amount computed by applying
the statutory rate of 34% to income before income taxes due to the effect
of the net operating loss. The principal difference between the accumulated
deficit for income tax purposes and for financial reporting purposes results
from non-cash stock compensation being charged to operations for financial
reporting purposes.
(6) Stockholders' (Deficit)
During October 2004 the Company issued 2,000,000 shares of common stock to
an officer pursuant to the exercise of options granted in October 2004 at
$.10 per share. The fair value of the shares issued was $.16 per share.
The difference between the fair value and the exercise price of $120,000
has been charged to operations during the period ended December 31, 2004.
In addition, the Company recorded a receivable for common stock of $200,000
for the amount due for the shares. During the quarter ended March 31, 2005,
the Company reduced the amount receivable for these shares to the current
market price of its Common stock. This reduction resulted in a charge to
operations of $117,640 during the quarter ended March 31, 2005. This officer
remitted an aggregate of $101,987 to the Company related to the receivable
for common stock during the period from October 1, 2004, through June 30,
2005. At June 30, 2005, $35,000 remained receivable for common stock.
During January through March 2005, the Company issued 2,000,000 shares of
common stock to a related party lender described in Note 4, for future
loans to be made to the Company pursuant to a line of credit. The fair
value of these shares of $180,000 was to be charged to operations as
additional interest over the term of the line of credit. The Company
recorded a charge to operations for the value of the shares as the line
of credit was terminated at March 31, 2005, and the balance of $405,000
was repaid in April 2005. In addition, the Company issued 200,000 shares
of common stock to a consultant and 1,000,000 shares to a related party
described in Note 4 for services. The fair value of these shares of
$68,000 was charged to operations.
During January 2005 the Company filed a Form SB-2 registration statement
covering the 8,000,000 common shares described in Note 7 and 2,200,000 of
the common shares described above. The registration statement was amended
through June 2005 to include an aggregate of 206,428,758 common shares
including the shares isuable pursuant to the conversion of the convertible
debentures and exercise of warrants issued as described in Note 8.
During April 2005 the Company increased its authorized shares to 250,000,000
of which 5,000,000 are preferred shares and 245,000,000 are common shares.
During May 2005 the Company issued 1,000,000 shares of common stock to an
affiliate for consulting services and charged the fair value of the shares
of $60,000 to operations.
Stock-based Compensation
During October 2004 the Company issued 2,000,000 options to purchase shares
of common stock to an officer. Compensation costs charged to operations
aggregated $120,000 for these options.
8
SFAS 123 requires the Company to provide proforma information regarding
net income and earnings per share as if compensation cost for the Company's
stock option plans had been determined in accordance with the fair value
based method prescribed in SFAS 123. The fair value of the option grants
is estimated on the date of grant utilizing the Black-Scholes option
pricing model with the following weighted average assumptions for grants
during the period ended June 30, 2005: expected life of options of 5 years,
expected volatility of 121%, risk-free interest rate of 3% and no dividend
yield. The weighted average fair value at the date of grant for options
granted during the period ended June 30, 2005, approximated $.14 per
option. These results may not be representative of those to be expected
in future years.
Under the provisions of SFAS 123, the Company's net income (loss) and
earnings (loss) per share would have been reduced (increased) to the
proforma amounts indicated below:
Net (loss)
As reported $(14,014,776)
Proforma $(14,174,776)
Basic and diluted (loss) per share
As reported $(.48)
Proforma $(.49)
A summary of stock option activity is as follows:
Weighted Weighted
Number average average
of exercise fair
shares price value
------ ----- -----
Balance at
September 30, 2004 934,112 $1.33 $1.33
Granted 2,000,000 $1.23 $1.23
Exercised/Forfeited (2,750,260) $1.23 $1.23
----------
Balance at
June 30, 2005 183,852 $1.31 $1.31
==========
The following table summarizes information about fixed-price stock options
at June 30, 2005:
Outstanding Exercisable
Weighted Weighted Weighted-
Average Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
------ ----------- ---- ----- ----------- -----
$1.01 31,852 2.0 years $1.01 31,852 $1.01
$1.25 100,000 5.0 years $1.25 100,000 $1.25
$1.31 52,000 5.0 years $1.31 52,000 $1.31
--------- ---------
183,852 183,852
========= =========
9
(7) Commitments, Concentrations and Contingencies
During the period ended June 30, 2005, the Company derived 46%, 15% and 10%
of its total sales from three customers. At June 30, 2005, $49,946 is due
from these customers.
During May 2003 Global Healthcare Laboratories, Inc. (Global) made a claim
against the Company for breach of contract under a master license agreement.
Management contended that Global committed fraud and multiple breaches of
the master license agreement and that the claim was without merit. The
matter was re-filed for the third time by the plaintiffs after two prior
dismissals by the Federal courts for failure to state a cause of action.
On August 31, 2004, a verdict was rendered in favor of the plaintiffs and
they were awarded a judgment in the sum of $2,501,191. The Company
initially intended to appeal the verdict, however on December 3, 2004, the
Company and Global settled the matter as follows:
The Company would make cash payments to Global aggregating $200,000 through
March 1, 2005, and would issue to Global an aggregate of 8,000,000 shares
of common stock. The shares to be issued were valued at their fair market
value of $1,120,000. The Company has recorded an accrual of $200,000 for
the cash payments due and a stock subscription of $1,120,000 for the common
shares issuable at September 30, 2004. The Company has agreed to file a
registration statement covering an aggregate of 10,200,000 shares of
common stock on or before January 15, 2005, and should it not do so an
additional 500,000 shares of common stock would have been due to Global.
The Company believes that it has complied with the filing requirement.
Global will be required to execute proxies giving the voting rights of
the shares issuable to an officer of the Company. The Company made payments
aggregating $200,000 to Global.
During the periods covered by these financial statements the Company issued
shares of common stock and subordinated debentures without registration under
the Securities Act of 1933. Although the Company believes that the sales did
not involve a public offering of its securities and that the Company did
comply with the "safe harbor" exemptions from registration, if such
exemptions were found not to apply, this could have a material impact on
the Company's financial position and results of operations. In addition,
the Company issued shares of common stock pursuant to Form S-8 registration
statements and pursuant to Regulation S. The Company believes that it
complied with the requirements of Form S-8 and Regulation S in regard to
these issuances, however if it were determined that the Company did not
comply with these provisions this could have a material impact on the
Company's financial position and results of operations.
During January 2005 and effective February 16, 2005, the Company entered
into a professional services agreement with an entity acting as an
independent contractor to distribute its products in the United States.
As compensation the Company agreed to pay a commission of the greater of
5% of invoiced shipments or $105,000 for the year ended December 31, 2005
and $144,000 for each of the years ended December 31, 2006 and 2007. The
agreement may be terminated by either party for any reason within 6 months
of the date of the agreement. Thereafter the Company may terminate the
agreement with 6 months notice.
During January 2005 the Company entered into a one year consulting agreement
with an entity to assist the Company with its business plan and introduce the
Company to potential investors. Should the Company decide to enter into a
funding transaction as a result of an introduction by the consultant the
consultant shall designate a registered broker Dealer to complete the
transaction. The consultant shall receive a cash fee of 10% of the funds
procured and warrants to purchase common stock equal to 10% of the total
shares issued for a period of 5 years at 105% of the price at which the
shares are sold. The shares underlying the warrants are subject to certain
registration rights.
10
(8) Basis of Reporting
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 has experienced
a significant loss from operations including the settlement of certain
litigation. For the period ended June 30, 2005, the Company incurred a
net loss of $14,014,776 and has an accumulated deficit of $28,219,639 at
June 30, 2005.
The Company's ability to continue as a going concern is contingent upon
its ability to secure additional financing, increase ownership equity and
attain profitable operations. In addition, the Company's ability to
continue as a going concern must be considered in light of the problems,
expenses and complications frequently encountered in established markets
and the competitive environment in which the Company operates.
The Company is pursuing financing for its operations and seeking additional
investments. In addition, the Company is seeking to expand its revenue base
by adding new customers and increasing its advertising. Failure to secure
such financing or to raise additional equity capital and to expand its
revenue base may result in the Company depleting its available funds and
not being able pay its obligations.
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.
(9) Correction of an Error and Restatements
During December 2005 the Company determined that the certain convertible
debt which had been accounted for as conventional convertible debt should
have been accounted for using the guidance of EITF 00-19 (see below).
The accompanying financial statements have been restated to reflect the
above correction. The adjustments increased the net loss for the three
months and nine months ended June 30, 2005, as previously reported from
$(583,317) and $(1,392,618) to $(3,877,364) and $(14,014,776) or $(.13)
and $(.48) per share. In addition, the liability for convertible debentures
previously reported on the balance sheet were reduced $1,440,000 to $0,
the amount reported on the balance sheet for derivative instruments was
increased from $0 to $14,041,914 and the amount reported on the balance
sheet for accounts payable and accrued expenses increased from $61,837
to $82,081.
CALLABLE SECURED CONVERTIBLE NOTES AND DERIVATIVE INSTRUMENT LIABILITIES
Derivative financial instruments
The Company does not use derivative instruments to hedge exposures to cash
flow, market, or foreign currency risks.
The Company reviews the terms of convertible debt and equity instruments
issued to determine whether there are embedded derivative instruments,
including the embedded conversion option, that are required to be
bifurcated and accounted for separately as a derivative financial
instrument. In circumstances where the convertible instrument contains
more than one embedded derivative instrument, including the conversion
option, that is required to be bifurcated, the bifurcated derivative
instruments are accounted for as a single, compound derivative instrument.
Also, in connection with the sale of convertible debt and equity
instruments, the Company may issue freestanding options or warrants that
may, depending on their terms, be accounted for as derivative instrument
liabilities, rather than as equity. The Company may also issue options or
warrants to non-employees in connection with consulting or other services
they provide.
11
When the risks and rewards of any embedded derivative instrument are not
"clearly and closely" related to the risks and rewards of the host
instrument, the embedded derivative instrument is generally required to
be bifurcated and accounted for separately. If the convertible instrument
is debt, or has debt-like characteristics, the risks and rewards
associated with the embedded conversion option are not "clearly and
closely" related to that debt host instrument. The conversion option has
the risks and rewards associated with an equity instrument, not a debt
instrument, because its value is related to the value of our common
stock. Nonetheless, if the host instrument is considered to be
"conventional convertible debt" (or "conventional convertible preferred
stock"), bifurcation of the embedded conversion option is generally not
required. However, if the instrument is not considered to be conventional
convertible debt (or conventional convertible preferred stock), bifurcation
of the embedded conversion option may be required in certain circumstances.
Certain instruments, including convertible debt and equity instruments and
the freestanding options and warrants issued in connection with those
convertible instruments, may be subject to registration rights agreements,
which impose penalties for failure to register the underlying common
stock by a defined date. If the convertible debt or equity instruments
are not considered to be "conventional", then the existence of the
potential cash penalties under the related registration rights agreement
requires that the embedded conversion option be accounted for as a
derivative instrument liability. Similarly, the potential cash penalties
under the related registration rights agreement may require us to account
for the freestanding options and warrants as derivative financial
instrument liabilities, rather than as equity. In addition, when the ability
to physical or net-share settle the conversion option or the exercise of
the freestanding options or warrants is deemed to be not within the control
of the company, the embedded conversion option or freestanding options or
warrants may be required to be accounted for as a derivative financial
instrument liability.
Derivative financial instruments are initially measured at their fair value.
For derivative financial instruments that are accounted for as liabilities,
the derivative instrument is initially recorded at its fair value and is
then re-valued at each reporting date, with changes in the fair value
reported as charges or credits to income. For option-based derivative
financial instruments, the Company uses the Black-Scholes option pricing
model to value the derivative instruments.
If freestanding options or warrants were issued in connection with the
issuance of convertible debt or equity instruments and will be accounted
for as derivative instrument liabilities (rather than as equity), the
total proceeds received are first allocated to the fair value of those
freestanding instruments. If the freestanding options or warrants are to
be accounted for as equity instruments, the proceeds are allocated between
the convertible instrument and those derivative equity instruments, based
on their relative fair values. When the convertible debt or equity
instruments contain embedded derivative instruments that are to be
bifurcated and accounted for as liabilities, the total proceeds allocated
to the convertible host instruments are first allocated to the fair value
of all the bifurcated derivative instruments. The remaining proceeds, if
any, are then allocated to the convertible instruments themselves, usually
resulting in those instruments being recorded at a discount from their
face amount.
To the extent that the fair values of the freestanding and/or bifurcated
derivative instrument liabilities exceed the total proceeds received, an
immediate charge to income is recognized, in order to initially record the
derivative instrument liabilities at their fair value.
The discount from the face value of the convertible debt, together with the
stated interest on the instrument, is amortized over the life of the
instrument through periodic charges to income, usually using the effective
interest method. When the instrument is convertible preferred stock, the
dividends payable are recognized as they accrue and, together with the
periodic amortization of the discount, are charged directly to retained
earnings.
12
The classification of derivative instruments, including whether such
instruments should be recorded as liabilities or as equity, is re-assessed
periodically, including at the end of each reporting period. If
re-classification is required, the fair value of the derivative
instrument, as of the determination date, is re-classified. Any previous
charges or credits to income for changes in the fair value of the
derivative instrument are not reversed. Derivative instrument liabilities
are classified in the balance sheet as current or non-current based on
whether or not net-cash settlement of the derivative instrument could be
required within twelve months of the balance sheet date.
On March 30, 2005, the Company entered into a Securities Purchase Agreement
with four accredited investors ("Note Holders") for the sale of up to (i)
$1,540,000 in Callable Secured Convertible Notes (the "Convertible Notes")
and (ii) warrants to purchase up to 1,540,000 shares of its common stock
(the "Warrants"). The Convertible Notes bear interest at 8% and have a
maturity date of three years from the date of issuance. The Company is
not required to make any principal payments during the term of the
Convertible Notes. The Convertible Notes are convertible into shares of
the Company's common stock at the Note Holders' option, at the lower of
(i) $0.09 per share or (ii) 60% of the average of the three lowest
intra-day trading prices for the common stock as quoted on the
Over-the-Counter Bulletin Board for the 20 trading days preceding the
conversion date. The warrants are exercisable for a period of five years
from the date of issuance and have an exercise price of $0.085 per share.
The full principal amount of the Notes is due upon the occurrence of an
event of default.
The Convertible Notes and the Warrants were issued in three tranches, on
March 30, 2005 ($740,000 of Convertible Notes and 740,000 Warrants), on
May 25, 2005 ($700,000 of Convertible Notes and 700,000 Warrants), and on
August 23, 2005 ($100,000 of Convertible Notes and 100,000 Warrants).
On August 31, 2005, the Company sold an additional $500,000 of Convertible
Notes and 500,000 Warrants to the same four investors. The terms of these
Convertible Notes and Warrants are the same as those previously issued,
except that the exercise price of the Warrants is $0.09 per share.
On October 31, 2005, the Company sold an additional $600,000 of Convertible
Notes and 600,000 Warrants to the same four investors. The terms of these
Convertible Notes and Warrants are the same as those previously issued,
except that the exercise price of the Warrants is $0.09 per share.
The conversion price of the Convertible Notes and the exercise price of the
warrants will be adjusted in the event that the Company issues common stock
at a price below the initial fixed conversion or exercise price, with the
exception of any shares of common stock issued in connection with the
Convertible Notes. The conversion price of the Convertible Notes and the
exercise price of the warrants may also be adjusted in certain circumstances
such as if the Company pays a stock dividend, subdivides or combines
outstanding shares of common stock into a greater or lesser number of
shares, or takes such other actions as would otherwise result in dilution
of the Note Holders' position. The Note Holders have contractually agreed
to restrict their ability to convert their Convertible Notes or exercise
their warrants and receive shares of the Company's common stock such that
the number of shares of common stock held by the Note Holders and their
affiliates after such conversion or exercise does not exceed 4.99% of
the then issued and outstanding shares of common stock. In addition,
the Company has granted the Note Holders registration rights and a
security interest in substantially all of the Company's assets. The
Company has the right to prepay the Convertible Notes under certain
circumstances at a premium ranging from 25% to 50% of the principal
amount, depending on the timing of such prepayment.
13
Pursuant to the terms of a Registration Rights Agreement entered into with
the Note Holders, the Company is obligated to register for resale, within
a defined time period, the shares underlying the Warrants and the shares
issuable on conversion of the Convertible Notes. The terms of the
Registration Rights Agreement provide that, in the event that the
registration statement does not become effective within 105 days of the
issuance of the Warrants or Convertible Notes, the Company is required to
pay to the Note Holders as liquidated damages, an amount equal to 2% per
month of the principal amount of the Convertible Notes. This amount may be
paid in cash or, at the Holder's option, in shares of common stock priced
at the conversion price then in effect on the date of the payment.
Because the Warrants are subject to a Registration Rights Agreement with
the Note Holders, they have been accounted for as derivative instrument
liabilities (see below) in accordance with EITF 00-19, "Accounting for
Derivative Financial Instruments Indexed To, and Potentially Settled In,
a Company's Own Common Stock" (EITF 00-19). Accordingly the fair value
of the warrants, amounting to an aggregate of $1,366,400, was recorded as
a derivative instrument liability. The fair value of the warrants was
determined using the Black-Scholes valuation model, based on the market
price of the common stock on the date the Warrants were issued, an expected
dividend yield of 0%, a risk-free interest rate based on constant maturity
rates published by the U.S. Federal Reserve, applicable to the life of
the Warrants, expected volatility of 50% and the five year life of the
Warrants.
The Company is required to re-measure the fair value of the warrants at each
reporting period until the registration statement is declared effective.
Accordingly, the Company re-measured the fair value of the Warrants at
June 30, 2005, using the Black-Scholes valuation model based on the market
price of the common stock on that date, an expected dividend yield of 0%,
a risk-free interest rate based on constant maturity rates published by
the U.S. Federal Reserve, applicable to the remaining term of the Warrants,
expected volatility of 50% and an expected life equal to the remaining
term of the Warrants. This resulted in a fair market value for the
warrants of $993,600 at June 30, 2005. Upon the Company meeting its
obligation to register the securities, the fair value of the Warrants on
that date will be reclassified to equity.
Because the conversion price of the Convertible Notes is not fixed, the
Convertible Notes are not "conventional convertible debt" as that term
is used in EITF 00-19. Accordingly, because the shares underlying the
conversion of the Convertible Notes are subject to the Registration
Rights Agreement with the Holders, the Company is required to bifurcate
and account separately for the embedded conversion options, together
with any other derivative instruments embedded in the Convertible Notes.
The conversion option related to each Convertible Note, together with the
embedded call options represented by the Note Holders' right to receive
interest payments and any registration rights penalties in common stock,
were treated, for each Convertible Note, as a single compound derivative
instrument, and were bifurcated from the Convertible Note and accounted
for separately as a derivative instrument liability (see below). The
bifurcated embedded derivative instruments, including the embedded
conversion options which were valued using the Black-Scholes valuation
model, were recorded at their initial fair value of an aggregate of
$18,627,556. Because the initial fair values of these embedded derivative
instruments, together with the fair values of the Warrants that were also
accounted for as derivative instrument liabilities and recorded at their
fair values, exceeded the proceeds received (the face amount of the
Convertible Notes), the difference was recorded as an immediate charge
to income.
The discount from the face amount of the Convertible Notes represented by
the value assigned to the Warrants and bifurcated derivative instruments
is being amortized over the period to the due date of each Convertible
Note, using the effective interest method.
14
A summary of the Callable Secured Convertible Notes and derivative
instrument liabilities at June 30, 2005, is as follows:
Callable Secured Convertible Notes; 8% per annum;
due March 30, 2008 $ 740,000
Less: face amount of Notes converted -
---------
740,000
Less: unamortized discount related to warrants and
bifurcated embedded derivative instruments (740,000)
---------
$ -
---------
Callable Secured Convertible Notes; 8% per annum;
due May 25, 2008 $ 700,000
Less: unamortized discount related to warrants and
bifurcated embedded derivative instruments (700,000)
---------
$ -
---------
Total carrying value at June 30, 2005 $ -
=========
Derivative financial instrument liabilities
We use the Black-Scholes valuation model to value the Warrants and the
embedded conversion option components of any bifurcated embedded
derivative instruments that are recorded as derivative liabilities.
In valuing the Warrants and the embedded conversion option components of
the bifurcated embedded derivative instruments, at the time they were
issued and at June 30, 2005, we used the market price of our common
stock on the date of valuation, an expected dividend yield of 0% and the
remaining period to the expiration date of the warrants or repayment date
of the Convertible Notes. All warrants and conversion options can be
exercised by the holder at any time.
Because of the limited historical trading period of our common stock, the
expected volatility of our common stock over the remaining life of the
conversion options and Warrants has been estimated at 50%. The risk-free
rates of return used were based on constant maturity rates published by
the U.S. Federal Reserve, applicable to the remaining life of the
conversion options or Warrants.
At June 30, 2005, the following derivative liabilities related to
common stock Warrants and embedded derivative instruments were outstanding:
Exercise Value-
Price Per Value-Issue June 30,
Issue Date Expiry Date Share Date 2005
- ---------------------------------------------------------------------------
03-30-2005 03-30-2010 740,000 warrants $0.085 $ 673,400 $ 510,600
05-25-2005 05-25-2010 700,000 warrants 0.085 693,000 483,000
---------
Fair value of freestanding derivative
instrument liabilities for warrants $ 993,600
---------
Value-
Value - Issue June 30,
Issue Date Expiry Date Date 2005
- ----------------------------------------------------------------------------
03-30-2005 03-30-2008 $617,676 convertible notes $9,176,010 $ 6,531,228
05-25-2005 05-25-2008 $700,000 convertible notes 9,451,556 6,517,086
-----------
Fair value of bifurcated embedded derivative instrument
liabilities associated with the above convertible notes $13,048,314
-----------
Total derivative financial instruments $14,041,914
===========
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Three months ended June 30, 2005 Compared with three months ended June 30,
2004 and Nine Months ended June 30,2005 compared with Nine months ended
June 30,2004
GENERAL
- -------
The Company is now headquartered at 7284 W. Palmetto Park Rd., Suite 207,
Boca Raton, Florida 33433 since January 1,2004. It does not foresee any need
to further expand its 2200 sq. ft. corporate facility. The Company has
elected to outsource the manufacturing of all its products at this time.
Results of Operations
- ---------------------
For the 2004 third fiscal quarter ended June 30, 2005, Sales decreased 22.0%
to $181,034 from $232,087. This decrease was primarily caused by Eckerd's
drugstores merger with CVS. CVS ceased ordering Snorenz at the end of
December 2004. The Company has attempted to re-open this account by
presenting the product to the category buyer and the decision by CVS is still
pending. The Company is hopeful that a positive decision for its product
lines will occur by October 1, 2005. Also affecting Sales were the overall
consumer demand for the products in this category "Cough and Cold" which
showed a sharp decline. This overall category decline has resulted in
Walgreen's no longer carrying the product lines as well.
For the Nine months ended June 30, 2005 sales decreased 11.70% to $664,678
from $744,288, for the nine months ending June 30, 2004. The decrease is
attributable to a decline in overall customer demand and the loss of several
accounts as described above.
Gross profit for the third quarter was $81,376 versus $133,627 for the year
ago quarter, a decrease of 39.1%. The decrease was due to lower sales. The
gross profit margin was 45.0% during the quarter ended June 30, 2005, as
compared to 57.6% during the quarter ended June 30, 2004. This decrease
resulted from lower sales as cost of sales on a quarter comparison where
virtually unchanged.
For the nine months ended June 30, 2005 Gross profit was $393,931 versus
$397,639 for the nine months ending June 30, 2004, a decrease of 0.9%. The
gross profit margin was 59.3% during the quarter ended June 30, 2005, as
compared to 53.4% during the quarter ended June 30, 2004. This increase
resulted from increased wholesale prices and the shipping of previously
manufactured inventory.
17
Operating expenses (selling, general and administrative expenses)for the
2005 quarter decreased to $557,582 from $1,062,432, a decrease of 47.5%.
The large decrease is due to several factors including, decreased legal
fees, consultants fees and overall operating costs.
Operating expenses for the nine months decreased from $1,873,503 to
$1,184,738, a decrease of 36.8%. The decrease for the nine months is
attributable to the Company's continued cost cutting program; also, the
Company has bought remnant advertising time and saved significant amounts in
order to effectively advertise the products on a reduced operating budget.
The Company is also waiting until the Fall of 2005 to advertise the products
in conjunction with new accounts ordering and placing the products on the
shelves.
Operating loss for the 2005 period was $536,206 as opposed to a loss of
$1,208,155 in the prior year's quarter. The loss was substantially lower
because of lower SGA and cost cutting measures by management.
Operating loss for the Nine months was $1,156,447 as compared to $1,890,964
for the nine months a year ago. The loss was substantially lower because of
lower SGA and cost cutting measures by management.
Interest expense increased from $39,850 in the year ago quarter to $47,111
for this quarter. Interest expense for the nine month period decreased from
$111,185 to $56,171. The decrease is directly attributable to less borrowings
by the Company.
For the third fiscal quarter the company reported a loss of $0.13 per share
versus a loss of $0.08 per share in the year ago quarter.
For the third quarter nine month comparison the Company lost $0.48 cents as
compared to a loss of $0.25 in the year ago quarter.
Liquidity and Capital Resources
- -------------------------------
Cash on hand at June 30, 2005 was $514,805 and the Company had working
capital of $661,479 at June 30, 2005.
Net cash used in operating activities was $963,390 during the nine months
ended June 30, 2005.
Net cash used in investing activities was $-0- during the nine months ended
June 30, 2005.
18
Net cash provided by financing activities was $1,264,487 during the nine
months ended June 30, 2005, which consisted of $101,987 from the proceeds
from the sale of management options and $175,000 of repayment of the original
credit facility and $1,337,500 from the convertible debenture.
The Company has affected a 5% price increase for all of its products.
The Company has also eliminated one-time burdens of legal, computer and other
non-recurring expenses. The Company has sufficient cash resources,
receivables and cash flow to provide for all general corporate operations in
the foreseeable future.
Basis of Reporting
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 has experienced a significant
loss from operations including the settlement of certain litigation. For the
period ended June 30, 2005, the Company incurred a net loss of $14,014,776
and has an accumulated deficit of $28,219,639 at June 30th, 2005.
The Company's ability to continue as a going concern is contingent upon its
ability to secure additional financing, increase ownership equity and attain
profitable operations. In addition, the Company's ability to continue as a
going concern must be considered in light of the problems, expenses and
complications frequently encountered in established markets and the
competitive environment in which the Company operates.
The Company is pursuing financing for its operations and seeking additional
investments. In addition, the Company is seeking to expand its revenue base
by adding new customers and increasing its advertising. Failure to secure
such financing or to raise additional equity capital and to expand its
revenue base may result in the Company depleting its available funds and not
being able pay its obligations.
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.
Derivative instruments
In connection with the sale of debt or equity instruments, we may sell
options or warrants to purchase our common stock. In certain circumstances,
these options or warrants may be classified as derivative liabilities, rather
than as equity. Additionally, the debt or equity instruments may contain
embedded derivative instruments, such as conversion options, which in certain
circumstances may be required to be bifurcated from the associated host
instrument and accounted for separately as a derivative instrument liability.
The identification of, and accounting for, derivative instruments is complex.
Our derivative instrument liabilities are re-valued at the end of each
reporting period, with changes in the fair value of the derivative liability
recorded as charges or credits to income, in the period in which the changes
occur. For options, warrants and bifurcated conversion options that are
accounted for as derivative instruments liabilities, we determine the fair
value of these instruments using the Black-Scholes option pricing model.
That model requires assumptions related to the remaining term of the
instruments and risk-free rates of return, our current common stock price
and expected dividend yield, and the expected volatility of our common stock
price over the life of the option. We have estimated the future volatility
of our common stock price based the history of our stock price. The
identification of, and accounting for, derivative instruments and the
assumptions used to value them can significantly affect our financial
statements.
19
CRITICAL ACCOUNTING POLICIES
- ----------------------------
Our discussion of results of operations and financial condition relies on our
consolidated financial statements that are prepared based on certain critical
accounting policies that require management to make judgments and estimates
that are subject to varying degrees of uncertainty. We believe that investors
need to be aware of these policies and how they impact our financial
reporting to gain a more complete understanding of our financial statements
as a whole, as well as our related discussion and analysis presented herein.
While we believe that these accounting policies are grounded on sound
measurement criteria, actual future events can and often do result in
outcomes that can be materially different from these estimates or forecasts.
The accounting policies and related risks described in the notes to our
financial statements for the year ended September 30, 2004 are those that
depend most heavily on these judgments and estimates.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
- -----------------------------------------
Recently issued accounting pronouncements and their effect on us are
discussed in the notes to the financial statements in our September 30, 2004
audited financial statements.
FORWARD LOOKING STATEMENTS
- --------------------------
When used throughout in this form 10QSB filing, the words "believe",
"should", "would", and similar expressions that are not historical are
intended to identify forward-looking statements that involve risks and
uncertainties. Such statements include, without limitation, expectations with
respect to the results for the next fiscal year, the Company's beliefs and
its views about the long term future of the industry and the Company, its
suppliers or its strategic business partners. In addition to factors that may
be described in the Company's other Securities and Exchange Commission
("SEC") filings, unforeseen circumstances or events could cause the Company's
financial performance to differ materially from that expressed in any
forward-looking statements made by, or on behalf of, the Company. The Company
does not undertake any responsibility to update the forward-looking
statements contained in this Form 10QSB filing.
Item 3. Controls & Procedures
As required by Rule 13a-15 under the Exchange Act, as of the date of the
filing of this report , the Company carried out an evaluation of the
effectiveness of the design and operation of the Company's disclosure
controls and procedures. This evaluation was carried out under the
supervision and with the participation of the Company's management, including
the Company's President, Chief Executive Officer and Chief Financial Officer.
Based upon that evaluation, the Company's President, Chief Executive Officer
and Chief Financial Officer concluded that the Company's disclosure controls
and procedures are effective. There have been no significant changes in the
Company's internal controls or in other factors, which could significantly
affect internal controls subsequent to the date the Company carried out its
evaluation.
Disclosure controls and procedures are controls and other procedures that are
designed to ensure that information required to be disclosed in Company
reports filed or submitted under the Exchange Act is recorded, processed,
summarized and reported, within the time periods specified in the Securities
and Exchange Commission's rules and forms. Disclosure controls and procedures
include, without limitation, controls and procedures designed to ensure that
information required to be disclosed in Company reports filed under the
Exchange Act is accumulated and communicated to management, including the
Company's Chief Executive Officer and Chief Financial Officer as appropriate,
to allow timely decisions regarding required disclosure.
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in the Company's Exchange
Acts reports is recorded, processed and summarized and is reported within the
time periods specified in the SEC's rules and forms, and that such
information is accumulated and communicated to the Company's management,
including its Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required disclosure. In
designing and evaluating the disclosure control procedures, no matter how
well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives, and management necessarily was
required to apply its judgment in evaluating the cost-benefit relationship
of possible controls and procedures.
20
PART II
-------
Item 1. LEGAL PROCEEDINGS
All legal proceedings disclosed in the prior filings have been settled by
the Company. The terms of the settlement were disclosed on From 8-K as
filed on December 12, 2004.
Item 2. CHANGE IN SECURITIES
Not Applicable.
Item 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On April 21st, 2005 the Company filed its Definitive Proxy Statement
requesting an increase of the authorized shares from 50,000,000 to
250,000,000. The results of the proxy vote which was scheduled for May 22,
2005 were extended to June 22nd, 2005. The results were that the amendment
passed by a majority vote of the shareholders
Item 5. OTHER INFORMATION
Not Applicable
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) 31.1 Certification of Chief Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, promulgated
under the Securities Exchange Act of 1934, as amended
31.2 Certification of Chief Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, promulgated
under the Securities Exchange Act of 1934, as amended
32.1 Certification of Chief Executive Officer Pursuant to
18 U.S.C. Section 1350, as adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer Pursuant to
18 U.S.C. Section 1350, as adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
21
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
Med Gen, Inc.
(Registrant)
Date: February 17, 2006
By: /s/Paul B. Kravitz
--------------------------
Paul B. Kravitz
Chief Executive Officer
22