Filed Pursuant to Rule 424(B)(3)
Registration File No. 333-134302
PROSPECTUS
-------------------------
28,000,000 Shares
AVITAR, INC.
Common Stock
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All of the shares of common stock offered in this Prospectus are being offered
by the selling security holders in transactions as described in the plan of
distribution. The Company will not receive any of the proceeds from the sales.
The total number of shares sold herewith consists of the following shares to be
issued to the selling stockholders: (i) up to 23,000,000 shares issuable upon
conversion of convertible notes, and (ii) up to 5,000,000 upon conversion of
Series E preferred stock. We are not selling any shares of common stock in this
offering and therefore will not receive any proceeds from this offering. All
costs associated with this registration will be borne by us.
Our common stock is quoted on the OTC Bulletin Board under the symbol
"AVTI.OB" On June 13, 2006, the closing price reported on the OTC Bulletin Board
was $0.26 per share.
THIS INVESTMENT IN THE COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD
PURCHASE SHARES ONLY IF YOU CAN AFFORD A COMPLETE LOSS. SEE "RISK FACTORS"
BEGINNING ON PAGE 3.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
The date of this Prospectus is June 14, 2006
TABLE OF CONTENTS
Page
Prospectus Summary ........................................................ 1
Risk Factors .............................................................. 3
Forward Looking Statements ................................................ 10
Use of Proceeds ........................................................... 11
Management's Discussion and Analysis or Plan of Operation ................. 12
Business .................................................................. 22
Description of Property ................................................... 27
Directors and Executive Officers .......................................... 28
Executive Compensation .................................................... 30
Security Ownership of Certain Beneficial Owners and Management ............ 33
Market for Common Equity and Related Stockholder Matters .................. 34
Selling Stockholders ...................................................... 35
Certain Relationships and Related Transactions ............................ 36
Description of Securities ................................................. 37
Plan of Distribution ...................................................... 38
Legal Matters ............................................................. 39
Experts ................................................................... 39
Where You Can Find More Information ....................................... 40
Disclosure of Commission Position on Indemnification
for Securities Act Liabilities ............................................ 40
Index to Consolidated Financial Statements ................................ F-1
You may only rely on the information contained in this prospectus or that we
have referred you to. We have not authorized anyone to provide you with
different information. This prospectus does not constitute an offer to sell or a
solicitation of an offer to buy any securities other than the common stock
offered by this prospectus. This prospectus does not constitute an offer to sell
or a solicitation of an offer to buy any common stock in any circumstances in
which such offer or solicitation is unlawful. Neither the delivery of this
prospectus nor any sale made in connection with this prospectus shall, under any
circumstances, create any implication that there has been no change in our
affairs since the date of this prospectus or that the information contained by
reference to this prospectus is correct as of any time after its date.
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus. You
should read the entire prospectus carefully, including the section entitled
"Risk Factors," before deciding to invest in our common stock. Avitar, Inc. is
referred to throughout this prospectus as "Avitar," "the Company," "we" or "us."
General
ABOUT AVITAR
Avitar, Inc., headquartered in Canton, Massachusetts, develops, manufactures and
markets innovative medical devices based on core technologies in oral fluid
diagnostics and customized polyurethane applications. The Company markets a
unique portfolio of substance abuse testing products and services that include:
- - ORALscreen(R), the world's first point-of-contact rapid oral fluid
screening device for drugs of abuse,
- - DRUGOMETER(TM), an instrument that automates the analysis, recording,
reporting and transmitting of results for the ORALscreen(R) drugs of abuse
tests, and
- - other ORALscreen(R)-related products and several other specialized tests
for drugs of abuse.
Avitar also markets an oral fluid collection system for DNA testing as well
as a proprietary line of polyurethane-based high tech medical devices.
The location of our principal executive offices is 65 Dan Road, Canton,
Massachusetts 02021; telephone: (781) 821-2440.
Recent Developments
On September 23, 2005, we entered into a securities purchase agreement with four
investment funds for the sale in three equal installments of an aggregate of
$3,000,000 in secured convertible notes (the "Notes") and five-year warrants
(the "Warrants") to purchase 6,000,000 shares of our common stock at $0.25 per
share and, after a one-for-fifty (1-for-50) reverse stock split (the "Reverse
Stock Split"), the Warrants were to purchase 120,000 shares of our common stock
at $12.50 per share.
We received the first installment of $1,000,000 gross proceeds on September 23,
2005 and the second installment of $1,000,000 on October 21, 2005. We received
one-half of the third installment on February 14, 2006. The balance of $500,000
was advanced in full by May 4, 2006. In consideration for the advances received,
we have issued Notes in the aggregate principal amount of $3,000,000 and
Warrants to purchase 3,000,000 shares of our common stock at $1.25 per share
(post-Reverse Stock Split).
(Originally, the September 2005 private placement provided for the issuance of
Warrants to purchase up to 6 million shares exercisable at $0.25 per share,
which were reduced to 120,000 shares exercisable at $12.50 per share as a result
of the 50-to-1 reverse stock split effective February 17, 2006. However, on May
4, 2006 the final funding of the $3,000,000 private placement was completed
without an effective registration statement, which was a condition to such final
funding. As part of the final funding, all the earlier Warrants were cancelled
and replaced with the currently outstanding Warrants to purchase up to 3 million
shares exercisable at $1.25 per share.)
The Notes bear interest at 8%, mature three years from the date of issuance, and
are convertible into shares of our common stock at any time, at the investors'
option, at 65% of the average of the three lowest intraday trading prices for
our common stock on the Over-The-Counter Bulletin Board for the 20 trading days
ending the day before the conversion date. We have the right to prepay the Notes
under certain circumstances at a premium ranging from 25% to 50% depending on
the timing of such prepayment. We have granted the investors a security interest
in substantially all of our assets. We agreed to file the registration statement
of which this prospectus forms a part for the purpose of registering the shares
issuable upon conversion of the Notes and exercise of the Warrants. Because the
registration statement was not declared effective by January 23, 2005, under the
terms of the registration rights agreement, we may became obligated to pay to
the investors liquidated damages in common stock or cash, at our election, in an
amount equal to 2% of the outstanding principal amount of the Notes per month
plus accrued and unpaid interest. In addition, since the registration statement
was not declared effective by February 7, 2006, we could be in default under the
Notes. However, the purchasers of the Notes have waived all liquidated damages
and defaults related to our failure to have the registration statement declared
effective by those dates provided that the registration statement is declared
effective by June 30,2006. The number of shares included in the registration
statement was based on an estimated conversion price representing 65% of the
average of the lowest three trading prices for the common stock during the
twenty trading day period ending one trading day prior to the assumed conversion
of the callable secured convertible notes, adjusted for the 1-for-50 Reverse
Stock Split effective 5 P.M. on February 17, 2006. If, as a result of the
declining price of our common stock, we will be required to register additional
shares, we will do so in a separate registration statement.
The investors may exercise the Warrants on a cashless basis if the shares
underlying the Warrants are not then registered. In the event of a cashless
exercise, we will not receive any proceeds. The investors have agreed to
restrict their ability to convert their Notes or exercise their Warrants and
receive shares of our common stock such that the number of shares of common
stock held by them and their affiliates in the aggregate after such conversion
or exercise does not exceed 4.99% of the then issued and outstanding shares of
common stock.
Our principal executive office is located at 65 Dan Road, Canton, Massachusetts
02021 and our telephone number at that location is (781) 821-2440.
This Offering
Shares offered by Selling
Stockholders...................... Up to 28,000,000 shares, consisting of up to
23,000,000 shares issuable upon the
conversion of secured convertible notes and
up to 5,000,000 shares issuable upon the
conversion of Series E convertible preferred
stock
Common Stock to be outstanding
after the offering................ 32,419,344*
Use of Proceeds................... We will not receive any proceeds from the
sale of the common stock hereunder. See "Use
of Proceeds" for a complete description.
Risk Factors...................... The purchase of our common stock involves a
high degree of risk. You should carefully
review and consider "Risk Factors" beginning
on page 3.
OTC Bulletin Board
Trading Symbol.................... AVTI.OB
* Based on the current issued and outstanding number of post-Reverse Stock Split
shares of 4,419,344 as of May 17, 2006, and assuming issuance of all shares
registered herewith, the number of shares offered herewith represents
approximately 86% of the total issued and outstanding shares of common stock.
RISK FACTORS
An investment in our shares involves a high degree of risk. Before making an
investment decision, you should carefully consider all of the risks described in
this prospectus. If any of the risks discussed in this prospectus actually
occur, our business, financial condition and results of operations could be
materially and adversely affected. If this were to happen, the price of our
shares could decline significantly and you may lose all or a part of your
investment. The risk factors described below are not the only ones that may
affect us. Our forward-looking statements in this prospectus are subject to the
following risks and uncertainties. Our actual results could differ materially
from those anticipated by our forward-looking statements as a result of the risk
factors below and any other risks that may affect us. See "Forward-Looking
Statements."
Risks Related to Our Business
- -----------------------------
THE COMPANY MAY NOT HAVE SUFFICIENT CASH FOR ITS CURRENT OPERATIONS AND IF IT IS
UNABLE TO RAISE NEW CAPITAL OR GENERATE SUFFICIENT CASH FROM OPERATIONS IT WILL
NOT BE ABLE TO FULFILL ITS FINANCIAL OBLIGATIONS.
The Company has a working capital deficit, which was approximately $1.4 million
at September 30, 2005 and approximately $2.4 million at March 31, 2005. During
fiscal year 2006, the Company's cash requirements are expected to include
primarily the funding of operating losses, the payment of outstanding accounts
payable, the repayment of certain notes payable, the funding of operating
capital to grow the Company's drugs of abuse testing products and services, and
the continued funding for the development of its ORALscreen(R) product line. The
Company is seeking additional capital and is attempting to raise an additional
$5,000,000 during calendar 2006 beyond the funds committed in the September 2005
private placement. However, there can be no assurance that these financings will
be achieved. If these financings were achieved, the Company would be able to
fund current operations until profitability or cash flow breakeven, but only if
its projected sales are achieved. Thereafter it will need additional funds for
operations, product expansion and debt repayment.
In the event of unforeseen circumstances affecting the economy and/or the
Company, this cash flow projection may be proven inaccurate, and the Company
will need additional funds for current operations as well as for its outstanding
obligations sooner than currently anticipated. The Company can give no assurance
that sources of funds will be available to fund its operations and other
obligations. If financing is unavailable, the Company may default on its
obligations, curtail operations or cease business altogether.
WE HAVE SUSTAINED LOSSES IN THE PAST AND WE EXPECT TO REPORT LOSSES IN THE
FUTURE; GOING CONCERN EXPLANATORY PARAGRAPH IN REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM.
We have incurred substantial losses that have reduced our stockholders' equity
and at times depleted our working capital. We funded our negative cash flows
from 1999 to date primarily by the sale of additional equity and the placement
of debt. We incurred losses of approximately $4.15 million during fiscal year
2002, $6.46 million during fiscal year 2003, $2.41 million during fiscal year
2004 (as restated) and $2.43 million during fiscal year 2005. The net loss for
the first half of fiscal year 2006 was $1.93 million.
The losses in fiscal year 2002 were incurred primarily from expenses associated
with the marketing of the new drug-testing kits and the development of test kits
for diseases. Economic conditions during fiscal year 2003 and 2004 and current
economic conditions have imposed significant constraints on capital raising and
have caused actual operating revenues to remain at a lower than expected level
during fiscal years 2003 through 2005 and during the first half of fiscal year
2006.
As a result of the Company's recurring losses from operations and working
capital deficit, the report of its independent registered public accounting firm
relating to the financial statements for fiscal year 2005 contains an
explanatory paragraph stating substantial doubt about the Company's ability to
continue as a going concern. Such report states that the ultimate outcome of
this matter could not be determined as of the date of such report (January 20,
2006).
PRINCIPAL SUPPLIER RISK
Suppliers of two key components are, in each case, the current sole source for
the Company. The inability to obtain components will have an adverse effect on
the business, revenues and prospects of the Company. Although the Company has an
inventory of these components, it may not last sufficiently long while the
Company finds a new supplier. There is no assurance that a new supplier will be
found for these components on a timely basis, or at all, if the current supplier
ceases to sell to the Company.
Although some of the parts and components used to manufacture our products are
available from multiple sources, we currently purchase most of our components
from single sources in an effort to obtain volume discounts. Lack of
availability of any of these parts and components could result in production
delays, increased costs, or costly redesign of our products. Any loss of
availability of an essential system component could result in a material adverse
change to our business, financial condition and results of operations.
NO ASSURANCE THAT FUTURE CAPITAL WILL BE AVAILABLE TO US; ADDITIONAL CAPITAL
WILL DILUTE THE HOLDINGS OF OUR STOCKHOLDERS.
If we need additional financing, we cannot give any assurance that it will be
available, or if available, that it will be available on terms favorable to our
stockholders. If funds are not available to satisfy any of our short-term and
long-term operating requirements, we may limit or suspend our operations in the
entirety or, under certain circumstances, seek protection from creditors. Our
recent equity offerings resulted in the dilution of our then existing
stockholders. It is possible that future financings may contain terms that could
result in similar or more substantial dilution than has already been incurred by
our stockholders from the sales of equity (including convertible debt and
preferred stock) with warrants since fiscal year 1998.
RISKS ARISING FROM THE REVERSE STOCK SPLIT
The one-for-fifty reverse stock split of all issued and outstanding shares of
common stock of Avitar was approved by our shareholders at our Annual Meeting on
January 18, 2006. The reverse stock split, whereby each outstanding 50 shares of
common stock were combined into and become one share of common stock, was
effective at 5 P.M. on February 17, 2006. In evaluating whether or not to
authorize the reverse stock split (and related decrease in authorized shares),
the Board of Directors also took into account various negative factors
associated with a reverse stock split. These factors included:
- - the negative perception of reverse stock splits held by some investors,
analysts and other stock market participants;
- - the fact that the stock price of some companies that have effected reverse
stock splits has subsequently declined back to pre-reverse stock split
levels;
- - the adverse effect on liquidity that might be caused by a reduced number of
shares outstanding; and
- - the increased proportion of unissued authorized shares to issued shares
could, under certain circumstances, have anti-takeover effects.
WE DEPEND ON THE DRUG OF ABUSE SCREEN SYSTEMS
We intend to continue to concentrate our efforts primarily on the development of
the ORALscreen(R) drug of abuse detection systems and we will be dependent upon
the successful development and marketing of those systems to generate revenues.
Acceptance of our systems may be adversely affected by:
- costs,
- concerns related to accuracy or false positive reports,
- a cultural resistance to the use of drug of abuse screening tests,
- the effectiveness of competing drug of abuse screening tests.
Any failure to achieve greater market acceptance of our systems will have a
material adverse effect on our business, financial condition and results of
operations.
THE SUCCESS OF COMPETITIVE PRODUCTS COULD HAVE AN ADVERSE EFFECT ON OUR
BUSINESS.
The Drug of Abuse Testing industry is intensely competitive, although at present
we have encountered only minimal direct competition in the rapid on-site (as
opposed to laboratory) oral fluid drug testing market. The significant
competitive factors in the industry include:
- price,
- convenience,
- accuracy,
- acceptance of new technologies,
- user satisfaction, and
- when applicable, government approval.
We believe our ORALscreen(R) systems offer several distinct advantages over the
use of blood or urine samples, including net cost savings, ease of use and
non-invasiveness. However, the success of any competing alternative to the
ORALscreen(R) systems for screening for drugs of abuse could have a material
adverse effect on our business, financial condition and results of operations.
Most of our competitors have substantially greater financial capabilities for
product development and marketing than we currently do. These financial
capabilities enable our competitors to market their systems in a more effective
manner.
SUBSTANTIAL REGULATION BY GOVERNMENT AGENCIES.
Many of our products are subject to regulation by the Food and Drug
Administration (the "FDA") and comparable agencies in various states and foreign
countries requiring, among other things, pre-market approval or clearance of new
medical or dental devices. In November 2000, the FDA proposed regulations that,
although still not in effect, in the future may require a pre-market approval or
clearance of our ORALscreen(R) products for sale to employers. In addition,
Avitar is subject to inspections by the FDA at all times, and may be subject to
inspections by state and foreign agencies. If the FDA believes that its legal
requirements have not been fulfilled, it has extensive enforcement powers,
including the ability to initiate action to physically seize products and/or to
enjoin their manufacture and distribution, to require recalls of certain types
of products, and to impose or seek to impose civil or criminal sanctions against
individuals or companies. Such submissions and review by the FDA could take
several years, after which there could be no assurance that approval would be
granted.
DEPENDENCE ON INTELLECTUAL PROPERTY; NO ASSURANCE AS TO PROTECTION OF
INTELLECTUAL PROPERTY.
Our ability to compete effectively with other companies will depend, in part, on
our ability to maintain the proprietary nature of our technologies. We rely
substantially on unpatented proprietary information and know-how, and there can
be no assurance that others will not develop such information and know-how
independently or otherwise obtain access to our technology. Similarly, there can
be no assurance that our proprietary technology will not infringe patents or
other rights owned by others. If we are unable to adequately safeguard and
exploit our methods and technologies, our ability to compete with other
companies, a majority of which have greater financial, technological, human and
other resources than the Company, our business would be materially adversely
affected.
RISK OF PRODUCT LIABILITY; LIMITED INSURANCE COVERAGE.
The testing, marketing and sale of medical and dental products entails a risk of
product liability claims by consumers and others. Avitar has maintained product
liability insurance coverage and currently has such insurance in the amount of
up to $5,000,000. This insurance will not cover liabilities caused by events
occurring after such policy is terminated or claims made after 60 days following
termination of the policy or in respect of events excluded from coverage. In the
event of a successful suit against Avitar, lack or insufficiency of insurance
coverage would have a material adverse effect on Avitar. Further, certain
distributors of medical and dental products require minimum product liability
insurance coverage as a condition precedent to purchasing or accepting products
for distribution. Failure to satisfy such insurance requirements could impede
the ability of Avitar to achieve broad distribution of its products, which would
have a material adverse effect on Avitar.
WE ARE DEPENDENT ON OUR MANAGEMENT AND KEY PERSONNEL TO SUCCEED.
Our principal executive officers and key personnel have extensive knowledge of
and experience with our products, the research and development efforts needed to
improve them and the development of marketing and sales programs to increase
their market penetration. The loss of the services of any of our executive
officers or other key personnel, or our failure to attract and retain other
skilled and experienced personnel, could have a material adverse effect on our
ability to manufacture, sell and market our products. Such events would probably
have a negative impact on our business and financial condition.
BARRIERS TO TAKEOVER
The Company is governed by the provisions of Section 203 of the Delaware General
Corporation Law, an anti-takeover law. In general, the law prohibits a public
Delaware corporation from engaging in a "business combination" with an
"interested stockholder" for a period of three years after the date of the
transaction in which the person became an interested stockholder, unless the
business combination is approved in a prescribed manner. "Business combination"
is defined to include mergers, asset sales and certain other transactions
resulting in a financial benefit to the stockholders. An "interested
stockholder" is defined as a person who, together with affiliates and
associates, owns (or within the prior three years, did own) 15% or more of a
corporation's voting stock. As a result of the application of Section 203,
potential acquirers of the Company may be discouraged from attempting to effect
an acquisition transaction with the Company, thereby possibly depriving holders
of the Company's securities of certain opportunities to sell or otherwise
dispose of such securities at above market prices pursuant to such transactions.
In addition, in the event of certain changes of control of the Company (as
defined in the Company's Equity Plan) outstanding options granted pursuant to
the Company's Equity Plan will become immediately exercisable in full. Such
acceleration of exercisability may also discourage potential acquirers of the
Company.
WE ARE AUTHORIZED TO ISSUE "BLANK CHECK" PREFERRED STOCK WHICH, IF ISSUED, MAY
ADVERSELY AFFECT THE RIGHTS OF HOLDERS OF OUR COMMON STOCK.
Our certificate of incorporation authorizes the issuance of up to 5,000,000
shares of "blank check" preferred stock with such designations, rights and
preferences as may be determined from time to time by our Board of Directors.
Accordingly, our Board of Directors is empowered, without stockholder approval,
to issue preferred stock with dividend, liquidation, conversion, voting or other
rights which would adversely affect the voting power or other rights of our
stockholders. In the event of issuance, the preferred stock could be utilized,
under certain circumstances, as a method of discouraging, delaying or preventing
a change in control, which could have the effect of discouraging bids for Avitar
and thereby prevent stockholders from receiving the maximum value for their
shares. We have no present intention to issue any shares of its preferred stock
in order to discourage or delay a change of control. However, there can be no
assurance that preferred stock will not be issued at some time in the future.
THE AVAILABILITY OF A LARGE NUMBER OF AUTHORIZED BUT UNISSUED SHARES OF COMMON
STOCK MAY, UPON THEIR ISSUANCE, LEAD TO DILUTION OF EXISTING SHAREHOLDERS.
We are authorized to issue 100,000,000 shares of common stock, of which as of
May 17, 2006 4,419,344 shares were issued and outstanding (in each case,
post-Reverse Stock Split) and, in addition to the convertible notes related to
the September 2005 financing and the Series E Preferred Shares, there are
approximately 4,100,000 shares estimated to be subject to outstanding options,
warrants and other convertible preferred stock and debt(in each case
post-Reverse Stock Split). In connection with the financing arrangement that we
entered into in September 2005, we also have outstanding callable secured
convertible notes that may be converted into an estimated 15,000,000 to
23,000,000 shares of common stock at current or recent market prices, and
outstanding warrants to purchase 3,000,000 shares of common stock. Assuming
conversion and exercise of all these instruments, we will be left with
approximately 55,000,000 to 75,000,000 authorized shares that remain unissued.
These shares may be issued by our Board of Directors without further stockholder
approval. The issuance of large numbers of shares, possibly at below market
prices, is likely to result in substantial dilution to the interests of other
stockholders. In addition, issuances of large numbers of shares may adversely
affect the market price of our common stock.
Risks Relating to Our Current Financing Arrangement:
- ----------------------------------------------------
THERE ARE A LARGE NUMBER OF SHARES UNDERLYING OUR CONVERTIBLE NOTES THAT ARE
BEING REGISTERED IN THIS PROSPECTUS AND THE SALE OF THESE SHARES MAY DEPRESS THE
MARKET PRICE OF OUR COMMON STOCK AND CAUSE DILUTION TO OUR EXISTING
SHAREHOLDERS.
As of May 8, 2006, we had 4,419,344 shares of common stock issued and
outstanding (post-Reverse Stock Split). In connection with the financing
arrangement that we entered into in September 2005, we also have outstanding
callable secured convertible notes that may be converted into an estimated
15,000,000 to 23,000,000 shares of common stock at current or recent market
prices, and outstanding warrants to purchase 3,000,000 shares of common stock.
In addition, the number of shares of common stock issuable upon conversion of
the outstanding callable secured convertible notes may increase if the market
price of our stock declines. Upon effectiveness of the registration statement of
which this prospectus forms a part, all of the shares, including all of the
shares issuable upon conversion of the notes, may be sold without restriction.
The sale of these shares may adversely affect the market price of our common
stock.
The variable price feature of our convertible notes could require us to issue a
substantially greater number of shares, which will cause further dilution to our
existing stockholders. The number of shares we will be required to issue upon
conversion of the notes will increase if the market price of our stock
decreases. The notes are convertible at a 35% discount below the then market
price. The following is an example of the amount of shares of our common stock
issuable upon conversion of the entire $3,000,000 principal amount in
convertible notes, based on market prices assumed to be 25%, 50% and 75% below
the closing sale price on May 17, 2006 of $0.25:
- --------------------------------------------------------------------------------
%BELOW MARKET/PRICE PER SHARE/WITH 35% DISCOUNT/NUMBER OF SHARES/PERCENTAGE*
- --------------------------------------------------------------------------------
25% $ 0.19 $ 0.12 25,000,000 85.0%
- --------------------------------------------------------------------------------
50% $ 0.13 $ 0.08 37,500,000 89.3%
- --------------------------------------------------------------------------------
75% $ 0.06 $ 0.04 75,000,000 94.4%
- --------------------------------------------------------------------------------
- -------
* Based upon 4,419,344 shares of common stock outstanding as of May 17, 2006
(post-Reverse Stock Split). The convertible notes contain provisions that
limit the stock ownership of the holders of those notes to 4.99%.
Nevertheless, the percentages set forth in the table reflect the shares
that may be issued to the holders in the aggregate as a percentage of the
total then outstanding shares of common stock.
As illustrated, the number of shares of common stock issuable in connection with
the conversion of the convertible notes will increase if the market price of our
stock declines, which will cause dilution to our existing stockholders.
THE LARGE NUMBER OF SHARES ISSUABLE UPON CONVERSION OF THE CONVERTIBLE NOTES MAY
RESULT IN A CHANGE OF CONTROL.
The convertible notes contain provisions that limit the stock ownership of the
holders of those notes to 4.99%. Nevertheless, as there is no limit on the
number of shares that may be issued under the convertible notes, these issuances
may result in the purchasers of the notes controlling us. The purchasers of the
notes may be able to exert substantial influence over all matters submitted to a
vote of the shareholders, including the election and removal of directors,
amendments to our certificate of incorporation and by-laws, and the approval of
a merger, consolidation or sale of all or substantially all of our assets. In
addition, this concentration of ownership could inhibit the management of our
business and affairs and have the effect of delaying, deferring or preventing a
change in control or impeding a merger, consolidation, takeover or other
business combination, which our shareholders may view favorably.
THE LOWER THE STOCK PRICE, THE GREATER THE NUMBER OF SHARES ISSUABLE UNDER THE
CONVERTIBLE NOTES.
The number of shares issuable upon conversion of the convertible notes, like the
outstanding shares of preferred stock is determined by the market price of our
common stock prevailing at the time of each conversion. The lower the market
price, the greater is the number of shares issuable under the agreement. Upon
issuance of the shares, to the extent that holders of those shares will attempt
to sell the shares into the market, these sales may further reduce the market
price of our common stock. This in turn will increase the number of shares
issuable under the agreement. This may lead to an escalation of lower market
prices and ever greater numbers of shares to be issued. A larger number of
shares issuable at a discount to a continuously declining stock price will
expose our stockholders to greater dilution and a reduction of the value of
their investment.
THE ISSUANCE OF OUR STOCK UPON CONVERSION OF THE CONVERTIBLE NOTES COULD
ENCOURAGE SHORT SALES BY THIRD PARTIES, WHICH COULD CONTRIBUTE TO THE FUTURE
DECLINE OF OUR STOCK PRICE AND MATERIALLY DILUTE EXISTING STOCKHOLDERS' EQUITY
AND VOTING RIGHTS.
The convertible notes have the potential to cause significant downward pressure
on the price of our common stock. This is particularly the case if the shares
issued upon conversion and placed into the market exceed the market's ability to
absorb the increased number of shares of stock. Such an event could place
further downward pressure on the price of our common stock. The opportunity
exists for short sellers and others to contribute to the future decline of our
stock price. If there are significant short sales of our stock, the price
decline that would result from this activity will cause the share price to
decline more so, which, in turn, may cause long holders of the stock to sell
their shares thereby contributing to sales of stock in the market. If there is
an imbalance on the sell side of the market for the stock, our stock price will
decline. If this occurs, the number of shares of our common stock that is
issuable upon conversion of the convertible notes will increase, which will
materially dilute existing stockholders' equity and voting rights.
IF WE ARE REQUIRED FOR ANY REASON TO REPAY OUR OUTSTANDING SECURED CONVERTIBLE
NOTES, WE COULD BE REQUIRED TO DEPLETE OUR WORKING CAPITAL, IF AVAILABLE, OR
RAISE ADDITIONAL FUNDS. OUR FAILURE TO REPAY THE SECURED CONVERTIBLE NOTES, IF
REQUIRED, COULD RESULT IN LEGAL ACTION AGAINST US AND THE TERMINATION OF OUR
BUSINESS.
In September 2005, we entered into a Securities Purchase Agreement for the sale
of an aggregate of $3,000,000 principal amount of secured convertible notes. The
secured convertible notes are due and payable, with 8% interest, three years
from the date of issuance, unless sooner converted into shares of our common
stock. In addition, any event of default such as our failure to repay the
principal or interest when due, our failure to issue shares of common stock upon
conversion by the holder, or our failure to timely file a registration statement
or have such registration statement declared effective, could require the early
repayment of the secured convertible notes, including a default interest rate of
15% on the outstanding principal balance of the notes if the default is not
cured within the specified grace period. We anticipate that the full amount of
the secured convertible notes will be converted into shares of our common stock,
in accordance with the terms of the secured convertible notes. If we were
required to repay the secured convertible notes, we would be required to use our
limited working capital and raise additional funds. If we were unable to repay
the notes when required, the note holders could commence legal action against us
and foreclose on all of our assets to recover the amounts due. Any such action
would require us to curtail or cease operations.
WE MAY BE OBLIGATED TO PAY LIQUIDATED DAMAGES AS A RESULT OF OUR FAILURE TO HAVE
THIS REGISTRATION STATEMENT DECLARED EFFECTIVE PRIOR TO JUNE 30, 2006,AND THE
PAYMENT OF LIQUIDATED DAMAGES WILL EITHER RESULT IN FURTHER DEPLETING OUR
WORKING CAPITAL OR ISSUANCE OF SHARES OF COMMON STOCK, WHICH WOULD CAUSE FURTHER
DILUTION TO OUR EXISTING SHAREHOLDERS.
Pursuant to the terms of our registration rights agreement entered into in
connection with our securities purchase agreement dated September 23, 2005, if
under certain circumstances we did not have a registration statement registering
the shares underlying the secured convertible notes and warrants declared
effective on or before January 23, 2006, we are obligated to pay liquidated
damages in the amount of 2.0% per month of the face amount of the issued and
outstanding secured convertible notes, which equals $50,000, until the
registration statement is declared effective. Because the registration statement
was not declared effective by January 23, 2006, we may have become obligated to
pay the investors the liquidated damages. In addition, since the registration
statement was not declared effective on February 8, 2006, we could be in default
under the Notes. However, the purchasers of the Notes have waived all liquidated
damages and defaults related to our failure to have the registration statement
declared effective by those dates provided that the registration statement is
declared effective by June 30, 2006 and the investors agreed that the 3 million
shares underlying the warrants were not registered at this time. At our option,
these liquidated damages, if and when payable, can be paid in cash or restricted
shares of our common stock. If we decide to pay the liquidated damages in cash,
we would be required to use our limited working capital and potentially raise
additional funds. If we decide to pay the liquidated damages in shares of common
stock, the number of shares issued would depend on our stock price at the time
that payment is due. The issuance of shares upon payment of liquidated damages
will have the effect of further diluting the proportionate equity interest and
voting power of holders of our common stock, including investors in this
offering.
The following risks relate principally to our common stock and its market value:
- -------------------------------------------------------------------------------
THERE IS A LIMITED MARKET FOR OUR COMMON STOCK THAT MAY MAKE IT MORE DIFFICULT
FOR YOU TO DISPOSE OF YOUR STOCK.
Our common stock has been quoted on the OTC Bulletin Board under the symbol
"AVTI.OB" since September 20, 2005. Accordingly, there can be no assurance as to
the liquidity of any markets that may develop for our common stock, the ability
of holders of our common stock to sell our common stock, or the prices at which
holders may be able to sell our common stock.
THE MARKET PRICE OF OUR STOCK HAS HISTORICALLY BEEN VOLATILE.
The volatility of our common stock imposes a greater risk of capital losses on
stockholders as compared to less volatile stocks. In addition, such volatility
makes it difficult to ascribe a stable valuation to a stockholder's holdings of
our common stock.
The market price of our common stock is likely to be highly volatile and could
fluctuate widely in price in response to various factors, many of which are
beyond our control, including:
o technological innovations or new products and services by us or our
competitors;
o changes in marketing, product pricing and sales strategies; o changes
in domestic or foreign governmental regulations or regulatory approval
processes;
o disputes relating to patent or proprietary rights;
o public concern as to the reliability of the OralScreen systems or drug
tests in general;
o additions or departures of key personnel;
o sales of our common stock or convertible debt or equity securities;
o our ability to execute our business plan;
o operating results below expectations;
o loss of any strategic relationship;
o industry developments;
o economic and other external factors; and
o period-to-period fluctuations in our financial results.
Because we have incurred substantial losses to date, you may consider any one of
these factors to be material. Our stock price may fluctuate widely as a result
of any of the above listed factors. Moreover, the possibility exists that the
stock market (and in particular the securities of technology companies such as
ours) could experience extreme price and volume fluctuations unrelated to
operating performance. These market fluctuations may also materially and
adversely affect the market price of our common stock.
WE HAVE NOT PAID DIVIDENDS AND DO NOT EXPECT TO PAY DIVIDENDS.
We have never paid cash dividends on our common stock and do not anticipate
paying cash dividends in the foreseeable future. The payment of dividends on our
common stock will depend on earnings, financial condition and other business and
economic factors affecting it at such time as the board of directors may
consider relevant. If we do not pay dividends, our common stock may be less
valuable because a return on your investment will only occur if its stock price
appreciates. Any return on investment may be limited to any appreciation in the
value of our common stock.
OUR COMMON STOCK IS DEEMED TO BE PENNY STOCK WITH A LIMITED TRADING MARKET.
Our common stock is currently quoted for trading on the OTC Bulletin Board,
which is generally considered to be a less efficient market than markets such as
NASDAQ or other national exchanges, and which may cause difficulty in conducting
trades and difficulty in obtaining future financing. Further, our securities are
subject to the "penny stock rules" adopted pursuant to Section 15 (g) of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). The penny
stock rules apply to non-NASDAQ companies whose common stock trades at less than
$5.00 per share or which have tangible net worth of less than $5,000,000
($2,000,000 if the company has been operating for three or more years). Such
rules require, among other things, that brokers who trade "penny stock" to
persons other than "established customers" complete certain documentation, make
suitability inquiries of investors and provide investors with certain
information concerning trading in the security, including a risk disclosure
document and quote information under certain circumstances. Penny stocks sold in
violation of the applicable rules may entitle the buyer of the stock to rescind
the sale and receive a full refund from the broker.
Many brokers have decided not to trade "penny stock" because of the requirements
of the penny stock rules and, as a result, the number of broker-dealers willing
to act as market makers in such securities is limited. In the event that we
remain subject to the "penny stock rules" for any significant period, there may
develop an adverse impact on the market, if any, for our securities. Because our
securities are subject to the "penny stock rules," investors will find it more
difficult to dispose of our securities. Further, for companies whose securities
are traded in the OTC Bulletin Board, it is more difficult: (i) to obtain
accurate quotations, (ii) to obtain coverage for significant news events because
major wire services, such as the Dow Jones News Service, generally do not
publish press releases about such companies, and (iii) to obtain needed capital.
FORWARD-LOOKING STATEMENTS
Our representatives and we may from time to time make written or oral statements
that are "forward-looking," including statements contained in this prospectus
and other filings with the Securities and Exchange Commission, reports to our
stockholders and news releases. All statements that express expectations,
estimates, forecasts or projections are forward-looking statements within the
meaning of the Securities Act and the Exchange Act. In addition, other written
or oral statements which constitute forward-looking statements may be made by us
or on our behalf. Words such as "expects," "anticipates," "intends," "plans,"
"believes," "seeks," "estimates," "projects," "forecasts," "may," "should,"
variations of such words and similar expressions are intended to identify such
forward-looking statements. These statements are not guarantees of future
performance and involve risks, uncertainties and assumptions that are difficult
to predict. Therefore, actual outcomes and results may differ materially from
what is expressed or forecasted in or suggested by such forward-looking
statements. We undertake no obligation to update publicly any forward-looking
statements, whether as a result of new information, future events or otherwise.
The Private Securities Litigation Reform Act of 1995 contains the safe harbor
provisions that cover these forward-looking statements under certain
circumstances. We are including this statement for purposes of complying with
these safe harbor provisions when and if applicable. Important factors on which
such statements are based are assumptions concerning uncertainties, including
but not limited to uncertainties associated with the following:
o continued losses and cash flow deficits;
o the continued availability of financing in the amounts, at the times
and on the terms required to support our future business;
o uncertain market acceptance of our products;
o accuracy, reliability and patent concerns regarding our products and
technology;
o competition;
o reliance on key personnel;
o volatility or decline of our stock price;
o changes in demand for our products and services;
o litigation with or legal claims and allegations by outside parties;
and
o insufficient revenues to cover operating costs.
USE OF PROCEEDS
This prospectus relates to shares of our common stock that may be offered and
sold from time to time by selling stockholders. We will receive no proceeds from
the sale of shares of common stock in this offering.
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discussion and analysis should be read in conjunction with the
Company's consolidated financial statements and the notes thereto appearing
elsewhere in this prospectus.
Restatement
As indicated in Note 1 of the Consolidated Financial Statements, the statements
of stockholders' deficit as of September 30, 2003 and 2004 and for the year
ended September 30, 2004 and the statement of operations for the year ended
September 30, 2004 included in this prospectus have been restated to correct an
error in accounting for the issuance of various securities and the derivative
features embedded therein. The effects of these restatements are described in
Note 1 of the Consolidated Financial Statements and the discussions below are
based on restated information.
One-for-Fifty (1 for 50) Reverse Stock Split
A one-for-fifty (1 for 50) reverse stock split of all outstanding shares of
common stock of Avitar was effective at 5 P.M. on February 17, 2006 (the
"Effective Time"). At the Effective Time, each outstanding 50 shares of common
stock were combined into and became one share of common stock. In the same
manner, all outstanding warrants, options and convertible securities are
appropriately and equitably adjusted as to the number of shares of common stock
and price per share.
Results of Operations
Years ended September 30, 2005 and 2004
Revenues
Sales for the fiscal year ended September 30, 2005 ("Fiscal 2005")
increased $460,367, or approximately 11%, to $4,508,914 from $4,048,547 for the
fiscal year ended September 30, 2004 ("Fiscal 2004"). The results for Fiscal
2005 primarily reflect the increase in the volume of sales of its OralScreen(R)
products of approximately $162,000 and foam products of approximately $364,000,
offset in part by a decrease in revenue from contraband detection services of
approximately $66,000.
Operating Expenses
Costs of sales were approximately 71% of sales in Fiscal 2005 compared to
approximately 67% of sales for Fiscal 2004. The change for Fiscal 2005 resulted
primarily from a shift in the product mix to the lower margin foam products (47%
in Fiscal 2005 versus 44% in Fiscal 2004), a change in customer mix for the
ORALscreen products and an increase of $79,000 for a defective lot of raw
materials for the ORALscreen products; offset in part by a reduction in warranty
expense of approximately $134,000.
Sales, general and administrative expenses for Fiscal 2005 increased
$928,561, or approximately 27%, to $4,329,331 from $3,400,770 for Fiscal 2004.
The change for Fiscal 2005 primarily included approximately $885,000 for
additional sales and marketing resources and approximately $132,000 for public
and investor relations consulting expense increases; offset in part by a
reduction of approximately $70,000 in legal expenses, approximately $54,000 in
general consulting expenses, approximately $38,000 in stock exchange fees and
approximately $168,000 in various other administrative expenses. Fiscal 2004
included a reduction for accrued royalty expense of approximately $242,000 as a
result of management's revision of estimates of amounts due to a former supplier
under a product development agreement. With respect to the revision in accrued
royalty expenses in Fiscal 2004, the Company, during the term of a product
development agreement with the supplier, had accrued the royalties due under
this agreement with expectation that the supplier would fulfill the terms of the
agreement. However, in 2002, the Company notified the supplier that the supplier
had failed to meet the terms of the product development agreement and therefore,
under the terms of this agreement, no royalties would be payable. Since being
notified, the supplier had done nothing to cure this default. In view of this
lapse in time and that other product undertakings by the supplier would prevent
the supplier from ever curing any of its defaults under the agreement, there was
no longer any need to maintain the royalty reserve for this supplier. In order
to achieve revenue growth, the Company will continue to incur increased expenses
to hire additional direct sales staff and expand marketing programs beyond
Fiscal 2005.
Research and development expenses for Fiscal 2005 were $724,254 compared to
$564,831 for Fiscal 2004. The increase was mainly the result of additional
personnel and related expenses of approximately $117,000 and material and
consulting expenses of approximately $45,000 for enhancements to ORALscreen
products; offset in part by reductions in various other development related
expenses of approximately $3,000. The Company plans to continue improving and
enhancing its ORALscreen products, and therefore will most likely incur
increased expenses for research and development beyond Fiscal 2005.
As of October 1, 2004, the Company's goodwill was $238,120, which was
associated with the acquisition of BJR in 2001. In Fiscal 2005, an adjustment to
the $238,120 of goodwill associated with the BJR acquisition was deemed
necessary. Based on the limited operating results of the business and estimates
of its fair value, the Company recorded an impairment of goodwill of $100,000 in
Fiscal 2005.
Other Income and Expense
Other income for Fiscal 2005 was $1,618,152 as compared to other income of
$561,370 for the fiscal year ended September 30, 2004. The amount for Fiscal
2005 reflected an increase in income of approximately $1,061,000 from changes in
the fair market value of derivative securities and warrants (see Note 1 of the
Consolidated Financial Statements).
Interest expense and financing costs were $223,864 for Fiscal 2005 compared
to $330,298 incurred during Fiscal 2004. The reduction for Fiscal 2005 primarily
reflected the reduction of approximately $206,000 in interest expense and
financing costs associated with the long-term debt of $1,250,000 that was
converted into preferred stock in May 2004 and the reduction in interest expense
on various other notes of approximately $51,000, offset primarily by interest
and financing costs of approximately $151,000 for the notes and convertible
notes issued from March to September 2005 and the equity credit line established
in February 2005.
Discontinued Operations
On December 16, 2003, the Company consummated the sale of the business and
net assets, excluding cash, of its USDTL subsidiary. For Fiscal 2005, no
activity was recorded for USDTL compared to a loss of $12,788 for Fiscal 2004.
The loss for the fiscal year ended September 30, 2004 resulted from a loss on
the disposal of USDTL of $17,235 which was offset in part by income from
operations of $4,447. In November 2005, the Company reached an arrangement with
the new owners of USDTL to conclude all outstanding matters related to the sale
of USDTL. Under the terms of this agreement, the Company received an immediate
lump sum payment of $120,000 rather than waiting for the 10 to 14 years that the
Company believed it would take to collect the entire $500,000 (see Notes 3 and
17 of the consolidated financial statements).
Net Loss
Primarily as a result of the factors described above, the Company had a net
loss of $2,433,157, $.03 per basic and diluted share, for Fiscal 2005 compared
to a net loss of $2,411,898, $.04 per basic and diluted share, for Fiscal 2004.
Six Months ended March 31, 2006 Compared to the Six Months ended March 31, 2005
Revenues
Sales for the three months ended March 31, 2006 increased $324,043, or
approximately 36%, to $1,297,266 from $955,223 for the corresponding period of
the prior year. For the six months ended March 31, 2006, sales increased
$213,273, or approximately 11%, to $2,204,536 from $1,991,263. The change for
the three months ended March 31, 2006 primarily reflects an increase in the
volume of sales for its OralScreen(R) and Foam Products of $340,000, offset in
part by a decrease of $16,000 in revenue from contraband detection services. The
change for the six months ended March 31, 2006 primarily reflects an increase in
the volume of sales for its OralScreen(R) and Foam products of $215,000, offset
in part by a decrease of $2,000 in revenue from contraband detection services.
Operating Expenses
Cost of sales for the three months ended March 31, 2006 were approximately
69% of sales compared to the cost of sales of approximately 75% of sales for the
three months ended March 31, 2005. For the six months ended March 31, 2006, the
cost of sales was 71% compared to 72% of sales for the same period of Fiscal
2005. The improvement for Fiscal 2006 resulted from the overall increase in
sales described above.
Selling, general and administrative expenses for the three months ended
March 31, 2006 decreased $13,228, or approximately 1%, to $1,018,392 from
$1,031,620 for the corresponding period of the prior year. For the six months
ended March 31, 2006, selling, general and administrative expenses increased
$92,717 or approximately 5%, to $2,056,999 from $1,964,282 for the six months
ended March 31, 2005. The change for the six-month period ended March 31, 2006
primarily resulted from the addition of sales and marketing resources. In order
to achieve revenue growth, the Company will most likely continue to incur
increased expenses to hire additional direct sales staff and expand marketing
programs during the remainder of FY2006 and beyond.
Expenses for research and development for the three months ended March 31,
2006 amounted to $109,248 compared to $183,306 for the corresponding period of
the prior year, a decrease of $74,058. For the six months ended March 31, 2006,
expenses for research and development were $238,954 versus $379,749 for the six
months ended March 31, 2005, a decrease of $140,795. The decrease for the
quarter ended March 31, 2006 was primarily attributable to a reduction in salary
expense of $16,000, consulting expense of $23,000 and material and various
development related expenses of $27,000. The change for the six months ended
March 31, 2006 resulted primarily from reduced salary and fringe benefit
expenses of $39,000, consulting expense of $55,000, material and various
development related expenses of $35,000. Although research and development
expenses were lower for the first half of Fiscal 2006, the Company must continue
developing and enhancing its ORALscreen products and therefore, will most likely
incur increased expenses for research and development during the remainder of
FY2006 and beyond.
Other Income and Expense
Interest expense and financing costs were $175,851 for the three months
ended March 31, 2006 compared to $23,183 incurred during the three months ended
March 31, 2005. For the six months ended March 31, 2006, interest expense and
financing costs amounted to $389,086 versus $36,369 for the corresponding period
of Fiscal 2005. The increase for the three months ended March 31, 2006 resulted
primarily from interest expense of approximately $43,000 and amortization of
deferred financing costs and debt discount of approximately $107,000 associated
with the short-term notes and convertible short and long-term notes totaling
approximately $3,500,000 that were executed by the Company in FY2005 and the
first half of FY2006. For the six months ended March 31, 2006, the change
primarily resulted from interest expense of approximately $93,000 and
amortization of deferred financing costs and debt discount of approximately
$259,000 associated with the short-term notes and convertible short and
long-term notes totaling approximately $3,500,000 that were executed by the
Company in FY2005 and the first half of FY2006
For the three months ended March 31, 2006, other expense amounted to
$128,640 compared to other income of $711,321 for the three months ended March
31, 2005. Other expense for the six months ended March 31, 2006 was $7,298
compared to other income of $190,691 for the six months ended March 31, 2005.
The amount for the quarter ended March 31, 2006 reflected a decrease in income
of approximately $840,000 from changes in the fair market value of derivative
securities and warrants. The amount for the six months ended March 31, 2006,
reflected a decrease in income of approximately $198,000 from changes in the
fair market value of derivative securities and warrants.
Discontinued Operations
On December 16, 2003, the Company consummated the sale of the business and
net assets, excluding cash, of its USDTL subsidiary. For the six months ended
March 31, 2006, other income amounted to $120,000 compared to no activity for
the corresponding period of the prior year. The income for the first half of
Fiscal 2006 resulted from the settlement described in Note 3 of the Consolidated
Financial Statements.
Net Loss
Primarily as a result of the factors described above, the Company had a net
loss of $1,034,986 for the three months ended March 31, 2006, as compared to net
loss of $286,175 for the three months ended March 31, 2005. For the six months
ended March 31, 2006, the Company had a net loss of $1,926,915 versus $1,629,065
for the corresponding period of Fiscal 2005. The loss per share was $.25 per
basic and diluted share for the three months ended March 31, 2006 compared to a
loss per share of $.11 per basic and diluted share for the three months ended
March 31, 2005. For the six months ended March 31, 2006, the loss per share was
$.48 per basic and diluted share versus a loss per share of $1.00 per basic and
diluted share for the six months ended March 31, 2005.
Financial Condition and Liquidity
At March 31, 2006, the Company had a stockholders'deficit of $6,250,907 and
cash and cash equivalents of $42,633. Our cash flows from financing activities
provided the primary source of funding during the six months ended March 31,
2006 and the Company will continue to rely on this type of funding until
profitability is reached. The following is a summary of cash flows for the
six-month period ended March 31, 2006:
Sources (use) of cash flows March 31, 2006
--------------------------- --------------
Operating activities $(1,379,759)
Investing activities (85,957)
Financing activities 1,107,986
-------------
Net decrease in cash and equivalents $ (357,730)
=============
Operating Activities. The net loss of $1,926,915 (comprised of
expenses totaling $4,251,451 less revenues and income from
discontinued operations of $2,324,536) was the major use of cash by
operations. When the net loss is adjusted for non-cash expenses such
as depreciation and amortization, amortization of debt discounts,
deferred financing costs, deferred rent and changes in the fair market
value of derivative securities and warrants, the cash needed to
finance the net loss was $1,571,142. Working capital requirements
necessitated the use of $49,967 to increase inventory levels to meet
anticipated demand for our products during the next several months. A
decrease in accounts receivable of $68,697, decreases in prepaid
expenses of $74,164 and an increase in accounts payable and accrued
expenses of $103,497 lessened working capital needs by $246,358. The
addition of $4,858 of other assets and the reduction of $150 in
deferred revenue further increased the operating cash needs.
Investing and Financing Activities. Cash used in investing consisted
of cash paid of $85,957 for additions to property, plant and
equipment. To finance the business, long-term notes (as described
below) were executed and approximated $1,380,000; of which $119,437
was used to repay various short and long-term debt and $155,417 was
used to redeem remaining shares of the Series A redeemable convertible
preferred stock and the accrued dividends for these shares.
At September 30, 2005, the Company had a working capital deficit of
approximately $1.4 million and cash and cash equivalents of $400,363. Cash flows
from financing activities provided the primary source of funding during the year
ended September 30, 2005 and the Company will continue to rely on this type of
funding until profitability is reached. The following is a summary of cash flows
for the year ended September 30, 2005:
September 30,
Sources (use) of cash flows 2005
------------------------------------------------------------
Operating activities $(4,140,888)
Investing activities (76,518)
Financing activities 4,108,893
Net decrease in cash and equivalents $ (108,513)
Operating Activities. The net loss of $2,433,157 (composed of expenses
totaling $8,560,223 less sales and other income of $6,127,066) was the major use
of cash by operations. When the net loss is adjusted for non-cash expenses such
as depreciation and amortization, amortization of debt discounts, deferred
financing costs, deferred rent and income from the changes in the fair market
value of derivative securities and warrants, the cash needed to finance the net
loss was $3,565,328. Working capital requirements necessitated the use of
$259,245 to pay aging accounts payable and reduce accrued expenses, $26,063 to
finance an increase in inventory levels to meet the expected demand for our
products, $142,698 to cover security and other deposits associated with the new
facility lease, $28,910 for prepaid expenses and other current assets and
$176,250 of prepaid revenue that became actual revenue during the year. In
addition, decreases in accounts receivable reduced operating cash needs by
$57,606.
Investing and Financing Activities. Cash of $76,518 was used for additions
to property, plant and equipment. To fulfill the major financing requirements of
the business, the Company through the issuance of notes and convertible notes
and sales of preferred stock, common stock and warrants (as described below),
generated $4,258,911; of which $150,018 was used to repay various short-term
notes payable.
During FY 2006, the Company's cash requirements are expected to include
primarily the funding of operating losses, the payment of outstanding accounts
payable, the repayment of certain notes payable, the funding of operating
capital to grow the Company's drugs of abuse testing products and services, and
the continued funding for the development of its ORALscreen product line.
In September 2005 and the first half of Fiscal 2006, the Company executed
notes payable with AJW Partners, LLC, AJW Offshore, Ltd., AJW Qualified
Partners, LLC and New Millennium Capital Partners II, LLC in the total principal
amount of $2,500,000 which is payable at maturity in September 2008, October
2008 and February 2009. Interest on these notes is 8% and is payable quarterly
in cash or the Company's common stock at the option of the Company. The Company
issued warrants to purchase 100,000 shares of common stock at $12.50 per share
for five years in connection with these notes, which as discussed below were
cancelled and replaced on May 4, 2006. In addition, the entire principal plus
any accrued and unpaid interest associated with these notes is convertible, at
the holder's option, into the Company's common stock at a conversion price of
65% of the average of the three lowest intraday trading prices of the common
stock for the twenty trading days preceding the date that the holders elect to
convert. Fees of approximately $340,000 incurred in connection with securing
these loans were recorded as a deferred financing charge. The collateral pledged
by the Company to secure these notes includes all assets of the Company.
Subsequent to March 31, 2006, the Company received the last installments of
$500,000 of this $3,000,000 long-term convertible note financing. The
outstanding warrants were cancelled on May 4, 2006 and replaced by 3 million
warrants exercisable for 7 years at $1.25 per share.
From April to August 2005, the Company executed convertible notes with an
individual in the total principal amount of $650,000 with interest at 10%. Each
note has a maturity date of six months from the date of the note and is payable
in ten monthly installments plus accrued interest commencing on the maturity
date of the note. The Company issued warrants to purchase 13,000 shares of
common stock at $1.65 to $4.95 per share for three (3) years in connection with
these notes. In addition, the entire principal plus accrued interest associated
with these notes is convertible into the Company's common stock at a conversion
price of the lesser of the closing price of the common stock on the date of the
loan or 85% of the average closing price of the common stock for the five (5)
trading days preceding the notice of conversion. In no event shall the
conversion price be lower than 50% of the closing price of the common stock on
the date of the loan.
In April and June 2005, the Company raised net proceeds of approximately
$1,335,000 from the sale of 1,500,000 shares of Series E Redeemable Convertible
Preferred Stock with a face value of $1,500,000 and Warrants to purchase 3,000
shares of the Company's common stock. The $1,500,000 of Series E Preferred Stock
are convertible into Common Stock at the lesser of $4.00 per share or 80% of the
average of the three lowest closing bid prices for the ten trading days
immediately prior to the notice of conversion, subject to adjustments and
limitations, and the Warrants are exercisable at $4.20 per share for a period of
three years. As of March 31, 2006, 724,351 shares of this preferred stock had
been converted into 735,556 shares of common stock and 775,649 were outstanding.
Upon the occurrence of specific events, the holders of the Series E Redeemable
Convertible Preferred Stock are entitled to redeem these shares under certain
provisions of the agreement covering the purchase of the preferred stock.
In December 2004, the Company sold 1,285 shares of Series A Redeemable
Convertible Preferred Stock and Warrants to purchase 12,000 shares of common
stock for which it received net proceeds of approximately $1,160,000. The Series
A Redeemable Convertible Preferred Stock, with a face value of $1,285,000, is
convertible into common stock at the lesser of $6.00 per share or 85% of the
average of the three lowest closing bid prices, as reported by Bloomberg, for
the ten trading days immediately prior to the notice of conversion subject to
adjustments and floor prices. As of March 31, 2006, 1,135 shares of this
preferred stock had been converted into 452,156 shares of common stock and the
remaining 150 shares of Series A redeemable convertible preferred stock, with a
face value of $150,000, were redeemed by the Company in October 2005 for
$155,417 which included accrued dividends of $5,417.
As security for full and faithful performance of all provisions of the
lease renewal for the facility at Canton, MA, the Company had to furnish to the
landlord an irrevocable letter of credit in the amount of $150,000. The letter
of credit was obtained from a bank that requires the Company to maintain
$150,000 on deposit with the bank as full collateral for the letter of credit.
The cash available at March 31, 2006, the proceeds of $500,000 from the
last installment of the $3,000,000 convertible note financing, and the
anticipated customer receipts are expected to be sufficient to fund the
operations of the Company through June 2006. Beyond that time, the Company will
require significant additional financing from outside sources to fund its
operations. The Company plans to continue working with placement agents and/or
investment fund managers in order to raise additional capital during FY2006 from
the sales of equity and/or debt securities. The investors involved in the
$3,000,000 convertible note financings described above have expressed their
intent to provide an additional $2,000,000 of financing on terms to be
negotiated. The Company plans to use the proceeds from these financings to
provide working capital and capital equipment funding to operate the Company, to
expand the Company's business, to further develop and enhance the ORALscreen
drug screening systems and to pursue the development of in-vitro oral fluid
diagnostic testing products. However, there can be no assurance that these
financings will be achieved. In addition, the Company may consider selling
assets and/or operations, including BJR. However, at the present time, there can
be no assurances that the Company would be successful in these efforts.
The Company has accumulated losses that have reduced shareholders' equity
to a deficit. As a result, as previously reported, the Company received a letter
dated January 30, 2004 from The American Stock Exchange ("AMEX" or the
"Exchange") noting that the Company's 2003 Annual Report on Form 10-KSB
indicates that the Company is not in compliance with all the continued listing
standards of AMEX. In its letter, the Exchange indicated that, in order to
maintain its AMEX listing, the Company must submit a plan that will bring it
into compliance with the continued listing standards within 18 months. The
Company submitted its plan. On March 17, 2004, the Exchange notified the Company
that it had accepted Avitar's plan, which permitted the Company to maintain its
listing on the AMEX. More specifically, the Exchange granted the Company an
extension through July 2005 subject to periodic reviews by the Exchange.
However, the Company did not regain compliance with the continued listing
standards.
On August 10, 2005, Avitar received notice from the Staff of AMEX
indicating that the Staff determined to proceed with the filing of an
application with the Securities and Exchange Commission to strike the common
stock of Avitar from listing and registration on the Exchange. This
determination by the Staff was based upon the failure of the Company to achieve
compliance with the continued listing standards of AMEX.
As indicated in the Staff notice, the Company failed to achieve compliance
with several continued listing standards of AMEX as set forth in the AMEX
Company Guide, specifically, having a deficit of shareholders' equity and losses
from continuing operations and/or net losses in its five most recent fiscal
years resulting in non-compliance with Sections 1003(a)(i-iii); losses that were
so substantial in relation to its overall operations or its existing financial
resources resulting in the opinion of the Exchange to be in non-compliance with
Section 1003(a)(iv); and finally its low selling price per share resulting in
non-compliance with Section 1003(f)(v). Consequently, the Company's common stock
was officially delisted by the AMEX on August 29, 2005.
Required payments for debt and minimum rentals as of September 30, 2005
were as follows:
- ---------------------------------------------------------------------------
Fiscal Operating Short- Long-
Year Leases Term Debt(1) Term Debt(2) Total
- ---------------------------------------------------------------------------
2006 $304,531 $918,945 $ - $1,223,476
2007 312,656 - - 312,656
2008 330,781 - 1,000,000 1,330,781
2009 348,906 - - 348,906
2010 271,875 - - 271,875
- -------------------------------------------------------------------------------
Total minimum $1,568,749 $918,945 $1,000,000 $3,487,694
payments
(1) Does not include interest which ranges from 7-12% per annum (See Note 8 to
Consolidated Financial Statements).
(2) Does not include interest of 8% per annum, payable quarterly (See Note 9 to
Consolidated Financial Statements).
Operating revenues are expected to grow during Fiscal 2006 as an increasing
number of employers in the United States and overseas convert to using
ORALscreen, Avitar's oral fluid drug testing products. In order to achieve the
revenue growth, the Company will need to increase its direct sales force and
implement an expanded, targeted marketing program. ORALscreen, as an instant
on-site diagnostic test, is part of the fastest growing segment of the
diagnostic test market. Inventories are currently at appropriate levels for
anticipated sales volumes and the Company, with its production capacity and the
arrangements with its current contract manufacturing sources, expects to be able
to maintain inventories at optimal levels. Based on current sales, expense and
cash flow projections, the Company believes that the current level of cash and
cash-equivalents on hand and, most importantly, a portion of the anticipated net
proceeds from the financing mentioned above would be sufficient to fund
operations until the Company achieves profitability. There can be no assurance
that the Company will consummate the above-mentioned financing, or that any or
all of the net proceeds sought thereby will be obtained. Furthermore, there can
be no assurance that the Company will have sufficient resources to achieve the
anticipated growth. Once the Company achieves profitability, the longer-term
cash requirements of the Company to fund operating activities, purchase capital
equipment, expand the existing business and develop new products are expected to
be met by the anticipated cash flow from operations and proceeds from the
financings described above. However, because there can be no assurances that
sales will materialize as forecasted, management will continue to closely
monitor and attempt to control costs at the Company and will continue to
actively seek the needed additional capital.
As a result of the Company's recurring losses from operations and working
capital deficit, the report of its independent registered public accounting firm
relating to the financial statements for Fiscal 2005 contains an explanatory
paragraph expressing substantial doubt about the Company's ability to continue
as a going concern. Such report states that the ultimate outcome of this matter
could not be determined as of the date of such report (January 20, 2006). The
Company's plans to address the situation are presented above. However, there are
no assurances that these endeavors will be successful or sufficient.
Recent Accounting Pronouncements
In December 2004, the FASB issued SFAS No.123R, "Share-Based Payment"
("SFAS 123R"), which replaces SFAS 123, "Accounting for Stock-Based
Compensation," and supersedes APB Opinion no. 25, "Accounting for Stock Issued
to Employees." SFAS 123R requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the financial
statements based on their fair values. The effective date for entities that file
as small business issuers is as of the beginning of the first reporting period
of the registrant's fiscal year that begins on or after December 15, 2005.
Therefore, under the current rules, the Company will be required to adopt SFAS
123R in the first quarter of fiscal 2007.
Under SFAS 123R, pro forma disclosures previously permitted will no longer
be an alternative to financial statement recognition. The Company must determine
the appropriate fair value model to be used for valuing share-based payments to
employees, the amortization method for compensation cost and the transition
method to be used at the date of adoption. The transition methods include
modified prospective and retrospective adoption options. Additionally, SFAS 123R
clarifies the timing for recognizing compensation expense for awards subject to
acceleration of vesting on retirement and also specifies the treatment of excess
tax benefits associated with stock compensation.
In March 2005, the SEC issued Staff Accounting Bulletin No. 107 ("SAB 107")
regarding the SEC's interpretation of SFAS 123R and the valuation of share-based
payments for public companies. Avitar is evaluating the requirements of SFAS
123R and SAB 107 and expects that the adoption of SFAS 123R will have a material
impact on Avitar's consolidated results of operations and earnings per share.
The Company has not yet determined the method of adoption or the effect of
adopting SFAS 123R, and it has not determined whether the adoption will result
in amounts that are similar to the current pro forma disclosures under SFAS 123.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs" ("SFAS
151"), an amendment of Accounting Research Bulletin ("ARB") No. 43, Chapter 4,
"Inventory Pricing". SFAS 151 amends previous guidance regarding treatment of
abnormal amounts of idle facility expense, freight, handling costs, and
spoilage. This statement requires that those items be recognized as current
period charges regardless of whether they meet the criterion of "so abnormal"
which was the criterion specified in ARB No. 43. In addition, this Statement
requires that allocation of fixed production overheads to the cost of the
production be based on normal capacity of the production facilities. This
pronouncement was effective for the Company beginning October 1, 2005. The
adoption of SFAS 151 by the Company did not have a material impact on its
consolidated results of operations and financial condition.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections" ("SFAS 154") which replaces APB Opinions No. 20 "Accounting
Changes" and SFAS No. 3, "Reporting Accounting Changes in Interim Financial
Statements An Amendment of APB Opinion No. 28". SFAS 154 provides guidance on
the accounting for and reporting of accounting changes and error corrections. It
establishes retrospective application, or the latest practicable date, as the
required method for reporting a change in accounting principle and the reporting
of a correction of an error. SFAS 154 is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005 and
is required to be adopted by Avitar in the first quarter of fiscal 2007. The
Company is currently evaluating the effect that the adoption of SFAS 154 will
have on its consolidated results of operations and financial condition, but does
not expect it will have a material impact.
Critical Accounting Policies
The Company's significant accounting policies are listed in Note 2 to the
consolidated financial statements for the year ended September 30, 2005.
However, certain of its accounting policies require the application of
significant judgment by its management, and such judgments are reflected in the
amounts reported in the consolidated financial statements. The Company considers
its accounting policies with respect to revenue recognition, use of estimates,
long-lived assets and goodwill as the most critical to its results of operations
and financial condition.
Revenue Recognition
The Company recognizes revenue from product sales upon shipment and
delivery with delivery being made F.O.B. to the carrier. Revenues from the sales
of services are recognized in the period the services are provided. These
revenues are recognized provided that a purchase order has been received or a
contract has been executed, there are no uncertainties regarding customer
acceptance, the sales price is fixed or determinable and collection is deemed
probable. If uncertainties regarding customer acceptance exist, the Company
recognizes revenue when those uncertainties are resolved. Amounts collected or
billed prior to satisfying the above revenue recognition criteria are recorded
as deferred revenue.
The Company does not offer its customers or distributors the right to
return product once it has been delivered in accordance with the terms of sale.
Product returns, which must be authorized by the Company, occur mainly under the
warranties associated with the product. The Company maintains sufficient
reserves for warranty costs. Price discounts for products are reflected in the
amount billed to the customer at the time of delivery. Rebates and payments have
not been material and are adequately covered by established allowances.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make 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, and reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Long-Lived Assets and Goodwill
The Company evaluates its long-lived assets under the provisions of SFAS
No. 144, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of." SFAS No. 144 establishes accounting standards for the
impairment of long-lived assets and certain identifiable intangibles to be held
and used and for long-lived assets, and certain identifiable intangibles to be
disposed of.
The Company evaluates Goodwill in accordance with provisions of SFAS No.
142. SFAS No. 142 requires among other things, that companies no longer amortize
goodwill, but test goodwill for impairment at least annually. In addition, SFAS
142 requires that the Company identify reporting units for the purpose of
assessing potential future impairments of goodwill, reassess the useful lives of
other existing recognized intangible assets, and cease amortization of
intangible assets with an indefinite useful life. An intangible asset with an
indefinite useful life should be tested for impairment in accordance with
guidelines in SFAS 142. SFAS 142 is required to be applied to all goodwill and
other intangible assets regardless of when those assets were initially
recognized.
In assessing the recoverability of its long-lived assets and goodwill,
Avitar must make assumptions in determining the fair value of the asset by
estimating future cash flows and considering other factors, including
significant changes in the manner or use of the assets, or negative industry
reports or economic conditions. If those estimates or their related assumptions
change in the future, the Company may be required to record impairment charges
for those assets.
As of September 30, 2005, the Company had a net carrying amount of goodwill
of approximately $138,000 (see Note 6 in the Notes to the Consolidated Financial
Statements).
Valuation of Derivative Securities
The Company accounts for the value of warrants issued and conversion and
put features granted to investors as part of the private placement of securities
or debt in accordance with the provisions of EITF Issue No. 00-19. Under ETIF
No. 00-19, the amount of the liability (Note 1 of the Consolidated Financial
Statements) is calculated on the date of sale or issuance of the securities or
debt based on a valuation utilizing a market value approach. This approach
determines the fair value of the securities sold by the Company by using one or
more methods that compare these securities to similar securities that have been
sold. The liability is marked-to-market adjusted to fair value at the end of
each quarter and the change recorded to other income (expense).
See "Forward-Looking Statements" on page 10 above.
BUSINESS
Introduction
Avitar, Inc. (the "Company" or "Avitar"), through its wholly-owned
subsidiary Avitar Technologies, Inc. ("ATI"), develops, manufactures, markets
and sells diagnostic point of contact tests and customized proprietary
hydrophilic polyurethane foam applications for medical, diagnostics, dental and
consumer use. During the fiscal year ended September 30, 2005 ("Fiscal 2005"),
the Company continued the development and marketing of innovative point of care
oral fluid drugs of abuse tests, which use the Company's foam as the means for
collecting the oral fluid sample. Through its wholly-owned subsidiary, BJR
Security, Inc. (`BJR"), the Company provides specialized contraband detection
and education services.
During the audit for Fiscal 2005, the Company was advised by its
independent registered public accounting firm that the method used to account
for sales of certain convertible preferred stock and convertible notes and the
issuance of warrants was not in accordance with the requirements of Emerging
Issues Task Force ("EITF") Issue No. 00-19. As a result, management determined
that certain previously issued financial statements were materially misstated.
The statements of stockholders' deficit as of September 30, 2003 and 2004 and
for the year ended September 30, 2004 and the statement of operations for the
year ended September 30, 2004 included in this Prospectus have been restated to
correct this error in accounting for the issuance of various securities and the
derivative features embedded therein. The effects of these restatements are
described in Note 1 of the Consolidated Financial Statements. The Company also
filed a report on Form 8-K describing the need to restate the financial
statements included in the reports on Form 10-QSB filed for the quarters ended
December 31, 2004, March 31, 2005 and June 30, 2005, which were filed on Forms
10-QSB/A on Ferbruary 10, 2006.
On December 16, 2003, the Company sold the business and net assets,
excluding cash, of its wholly owned-subsidiary, United States Drug Testing
Laboratories, Inc. ("USDTL"), which operated a certified laboratory and provided
specialized drug testing services primarily utilizing hair and meconium as the
samples. Therefore, USDTL is considered a discontinued operation and this report
reflects the continued operations of the Company.
Products
Currently, the Company offers the following products, which utilize its
proprietary medical polyurethane foam technology:
Diagnostic Test Products and Drug Detection Services
The Company makes products and offers services for the diagnostic test
applications and contraband detection needs described below. These products
accounted for approximately 53% of the Company's revenue in Fiscal 2005 and
approximately 57% of the Company's revenue in Fiscal 2004.
Drugs of Abuse Point of Collection Tests . The Company's ORALscreen (R) and
ORALscreen DRUGOMETER(TM) are oral fluid-based, rapid on-site assay systems for
detecting drugs of abuse such as opiates (including heroin, morphine, codeine
and synthetic opiates like Oxycocone-Oxycontin(R), Percoset(R),
Hydrocodone-Vicodin(R) and others), cocaine (including crack), marijuana and
methamphetamines (including Meth, Ecstasy and others). These tests are performed
on-site and yield accurate results in a 5-15 minute period of time. In addition,
Avitar offers ORALconfirm(TM), an oral fluid laboratory test to confirm the
results of ORALscreen tests, and ORALscreen OSR(TM), an instrument that
automates the reading, recording, reporting and transmitting of results for the
ORALscreen tests. The National Institute of Drug Abuse has reported that 10% of
workers in the United States abuse drugs, resulting in an annual cost in excess
of $110 billion to employers. Currently, approximately $1.5 billion annually is
spent in the United States for drugs of abuse tests, the majority of which are
for pre-employment testing. Significant advantages exist for saliva to replace
urine in many of the drug tests and at the same time, to expand the market where
current infrastructure cost limitations prohibit the use of these much needed
drug tests. Use of the ORALscreen products will provide employers with the
ability to implement a random testing program that has been proven to be a more
effective tool for deterring the use of drugs by employees in the workplace. The
primary customers for these products are employers, schools, and military
services.
Contraband Detection Services. The Company's highly trained dogs detect the
presence of contraband items in a variety of settings including schools, cruise
ships, warehouses and other commercial entities. Each dog is task specific,
alerting on only one odor (narcotics, explosives or firearms).
Foam Disposable Products
The Company produces medical-grade hydrophilic polyurethane foam
disposables fabricated for the applications described below. These products
accounted for approximately 47% of the Company's revenue in Fiscal 2005 and
approximately 43% of the Company's revenue in Fiscal 2004.
Wound Dressings. Avitar's Hydrasorb(R) ("Hydrasorb") wound dressing product
is a highly absorbent topical dressing for moderate to heavy exudating wounds.
These dressings have a unique construction that provide a moist wound healing
environment which promotes skin growth and closure. The Hydrasorb product is
marketed internationally by the Tyco Healthcare , by Abbott Laboratories, Ltd.
and other specialty distributors worldwide. In addition to the Hydrasorb line,
the Company has custom developed specialty wound dressings for the cardiac
catheter lab market as well as the orthopedic market.
Custom Foam Products. The Company continues to have applications for its
proprietary technologies in a variety of other medical/consumer markets. They
include the Illizarov Dressing used for dressing external bone fixators in
orthopedic procedures and a molded dental applicator for a consumer teeth
bleaching system and a device used by astronauts for relieving ear pressure
while in a pressurized space suit. Customers for these products include Smith
and Nephew, CCA Industries and NASA.
Development
The Company employs a product strategy that is based on its expertise in
research and development with oral fluid diagnostics, and when appropriate,
forming partnerships with market leading companies and recognized persons or
entities in diagnostic testing and foam products application areas. With this
approach, proprietary products are either developed with internal sources or
co-developed through the generation and development of product ideas either
internally or through these strategic partnerships. To any such partnership,
Avitar contributes the proprietary foam technology, the oral fluid processing
expertise, the product design, development and prototyping, and the start-up and
commercial-scale manufacturing. The ability of the Company to keep current on
technology and purchase new equipment in connection with development of new,
improved products will be affected by its existing and future need for, and the
availability of, financing.
Products go through several stages of development. After each stage, the
Company will conduct studies to determine the effectiveness of each product.
Once a product is developed and the Company determines it may be commercially
viable, Avitar will obtain governmental approvals, if necessary, prior to
marketing the product. See "Government Regulation." There can be no assurance,
however, that such approvals will actually be obtained. The Company intends to
conduct marketing trials with any new product to determine the effectiveness of
the product. If such marketing trials prove to be successful and after the
product is ready for marketing, Avitar will begin selling the product. See
"Sales and Marketing" below.
Sales and Marketing
To sell its ORALscreen products, the Company relies on its direct sales
force, its strategic partners and a network of distributors that currently sell
to the drugs of abuse testing market. The Company intends to expand its sales
and marketing staff from its current level of fourteen (14) full-time employees
to at least twenty (20) full-time employees and to continue to explore strategic
partnering arrangements with companies that have established distribution
channels such as significant diagnostic test and health care product companies
and employee related service organizations. Avitar anticipates that such
arrangements may involve the grant by Avitar of the exclusive or semi-exclusive
rights to sell specific products to specified market segments and/or in
particular geographic territories in exchange for a royalty, joint venture or
other financial interest. The Company generally has sold, and intends to
continue to sell, its wound dressing and custom foam products through large,
recognized distributors of dental and medical products and does not anticipate
that a large direct sales force will be required for these products. If the
Company is unable to establish satisfactory product distribution arrangements in
the manner described above, it will be required to devote substantial resources
to the expansion of its direct sales force. There can be no assurance that
Avitar would have the resources required for such an endeavor.
To introduce its products to direct customers and targeted distributors,
the Company participates in trade shows, and conducts webinars and e-briefings.
Avitar also conducts user trials to support the marketing efforts of its
distribution partners. The Company believes that these arrangements will be more
effective in promoting and distributing its products in view of Avitar's limited
resources and the extensive marketing networks of such distributors.
The Company's most significant distribution arrangements are summarized as
follows:
Drugs of AbuseTest. In January 2001, Avitar entered into a strategic
partnership agreement with the Pinkerton Services Group ("PSG") of the Pinkerton
Corporation whereby Avitar granted PSG the right to distribute the Company's
ORALscreen product line and PSG granted Avitar the right to sell PSG's third
party administration services to Avitar customers. Under this arrangement, PSG
is required to offer only Avitar's ORALscreen as its oral fluid drug testing
products. In July 2001, this agreement with PSG was assigned to ChoicePoint,
Inc. ("ChoicePoint") upon the completion of its acquisition of PSG. ChoicePoint
is one of the largest third party administrators of employer drug testing
programs in the United States.
In October 2001, the Company entered into an agreement with Quest
Diagnostics, Inc. ("Quest"). Under this agreement, Avitar granted Quest the
right to distribute the Company's ORALscreen product line.
Wound Dressings. In December 1999, the Company entered into a Supply
Agreement with the Kendall Company ("Kendall"), now owned by Tyco Healthcare,
for the distribution of its Hydrasorb products in the United States beginning
January 1, 2000. In August 2000, the Company amended this Supply Agreement to
permit Kendall to distribute the Hydrasorb products internationally.
Since November 1993, the Company has maintained a distribution agreement
with Knoll Pharma (the "Knoll Agreement") pursuant to which Knoll, now owned by
Abbott Laboratories, Ltd., was granted the right to distribute Hydrasorb
products throughout Canada. The Knoll Agreement provides that Hydrasorb products
are to be sold at agreed upon prices (subject to annual inflation adjustments)
and that certain minimum quantities are maintained.
Custom Foam Products. Custom medical foam products (including the Illizarov
dressing and certain nasal and sinus products) are marketed and distributed (in
the United States and abroad) primarily by Smith & Nephew on a non-exclusive
basis pursuant to an oral agreement.
Manufacturing and Supply
The Company's only manufacturing facility is located in Canton,
Massachusetts and as of September 30, 2005, comprises approximately 37,000
square feet, of which 10,000 square feet are currently being used for
administrative and office space and 27,000 square feet are being used for
product manufacturing and warehousing.
Given the use of certain products in the diagnostic tests, medical and
dental markets, the Company is required to conform to the Food and Drug
Administration ("FDA") Good Manufacturing Practice regulations, International
Standard Organization ("ISO") rules and various other statutory and regulatory
requirements applicable to the manufacture and sale of medical devices. Avitar
is subject to inspections by the FDA at all times. See "Government Regulation".
The Company does not have written agreements with most of its suppliers of
raw materials and laboratory supplies. While the Company purchases some product
components from single sources, most of the supplies used can be obtained from
more than one source. Avitar acquires the same key component for its customized
foam products and Hydrasorb wound dressings from a single supplier. The Company
also purchases a main component of its ORALscreen products from one source.
Avitar's current suppliers of such key components are the only vendors which
presently meet Avitar's specifications for such components. The loss of these
suppliers would, at a minimum, require the Company to locate other satisfactory
vendors, which would result in a period of time during which manufacturing and
sales of products utilizing such components may be suspended and could have a
material adverse effect on Avitar's financial condition and operations. Avitar
believes that alternative sources could be found for such key components and
expects that the cost of such components from an alternative source would be
similar. The Company also believes that alternative sources of supply are
available for its remaining product components and that the loss of any such
supplier would not have a material adverse effect upon Avitar's business.
Government Regulation
Avitar and many of its products are subject to regulation by the FDA and
the corresponding agencies of the states and foreign countries in which the
Company sells its products. Accordingly, the Company is required to comply with
the FDA's Current Good Manufacturing Practice (CGMP) requirements for medical
devices, ISO rules and similar other state and foreign country requirements
governing the manufacture, marketing, distribution, labeling, registration,
notification, clearance and/or pre-market approval of drugs, medical and dental
devices and cosmetics, as well as record keeping and reporting requirements
applicable to such products. Specifically, the CGMP requirements govern the
methods used in, and the facilities and controls used for, the design,
manufacture, packaging, labeling, storage, installation and servicing of all
finished medical devices intended for human use. These requirements are intended
to ensure that the finished devices will be safe and effective and otherwise in
compliance with the Federal Food, Drug and Cosmetic Act. Avitar's wound dressing
products have been classified as Class I devices for these regulations. The
Company believes that it is in compliance with all such requirements. In
addition, the Company is subject to inspections by the FDA at all times, and may
be subject to inspections by state and foreign agencies. If the FDA believes
that its legal requirements have not been fulfilled, it has extensive
enforcement powers, including the ability to initiate action to physically seize
products or to enjoin their manufacture and distribution, to require recalls of
certain types of products, and to impose or seek to impose civil or criminal
sanctions against individuals or companies violating applicable statutes.
In addition, there can be no assurance that the FDA or the U.S. Federal
Government will not enact further changes in the current rules and regulations
with respect to products, which Avitar already markets or may plan to market in
the future. If Avitar is unable to demonstrate compliance with such new or
modified requirements, sales of affected products may be significantly limited
or prohibited until and unless such requirements are met.
The laboratory and contraband detection services offered by the Company are
subject to licensing requirements of the states in which these services are
provided.
Competition
The Company believes that the principal competitive factors in Avitar's
markets are innovative product design, product quality, established strategic
customer relationships, name recognition, distribution and price. At least
twenty (20) companies of all sizes, including major diagnostic test, dental and
health care companies, are engaged in activities similar to those of Avitar.
Most of Avitar's competitors have substantially greater financial, marketing,
administrative and other resources and larger research and development staffs.
Although Avitar may not have the development resources of many of its
competitors, the Company believes its product design and development experience
allows it to compete favorably in providing innovative products and services in
Avitar's markets. Of the approximately five (5) instant oral fluid based drugs
of abuse testing products currently being offered, Avitar's ORALscreen
represents one of the most comprehensive, state-of-the-art test for drugs of
abuse currently being provided. Furthermore, the Company believes that its
Hydrasorb wound dressings, and custom foam products possess qualities with
significant advantages over competing products, including cost effectiveness. In
addition to the Company's national sales force, ChoicePoint, Quest and many
smaller, local companies are marketing and distributing the Company's ORALscreen
products. Tyco, Abbott and mediBayreuth ("Medi") are distributing the Company's
Hydrasorb wound dressings. See "Products", "Sales and Marketing".
In addition, colleges, universities, governmental agencies and other public
and private research organizations will continue to conduct research and are
becoming more active in seeking patent protection and licensing arrangements to
collect royalties for use of technology that they have developed, some of which
may be directly competitive with that of Avitar. In addition, these institutions
compete with companies such as Avitar in recruiting highly qualified scientific
personnel.
The Company believes that its product markets are highly fragmented with
many different companies competing with regard to a specific product or product
category. As a result, Avitar's competition varies from product to product.
Avitar's primary competitors in the wound dressing market include Bristol Meyers
Squibb, Johnson & Johnson, Smith and Nephew, 3M and Acme United. In the drugs of
abuse test market, the largest competitors are Varian Instruments, American
BioMedica Corp., OraSure Technologies, Inc. and Cozart Bioscience Ltd.
Intellectual Property
Trade secrets, proprietary information and know-how are important to the
Company's scientific and commercial success. Avitar currently relies on a
combination of patents, trade secrets, trademark law and non-disclosure
agreements to establish and protect its proprietary rights in its products.
Avitar currently holds numerous United States patents, has applications pending
for additional patents and has licenses to use certain patents. In addition, the
Company has certain registered and other trademarks.
The Company believes that its products, trademarks and other proprietary
rights do not infringe upon the proprietary rights of third parties.
Product Liability; Insurance Coverage
The testing, marketing and sales of diagnostic test, medical and dental
products and services entail a high risk of product liability and professional
liability claims by consumers and others. Claims may be asserted against the
Company by end-users of any of Avitar's products. As of September 30, 2005, the
Company had product liability insurance coverage in the amount of $7,000,000. No
claims had been asserted against this coverage. This insurance will not cover
liabilities caused by events occurring prior to the time such policy was
purchased by the Company or liabilities caused by events occurring after such
policy is terminated or for claims made after 60 days following termination of
the policy. Further, certain distributors of diagnostic test, medical and dental
products require minimum product liability insurance coverage as a condition
precedent to purchasing or accepting products for distribution.
Employees
At September 30, 2005, the Company had 67 full-time employees, including 4
in research and development, 42 in manufacturing, supply, and direct service
operations, 14 in sales and marketing and 7 in administration. None of the
employees is subject to a collective bargaining agreement. The Company believes
its relationship with its employees to be satisfactory.
DESCRIPTION OF PROPERTY
The Company leases approximately 40,000 square feet of space that includes
37,000 square feet in Canton, Massachusetts for its manufacturing facility and
administrative offices until June 2010 and approximately 3,000 square feet in
Gainesville, Texas for the contraband detection service operation of BJR until
February 2006. The current annual rent is approximately $305,000 for the Canton
facility (excluding assessment for operating expenses) and $24,000 for the
Gainesville facility. All facilities are in satisfactory condition for their
purposes.
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Company and their respective ages
and positions with the Company, as of September 30, 2005, along with certain
biographical information (based solely on information supplied by them), are as
follows:
Name Age Title
- ---- --- -----
Peter P. Phildius 75 Chairman of the Board and Chief Executive
Officer/Director
Douglas W. Scott 59 President and Chief Operating Officer/
Director
Jay C. Leatherman Jr. 61 Vice President, Chief Financial Officer
and Secretary
Richard Anderson 54 Vice President of Research and Development
Peter Cholakis 50 Vice President of Marketing
James Groth (1)(2) 66 Director
Neil R. Gordon (1)(2) 57 Director
Charles R. McCarthy (1)(2) 66 Director
- --------------------------------------------------------------------------------
1.Member of Audit Committee.
2.Member of Compensation Committee.
PETER P. PHILDIUS
Mr. Phildius has been Chairman of the Company's Board of Directors since
October 1990 and Chief Executive Officer since July 1996. He has been a general
partner in Phildius, Kenyon & Scott ("PK&S") since the firm's founding in 1985.
Prior to 1985, Mr. Phildius was an independent consultant and Chairman and
co-founder of Nutritional Management, Inc., a company that operates weight loss
clinics (1983 - 1985), President and Chief Operating Officer of Delmed, Inc., a
medical products company (1982 - 1983), President and Chief Operating Officer of
National Medical Care, Inc., a dialysis and medical products company (1979 -
1981), and held a variety of senior management positions with Baxter
Laboratories Inc. ("Baxter"), a hospital supply company and the predecessor of
Baxter Healthcare Corporation. During the last eight years of his 18 year career
at Baxter (1961 - 1979), Mr. Phildius was Group Vice President and President of
the Parenteral Division, President of the Artificial Organs Division and
President of the Fenwal Division.
DOUGLAS W. SCOTT
Mr. Scott has been the Chief Operating Officer since July 1996, was the
Chief Executive Officer from August 1989 until July 1996 and has been a director
of the Company since August 1989. Mr. Scott has been a general partner in PK&S
since its founding in 1985. Prior to 1985, Mr. Scott was Executive Vice
President of Nutritional Management, Inc. (1983 - 1985); Senior Vice President,
Operations of Delmed, Inc. (1982 - 1983); Vice President, Quality Assurance of
Frito-Lay, Inc., a consumer products company (1980 - 1982); and held several
senior positions at Baxter from 1970 - 1980. The last two of these senior
positions at Baxter were General Manager of the Vicra Division and General
Manager of Irish Operations. Mr. Scott is also a director of Candela
Corporation, a publicly-traded company in the business of manufacturing and
marketing medical lasers. Mr. Scott received an M.B.A. from Harvard Business
School.
JAY C. LEATHERMAN, JR.
Mr. Leatherman has served as the Company's Chief Financial Officer since
October 1992 and its Secretary since July 1994. He has over 20 years experience
in financial management in the health care field. Mr. Leatherman served as Vice
President and Chief Financial Officer of 3030 Park, Inc. and 3030 Park
Management Company from 1985 to 1992, responsible for financial, management
information services and business development functions for this continuing care
retirement complex and management services and consulting company. He served as
Director of Finance and Business Services for the Visiting Nurses Association of
New Haven, Inc. from 1977 to 1985. In addition, he served in a variety of
accounting and financial positions with Westinghouse Electric Corporation from
1969 to 1977. Mr. Leatherman has a Bachelor's Degree in Business Administration
from the University of Hawaii.
RICHARD ANDERSON
Dr. Anderson has served as the Company's Vice President of Research and
Development since June 2004. He has over 20 years of experience in product
development and corporate management in the medical diagnostics and life
sciences industries. He has held technology management positions with Genicon
Sciences, Nanogen, Inc. (NGEN-NASDAQ) as vice president of product development
and, was a co-founder of Biosite Incorporated (BSTE-NASDAQ), a leading supplier
of urine-based rapid drugs-of-abuse tests for the clinical diagnostics market.
He has also held research and development positions with Hybritech (acquired by
Eli Lilly & Company [LLY-NYSE]) and Miles Laboratories.
PETER CHOLAKIS
Mr. Cholakis has served as the Company's Vice President of Marketing since
February 2004. He has over 20 years of senior marketing experience and is
leading Avitar's marketing campaign in penetrating the $1.5 billion
drugs-of-abuse market with its point-of-care oral fluid drugs-of-abuse test,
ORALscreen(R) Before joining Avitar, Mr. Cholakis worked for VFA, a Boston-based
enterprise software and services firm as vice president of marketing. Prior to
that, he held key marketing and sales positions in the high technology product
and consultative service markets.
JAMES GROTH
Mr. Groth has served as a director of the Company since January 1990. Mr.
Groth has been President of Mountainside Corporation, a provider of corporate
sponsored functions, for over the past 15 years.
NEIL R. GORDON
Mr. Gordon has served as a director since June 1997. He has been President
of N.R. Gordon & Company, Inc., a company that provides a broad range of
financial consulting services, since 1995. From 1981 to 1995, he was associated
with Ekco Group, Inc. and served as its Treasurer from 1987 to 1995. Mr. Gordon
has also served as Director of Financing and Accounting for Empire of Carolina,
Inc. He received a Bachelor of Science Degree from Pennsylvania State
University. Mr. Gordon is also a director of Datameg Corporation, a
publicly-traded company focused on supplying products and related services that
support critical network performance requirements in the voice, data and video
communications industry.
CHARLES R. MCCARTHY, JR.
Mr. McCarthy has served as a director since February 1999. He has been
counsel in the Washington D.C. law firm, O'Connor & Hannan, since 1993. He is
currently a director of Interactive Technology.Com, Limited. Previously, Mr.
McCarthy was General Counsel to the National Association of Corporate Directors,
served as a trial attorney with the Securities and Exchange Commission, was Blue
Sky Securities Commissioner for the District of Columbia and was a law professor
teaching securities law topics and served as a Board member of and counsel to a
number of public companies over the last 30 years.
Section 16(a) Beneficial Ownership Reporting Compliance.
Section 16(a) of the Securities Exchange Act ("SEC") of 1934 requires the
Company's officers and directors, and persons who own more than ten percent of a
registered class of the Company's equity securities to file reports of ownership
and changes in ownership with the Securities and Exchange Commission. Officers,
directors and greater than ten-percent shareholders are required by SEC
regulation to furnish the Company with copies of all Section 16(a) forms they
file.
Based on its review of the copies of such forms received by it, the Company
believes that, during Fiscal 2005, all filing requirements applicable to its
officers, directors and greater than ten-percent shareholders were met.
Code of Ethics
Avitar has historically operated under informal ethical guidelines, under
which the Company's principal executive, financial and accounting officers, are
held accountable. In accordance with these guidelines, the Company has always
promoted honest, ethical and lawful conduct throughout the organization. The
Company adopted a written code of ethics as of June 2004.
EXECUTIVE COMPENSATION
The information in this section concerning compensation options and their
related exercise prices are pre-reverse stock split.
Summary Compensation Table. The following table sets forth compensation earned
by or paid to the Chief Executive Officer, Chief Operating Officer and other
executive officers for Fiscal 2005 and, to the extent required by applicable
Commission rules, the preceding two fiscal years.
Annual Compensation Long-Term
Name/Position Year Salary(1) Bonus Compensation Options
Peter P. Phildius 2005 $200,000 $0 453,600(2)
(Chairman of the Board/ 2004 $200,000 $0 0
Chief Executive Officer) 2003(4) $171,661 $0 0
Douglas W. Scott 2005 $180,000 $0 237,600(2)
(President/ 2004 $180,000 $0 0
Chief Operating Officer) 2003(4) $154,500 $0 0
Jay C. Leatherman, Jr. 2005 $140,000 $0 157,500(2)
(Chief Financial Officer) 2004 $140,000 $0 0
2003(4) $120,616 $0 0
Douglas Lewis 2005(3) $ - $0 0
(Vice President/President 2004(3) $ - $0 0
of USDTL) 2003 $126,000 $0 0
Richard Anderson 2005 $140,000 $0 0
(Vice President of Research 2004(5) $ - $0 400,000(6)
& Development) 2003 $ - $0 0
Peter Cholakis 2005 $143,747 $0 0
(Vice President of 2004(5) $ - $0 400,000(7)
Marketing) 2003 $ - $0 0
David Greaves 2005 $184,130 $0 0
(Vice President of Sales) 2004(5) $ - $0 400,000(6)
2003 $ - $0 0
(1) Does not include amounts reimbursed for business-related expenses incurred
by the executive officers on behalf of the Company.
(2) Reflects additional stock options granted to executive officers by the
Company's Board of Directors in October 2004.
(3) Resigned on December 1, 2003 as part of the sale of USDTL and therefore did
not have any compensation in Fiscal 2005 and had compensation less than
$100,000 in Fiscal 2004.
(4) Reflects temporary salary reductions in effect during Fiscal 2003.
(5) Compensation was less than $100,000.
(6) Reflects stock options granted to executive officers by the Company's Board
of Directors in June 2004.
(7) Reflects stock options granted to executive officers by the Company's Board
of Directors in February 2004.
Stock Option Grants in Last Fiscal Year. Stock options were granted to
the following executive officers during Fiscal 2005:
% of Total
Options
Options Granted In Exercise Expiration
Name Granted Fiscal Year Price Date
- ---------------------- -------- ----------- --------- -----------
Peter Phildius 453,600 19.6% $0.07 10/04/2014
Douglas Scott 237,600 10.3% $0.07 10/04/2014
Jay Leatherman 157,500 6.8% $0.07 10/04/2014
Option Exercises in Last Fiscal Year and Year-Ended Option Values. No stock
options or stock appreciation rights were exercised by the executive officers in
Fiscal 2005.
As of September 30, 2005, the executive officers held options as follows,
none of which are in the money:
Options Value of Options
Total Options Exercisable Exercisable Not Exercisable
Peter Phildius 2,382,200 1,197,200 $ 0 $ 0
Douglas Scott 1,385,600 765,230 0 0
Jay Leatherman 806,250 392,500 0 0
Richard Anderson 400,000 80,000 0 0
Peter Cholakis 400,000 80,000 0 0
David Greaves 400,000 80,000 0 0
Employment Agreements. Messrs. Phildius and Scott are covered by Employment
Agreements (the "Employment Agreements") which commenced on May 19, 1995.
Pursuant to the Employment Agreements, if Messrs. Phildius and/or Scott are
terminated without "Cause" (as such term is defined in the Employment
Agreements) by the Company or if Messrs. Phildius and/or Scott terminate their
employment as a result of a breach by the Company of its obligations under such
Agreements, he will be entitled to receive his annual base salary ($200,000 for
Mr. Phildius and $180,000 for Mr. Scott) for a period of up to 18 months
following such termination. In addition, if there is a "Change of Control" of
the Company (as such term is defined in the Employment Agreements) and, within
two years following such "Change of Control", either of Messrs. Phildius or
Scott is terminated without cause by the Company or terminates his employment as
a result of a breach by the Company, such executive will be entitled to certain
payments and benefits, including the payment, in a lump sum, of an amount equal
to up to two times the sum of (i) the executive's annual base salary and (ii)
the executive's most recent annual bonus (if any). In addition, pursuant to the
Employment Agreements, which have a three-year term (subject to extension),
Messrs. Phildius and Scott are each entitled to annual bonus payments of up to
$150,000 if the Company achieves certain levels of pre-tax income (as such term
is defined in such Agreements) or alternative net income objectives established
by the Board of Directors.
In July 1999, the Company entered into employment agreements with two
executives of USDTL. The agreements provide for annual compensation aggregating
$226,000 per year, plus cost-of-living increases and bonuses or commissions, as
defined. The agreements terminated on December 1, 2003. Expenses under these
agreements totaled approximately $0 and $40,800 in 2005 and 2004, respectively.
Director Compensation. During Fiscal 2005 in accordance with a plan
approved by the Company on September 25, 2001, the Company compensated its
non-management directors with a $5,000 annual retainer, $1,000 for each board
meeting attended and $500 for each committee meeting attended. In addition, a
plan approved by the Company on August 3, 2004 provides for each non-management
director to be granted options covering 100,000 shares of the Company's common
stock upon initial election to the Board and 75,000 shares of the Company's
common stock for each year in which he/she was selected to serve as a director.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The following table sets forth the number of shares of the Common Stock
(post-reverse stock split) beneficially owned as of May 17, 2006 by (i) each
person believed by Avitar to be the beneficial owner of more than 5% of the
Common Stock; (ii) each director; (iii) the Chief Executive Officer and its four
most highly compensated executive officers (other than the Chief Executive
Officer) who earn over $100,000 a year; and (iv) all directors and executive
officers as a group. Beneficial ownership by the stockholders has been
determined in accordance with the rules promulgated under Section 13(d) of the
Securities Exchange Act of 1934, as amended. All shares of the Common Stock are
owned both of record and beneficially, unless otherwise indicated.
Name and Address of Beneficial Owner (1) No. Owned %
- -------------------------------------------------------------------------------
Peter P. Phildius (2)(3)(9)(11) 94,277 2.9
Douglas W. Scott (2)(4)(9)(12) 65,480 2.3
Phildius, Kenyon & Scott("PK&S") (2)(9) 34,652 *
Jay C. Leatherman, Jr.(2)(5) 8,818 *
Richard Anderson (2)(15) 1,600 *
Peter Cholakis (2)(16) 3,200 *
James Groth (2)(6)(13) 5,644 *
Neil R.Gordon (2)(7) 6,562 *
Charles R. McCarthy (2)(8) 7,203 *
David Brown (10) 520,277 11.1
Gryphon Master Fund, LP (14) 236,866 5.1
All directors and executive officers
as a group (3)(4)(5)(6)(7)(8)(9)(11)
(12)(13)(15)(16) 153,332 3.4
* Indicates beneficial ownership of less than one (1%) percent.
(1) Information with respect to holders of more than five (5%) percent of the
outstanding shares of the Company's Common Stock was derived from, to the
extent available, Schedules 13D and the amendments thereto on file with the
Commission and the Company's records regarding stock issuances.
(2) The business address of such persons, for the purpose hereof, is c/o
Avitar, Inc., 65 Dan Road, Canton, MA 02021.
(3) Includes 33,362 shares of the Company's Common Stock, options and warrants
to purchase 26,263 shares of the Company's Common Stock. Also includes the
securities of the Company beneficially owned by PK&S as described below in
Note 9.
(4) Includes 14,310 shares of the Company's Common Stock and options to
purchase 16,518 shares of the Company's Common Stock. Also includes the
securities of the Company beneficially owned by PK&S as described below in
Note 9.
(5) Includes 113 shares of the Company's Common Stock, and options to purchase
8,705 shares of the Company's Common Stock.
(6) Includes 1,494 shares of the Company's Common Stock and options to purchase
4,150 shares of the Company's Common Stock.
(7) Includes 1,852 shares of the Company's Common Stock, warrants to purchase
800 shares of the Company's Common Stock granted to such director under a
consulting agreement to provide services to the Company and options to
purchase 3,950 shares of the Company's Common Stock.
(8) Includes 3,453 shares of the Common Stock and options to purchase 3,750
shares of the Common Stock.
(9) Represents ownership of 34,652 shares of the Company's Common Stock. PK&S
is a partnership of which Mr. Phildius and Mr. Scott are general partners.
(10) The business address for such person is 4101 Evans Avenue, Fort Meyers, FL
33901. Includes 242,277 shares of the Company's Common Stock, warrants to
purchase 18,000 shares of the Company's Common Stock and notes convertible
into 260,000 shares of the Company's Common Stock.
(11) Does not include 672 shares of the Common Stock owned by Mr. Phildius'
wife, all of which he disclaims beneficial ownership.
(12) Does not include 300 shares of the Common Stock owned by Mr. Scott's
children, all of which he disclaims beneficial ownership.
(13) Does not include 219 shares of the Company's Common Stock owned by a trust
established for Mr. Groth's children, all of which he disclaims beneficial
ownership
(14) The business address for such entity is 500 Crescent Court, #270, Dallas,
TX 75201. Represents preferred stock convertible into 236,866 shares of the
Company's Common Stock, but limited to 9.9% beneficial holding.
(15) Includes options to purchase 1,600 shares of the Company's Common Stock.
(16) Includes options to purchase 3,200 shares of the Company's Common Stock.
Securities authorized for issuance under equity compensation plans.
Equity Compensation Plan Information
As of September 30, 2005
(Pre-reverse stock split)
Number of securities to Weighted-average Number of securities
be issued upon exercise exercise price of remaining available for
of outstanding options, outstanding options, future issuance under
warrants and rights warrants and rights equity compensation
plans (excluding
securities reflected in
Plan category (a) (b) (c)
---------------------------------------------------------------------------------------------------------
Equity compensation plans
approved by security
holders 742,500 $.41 107,500
Equity compensation plans
not approved by security
holders 8,963,250 $.37 6,036,750
Total 9,705,750 $.38 6,144,250
See information concerning compensation plans not approved by
shareholders in Consolidated Financial Statements, Note 13, Stockholders'
Equity, Common Stock Purchase Warrants and Stock Options.
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Price Data. The Company's Common Stock is quoted on the Over The Counter
Bulletin Board ("OTCBB") under the symbol AVTI.OB From March 6, 2000 until
August 26, 2005, the Company's Common Stock had been traded on the American
Stock Exchange ("AMEX") under the symbol AVR. The table below sets forth the
high and low sales prices for the Company's Common Stock as quoted on AMEX for
the periods indicated, except for the last month of the Fourth Quarter of Fiscal
2005 and thereafter as quoted on the OTCBB. All of the price quotes for the
quarters are pre-reverse stock split.
High Low
Fiscal 2004
First Quarter .32 .15
Second Quarter .37 .18
Third Quarter .24 .10
Fourth Quarter .14 .08
Fiscal 2005
First Quarter .21 .06
Second Quarter .16 .08
Third Quarter .11 .05
Fourth Quarter .07 .01
Fiscal 2006
First Quarter .02 .01
As of May 5, 2006 the last sales price for the Company's Common Stock was
$.27 per share after the 1-for-50 reverse stock split that was effective 5:00
p.m. on February 17, 2006.
Fiscal 2006 (Post Reverse Stock Split)
Second Quarter (January to March 2006) 1.00 .40
Holders. The Company had approximately 350 owners of record and, it
believes, in excess of 9,000 beneficial owners of the Company's Common Stock as
of May 17, 2006.
Dividends. Since its inception, the Company has not paid or declared any
cash dividends on its Common Stock. The Company intends to retain future
earnings, if any, that may be generated from its operations to help finance the
operations and expansion of the Company and accordingly does not plan, for the
reasonably foreseeable future, to pay cash dividends to holders of its Common
Stock. Any decisions as to the future payment of dividends will depend on the
earnings, if any, and financial position of the Company and such other factors
as its Board of Directors may deem relevant.
Securities authorized for issuance under equity compensation plans. See
Equity Compensation Plan Information in Item 11, Security Ownership of Certain
Beneficial Owners and Management and Related Stockholder Matters, below.
Issuances of securities without registration during the fourth quarter of
Fiscal 2005. During the quarter ended September 30, 2005 the Company issued
8,923,889 shares of common stock to holders of Series A Redeemable Convertible
Preferred Stock upon the conversion of their preferred stock and the payment of
related dividends. The Company also issued 8,410,653 shares of common stock to
holders of Series E Redeemable Convertible Preferred Stock upon the conversion
of their preferred stock. The exemption for registration of these securities is
based upon Section 4(2) of the Securities Act because the issuances were made to
accredited investors in private placements.
SELLING STOCKHOLDERS
The 28,000,000 shares of common stock offered herein are reserved for
possible issuance upon conversion of $3 million of convertible notes and
$780,000 Series E convertible preferred stock.
The conversion rights and warrants related to the $3 million of convertible
notes were granted in a private placement pursuant to a Securities Purchase
Agreement and related agreements entered into with the entities listed below on
September 23, 2005 and amended on May 4, 2006.
The securities issued in the September 2005 private placement (with the
final closing on May 4, 2006) are $3 million of 8% Secured Convertible Notes and
Warrants to purchase 3 million shares of the Company's common stock in exchange
for gross proceeds of $3 million, of which $1 million (less $50,000 withheld for
expenses related to the transaction)was paid in the first closing on September
23, 2005. A second tranche of $1 million was paid on October 21, 2005. One-half
of the third tranche ($500,000) was paid on February 14, 2006 and the balance of
the third tranche of $500,000 was paid by May 4, 2006. The Notes are convertible
into common stock at 65% of the average of the three (3) lowest intraday trading
prices for the twenty (20) trading days immediately prior to the notice of
conversion and the Warrants are exercisable at $1.25 per share.
(Originally, the September 2005 private placement provided for the issuance
of Warrants to purchase up to 6 million shares exercisable at $0.25 per share,
which were reduced to 120,000 shares exercisable at $12.50 per share as a result
of the 50-to-1 reverse stock split effective February 17, 2006. However, on May
4, 2006 the final funding of the $3,000,000 private placement was completed
without an effective registration statement, which was a condition to such final
funding. As part of the final funding, all the earlier Warrants were cancelled
and replaced with the currently outstanding Warrants to purchase up to 3 million
shares exercisable at $1.25 per share.)
Absent registration under the Securities Act, the shares of common stock
offered herein are subject to certain limitations on resale. The Registration
Statement of which this Prospectus forms a part has been filed in satisfaction
of certain registration rights we granted to the entities listed below. The
following table assumes that the entities listed below will sell all of the
common stock offered herein set forth opposite their respective names. However,
the entities listed below may sell only a portion or may sell none of the shares
set forth opposite their names.
In the information immediately following this table and footnotes, we
describe each selling shareholder's relationship to the Company and how each
selling shareholder acquired rights to the shares to be sold in this offering.
Common Shares Common Shares
Beneficially Owned Beneficially Owned
Prior to the Number of After the Offering
Offering (1) Shares to be Sold ____________________
Number Percent in the Number of Percent
of Shares of Class(5) Offering (2)(3) Shares of Class
-------- -------- --------- ------- --------
AJW
Partners, LLC 185,187 (4) * % 2,806,000 185,187 *%
AJW Offshore,
Ltd. 795,393 (4) 2.61% 12,052,000 795,393 2.61%
AJW Qualified
Partners, LLC 516,095 (4) 1.70% 7,820,000 516,095 1.70%
New Millennium
Capital Partners
II, LLC 21,251 (4) * % 322,000 21,251 *%
Cornell
Capital
Partners, L.P. 470,175 (6) 4.99% 5,000,000 (7) 3,000(8) *%
- ----------------------------------------------------------------------------------------------------
Grand Total . 28,000,000 1,520,926 4.31%
(1) Shares beneficially held as of May 17, 2006 to the knowledge of the
Company. These shares are underlying the Convertible Notes and Warrants
issuable pursuant to the Securities Purchase Agreement entered into on
September 23, 2005 and amended on May 4, 2006 between all the above- listed
entities (the "Purchasers") [other than Cornell Capital Partners, L.P.] and
Avitar. The Notes are convertible into common stock at 65% of the average
of the three lowest trading prices for the twenty (20) trading days
immediately prior to the notice of conversion, subject to adjustments; but
all limited to issuance of shares of no more than 4.99% beneficial
ownership pursuant to the Securities Purchase Agreement. The number of
shares registered reflects the effect of the one-for-fifty Reverse Stock
Split (effective 5 P.M., February 17, 2006).
(2) Based upon recent market prices, shares underlying the Convertible Notes
issuable pursuant to the Securities Purchase Agreement entered into on
September 23, 2005 and amended on May 4, 2006 between Avitar and the
above-listed Purchasers, but adjusted for the one-for-fifty Reverse Stock
Split (effective 5 P.M., February 17, 2006).
(3) Registered shares include additional shares to be issued based on a good
faith estimate of the number of shares issuable upon conversion of the
secured convertible notes. Because the number of shares of common stock
issuable upon conversion of the secured convertible notes is dependent in
part upon the market price of the common stock prior to each conversion,
the actual number of shares of common stock that will be issued upon
conversion will fluctuate daily and cannot be determined at this time.
Under the terms of the secured convertible notes, for purposes of
determining the total number of shares to be included in this registration
statement, we could be required to multiply by two the number of shares
issuable upon conversion of the convertible notes; but the investors agreed
with the Company to limit the number of registrable shares based upon the
good faith estimate of the number of shares upon conversions.
(4) These selling stockholders [other than Cornell Capital Partners, L.P.] are
affiliates of each other by reason of common control. AJW Partners, LLC is
a private investment fund that is owned by its investors and managed by SMS
Group, LLC. SMS Group, LLC, of which Mr. Corey S. Ribotsky is the fund
manager, has voting and investment control, through Mr. Ribotsky, over the
shares listed above owned by AJW Partners, LLC. AJW Offshore, Ltd.,
formerly known as AJW/New Millennium Offshore, Ltd., is a private
investment fund that is owned by its investors and managed by First Street
Manager II, LLC. First Street Manager II, LLC, of which Corey S. Ribotsky
is the fund manager, has voting and investment control, through Mr.
Ribotsky, over the shares owned by AJW Offshore, Ltd. AJW Qualified
Partners, LLC, formerly known as Pegasus Capital Partners, LLC, is a
private investment fund that is owned by its investors and managed by AJW
Manager, LLC, of which Corey S. Ribotsky and Lloyd A. Groveman are the fund
managers, have voting and investment control, through Messrs. Ribotsky and
Groveman, over the shares listed above owned by AJW Qualified Partners,
LLC. New Millennium Capital Partners II, LLC, is a private investment fund
that is owned by its investors and managed by First Street Manager II, LLC.
First Street Manager II, LLC, of which Corey S. Ribotsky is the fund
manager, has voting and investment control, through Mr. Ribotsky, over the
shares owned by New Millennium Capital Partners II, LLC. The selling
stockholders have advised us that they are not broker-dealers or affiliates
of broker-dealers and that they believe they are not required to be
broker-dealers. The shares related to warrants for each of the Selling
Stockholders are as follows: AJW Partners, LLC: 366,000; AJW Offshore,
Ltd.: 1,572,000; AJW Qualified Partners, LLC: 1,020,000; New Millenium
Capital Partners II, LLC: 42,000; but none of the shares related to these
warrants are registered under this Registration Statement.
(5) The number and percentage of shares beneficially owned is determined in
accordance with Rule 13d-3 of the Securities Exchange Act of 1934, and the
information is not necessarily indicative of beneficial ownership for any
other purpose. Under such rule, beneficial ownership includes any shares as
to which the selling stockholders has sole or shared voting power or
investment power and also any shares, which the selling stockholders has
the right to acquire within 60 days. The actual number of shares of common
stock issuable upon the conversion of the secured convertible notes is
subject to adjustment depending on, among other factors, the future market
price of the common stock, and could be materially less or more than the
number estimated in the table. The percentage of shares owned by each is
based on a total outstanding number of 4,419,344 as of May 17, 2006.
(6) The shares beneficially held by Cornell Capital Partners, L.P. prior to the
offering were calculated as follows (all post-reverse stock split):
Warrants issued in April and June 2005 3,000
Shares Being Registered 5,000,000
Outstanding Shares 4,419,344
---------
Total 9,422,344
Allowable Ownership (4.99% of 9,422,344 ) 470,175
(7) Shares underlying $780,000 Series E Convertible Preferred Stock (based upon
recent market conversion prices). Avitar committed to issue the $780,000
Series E Convertible Preferred Stock to Cornell Capital Partners, L.P.
pursuant to two Securities Purchase Agreements delivered on April 19, 2005
and June 3, 2005 as part of a private placement in exchange for total gross
proceeds of $780,000 ($375,000 of which was paid on June 3, 2005 and
$375,000 was paid at a second closing within 30 days). The net proceeds of
the two above-referenced Securities Purchase Agreements delivered in April
and June 2005 were $1,335,000. The Series E Convertible Preferred Stock are
convertible into common stock at the lesser of $0.08 per share and 80% of
the average of the three (3) lowest closing bid prices for the ten (10)
trading days immediately prior to the notice of conversion, subject to
adjustments and automatically convert on the second anniversary date of the
first issuance of Series E Convertible Preferred Stock, April 19, 2007,
together with dividends at 5% per annum that may be paid by issuance of
stock; but all limited to issuance of shares of no more than 4.99%
beneficial ownership pursuant to the Securities Purchase Agreements between
the Company and Cornell Capital Partners, L.P. and any shares issued for
dividends of Series E Convertible Preferred Stock are not registered under
this Registration Statement. Yorkville Advisors, LLC is the general partner
of Cornell Capital Partners. As general partner, Yorkville Advisors, LLC
controls and makes all investment decisions for Cornell Capital Partners.
Mark Angelo, the managing member of Yorkville Advisors, LLC, makes the
investment decisions on behalf of and controls Yorkville Advisors, LLC.
(8) Warrants issued in April and June 2005 3,000
* Less than one percent (1%).
SHARES ACQUIRED IN FINANCING TRANSACTIONS WITH AVITAR
The following is a description of the selling shareholders relationship to us
and how each selling shareholder acquired the shares to be sold in this
offering:
On September 23, 2005, we entered into a securities purchase agreement with four
investment funds, which are all of the selling shareholders other than Cornell
Capital Partners, L.P., for the sale in three installments of an aggregate of
$3,000,000 in secured convertible notes (the "Notes") and five-year warrants to
purchase 6,000,000 shares of our common stock at $0.25 per Share (120,000 shares
at $12.50 per share post-Reverse Stock Split). We received the first installment
of $1,000,000 (less $50,000 withheld for expenses related to the transaction)and
issued warrants to purchase an aggregate of 2,000,000 shares of our common stock
on September 23, 2005. Under our agreement with these investors, additional
funds in the amount of $1,000,000 were advanced on October 21, 2005, within two
days of the filing date of a registration statement related to shares underlying
the Notes and Warrants. The third tranche was to be advanced at the latest upon
effectiveness of a registration statement. One-half of the third tranche
($500,000) was paid on February 14, 2006, the day after the Company had filed a
registration statement on Form SB-2. However, the registration statement, even
after amendments, did not become effective and was withdrawn on April 18, 2006.
On May 4, 2006, although there still was no effective registration statement,
the investors agreed to fund the remainder of the $3,000,000 and the outstanding
warrants were cancelled and replaced by 3 million warrants exercisable for 7
years at $1.25 per share.
The Notes bear interest at 8%, mature three years from the date of issuance, and
are convertible into our common stock at any time, at the investors' option, at
a price per share equal to 65% of the average of the three lowest intraday
trading prices for the Common Stock on the Over-The-Counter Bulletin Board for
the 20 trading days ending the day before the conversion date. We have the right
to prepay the Notes under certain circumstances at a premium ranging from 25% to
50% depending on the timing of such prepayment. We have granted the investors a
security interest in substantially all of our assets. We agreed to file the
registration statement of which this prospectus forms a part for the purpose of
registering the shares issuable upon conversion of the Notes and exercise of the
related warrants. Since we did not have a registration statement registering the
shares underlying the Notes and Warrants declared effective on or before January
23, 2006, we may be obligated to pay liquidated damages in the amount of 2.0%
per month of the face amount of the issued and outstanding secured convertible
notes outstanding, which now equals $60,000, until the registration statement is
declared effective. In addition, when the registration statement was not
declared effective by February 7, 2006, we could have been in default under the
Notes. However, the purchasers of the Notes have agreed that all liquidated
damages and defaults related to our failure to have the registration statement
declared effective by those dates will not apply provided that the registration
statement is declared effective by June 30, 2006 and the investors agreed that
the 3 million shares underlying the warrants were not registered at this time.
At our option, these liquidated damages, if and when payable, can be paid in
cash or restricted shares of our common stock.
The investors may exercise the warrants on a cashless basis if the shares
underlying the warrants are not then registered. In the event of a cashless
exercise, we will not receive any proceeds. The investors have agreed to
restrict their ability to convert their secured convertible notes or exercise
their warrants and receive shares of our common stock such that the number of
shares of common stock held by them and their affiliates in the aggregate after
such conversion or exercise does not exceed 4.99% of the then issued and
outstanding shares of common stock.
None of the selling shareholders has held a position or office, or had any other
material relationship, with the Company.
SHARES ACQUIRED BY CORNELL CAPITAL PARTNERS, L.P. IN FINANCING TRANSACTIONS WITH
AVITAR
- - CORNELL CAPITAL PARTNERS, LP. Cornell Capital Partners, LP is the investor
under the Securities Purchase Agreements in April and June 2005 and a
holder of the Series E Convertible Preferred Stock and related Warrants.
Yorkville Advisors, LLC is the general partner of Cornell Capital Partners.
As general partner, Yorkville Advisors, LLC controls and makes all
investment decisions for Cornell Capital Partners. Mark Angelo, the
managing member of Yorkville Advisors, makes the investment decisions on
behalf of and controls Yorkville Advisors. Cornell Capital Partners
acquired all shares being registered in this offering in financing
transactions with Avitar. Those transactions are explained below. Cornell
Capital Partners, LP has advised us that they are not broker-dealers or
affiliates of broker-dealers and that they believe they are not required to
be broker-dealers.
- - SECURITIES PURCHASE AGREEMENT. On June 3, 2005, we entered into a
Securities Purchase Agreement with Cornell Capital Partners. Pursuant to
the Securities Purchase Agreement, we issued $750,000 of the Company's
Series E Convertible Preferred Stock and Warrants to purchase 75,000 shares
of the Company's common stock in exchange for gross proceeds of $750,000,
of which $375,000 was paid in the first closing and a second tranche of
$375,000 was paid at the second closing within 30 days. The $750,000 Series
E Convertible Preferred Stock are convertible into common stock at the
lesser of $0.08 per share or 80% of the average of the three (3) lowest
closing bid prices for the ten (10) trading days immediately prior to the
notice of conversion, subject to adjustments and limitations, and the
Warrants are exercisable at $0.084 per share. On April 19, 2005, we
previously entered into a similar Securities Purchase Agreement with
Cornell Capital Partners covering $750,000 of the Company's Series E
Convertible Preferred Stock and Warrants to purchase 75,000 shares of the
Company's common stock in exchange for gross proceeds of $750,000. The
securities involved in these earlier transactions were registered for
resale under Registration Statements on Form S-3 that became effective on
July 14, 2005 and May 20,2005.
The Series E Convertible Preferred Stock has a potential approximate
two-year term accruing dividends at 5% per year until automatic conversion on
its second anniversary date, April 19, 2007. If Cornell Capital Partners chooses
to have dividends be payable in common stock of the Company, rather than cash,
this could have a further dilutive impact on our stockholders and could cause
our stock price to decline. At maturity, the Series E Convertible Preferred
Stock will automatically convert into shares of common stock at the then market
conversion price. We are registering 1,950,000 shares of common stock under this
prospectus based on recent market conversion prices under the Series E
Convertible Preferred Stock; however, none of the shares registered under this
Registration Statement are shares that may be issued for dividends of Series E
Convertible Preferred Stock.
Material Relationships With Cornell Capital Partners, LP.
The Company and Cornell Capital Partners, LP. ("Cornell") first created a
material relationship in February 2005 when they entered into a Standby Equity
Distribution Agreement ("SEDA"). Under the SEDA, Cornell committed to provide
the Company up to $10 million in $250,000 tranches at any time over a 24-month
period. The initial fees paid to Cornell and to its placement agent for the SEDA
were 1,075,732 shares of common stock valued at $125,000. However, prior to
entering into the first Securities Purchase Agreement for the sale of the Series
E Preferred Stock, the Company entered into a Termination Agreement terminating
the SEDA so that none of the parties have any rights or obligations with respect
to the SEDA.
After the SEDA was terminated, the Company in April and June 2005 entered
into the Securities Purchase Agreements for the sale to Cornell of an aggregate
of $1.5 million of Series E Redeemable Convertible Preferred Stock. The Series E
Preferred Stock transactions with Cornell are not part of the terminated SEDA.
The Company raised net proceeds of approximately $1,335,000 from the sale of
Series E Redeemable Convertible Preferred Stock with a face value of $1,500,000
and Warrants to purchase 3,000 shares (post-reverse stock split) of the
Company's common stock. The shares of Series E Preferred Stock are convertible
into common stock at the lesser of $4.00 per share (post-reverse stock split) or
80% of the average of the three lowest closing bid prices for the ten trading
days immediately prior to the notice of conversion, subject to adjustments and
limitations, and any remaining unconverted shares of Series E Preferred Stock
are to be automatically converted into common stock on April 22, 2007 (the
second anniversary of the first issuance of Series E Preferred Stock). The
Warrants are exercisable at $4.20 per share (post-reverse stock split) for a
period of three years.
Pursuant to Registration Rights Agreements with Cornell, 30,000,000 shares
of common stock (pre-reverse stock split) were registered for resale under
Registration Statements effective in May and July 2005. Soon after these
registration statements became effective, all of these shares were sold by
Cornell after converting approximately $720,000 of the Series E Preferred Stock.
The additional 5,000,000 shares of common stock (post-reverse stock split),
underlying the remaining $780,000 of Series E Preferred Stock held by Cornell,
were registered for resale by Cornell under the Registration Statement of which
this prospectus is a part.
The Company may elect -- and has plans -- to establish a SEDA in the
future. If the Company does elect to establish a SEDA in the future and chooses
to establish the SEDA with Cornell, Cornell has agreed in the Termination
Agreement to apply the fees paid in the terminated SEDA to the fees payable in
any future SEDA with the Company. Further, if the Company in the future requests
a SEDA with Cornell on terms identical to those in the terminated SEDA, then
Cornell may enter into the new SEDA within 90 days after all amounts due under
the April 2005 Securities Purchase Agreement have been fully satisfied (probably
by conversion of the Series E Preferred Stock into common stock) or, if Cornell
elects not to enter into the new SEDA on identical terms, it would be required
to refund to the Company the fees that were paid to Cornell for the terminated
SEDA. This arrangement relates only to fees in any future SEDA between the
Company and Cornell and is intended to avoid any double billing of fees by
Cornell in any future SEDA.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
PK&S, a 1.8 % beneficial owner of the Company, provided consulting services
to the Company from September 1989 to May 1995. On May 28, 1992, the Company
entered into a written consulting agreement with PK&S, which reflected the
provisions of a previous oral agreement approved by the Company's Board of
Directors in October 1990. Pursuant to its arrangement with the Company, PK&S
provided the services of each of Messrs. Phildius and Scott to the Company.
On May 19, 1995, the Company's Consulting Agreement ended and was replaced
by the Employment Agreements with Messrs. Phildius and Scott (See "Employment
Agreements"). As requested by Messrs. Phildius and Scott and approved by the
Company's Board of Directors, the salary and benefits provided under the
Employment Agreements will be paid directly to PK&S. Under the terms of the
current employment agreements with Peter Phildius and Douglas Scott described
above, the Company pays their salaries and related expenses directly to PK&S.
The aggregate of salaries, fringe benefits and reimbursement of expenses paid to
PK&S by the Company on behalf of Messrs. Phildius and Scott for fiscal years
2005 and 2004 totaled $414,709 and $420,103 respectively.
DESCRIPTION OF SECURITIES
The following description of our capital stock and provisions of our certificate
of incorporation and bylaws, each as amended, is only a summary. You should also
refer to the copies of our articles of incorporation and bylaws which are
incorporated as exhibits to our Annual Report on 10-KSB for the fiscal year
ended September 30, 2005 and the subsequent Current Report on Form 8-K filed on
February 23, 2006. Unless otherwise noted, references to number of shares are
post-the reverse stock split that was effective at 5:00 p.m. on February 17,
2006. Our authorized capital stock consists of 100,000,000 shares of common
stock, par value $0.01 per share, and 5,000,000 shares of preferred stock $0.001
par value per share. As of May 17, 2006, there were 4,419,344 shares of common
stock issued and outstanding and 5,689 shares of preferred stock issued and
outstanding.
Common Stock
We are authorized to issue 100,000,000 shares of common stock of which as of May
8, 2006, 4,413,259 shares are issued and outstanding. Holders of our common
stock are entitled to one vote for each share held on all matters submitted to a
vote of our stockholders. Holders of our common stock are entitled to receive
dividends ratably, if any, as may be declared by the board of directors out of
legally available funds, subject to any preferential dividend rights of any
outstanding preferred stock. Upon our liquidation, dissolution or winding up,
the holders of our common stock are entitled to receive ratably our net assets
available after the payment of all debts and other liabilities and subject to
the prior rights of any outstanding preferred stock. Holders of our common stock
have no preemptive, subscription, redemption or conversion rights. The
outstanding shares of common stock are fully paid and nonassessable. The rights,
preferences and privileges of holders of our common stock are subject to, and
may be adversely affected by, the rights of holders of shares of any series of
preferred stock that we may designate and issue in the future without further
stockholder approval.
Preferred Stock
Our board of directors is authorized, without further stockholder approval, to
issue from time to time up to a total of 5,000,000 shares of preferred stock in
one or more series and to fix or alter the designations, preferences, rights and
any qualifications, limitations or restrictions of the shares of each series,
including the dividend rights, dividend rates, conversion rights, voting rights,
term of redemption, redemption price or prices, liquidation preferences and the
number of shares constituting any series or designations of these series without
further vote or action by the stockholders. The issuance of preferred stock may
have the effect of delaying, deferring or preventing a change in control of our
management without further action by the stockholders and may adversely affect
the voting and other rights of the holders of common stock. The issuance of
preferred stock with voting and conversion rights may adversely affect the
voting power of the holders of common stock, including the loss of voting
control to others. As of May 17, 2006, there were outstanding:
o 5,689 shares of Series B Preferred Stock,
o 775,649 shares of Series E Redeemable Convertible Preferred Stock
($775,649 face value),
o 28,608 shares of Series C Convertible Preferred Stock, and
o 2,000 shares of 6% Convertible Preferred Stock ($2,000,000 face
value).
In the aggregate, these preferred shares are convertible into approximately
5,900,000 shares of common stock.
Warrants
In summary and in the aggregate, as of May 5, 2006, there were outstanding
Warrants to acquire approximately 3,393,191 shares as detailed below
Warrants to acquire 1,100 shares that expire in 2006 and that are currently
exercisable at $35.50 to $39.50 per share.
Warrants to acquire 14,000 shares that expire in 2007 and that are currently
exercisable at $42.50 per share.
Warrants to acquire 13,500 shares that expire in 2007 and that are currently
exercisable at $15.50 per share.
Warrants to acquire 4,260 shares that expire in 2006 and that are currently
exercisable at $0.50 to $12.50 per share.
Warrants to acquire 86,539 shares that expire in 2005 to 2007 and that are
currently exercisable at $10.00 to $15.00 per share.
Warrants to acquire 2,000 shares that expire in 2006 and that are currently
exercisable at $10.00 per share.
Warrants to acquire 30,000 shares that expire in 2013 and that are currently
exercisable at $10.00 per share.
Warrants to acquire 4,500 shares that expire in 2009 and that are currently
exercisable at $4.75 to $6.30 per share.
Warrants to acquire 2,700 shares that expire in 2009 and that are currently
exercisable at $4.75 to $6.30 per share.
Warrants to acquire 15,000 shares that expire in 2008 to 2009 and that are
currently exercisable at $4.20 to $6.30 per share.
Warrants to acquire 1,542 shares that expire in 2009 and that are currently
exercisable at $6.30 per share.
Warrants to acquire 58,000 shares that expire in 2008 to 2010 and that are
currently exercisable at $1.65 to $12.50 per share.
Warrants to acquire 160,000 shares that expire in 2010 to 2011 and that are
currently exercisable at $12.50 per share.
Warrants to acquire 3,000,000 shares that expire in 2013 and that are currently
exercisable at $1.25 per share.
Transfer Agent and Registrar
The transfer agent and registrar for our common stock is Continental Stock
Transfer & Trust Company, 17 Battery Place, New York, NY 10004.
PLAN OF DISTRIBUTION
The selling stockholders, or their pledgees, donees, transferees, or any of
their successors in interest selling shares received from the named selling
stockholders as a gift, partnership distribution or other non-sale-related
transfer after the date of this prospectus (all of whom may be a selling
stockholder) may sell the common stock offered by this prospectus from time to
time on any stock exchange or automated interdealer quotation system on which
the common stock is listed or quoted at the time of sale, in the
over-the-counter market, in privately negotiated transactions or otherwise, at
fixed prices that may be changed, at market prices prevailing at the time of
sale, at prices related to prevailing market prices or at prices otherwise
negotiated. The selling stockholders may sell the common stock by one or more of
the following methods, without limitation:
o Block trades in which the broker or dealer so engaged will attempt to
sell the common stock as agent but may position and resell a portion
of the block as principal to facilitate the transaction;
o An exchange distribution in accordance with the rules of any stock
exchange on which the common stock is listed;
o Ordinary brokerage transactions and transactions in which the broker
solicits purchases;
o Privately negotiated transactions;
o In connection with short sales of company shares;
o Through the distribution of common stock by any selling stockholder to
its partners, members or stockholders;
o By pledge to secure debts of other obligations;
o In connection with the writing of non-traded and exchange-traded call
options, in hedge transactions and in settlement of other transactions
in standardized or over-the-counter options;
o Purchases by a broker-dealer as principal and resale by the
broker-dealer for its account; or
o In a combination of any of the above.
These transactions may include crosses, which are transactions in which the same
broker acts as an agent on both sides of the trade. The selling stockholders may
also transfer the common stock by gift. We do not know of any arrangements by
the selling stockholders for the sale of any of the common stock.
The selling stockholders may engage brokers and dealers, and any brokers or
dealers may arrange for other brokers or dealers to participate in effecting
sales of the common stock. These brokers or dealers may act as principals, or as
an agent of a selling stockholder. Broker-dealers may agree with a selling
stockholder to sell a specified number of the stocks at a stipulated price per
share. If the broker-dealer is unable to sell common stock acting as agent for a
selling stockholder, it may purchase as principal any unsold shares at the
stipulated price. Broker-dealers who acquire common stock as principals may
thereafter resell the shares from time to time in transactions in any stock
exchange or automated interdealer quotation system on which the common stock is
then listed, at prices and on terms then prevailing at the time of sale, at
prices related to the then-current market price or in negotiated transactions.
Broker-dealers may use block transactions and sales to and through broker-
ealers, including transactions of the nature described above. The selling
stockholders may also sell the common stock in accordance with Rule 144 or Rule
144A under the Securities Act, rather than pursuant to this prospectus. In order
to comply with the securities laws of some states, if applicable, the shares of
common stock may be sold in these jurisdictions only through registered or
licensed brokers or dealers.
From time to time, one or more of the selling stockholders may pledge,
hypothecate or grant a security interest in some or all of the shares owned by
them. The pledgees, secured parties or person to whom the shares have been
hypothecated will, upon foreclosure in the event of default, be deemed to be
selling stockholders. The number of a selling stockholder's shares offered under
this prospectus will decrease as and when it takes such actions. The plan of
distribution for that selling stockholder's shares will otherwise remain
unchanged. In addition, a selling stockholder may, from time to time, sell the
shares short, and, in those instances, this prospectus may be delivered in
connection with the short sales and the shares offered under this prospectus may
be used to cover short sales.
To the extent required under the Securities Act, the aggregate amount of selling
stockholders' shares being offered and the terms of the offering, the names of
any agents, brokers, dealers or underwriters, any applicable commission and
other material facts with respect to a particular offer will be set forth in an
accompanying prospectus supplement or a post-effective amendment to the
registration statement of which this prospectus is a part, as appropriate. Any
underwriters, dealers, brokers or agents participating in the distribution of
the common stock may receive compensation in the form of underwriting discounts,
concessions, commissions or fees from a selling stockholder and/or purchasers of
selling stockholders' shares, for whom they may act (which compensation as to a
particular broker-dealer might be less than or in excess of customary
commissions). Neither we nor any selling stockholder can presently estimate the
amount of any such compensation.
The selling stockholders and any underwriters, brokers, dealers or agents that
participate in the distribution of the common stock will be deemed to be
"underwriters" within the meaning of the Securities Act, and any discounts,
concessions, commissions or fees received by them and any profit on the resale
of the securities sold by them may be deemed to be underwriting discounts and
commissions. If a selling stockholder is deemed to be an underwriter, the
selling stockholder may be subject to certain statutory liabilities including,
but not limited to Sections 11, 12 and 17 of the Securities Act and Rule 10b-5
under the Exchange Act. Selling stockholders who are deemed underwriters within
the meaning of the Securities Act will be subject to the prospectus delivery
requirements of the Securities Act. The SEC staff is of a view that selling
stockholders who are registered broker-dealers are deemed to be underwriters
under the Securities Act while affiliates of registered broker-dealers may be
underwriters under the Securities Act. We will not pay any compensation or give
any discounts or commissions to any underwriter in connection with the
securities being offered by this prospectus.
A selling stockholder may enter into hedging transactions with broker-dealers
and the broker-dealers may engage in short sales of the common stock in the
course of hedging the positions they assume with that selling stockholder,
including, without limitation, in connection with distributions of the common
stock by those broker-dealers. A selling stockholder may enter into option or
other transactions with broker-dealers, who may then resell or otherwise
transfer the common stock. A selling stockholder may also loan or pledge the
common stock offered hereby to a broker-dealer and the broker-dealer may sell
the common stock offered by this prospectus so loaned or upon a default may sell
or otherwise transfer the pledged common stock offered by this prospectus. The
selling stockholders and other persons participating in the sale or distribution
of the common stock will be subject to applicable provisions of the Exchange
Act, and the rules and regulations under the Exchange Act, including Regulation
M. This regulation may limit the timing of purchases and sales of any of the
common stock by the selling stockholders and any other person. The
anti-manipulation rules under the Exchange Act may apply to sales of common
stock in the market and o the activities of the selling stockholders and their
affiliates. Regulation M may restrict the ability of any person engaged in the
distribution of the common stock to engage in market-making activities with
respect to the particular common stock being distributed for a period of up to
five business days before the distribution. These restrictions may affect the
marketability of the common stock and the ability of any person or entity to
engage in market-making activities with respect to the common stock.
We have agreed to indemnify the selling stockholders and any brokers, dealers
and agents who may be deemed to be underwriters, if any, of the common stock
offered by this prospectus, against specified liabilities, including liabilities
under the Securities Act. The selling stockholder has agreed to indemnify us
against specified liabilities.
The issued and outstanding common stock, as well as the common stock to be
issued offered by this prospectus was originally, or will be, issued to the
selling stockholders pursuant to an exemption from the registration requirements
of the Securities Act, as amended. We agreed to register the common stock issued
or to be issued to the selling stockholders under the Securities Act, and to
keep the registration statement of which this prospectus is a part effective
until all of the securities registered under this registration statement have
been sold. We have agreed to pay all expenses incident to the registration of
the common stock held by the selling stockholders in connection with this
offering, but all selling expenses related to the securities registered shall be
borne by the individual holders of such securities.
We cannot assure you that the selling stockholders will sell all or any portion
of the common stock offered by this prospectus. In addition, we cannot assure
you that a selling stockholder will not transfer the shares of our common stock
by other means not described in this prospectus.
LEGAL MATTERS
The validity of the common stock has been passed upon by Dolgenos Newman &
Cronin LLP, New York, New York.
EXPERTS
The financial statements as of September 30, 2005 and for the two years in the
period then ended in this Registration Statement have been audited by BDO
Seidman, LLP, an independent registered public accounting firm, to the extent
and for the periods set forth in their report (which contains an explanatory
paragraph regarding the Company's ability to continue as a going concern) and
are incorporated herein in reliance upon such report given upon the authority of
said firm as experts in auditing and accounting.
WHERE YOU CAN FIND MORE INFORMATION
We filed with the SEC a registration statement on Form SB-2 under the Securities
Act for the common stock to be sold in this offering. This prospectus does not
contain all of the information in the registration statement and the exhibits
and schedules that were filed with the registration statement. For further
information with respect to the common stock and us, we refer you to the
registration statement and the exhibits and schedules that were filed with the
registration statement. Statements made in this prospectus regarding the
contents of any contract, agreement or other document that is filed as an
exhibit to the registration statement are not necessarily complete, and we refer
you to the full text of the contract or other document filed as an exhibit to
the registration statement. A copy of the registration statement and the
exhibits and schedules that were filed with the registration statement may be
inspected without charge at the public reference facilities maintained by the
SEC in Room 1024, 450 Fifth Street, NW, Washington, DC 20549. Copies of all or
any part of the registration statement may be obtained from the SEC upon payment
of the prescribed fee. Information regarding the operation of the public
reference rooms may be obtained by calling the SEC at 1-800-SEC-0330. The SEC
maintains a web site that contains reports, proxy and information statements and
other information regarding registrants that file electronically with the SEC.
The address of the site is http://www.sec.gov.
DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES ACT
LIABILITIES
Our Certificate of Incorporation, as amended, provides to the fullest extent
permitted by Delaware law, our directors or officers shall not be personally
liable to us or our shareholders for damages for breach of such director's or
officer's fiduciary duty. The effect of this provision of our Certificate of
Incorporation, as amended, is to eliminate our rights and the rights of our
shareholders (through shareholders' derivative suits on behalf of our company)
to recover damages against a director or officer for breach of the fiduciary
duty of care as a director or officer (including breaches resulting from
negligent or grossly negligent behavior), except under certain situations
defined by statute. We believe that the indemnification provisions in our
Certificate of Incorporation, as amended, are necessary to attract and retain
qualified persons as directors and officers.
Section 145 of the Delaware General Corporation Law provides that a corporation
may indemnify a director, officer, employee or agent made a party to an action
by reason of that fact that he or she was a director, officer, employee or agent
of the corporation or was serving at the request of the corporation against
expenses actually and reasonably incurred by him or her in connection with such
action if he or she acted in good faith and in a manner he or she reasonably
believed to be in, or not opposed to, the best interests of the corporation and
with respect to any criminal action, had no reasonable cause to believe his or
her conduct was unlawful.
Insofar as indemnification for liabilities arising under the Securities Act of
1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
AVITAR INC.
INDEX TO FINANCIAL STATEMENTS
Consolidated Financial Statements
Years Ended September 30, 2005 and 2004
Avitar, Inc. and Subsidiaries
Contents
Report of independent registered public accounting firm F-2
Consolidated financial statements:
Balance sheet F-3 to F-4
Statements of operations F-5
Statements of stockholders' deficit F-6
Statements of cash flows F-7 to F-9
Notes to consolidated financial statements F-10 to F-41
Consolidated financial statements for the quarter and six months
ended March 31, 2006 (Unaudited) F-42 to F-52
Balance sheet F-42
Statements of operations F-43
Statements of stockholders' deficit F-44
Statements of cash flows F-45
Notes to consolidated financial statements F-46
Avitar, Inc. and
Subsidiaries
Consolidated Financial Statements
Years Ended September 30, 2005 and 2004
Avitar, Inc. and Subsidiaries
Contents
Report of independent registered public accounting firm F-2
Consolidated financial statements:
Balance sheet F-3 to F-4
Statements of operations F-5
Statements of stockholders' deficit F-6
Statements of cash flows F-7 to F-9
Notes to consolidated financial statements F-10 to F-41
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Avitar, Inc.
We have audited the accompanying consolidated balance sheet of Avitar, Inc. and
subsidiaries as of September 30, 2005, and the related consolidated statements
of operations, stockholders' deficit and cash flows for each of the two years in
the period ended September 30, 2005. These consolidated financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board ("United States"). Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. The Company
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audits included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company's internal control
over financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Avitar, Inc. and
subsidiaries as of September 30, 2005, and the results of their operations and
their cash flows for each of the two years in the period ended September 30,
2005, in conformity with accounting principles generally accepted in the United
States of America.
As discussed in Note 1, the Company has restated its statement of stockholders'
deficit as of September 30, 2003 and 2004 and for the year ended September 30,
2004 and its statement of operations for the year ended September 30, 2004.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has suffered recurring losses
from operations and has working capital and stockholder deficits as of September
30, 2005. These matters raise substantial doubt about its ability to continue as
a going concern. Management's plans in regard to these matters are also
described in Note 1. The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
/s/ BDO Seidman, LLP
Boston, Massachusetts
January 20, 2006
Avitar, Inc. and Subsidiaries
Consolidated Balance Sheet
September 30, 2005
- ----------------------------------------------------------------------------
Assets
Current:
Cash and cash equivalents $400,363
Accounts receivable, less allowance for doubtful
accounts of $12,000 (Note 15) 578,131
Inventories (Note 4) 374,916
Prepaid expenses and other current assets (including
related party receivables of $5,300) 203,390
- ----------------------------------------------------------------------------
Total current assets 1,556,800
Property and equipment, net (Note 5) 302,734
Goodwill (Note 6) 138,120
Other assets, net (Notes 7) 429,954
- ----------------------------------------------------------------------------
$ 2,427,608
============================================================================
See accompanying notes to consolidated financial statements.
Avitar, Inc. and Subsidiaries
Consolidated Balance Sheet
September 30, 2005
- ----------------------------------------------------------------------------------------------------
Liabilities and Stockholders' Deficit
Current liabilities:
Notes payable (Note 8) $ 309,013
Convertible notes payable (Note 8) 567,271
Accounts payable (including $76,000 due to related parties) (Note 19) 574,595
Accrued expenses 832,959
Deferred revenue 16,250
Current portion of deferred lessor incentive (Note 10) 13,400
Fair value of warrants (Note 13) 116,151
Fair value of embedded derivatives 526,800
- ----------------------------------------------------------------------------------------------------
Total current liabilities 2,956,439
Convertible notes payable (Note 9) 681,596
Deferred lessor incentive, less current portion (Note 10) 50,250
Total liabilities 3,688,285
Redeemable convertible preferred stock and convertible
preferred stock (Note 11) 3,345,000
Commitments (Notes 12 and 13)
Stockholders' deficit (Note 13):
Series B convertible preferred stock, $.01 par value; authorized 5,000,000 shares;
5,689 shares issued and outstanding, with aggregate liquidation value -
Series B - $9,262 58
Common stock, $.01 par value; authorized 300,000,000 shares; 190,659,393 shares
issued and outstanding 1,906,594
Additional paid-in capital 46,992,195
Accumulated deficit (53,504,524)
- ----------------------------------------------------------------------------------------------------
Total stockholders' deficit (4,605,677)
- ----------------------------------------------------------------------------------------------------
$ 2,427,608
====================================================================================================
See accompanying notes to consolidated financial statements.
Avitar, Inc. and Subsidiaries
Consolidated Statements of Operations
Years ended September 30, 2005 2004
(as restated)
Sales (Note 15) $ 4,508,914 $ 4,048,547
- ---------------------------------------------------------------------------------------------
Operating expenses:
Cost of sales 3,182,774 2,713,128
Selling, general and administrative (Note 18) 4,329,331 3,400,770
Research and development 724,254 564,831
Goodwill impairment (Note 6)
100,000 -
- ---------------------------------------------------------------------------------------------
Total operating expenses 8,426,359 6,678,729
- ---------------------------------------------------------------------------------------------
Loss from operations (3,827,445) (2,630,182)
- ---------------------------------------------------------------------------------------------
Other income (expense):
Interest expense and financing costs (includes $ 2,398 and $ 6,980 to related
parties in 2005 and 2004, respectively)
(Notes 8 and 16) (223,864) (330,298)
Other income, net 1,618,152 561,370
- ---------------------------------------------------------------------------------------------
Total other income (expense), net 1,394,288 231,072
- ---------------------------------------------------------------------------------------------
Loss from continuing operations (2,433,157) (2,399,110)
- ---------------------------------------------------------------------------------------------
Discontinued operations (Notes 3 and 6):
Income from operations of USDTL - 4,447
Loss from disposal of discontinued operations - (17,235)
- ---------------------------------------------------------------------------------------------
Loss from discontinued operations - (12,788)
- ---------------------------------------------------------------------------------------------
Net loss $(2,433,157) $(2,411,898)
- ---------------------------------------------------------------------------------------------
Preferred stock dividends (197,831) (145,579)
Deemed dividends in connection with preferred stock sales (2,145,260) (1,715,000)
Net loss attributable to common shareholders $(4,776,248) $(4,272,477)
=============================================================================================
Basic and diluted loss per share from continuing
operations (Note 13) $(.03) $ (.04)
- ---------------------------------------------------------------------------------------------
Basic and diluted net loss per share (Note 13) $(.03) $ (.04)
=============================================================================================
See accompanying notes to consolidated financial statement
Avitar, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Deficit
(Note 13)
Additional
Preferred Stock Common Stock Paid-in
Years ended September 30, 2005 and 2004 Shares Amount Shares Amount Capital
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2003 (As previously reported) 137,302 $1,372 88,868,196 $888,682 $46,093,947
Adjustment (Note 1) (35,941) (359) - - (1,207,476)
Balance at September 30, 2003 (As restated) 101,261 $ 1,013 88,868,196 $888,682 $44,886,471
Sale of common stock - - 36,156 362 4,544
Sale of preferred stock and warrants, net of expenses 250 3 - - 771,621
Conversion of Series A, Series B, Series D, 8% redeemable
preferred stock into common stock (94,322) (943) 21,074,721 210,748 729,147
Exercise of warrants - - 11,903,844 119,038 (119,038)
Payment of preferred stock dividend, Series A preferred stock - - 85,848 858 6,237
Payment of preferred stock dividend, 6% preferred stock - - - -
Issuance of common stock for interest on long-term debt - - 1,149,400 11,494 147,515
Net loss - - - - -
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2004 (As restated) 7,189 $ 73 123,118,165 $1,231,182 $46,426,497
- ------------------------------------------------------------------------------------------------------------------------------------
Sale of common stock - - 71,025 710 4,515
Conversion of Series A convertible preferred stock into common
stock (1,500) (15) 17,173,239 171,732 (171,717)
Conversion of Series A redeemable convertible preferred stock
into common stock 35,813,659 358,137 2,177,910
Conversion of Series E redeemable convertible preferred stock
into common stock 12,319,680 123,197 593,970
Payment of preferred stock dividend, Series A preferred stock - - 1,087,893 10,879 60,500
Accretion of mandatorily redeemable preferred stock (2,213,723)
Common stock issued to establish equity credit line 1,075,732 10,757 114,243
Net loss - - - - -
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at September 30, 2005 5,689 $ 58 190,659,393 $1,906,594 $46,992,195
Avitar, Inc. and Subsidiaries
Consolidated Statements of Stockholders' Deficit
(Note 13)(Continued)
Total
Accumulated Stockholders'
Years ended September 30, 2005 and 2004 Deficit Deficit
- ------------------------------------------------------------------------------------------------------
Balance at September 30, 2003 (As previously reported) $(48,564,885) $(1,580,884)
Adjustment (Note 1) - (1,207,835)
Balance at September 30, 2003 (As restated) $(48,564,885) $(2,788,719)
Sale of common stock - 4,906
Sale of preferred stock and warrants, net of expenses - 771,624
Conversion of Series A, Series B, Series D, 8% redeemable
preferred stock into common stock - 938,953
Exercise of warrants - -
Payment of preferred stock dividend, Series A preferred stock (7,095) -
Payment of preferred stock dividend, 6% preferred stock (16,110) (16,110)
Issuance of common stock for interest on long-term debt - 159,009
- ------------------------------------------------------------------------------------------------------
Net loss (2,411,898) (2,411,898)
- ------------------------------------------------------------------------------------------------------
Balance at September 30, 2004 (As restated) $(50,999,988) $(3,342,235)
- ------------------------------------------------------------------------------------------------------
Sale of common stock - 5,225
Conversion of Series A convertible preferred stock into common
stock - -
Conversion of Series A redeemable convertible preferred stock
into common stock - 2,536,047
Conversion of Series E redeemable convertible preferred stock
into common stock - 717,167
Payment of preferred stock dividend, Series A preferred stock (71,379) -
Accretion of mandatorily redeemable preferred stock (2,213,723)
Common stock issued to establish equity credit line 125,000
- ----------------------------------------------------------------------------------------------------
Net loss (2,433,157) (2,433,157)
- ----------------------------------------------------------------------------------------------------
Balance at September 30, 2005 $(53,504,524) $(4,605,677)
Avitar, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years ended September 30, 2005 2004
(as restated)
- ----------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net loss $ (2,433,157) $ (2,411,898)
Adjustments to reconcile net loss to net cash used in
operating activities:
Loss from disposal of discontinued operation - 17,235
Depreciation and amortization 147,376 116,230
Amortization of debt discount and deferred financing costs 147,827 101,084
Amortization of deferred rent expense and deferred lessor
incentive 90,225 124,766
Goodwill impairment 100,000 -
Income from changes in value of embedded derivatives and warrants (1,617,599) (556,862)
Common stock and warrants for interest on short-term and
long-term debt - 114,236
Loss on the extinguishment of long-term debt - 66,000
Changes in operating assets and liabilities:
Accounts receivable 57,606 (118,176)
Inventories (26,063) (98,925)
Prepaid expenses and other current assets (28,910) (46,199)
Other assets (142,698) 1,707
Accounts payable and accrued expenses (259,245) (884,309)
- ----------------------------------------------------------------------------------------------------------------
Deferred revenue (176,250) (20,250)
Net cash used in operating activities (4,140,888) (3,595,361)
- ----------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of property and equipment (76,518) (159,466)
Proceeds from the sale of USDTL - 500,000
Net cash provided by (used in) investing activities (76,518) 340,534
- ----------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Repayment of short-term debt (150,018) (140,233)
Repayments of notes payable and long-term debt - (11,279)
Proceeds from short-term debt 261,411
- ----------------------------------------------------------------------------------------------------------------
Proceeds from the issuance of convertible short-term debt and warrants 650,000
Net proceeds from the issuance of convertible long-term debt and warrants 850,000
Sales of preferred stock, common stock and warrants 2,497,500 2,800,406
Payment of preferred stock dividend - (16,110)
Net cash provided by financing activities 4,108,893 2,632,784
- ----------------------------------------------------------------------------------------------------------------
Net decrease in cash and cash equivalents (108,513) (622,043)
Cash and cash equivalents, beginning of year 508,876 1,130,919
- ----------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 400,363 $ 508,876
- ----------------------------------------------------------------------------------------------------------------
Avitar, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(Concluded)
Years ended September 30, 2005 2004
- -----------------------------------------------------------------------------------------------------------------
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 47,682 $ 10,843
Supplemental schedule of noncash investing and
financing activities:
During 2005, 2,093 shares of Series A redeemable convertible
preferred stock were converted into 35,813,659 shares
of common stock.
During 2005, 1500 shares of Series A convertible preferred stock
Were converted into 17,173,239 shares of common
Stock.
During 2005, 1,087,893 shares of common stock were issued as payment
of dividends for Series A convertible and redeemable
convertible preferred stock.
During 2005, 500,000 shares of Series E redeemable convertible
preferred stock were converted into 12,319,680 shares of
common stock
During 2005, 1,075,732 shares of common stock were issued as
payment of investor and placement agent fees in connection
with SEDA financing. $ 125,000 $ 32,802
During 2005, lessor provided the Company with leasehold
improvements of $67,000 as an incentive to renew the lease
for the facility at Canton, MA. $ 67,000 $ 125,000
Years ended September 30, 2005 2004
- ------------------------------------------------------------------------------------------------------------------
During 2004, 1,149,400 shares of common stock were issued
for interest on long-term debt, of which 497,473 shares were
payment of accrued interest of $44,773.
During 2004, 700 shares of 8% redeemable convertible preferred
stock were converted into 4,666,667 shares of common stock $1,250,000
During 2004, $1,250,000 of long-term debt was converted into
1,316 shares of Series A redeemable convertible preferred stock
During 2004, 358 shares of Series A redeemable convertible preferred
Stock were converted into 5,163,986 shares of common stock
During 2004, 989 shares of Series A and B convertible preferred stock were
converted into 8,444,078 shares of common stock.
During 2004, 93,333 shares of Series D convertible preferred stock were
converted into 2,799,990 shares of common stock.
During 2004, 85,848 shares of common stock were issued for payment
of dividends for Series A convertible preferred stock and redeemable
convertible preferred stock.
See accompanying notes to consolidated financial statements.
1. Description of Business and Basis of Presentation
Avitar, Inc. ("Avitar" or the "Company"), through its
wholly-owned subsidiaries, Avitar Technologies, Inc. ("ATI"), and
BJR Security, Inc. ("BJR"), designs, develops, manufactures and
markets diagnostic test and medical products and provides
contraband detection services. Avitar sells its products and
services to employers, diagnostic test distributors, large
medical supply companies, governmental agencies, schools and
corporations. The Company operates in one reportable segment
since revenues of its contraband detection business represent an
immaterial portion of its total revenues. In December 2003,
Avitar consummated the sale of the business and net assets,
excluding cash, of its wholly-owned subsidiary, United States
Drug Testing Laboratories, Inc. ("USDTL"). The Company received
$500,000 in cash upon the closing of the sale and is entitled to
receive an additional $500,000 as the buyer of USDTL achieves
certain revenue targets. Subsequent to September 30, 2005, the
Company negotiated an agreement with the new owners of USDTL to
settle all outstanding matters related to the sale of USDTL (see
Note 17). The USDTL business has been treated as a discontinued
operation (see Note 3). Due to the current financial condition at
Avitar, the Company may consider selling assets and/or
operations, including BJR. However, at the present time, there
can be no assurances that the Company would be successful in
these efforts.
The Company's consolidated financial statements have been
presented on the basis that it is a going concern, which
contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. The Company has
suffered recurring losses from operations and has a working
capital deficit of $1,399,639 and a stockholders' deficit of
$4,605,677 as of September 30, 2005. The Company raised net
proceeds aggregating approximately $2,498,000 during the year
ended September 30, 2005 from the sale of stock and warrants. In
addition, the Company raised gross proceeds of $900,000 from
short-term convertible notes and $1,000,000 from long-term
convertible notes. Subsequent to September 30, 2005, the Company
raised gross proceeds of $1,000,000 from long-term convertible
notes (see Note 17). The Company is working with placement agents
and investment fund mangers to obtain additional equity or debt
financing. Based upon cash flow projections, the Company believes
the anticipated cash flow from operations and most importantly,
the expected net proceeds from future equity financings will be
sufficient to finance the Company's operating needs until the
operations achieve profitability. There can be no assurances that
forecasted results will be achieved or that additional financing
will be obtained. The financial statements do not include any
adjustments relating to the recoverability and classification of
asset amounts or the amounts and classification of liabilities
that might be necessary should the Company be unable to continue
as a going concern.
1. Description of Business and Basis of Presentation (Continued)
During the audit for Fiscal 2005, the Company was advised by its
independent registered public accounting firm that the method
used to account for sales of certain convertible preferred stock
and convertible notes was not in accordance with the requirements
of Emerging Issues Task Force ("EITF") Issue No. 00-19
"Accounting for Derivative Financial Instruments Indexed To and
Potentially Settled In, a Company's Own Stock". The statements of
stockholders' deficit as of September 30, 2003 and 2004 and for
the year ended September 30, 2004 and the statement of operations
for the year ended September 30, 2004 included herein have been
restated to correct the error in accounting for the issuance of
various securities and the derivative features embedded therein.
These restatements resulted in a stockholders' deficit of
$2,788,719 at September 30, 2003 (an increase of $1,207,835) , a
stockholders' deficit of $3,342,235 at September 30, 2004 (an
increase of $2,674,847) and a net loss of $2,411,898 for the year
ended September 30, 2004 (a decrease of $556,862 or $.01 per
share). The Company will file a report on Form 8-K describing the
need to restate the financial statements included in the reports
on Form 10-QSB filed for the quarters ended December 31, 2004,
March 31, 2005 and June 30, 2005.
2. Summary of Significant
Accounting Policies
Concentration of Credit Risk and Significant Customers
Financial instruments that subject the Company to credit risk
consist primarily of cash, cash equivalents and trade accounts
receivable. The Company places its cash and cash equivalents in
established financial institutions. The Company has no
significant off-balance-sheet concentration of credit risk such
as foreign exchange contracts, options contracts or other foreign
hedging arrangements. The Company's accounts receivable credit
risk is not concentrated within any one geographic area. The
Company has not experienced any significant losses related to
receivables from any individual customers or groups of customers
in any specific industry or by geographic area. Due to these
factors, no additional credit risk beyond amounts provided for
collection losses is believed by management to be inherent in the
Company's accounts receivable.
2. Summary of Significant
Accounting Policies (Continued)
Accounts receivable are customer obligations due under normal
trade terms. The Company sells its products to employers,
distributors and OEM customers. The Company generally requires
signed sales agreements, non-refundable advance payments and
purchase orders depending upon the type of customer, and letters
of credit may be required in certain circumstances. Accounts
receivable is stated at the amount billed to the customer less a
valuation allowance for doubtful accounts.
Senior management reviews accounts receivable on a monthly basis
to determine if any receivables could potentially be
uncollectible. The Company includes specific accounts receivable
balances that are determined to be uncollectible in its overall
allowance for doubtful accounts. After all attempts to collect a
receivable have failed, the receivable is written off against the
allowance. Based on available information, the Company believes
its allowance for doubtful accounts as of September 30, 2005 of
$12,000 is adequate.
See Note 15 for information on customers that individually
comprise greater than 10% of total revenues.
Estimates and Assumptions
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make 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 and the
reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. All significant
inter-company balances and transactions have been eliminated.
Revenue Recognition
The Company recognizes revenue from product sales upon shipment
and delivery with delivery being made F.O.B. to the carrier.
Revenue from the sales of services is recognized in the period
the services are provided. These revenues are recognized provided
that a purchase order has been received or a contract has been
executed, there are no uncertainties regarding customer
acceptance, the sales price is fixed or determinable and
collection is deemed probable. If uncertainties regarding
customer acceptance exist, the Company recognizes revenue when
those uncertainties are resolved. Amounts collected or billed
prior to satisfying the above revenue
2. Summary of Significant
Accounting Policies (Continued)
recognition criteria are recorded as deferred revenue. The
Company does not offer its customers or distributors the right to
return product once it has been delivered in accordance with the
terms of sale. Product returns, which must be authorized by the
Company, occur mainly under the warranties associated with the
product. The Company maintains sufficient reserves to handle
warranty costs. Price discounts for products are reflected in the
amount billed to the customer at the time of delivery. Rebates
and payments have not been material and are adequately covered by
established allowances.
Cash Equivalents
The Company considers all highly liquid investments and
interest-bearing certificates of deposit with original maturities
of three months or less to be cash equivalents.
Inventories
Inventories are recorded at the lower of cost (determined on a
first-in, first-out basis) or market. The inventories of the
ORALscreen products and some components of the foam products are
subject to expiration dating. Senior management reviews the
inventories on a periodic basis to insure that adequate reserves
have been established to cover product obsolescence and unusable
inventory. These decisions are based on the levels of inventories
on hand in relation to the estimated forecast of product demand,
production requirements over the next twelve months and the
expiration dates of the raw materials and finished goods.
Forecasting of product demand can be a complex process,
especially for ORALscreen instant drug tests. Although every
effort is made to insure the accuracy of these forecasts of
future product demand, any significant unanticipated changes in
demand could have a significant impact on the carrying value of
the Company's inventories and reported operating results.
Property and Equipment
Property and equipment (including equipment under capital leases)
is recorded at cost at the date of acquisition. Depreciation is
computed using the straight-line method over the estimated useful
lives of the assets (three to seven years). Leasehold
improvements are amortized over the shorter of their estimated
useful life or lease term. Expenditures for repairs and
maintenance are expensed as incurred.
2. Summary of Significant
Accounting Policies (Continued)
Long-lived Assets
The Company evaluates its long-lived assets under the provisions
of Statement of Financial Accounting Standards ("SFAS") No. 144,
"Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of." SFAS No. 144 establishes
accounting standards for the impairment of long-lived assets and
certain identifiable intangibles to be held and used and for
long-lived assets, and certain identifiable intangibles to be
disposed of.
In assessing the recoverability of its long-lived assets, the
Company must make assumptions in determining the fair value of
the asset by estimating future cash flows and considering other
factors, including significant changes in the manner or use of
the assets, or negative industry reports or economic conditions.
If those estimates or their related assumptions change in the
future, the Company may be required to record impairment charges
for those assets.
Goodwill
Effective October 1, 2002, the Company adopted SFAS No. 142,
"Goodwill and Other Intangible Assets". Prior to the adoption of
SFAS No. 142, goodwill resulting from the excess of cost over
fair value of net assets acquired was amortized on a
straight-line basis over 10 years. SFAS No. 142 requires among
other things, that companies no longer amortize goodwill, but
test goodwill for impairment at least annually. In addition, SFAS
142 requires that the Company identify reporting units for the
purpose of assessing potential future impairments of goodwill,
reassess the useful lives of other existing recognized intangible
assets, and cease amortization of intangible assets with an
indefinite useful life. An intangible asset with an indefinite
useful life should be tested for impairment in accordance with
guidelines in SFAS 142. SFAS 142 is required to be applied to all
goodwill and other intangible assets regardless of when those
2. Summary of Significant
Accounting Policies (Continued)
assets were initially recognized. The Company will recognize an
impairment of goodwill if the fair value of the acquired business
is determined to be less than the carrying amount of the
goodwill. If the Company determines that the goodwill has been
impaired, the measurement of the impairment will be equal to the
excess of the carrying amount of the goodwill over the amount of
the fair value of the asset. If an impairment of goodwill were to
occur, the Company would reflect the impairment through a
reduction in the carrying value of goodwill. Based on the limited
operating results of the business and the estimates of its fair
value, the Company recorded an impairment of goodwill for
$100,000 in Fiscal 2005 (see Note 6).
Patents
Patent costs are being amortized over their estimated useful
lives of 5 - 7 years by the straight-line method.
Research and Development
Research and development costs are expensed as incurred.
Income (Loss)Per Share of
Common Stock
The Company follows SFAS No. 128 "Earnings per Share." Under SFAS
128, basic earnings per share excludes the effect of any dilutive
options, warrants or convertible securities and is computed by
dividing the net income (loss) available to common shareholders
by the weighted average number of common shares outstanding for
the period. Diluted earnings per share is computed by dividing
the net income (loss) available to common shareholders by the sum
of the weighted average number of common shares and common share
equivalents computed using the average market price for the
period under the treasury stock method (when dilutive).
2. Summary of
Significant
Accounting
Policies
(Continued)
Stock Options
The Company accounts for its stock-based compensation plans using
the intrinsic value method in accordance with the provisions of
APB Opinion No. 25, "Accounting for Stock Issued to Employees",
and complies with the disclosure provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation", and SFAS No. 148,
"Accounting for Stock-Based Compensation-Transition and
Disclosure". No stock-based employee compensation cost was
reflected in net loss for the years ended 2005 and 2004, as all
options granted under those plans had an exercise price equal to
the fair market value of the underlying common stock on the date
of grant.
The following table illustrates, in accordance with the
provisions of SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure", the effect on net loss
and loss per share if the Company had applied the fair value
recognition provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation", to stock-based employee compensation.
Year Ended September 30,
2005 2004
(as restated)
Net loss $(2,433,157) $(2,411,898)
Add: stock based employee compensation
expense included in reported net loss,
net of tax
- -
Deduct: total stock based employee
compensation expense determined
under the fair value based method for
all awards, net of tax (122,238) (106,400)
Pro forma net loss $(2,555,385) $(2,518,298)
===============================================================================
Loss per share:
Basic and diluted - as reported $(.02) $(.02)
Basic and diluted - pro forma (.02) (.02)
2. Summary of Significant
Accounting Policies (Continued)
In determining the pro forma amounts above, the Company estimated
the fair value of each option granted using the Black-Scholes
option pricing model with the following weighted-average
assumptions used for grants:
2005 2004
Risk free interest rate 2.5-3.8 % 2.5%
Expected dividend yield - -
Expected lives 10 years 10 years
Expected volatility 80% 80%
The weighted average fair value of options granted in fiscal 2005
and 2004 was $0.07 and $0.13, respectively.
Income Taxes
Income taxes are accounted for using the liability method as set
forth in SFAS No. 109, "Accounting for Income Taxes." Under this
method, deferred income taxes are provided on the differences in
basis of assets and liabilities between financial reporting and
tax returns using enacted rates. Valuation allowances have been
recorded (see Note 14).
Fair Value of
Financial
Instruments
The carrying amounts of cash, accounts receivable and accounts
payable approximate fair value because of the short-term nature
of these items. The current fair values of the short-term and
long-term debt approximate fair value because their interest
rates approximate prevailing market rates. The fair value of
derivative instruments is based on valuations using a market
value approach. This approach determines the fair value of the
securities sold by the Company by using one or more methods that
compare these securities to similar securities that have been
sold.
Advertising
The Company expenses advertising costs as incurred. Advertising
expense was approximately $3,000 and $0 in fiscal 2005 and 2004,
respectively.
Principal Supplier Risk
The Company does not have written agreements with most of its
suppliers of raw materials and laboratory supplies. While the
Company purchases some product components from single sources,
most of the supplies used can be obtained from more than one
source. Avitar acquires the same key component for its customized
foam products and Hydrasorb wound dressings from a single
supplier. The Company also purchases a main component of its
ORALscreen products from one source. Avitar's current suppliers
of such key components are the only vendors which presently meet
Avitar's specifications for such
2. Summary of Significant
Accounting Policies (Continued)
components. The loss of these suppliers would, at a minimum,
require the Company to locate other satisfactory vendors, which
would result in a period of time during which manufacturing and
sales of products utilizing such components may be suspended and
could have a material adverse effect on Avitar's financial
condition and operations. Avitar, believes that alternative
sources could be found for such key components and expects that
the cost of such components from an alternative source would be
similar. The Company also believes that alternative sources of
supply are available for its remaining product components and
that the loss of any such supplier would not have a material
adverse effect upon Avitar's business.
Derivatives
The Company has issued and outstanding convertible debt and
certain convertible equity instruments with embedded derivative
features. The Company analyzes these financial instruments in
accordance with SFAS No. 133 and EITF Issue Nos. 00-19 and 05-02
to determine if these hybrid contracts have embedded derivatives
which must be bifurcated. In addition, free-standing warrants are
accounted for as equity or liabilities in accordance with the
provisions of EITF Issue No. 00-19. As of September 30, 2005, the
Company could not be sure it had adequate authorized shares for
the conversion or exercise of all outstanding instruments due to
certain conversion rates which vary with the fair value of the
Company's common stock and therefore all embedded derivatives and
free standing warrants are recorded at fair value,
marked-to-market at each reporting period, and are carried on a
separate line of the accompanying balance sheet. If there is more
than one embedded derivative, their value is considered in the
aggregate.
New Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123R, "Share-Based
Payment" ("SFAS 123R"), which replaces SFAS 123, "Accounting for
Stock-Based Compensation," and supersedes APB Opinion no. 25,
"Accounting for Stock Issued to Employees." SFAS 123R requires
all share-based payments to employees, including grants of
employee stock options, to be recognized in the financial
statements based on their fair values beginning with the first
interim or annual period after June 15, 2005. In April 2005, the
Securities and Exchange Commission (the "SEC") postponed the
effective date of SFAS 123R until the issuer's first fiscal year
beginning after June 15, 2005. Under the current rules, the
Company will be required to adopt SFAS 123R in the second quarter
of fiscal 2006.
Under SFAS 123R, pro forma disclosures previously permitted will
no longer be an alternative to financial statement recognition.
The Company must determine the appropriate fair value model to be
used for valuing share-based payments to employees, the
amortization method for compensation cost and the transition
method to be used at the date of adoption. The transition methods
include modified prospective and retrospective adoption options.
Additionally, SFAS 123R clarifies the timing for recognizing
compensation expense for awards subject to acceleration of
vesting on retirement and also specifies the treatment of excess
tax benefits associated with stock compensation.
2. Summary of Significant
Accounting Policies (Continued)
In March 2005, the SEC issued Staff Accounting Bulletin No. 107
("SAB 107") regarding the SEC's interpretation of SFAS 123R and
the valuation of share-based payments for public companies.
Avitar is evaluating the requirements of SFAS 123R and SAB 107
and expects that the adoption of SFAS 123R will have a material
impact on Avitar's consolidated results of operations and
earnings per share. The Company has not yet determined the method
of adoption or the effect of adopting SFAS 123R, and it has not
determined whether the adoption will result in amounts that are
similar to the current pro forma disclosures under SFAS 123.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs"
("SFAS 151"), an amendment of Accounting Research Bulletin
("ARB") No. 43, Chapter 4, "Inventory Pricing". SFAS 151 amends
previous guidance regarding treatment of abnormal amounts of idle
facility expense, freight, handling costs, and spoilage. This
statement requires that those items be recognized as current
period charges regardless of whether they meet the criterion of
"so abnormal" which was the criterion specified in ARB No. 43. In
addition, this Statement requires that allocation of fixed
production overheads to the cost of the production be based on
normal capacity of the production facilities. This pronouncement
is effective for the Company for fiscal periods beginning after
October 1, 2005. The Company is currently evaluating the effect
that the adoption of SFAS 151 will have on its consolidated
results of operations and financial condition, but it is not
expected to have a material impact.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes
and Error Corrections" ("SFAS 154") which replaces APB Opinions
No. 20 "Accounting Changes" and SFAS No. 3, "Reporting Accounting
Changes in Interim Financial Statements" An Amendment of APB
Opinion No. 28. SFAS 154 provides guidance on the accounting for
and reporting of accounting changes and error corrections. It
establishes retrospective application, or the latest practicable
date, as the required method for reporting a change in accounting
principle and the reporting of a correction of an error. SFAS 154
is effective for accounting changes and corrections of errors
made in fiscal years beginning after December 15, 2005 and is
required to be adopted by Avitar in the first quarter of fiscal
2007. The Company is currently evaluating the effect that the
adoption of SFAS 154 will have on its consolidated results of
operations and financial condition, but does not expect it will
have a material impact.
3. Discontinued Operations
On December 16, 2003, the Company consummated a sale of USDTL's
business and net assets, excluding cash. The Company received
$500,000 in cash upon the closing of the sale and is entitled to
receive an additional $500,000 as the buyer of USDTL achieves
specified revenue targets. Under the terms of the sale, the buyer
must pay the Company 10% of certain annual revenues in excess of
$1,500,000 beginning with the calendar year ending December 31,
2004, less any amounts due from the Company for the purchase of
services from the buyer. Due to the contingent nature of the
additional $500,000, the payments will be recorded as revenues
when they are received. Subsequent to September 30, 2005, the
Company negotiated an agreement with the new owners of USDTL to
settle all outstanding matters related to the sale of USDTL (see
Note 17). The accompanying financial statements have been
restated to reflect USDTL as a discontinued operation. Following
is a summary of the results of operations of USDTL:
Years ended September 30, 2005 2004
--------------------------------------------------------------------------
Sales $ - $ 289,501
Operating expenses - 284,223
Other expense - (18,066)
Loss from discontinued operations $ - $ (12,788)
--------------------------------------------------------------------------
Other expense in 2004 includes a loss from the disposal of USDTL
of $17,235.
4. Inventories
Inventories consist of the following:
September 30, 2005
---------------------------------------------------------------
Raw materials $ 201,487
Work-in-process 72,353
Finished goods 101,076
-----------
Total $ 374,916
===============================================================
5. Property and Equipment
Property and equipment consists of the following:
September 30, 2005
--------------------------------------------------------------
Equipment $ 1,348,687
Furniture and fixtures 262,433
Leasehold improvements 137,618
Construction in progress 9,746
--------------------------------------------------------------
1,758,484
Less: accumulated depreciation
and amortization 1,455,750
--------------------------------------------------------------
$ 302,734
--------------------------------------------------------------
6. Goodwill
As of October 1, 2004, the Company's goodwill was $238,120 which
was associated with the acquisition of BJR in 2001. In Fiscal,
2005, an impairment adjustment to the $238,120 of goodwill
associated with the BJR acquisition was deemed necessary. Based
on the limited operating results of the business and the
estimates of its fair value, the Company recorded an impairment
of goodwill for $100,000 in Fiscal 2005.
7. Other Assets
Other assets consist of the following:
September 30, 2005
-------------------------------------------------------------
Patents $ 149,966
Deposits 2,000
Deposit for Letter of Credit (Note12) 150,000
Deferred Financing Costs 285,565
Related party receivables (long-term portion) 4,500
-------------------------------------------------------------
592,031
Less accumulated amortization 162,077
-------------------------------------------------------------
Other assets, net $ 429,954
-------------------------------------------------------------
Included in the above are patent costs of $149,966 with related
accumulation amortization costs of $119,221. The patents have a
weighted average amortization period of 7 years. Amortization
expense related to the patents was $13,019 and $13,000 for fiscal
2005 and 2004, respectively. Also included in the above are
deferred financing costs of $125,000 for the Equity Credit Line
established with Cornell Capital Partners, LLC in February 2005
and $160,565 for the convertible notes executed in September 2005
(see Note 9 and 11). Amortization expense related to the deferred
financing costs amounted to $42,856 for fiscal 2005.
Estimated amortization expense for the next five years is as
follows:
Deferred
September 30, Patents Financing Costs Total
2006 $13,000 $118,022 $131,022
2007 8,000 72,356 80,356
2008 3,000 52,332 55,332
2009 2,000 - 2,000
2010 2,000 - 2,000
Thereafter 2,745 - 2,745
8. Short-Term Debt
Short-term debt consists of the following:
September 30, 2005
--------------------------------------------------------------------------------------
Notes Payable:
Note payable to insurance company, interest at 9.75%, payable in
monthly principal installments of $8,393 plus accrued interest
through February 2006. $41,546
Note payable to insurance company, interest at 7.0%, payable in
monthly installments of approximately $5,775 through October
2005. 5,775
Notes payable to insurance company, interest at 7.95%, payable in
monthly installments of approximately $5,420 through October
2005. 5,425
Notes payable to insurance company, interest at 7.5%, payable in
monthly installments of approximately $1,253 through February
2006. 6,267
Notes payable to individual, interest at 1% per month payable in
installments of $75,000 on November 1, 2005, $25,000 per month
from December 2005 to February 2006 and $16,667 per month from
April
2006 to September 2006. 250,000
--------------------------------------------------------------------------------------
Total notes payable 309,013
--------------------------------------------------------------------------------------
Convertible notes payable (total face value of $650,000 less
unamortized discount of $82,729 as of September 30, 2005) to
individual, interest at 10%, payable in variable monthly
installments plus accrued interest
from October 1, 2005 to June 2006 (see description below). 567,271
--------------------------------------------------------------------------------------
$876,284
======================================================================================
From April to August 2005, the Company executed convertible notes
with an individual in the total principal amount of $650,000 with
interest at 10%. Each note has a maturity date of six months from
the date of the note and is payable in ten monthly installments
plus accrued interest commencing on the maturity date of the
note. The Company issued warrants to purchase 650,000 shares of
common stock at $.033 to $.099 per share for three (3) years in
connection with these notes. In addition, the entire principal
plus accrued interest associated with these notes is convertible
into the Company's common stock at a conversion price of the
lesser of the closing price of the common stock on the date of
the loan or 85% of the average closing price of the common stock
for the five (5) trading days preceding the notice of conversion.
In no event shall the conversion price be lower than 50% of the
closing price of the common stock on the date of the loan. A
discount to debt totaling $172,930 ($156,800 for the value of the
conversion feature of these notes and $16,130 for the value of
the warrants issued in connection with these notes) was recorded
during FY2005 and is being amortized over the term of the notes.
The unamortized discount was $82,729 as of September 30, 2005. A
liability of approximately $173,000 was recorded for the fair
value of the warrants issued in connection with the $650,000 of
notes and the conversion feature.
9. Long-Term Debt
Long-term debt consists of the following:
September 30, 2005
Convertible notes payable (face value of $1,000,000 less
unamortized discount of $318,404 as of September 30, 2005) to
investors, maturing September 2008, outstanding principal payable
at maturity, interest at 8%, payable quarterly. $681,596
----------------------------------------------------------------------------------
Long-term debt $681,596
==================================================================================
In September 2005, the Company executed notes payable with AJW
Partners, LLC, AJW Offshore, Ltd., AJW Qualified Partners, LLC
and New Millennium Capital Partners II, LLC in the total
principal amount of $1,000,000 which is payable at maturity in
September 2008. Interest on these notes is 8% and is payable
quarterly in cash or the Company's common stock at the option of
the Company. The Company issued warrants to purchase 2,000,000
shares of common stock at $.25 per share for five years in
connection with these notes. In addition, the entire principal
plus any accrued and unpaid interest associated with these notes
is convertible, at the holder's option, into the Company's common
stock at a conversion price of 65% of the average of the three
lowest intraday trading prices of the common stock for the twenty
trading days preceding the date that the holders elect to
convert. A discount to debt totaling $320,500 ($283,500 for the
fair value of the conversion feature of these notes and $37,000
for the fair value of the warrants issued in connection with
these notes) was recorded during FY2005 and is being amortized
over the term of the notes. The unamortized discount was $318,404
as of September 30, 2005. Fees of approximately $150,000 incurred
in connection with securing these loans were recorded as a
deferred financing charge. The collateral pledged by the Company
to secure these notes includes all assets of the Company. A
liability of approximately $321,000 was recorded for the fair
value of the warrants issued in connection with the $1,000,000 of
notes and the conversion feature.
10. Deferred Lessor Incentive
As an incentive to renew the lease of its facility in Canton, MA
for a period of five years (see Note 12), the Lessor provided the
Company with leasehold improvements of approximately $67,000.
Accordingly, the Company recorded a deferred lessor incentive and
will amortize it as a reduction to rent expense over the term of
the lease. In 2005, $3,350 of the deferred incentive was
amortized. As of September 30, 2005, the remaining balance was
$63,650 of which, $13,400 was classified as current.
11. Redeemable Convertible
Preferred Stock and
Convertible Preferred Stock
As of September 30, 2005, the Company had the following
redeemable convertible and convertible preferred stock
outstanding:
Less Costs
and Proceeds
Allocated to Accretion
Warrants and To
Number Face Conversion Redemption Carrying
Instrument of Shares Value Features Value Value
------------------------------------------------------------------------------------------
Series E
Redeemable
Convertible
Preferred
Stock 1,000,000 $1,000,000 $724,667 $ 724,667 $1,000,000
Series A
Redeemable
Convertible
Preferred
Stock 150 150,000 123,532 123,532 150,000
Series C
Convertible
Preferred
Stock 36,941 195,000 - - 195,000
6%
Convertible
Preferred
Stock 2,000 2,000,000 - - 2,000,000
-----------------------------------------------------------------------------------------
Total $3,345,000
-----------------------------------------------------------------------------------------
The Series C and 6% Convertible Preferred stock are carried on
the balance sheet outside of permanent equity as the Company
cannot be sure it has adequate authorized shares for their
conversion, as of September 30, 2005.
In the April and June 2005, the Company raised net proceeds of
approximately $1,335,000 from the sale of 1,500,000 shares of
Series E Redeemable Convertible Preferred Stock with a face value
of $1,500,000 and Warrants to purchase 150,000 shares of the
Company's common stock. The $1,500,000 of Series E Preferred
Stock are convertible into Common Stock at the lesser of $.08 per
share or 80% of the average of the three lowest closing bid
prices for the ten trading days immediately prior to the notice
of conversion, subject to adjustments and limitations, and the
Warrants are exercisable at $.084 per share for a period of three
years. The warrants issued in connection with the sale of
1,500,000 shares of preferred stock and the conversion feature
resulted in a deemed dividend of $1,087,000 being recorded and
included in the earnings per share calculation for the year ended
September 30, 2005. A liability of approximately $1,087,000 was
recorded for the original fair value of the warrants issued in
connection with the sale of the 1,500,000 shares of preferred
stock and the conversion feature which was $201,903 at September
30, 2005. As of September 30, 2005, 500,000 shares of this
preferred stock had been converted into 12,319,680 shares of
common stock and 1,000,000 were outstanding. Upon the occurrence
of specific events, the holders of the Series E Redeemable
Convertible Preferred Stock are entitled to redeem these shares
under certain provisions of the agreement covering the purchase
of the preferred stock. Accordingly, this security was not
classified as permanent equity.
In December 2004, the Company sold 1,285 shares of Series A
Redeemable Convertible Preferred Stock and Warrants to purchase
600,000 shares of common stock for which it received net proceeds
of approximately $1,160,000. The Series A Redeemable Convertible
Preferred Stock, with a face value of $1,285,000, is convertible
into common stock at the lesser of $.12 per share or 85% of the
average of the three lowest closing bid prices, as reported by
Bloomberg, for the ten trading days immediately prior to the
notice of conversion subject to adjustments and floor prices. The
Warrants are exercisable at $.126 per share. The warrants issued
in connection with the sale of 1,285 shares of preferred stock
and the conversion feature resulted in a deemed dividend of
$1,058,260 being recorded and included in the earnings per share
calculation for the year ended September 30, 2005. A liability of
approximately $1,058,260 was recorded for the original fair value
of the warrants issued in connection with the sale of the 1,285
shares of preferred stock, and the conversion feature which was
$29,820 at September 30, 2005. As of September 30, 2005, 1,135
shares of this preferred stock had been converted into 22,607,777
shares of common stock and 150 shares were outstanding. Upon the
occurrence of specific events, the holders of the Series A
Redeemable Convertible Preferred Stock are entitled to redeem
these shares under certain provisions of the agreement covering
the purchase of the preferred stock. Accordingly, this security
was not classified as equity. Subsequent to September 30, 2005,
the remaining 150 shares were redeemed by the Company (see Note
17).
In May 2004, the Company settled a long-term note of $1,250,000
with a maturity date of August 2005 with 1,316 shares of Series A
Redeemable Convertible Preferred Stock. In addition, $66,000 of
interest and financing charges for the loss on extinguishment of
long-term debt were recorded during 2004. The Series A Redeemable
Convertible Preferred Stock, with a face value of $1,316,000, is
convertible into common stock at the lesser of $.12 per share or
85% of the average of the three lowest closing bid prices, as
reported by Bloomberg, for the ten trading days immediately prior
to the notice of conversion subject to adjustments and floor
prices. The holder was entitled to redeem these shares under
certain provisions of the agreement covering the purchase of the
preferred stock. The conversion feature of these preferred shares
resulted in a deemed dividend of $329,000 being recorded and
included in the earnings per share calculation for 2004. In 2004,
358 shares of the preferred stock, with a face value of $358,000
were converted into 5,163,986 shares of common stock. The
remaining 958 shares of this issuance of Series A Redeemable
Convertible Preferred Stock, with a face value of $958,000, were
converted into 13,205,882 shares of common stock during 2005.
The 36,941 shares of Series C convertible preferred stock entitle
the holder of each share, on each anniversary date of the
investment, to convert into the number of shares of common stock
derived by dividing the purchase price paid for each share of the
preferred stock by the average price of the Company's common
stock for the five trading days prior to conversion subject to
anti-dilution provisions and receive royalties of 5% of revenues
related to disease diagnostic testing from the preceding fiscal
year. There were no royalties earned for the years ended
September 30, 2005 or 2004. After one year from the date of
issuance the Company may redeem in whole or in part, into the
number of shares of the Company's common stock derived by
dividing the redemption price, as defined, by the average closing
price of the Company's common stock for the five trading days
prior to the redemption date, and liquidating distributions of an
amount per share equal to the amount of unpaid royalties due to
the holder in the event of liquidation. During 2005 and 2004,
none of these shares was converted into shares of common stock.
The 2,000 shares of 6% convertible preferred stock entitle the
holder to convert, at any time, $1,000,000 invested in 2004 and
$1,000,000 invested in 2003 into shares of common stock at a
conversion price of $.216 and $.15 per share, respectively,
subject to anti-dilution provisions and to receive annual cash
dividends of 6%, payable semi-annually. Warrants to purchase
4,629,630 and 6,666,667 shares of common stock at exercise prices
of $.135 and $.05 per share, respectively, that were issued in
connection with the preferred stock and conversion feature
resulted in a deemed dividend totaling $2,000,000, of which
$1,000,000 was recorded and included in the loss per share
calculation for each of the years ended September 30, 2004 and
September 30, 2003. At September 30, 2004, all the warrants
issued in connection with the 6% convertible preferred stock were
exercised on a cashless basis into 6,790,124 shares of common
stock. Undeclared and unpaid dividends totaled $214,352 and
$94,354 at September 30, 2005 and 2004, respectively. No
dividends were paid in 2005 or 2004.
12. Commitments Leases
ATI and BJR lease office space under non-cancelable operating
leases which expire at various dates through 2010. In July 2005,
the Company renewed the lease for ATI's facility at Canton, MA
for a period of five (5) years. Under the terms of the renewal,
the lessor provided the Company with leasehold improvements of
approximately $67,000 (see Note 10). In addition, the Company
spent $18,243 for leasehold improvements. Certain additional
costs are incurred in connection with the leases and the leases
may be renewed for additional periods.
Rental expense under all operating leases charged to operations
for the years ended September 30, 2005 and 2004 totaled
approximately $471,000 and $494,000, respectively.
12. Commitments
(Continued)
Leases (Continued)
Future minimum rentals are as follows:
-----------------------------------------------------------------
Year ending September 30, Operating
-----------------------------------------------------------------
2006 $ 304,531
2007 312,656
2008 330,781
2009 348,906
2010 and thereafter 271,875
-----------------------------------------------------------------
Total minimum lease payments $1,568,749
=================================================================
Employment Agreements
The Company entered into Employment Agreements (the "Employment
Agreements") with its two principal executives, which payments
thereunder were subsequently assigned to a related party.
Pursuant to the Employment Agreements, if Messrs. Phildius and/or
Scott are terminated without "Cause" (as such term is defined in
the Employment Agreements) by the Company or if Messrs. Phildius
and/or Scott terminate their employment as a result of a breach
by the Company of its obligations under such Agreements, he will
be entitled to receive his annual base salary ($200,000 for Mr.
Phildius and $180,000 for Mr. Scott) for a period of up to 18
months following such termination. In addition, if there is a
"Change of Control" of the Company (as such term is defined in
the Employment Agreements) and, within two years following such
"Change of Control", either of Messrs. Phildius or Scott is
terminated without cause by the Company or terminates his
employment as a result of a breach by the Company, such executive
will be entitled to certain payments and benefits, including the
payment, in a lump sum, of an amount equal to up to two times the
sum of (i) the executive's annual base salary and (ii) the
executive's most recent annual bonus (if any). In addition,
pursuant to the Employment Agreements, Messrs. Phildius and Scott
are each entitled to annual bonus payments of up to $150,000 if
the Company achieves certain levels of pre-tax income (as such
term is defined in such Agreements) or alternative net income
objectives established by the Board of Directors. The agreements
renew automatically on an annual basis and may be terminated upon
60 days written notice by either party. Expenses under these
agreements totaled approximately $380,000 in each of fiscal years
2005 and 2004.
12. Commitments
(Continued)
Retirement Plan
In February 1998, the Company adopted a defined contribution
retirement plan which qualifies under Section 401(k) of the
Internal Revenue Code, covering substantially all employees.
Participant contributions are made as defined in the Plan
agreement. Employer contributions are made at the discretion of
the Company. No Company contributions were made in 2005 or 2004.
Letter of Credit
As security for full and faithful performance of all provisions
of the lease renewal for the facility at Canton, MA, the Company
had to furnish to the landlord an irrevocable letter of credit in
the amount of $150,000. The letter of credit was obtained from a
bank that requires the Company to maintain $150,000 on deposit
with the bank as full collateral for the letter of credit.
13. Stockholders'
Equity(Deficit)
Preferred Stock
Preferred stock shares outstanding consist of the following:
September 30, 2005
-----------------------------------------------------
Series B 5,689
-----------------------------------------------------
Total 5,689
=====================================================
The 5,689 shares of Series B convertible preferred stock issued
and outstanding entitle the holder of each share to: convert it,
at any time, at the option of the holder, into ten shares of
common stock subject to antidilution provisions and receive
dividends amounting to an annual 8% cash dividend or 10% stock
dividend payable in shares of Series B preferred stock computed
on the amount invested, at the discretion of the Company. After
one year from the date of issuance, the Company may redeem, in
whole or in part, the outstanding shares at the offering price in
the event that the average closing price of ten shares of the
Company's common stock shall equal or exceed 300% of the offering
price for any 20 consecutive trading days prior to the notice of
redemption; and liquidating distributions of an amount per share
equal to the offering price. During 2005, none of these shares
was converted into shares of common stock. In 2004, 239 of these
shares were converted into 2,390 shares of common stock.
Undeclared and unpaid dividends amounted to $6,425 and $4,647 at
September 30, 2005 and 2004, respectively. No dividends were paid
in 2005 or 2004.
13. Stockholders' Equity(Deficit) (Continued)
Preferred Stock
(Continued)
The 1,500 shares of Series A Convertible Preferred Stock, with a
face value of $1,500,000, that were outstanding as of September
30, 2004 entitled the holder to receive annual dividends of 4%
payable quarterly and convert, at any time, $1,250,000 and
$250,000 into shares of common stock at the lesser of $.12 and
$.09 per share, respectively, or 85% of the average of the three
lowest closing bid prices, as reported by Bloomberg, for the ten
trading days immediately prior to the notice of conversion
subject to adjustments and floor prices. During 2004, a total of
2,250 shares of the Series A Convertible Preferred Stock, with a
face value of $2,250,000 were sold. Warrants to purchase 100,000
and 125,000 shares of common stock at exercise prices of $.126
and $.095 per share, respectively, that were issued in connection
with the preferred stock and conversion feature for sales of the
preferred stock in 2004 (2,250 shares) resulted in a deemed
dividend totaling $386,000 which was recorded and included in the
loss per share calculation for the year ended September 30, 2004.
As of September 30, 2005, all remaining 1,500 shares of the
Series A Convertible Preferred Stock, with a face value of
$1,500,000, were converted into 17,173,239 shares of common stock
and all dividends thereon were paid. Dividends paid in 2005 and
2004 amounted to $31,001 and $4,201, respectively.
13. Stockholders' Equity(Deficit) (Continued)
Common Stock
Purchase
Warrants
The Company has outstanding warrants entitling the holders to
purchase common stock at the applicable exercise price. In fiscal
2005, no warrants were exercised and warrants covering 1,762,150
shares expired. During fiscal 2004, warrants were exercised for
11,903,844 shares and warrants covering 13,126,164 shares
expired. In fiscal 2005 and 2004, warrants covering 6,393,766 and
5,207,388 shares were issued, respectively, primarily in
connection with convertible notes, common stock and preferred
stock issuances. The fair value of warrants for the right to
purchase 750,000 shares of common stock related to the preferred
stock and redeemable preferred stock issuances in fiscal 2005
amounted to $75,068 that was part of the deemed dividend of
approximately $2,145,000 recorded and included in the earnings
per share calculation for the year ended September 30, 2005
described in Note 11. This amount was recorded and included in
the earnings per share calculation. The fair value of warrants
for the right to purchase 4,854,630 shares of common stock
related to the preferred stock and redeemable preferred stock
issuances in fiscal 2004 resulted in a deemed dividend of
approximately $1,715,000 for the warrants and conversion feature.
This amount was recorded and included in the earnings per share
calculation. The fair value of the warrants for the right to
purchase 5,566,666 shares of common stock issued in 2005 for
discount on notes payable and deferred financing costs related to
convertible notes amounted to approximately $76,368. The fair
value of outstanding warrants at September 30, 2005 is included
on a separate line on the accompanying balance sheet. The
following is a summary of outstanding warrants (all of which are
exercisable) at September 30, 2005.
Exercise Shares Expiration Fair
Price Issuable Date Value
- ----------------------------------------------------------------------------------------------------------------------------
Warrants issued in connection with services in 2001 $.71-$.79 55,000 2006 $ 77
Warrants issued in connection with common
stock issuances in 2002 $.85 700,000 2007 884
Warrants issued in connection with long-term
note payable in 2002 $.31 675,000 2007 2,144
Warrants issued in connection with discounts on
notes payable in 2003 $.01-$.25 213,000 2006 1,618
Warrants issued in connection with common stock
sales in 2003 $.20-$.30 4,326,946 2005-2007 6,781
Warrants issued to placement agent in connection
with sales of preferred stock in 2003 $.20 100,000 2006 161
Warrants issued in connection with deferred rent
costs associated with restructure of facility
lease in 2003 $.20 1,500,000 2013 15,821
Warrants issued in connection with preferred stock
sales in 2004 $.095-$.126 225,000 2009 1,387
Warrants issued to placement agent in connection
with sales of preferred stock in 2003 $.095-$.126 135,000 2009 950
Warrants issued in connection with preferred stock
sales in 2005 $.084-$.126 750,000 2008-2009 12,923
Warrants issued to placement agent in connection
with sales of preferred stock in 2005 $.126 77,100 2009 458
Warrants issued in connection with issuance of
notes payable and convertible notes payable
in 2005 $.033-$.25 2,900,000 2008-2010 34,281
Warrants issued to placement agent in connection
with issuance of convertible notes payable
in 2005 $.25 2,666,666 2010 38,666
---------- --------
Total Shares Issuable 14,323,712 $116,151
========== ========
13. Stockholders' Equity(Deficit) (Continued)
Stock Options
The Company has stock option plans providing for the granting of
incentive stock options for up to 750,000 shares of common stock
to certain employees to purchase common stock at not less than
100% of the fair market value on the date of grant. Each option
granted under the plan may be exercised only during the
continuance of the optionee's employment with the Company or
during certain additional periods following the death or
termination of the optionee. Options granted before fiscal 1999
under the Plan vest after the completion of two years of
continuous service to the Company or at a rate of 50% per year.
Beginning fiscal 1999, options granted vest at a rate of 20% per
year.
During fiscal 1995, the Company adopted a directors' plan, (the
"Directors' Plan"). Under the Directors' Plan, each nonmanagement
director is to be granted options covering 5,000 shares of common
stock initially upon election to the Board, and each year in
which he/she is elected to serve as a director. In fiscal 2001,
the Company adopted a compensation plan for outside directors
that provides for each non-management director to receive options
covering 100,000 shares of common stock upon initial election to
the Board and to receive annual grants of 30,000 shares of common
stock at the fair market value on the date of grant which vest
over three years. In September 2004, the Company increased the
annual grants to 75,000 per year for a non-management director.
Options issued to outside directors totaled 315,000 in fiscal
2005 and 0 in fiscal 2004.
13. Stockholders' Equity(Deficit) (Continued)
Stock Options
(Continued)
During fiscal 2005 and 2004, options to purchase 2,313,700 and
2,061,900 common shares, respectively, were granted primarily to
employees of the Company with exercise prices equal to the
stock's fair value on the grant date. Of the options granted in
fiscal 2005, 1,848,700 were granted outside of the Company's
established plans to management with all of these options
beginning to vest on the anniversary date of the grant at a rate
of 20% per year or in full at the retirement of optionee who has
attained 65 years of age. During fiscal 2005, options to purchase
1,110,000 shares held by employees of the Company were forfeited
or expired and no options held by employees were exercised.
A summary of option transactions is as follows:
Weighted
Average
Shares Price Price
-----------------------------------------------------------------------------
Outstanding at September 30, 2003 8,142,498 $ .72 $.17-$3.19
Forfeited/expired (1,702,348) 1.10 .20 -3.11
Granted 2,061,900 .15 .07 - .30
-----------------------------------------------------------------------------
Outstanding at September 30, 2004 8,502,050 .44 .07 -3.19
Forfeited/expired (1,110,000) .28 .20 -1.25
Granted 2,313,700 .08 .07 - .15
-----------------------------------------------------------------------------
Outstanding at September 30, 2005 9,705,750 $ .38 $.07-$3.19
-----------------------------------------------------------------------------
13. Stockholders' Equity(Deficit) (Continued)
Stock Options
(Continued)
The following tables summarize information about stock options
outstanding and exercisable at September 30, 2005:
Options Outstanding
Weighted-
Number Average Weighted-
Range of of Shares at Remaining Average
Exercise September 30, Contractual Exercise
Prices 2005 Life (years) Price
-----------------------------------------------------------------------------
$ 0.01- $ 0.20 3,864,600 8.9 $ 0.10
0.21- 0.30 875,000 5.4 0.27
0.33- 0.59 3,225,900 3.3 0.35
0.66- 0.94 806,000 5.9 0.75
1.09- 1.36 845,750 5.7 1.26
1.71- 1.71 10,000 4.1 1.71
-----------------------------------------------------------------------------
3.11- 3.19 78,500 4.3 3.13
-----------------------------------------------------------------------------
$ 0.07- $ 3.19 9,705,750 6.14 $ .38
-----------------------------------------------------------------------------
Options Exercisable
Weighted-
Number Average Weighted-
Range of of Shares at Remaining Average
Exercise September 30, Contractual Exercise
Prices 2005 Life (years) Price
-----------------------------------------------------------------------------
$ 0.01- $ 0.20 423,380 7.4 $ 0.12
0.21- 0.30 533,000 3.4 0.26
0.33- 0.59 1,684,650 3.3 0.35
0.66- 0.94 702,300 5.9 0.76
1.09- 1.36 569,450 5.7 1.29
1.71- 1.71 10,000 4.1 1.71
3.11- 3.19 78,500 4.3 3.13
-----------------------------------------------------------------------------
$ 0.07- $ 3.19 4,001,280 4.57 $ .57
-----------------------------------------------------------------------------
13. Stockholders' Equity(Deficit) (Continued)
Loss Per Share
The following data shows the amounts used in computing loss per
share:
September 30, 2005 2004
--------------------------------------------------------------------------------------
Loss from continuing operations before
discontinued operations $ (2,433,157) $ (2,399,110)
Less:
Preferred stock dividends (197,831) (145,579)
Deemed dividends in connection with
preferred stock sales (2,145,260) (1,715,000)
--------------------------------------------------------------------------------------
Loss attributable to common stockholders
from continuing operations before
discontinued operations (4,776,248) (4,259,689)
Add:
Loss from discontinued operations - (12,788)
--------------------------------------------------------------------------------------
Net loss attributable to common shareholders $ (4,776,248) $ (4,272,477)
======================================================================================
Weighted average number of common
shares outstanding 155,778,681 106,658,715
======================================================================================
The following is the basic and diluted loss per share
calculation:
September 30, 2005 2004
----------------------------------------------------------------
Loss per share attributable to common
shareholders before discontinued
operations $(0.03) $(0.04)
Impact of discontinued operations - -
----------------------------------------------------------------
Basic and diluted net loss per share
attributable to common shareholders $(0.03) $(0.04)
----------------------------------------------------------------
13. Stockholders' Equity(Deficit) (Continued)
Loss Per
Share (Continued)
The following table summarizes securities that were outstanding
as of September 30, 2005 and 2004, but not reflected in the
calculation of diluted net loss per share because such shares are
antidilutive:
September 30, 2005 2004
--------------------------------------------------------------------------------------
Stock options 9,705,750 8,502,050
Stock warrants 14,323,712 9,692,096
Redeemable convertible preferred stock
and convertible preferred stock 83,291,891 40,892,498
Convertible notes payable 113,098,290 -
The calculation of the shares above for the redeemable
convertible preferred stock and convertible preferred stock and
the convertible notes were based on the market price of the
common stock as of September 30, 2005 and 2004, respectively.
14. Income Taxes
No provision for Federal income taxes has been made for the years
ended September 30, 2005 or 2004, due to the Company's operating
losses. At September 30, 2005, the Company has unused net
operating loss carryforwards of approximately $50,000,000
including approximately $11,000,000 acquired from ATI which
expire at various dates through 2024. Most of this amount is
subject to annual limitations due to various "changes in
ownership" that have occurred over the past few years.
Accordingly, most of the net operating loss carryforwards will
not be available to use in the future.
As of September 30, 2005, the deferred tax assets related to the
net operating loss carryforwards have been fully offset by
valuation allowances, since the utilization of such amounts is
uncertain.
15. Major Customers
and Suppliers
Customers in excess of 10% of total sales are:
Years ended September 30, 2005 2004
-------------------------------------------------------------
Customer A $1,276,822 $880,322
Accounts receivable from major customers totaled approximately
$205,000 at September 30, 2005.
The Company's current suppliers of certain key material
components are the only vendors that meet the Company's
specifications for such components. The loss of these suppliers
could have a material adverse effect on the Company.
16. Interest Expense
and Financing Costs
Interest expense and financing costs for 2005 and 2004 are:
2005 2004
Interest on short-term and long-term debt $ 76,037 $ 163,214
Discount and deferred financing costs on
long term debt (Notes 9 & 10) 45,706 01,084
Discount on short-term notes payable 112,482 -
Extinguishment of long-term debt (Note 10) - 66,000
Total Interest and Financing Costs $ 234,225 $ 330,298
17. Subsequent Events
From October through December 21, 2005, 224,351 shares of the
Series E redeemable convertible preferred stock with a face value
of $224,351 were converted into 25,458,087 shares of common
stock. In addition, the remaining 150 shares of Series A
redeemable convertible preferred stock, with a face value of
$150,000, were redeemed by the Company for $155,417 which
included accrued dividends of $5,417.
During October 2005, the Company executed additional notes
payable with AJW Partners, LLC, AJW Offshore, Ltd., AJW Qualified
Partners, LLC and New Millennium Capital Partners II, LLC in the
total principal amount of $1,000,000 which is payable at maturity
in October 2008. Interest on these notes is 8% and is payable
quarterly in cash or the Company's common stock at the option of
the Company. The Company issued warrants to purchase 2,000,000
shares of common stock at $.25 per share for five (5) years in
connection with these notes. In addition, the entire principal
plus accrued interest associated with these notes is convertible,
at the holder's option, into the Company's common stock at a
conversion price of 65% of the average of the three (3) lowest
intraday trading prices of the common stock for the twenty (20)
trading days preceding the date that the holders elect to
convert.
17. Subsequent Events
(Continued)
In November, the Company reached an arrangement with the new
owners of USDTL to conclude all outstanding matters related to
the sale of USDTL. Under the terms of this agreement, the Company
received an immediate lump sum payment of $120,000 rather than
waiting for the 10 to 14 years that the Company believed it would
take to collect the entire $500,000 (See Note 3).
18. Change in Accounting
Estimate
The Statement of Operations for the year ended September 30, 2004
reflects a reduction to accrued royalty expense of approximately
$242,000 due to management's revision of estimates of amounts due
to a former supplier under a development agreement. The reduction
of the accrual resulted in reducing selling, general and
administration expenses in the consolidated statement of
operations for fiscal 2004 by $242,000.
19. Related Party Payable
At September 30, 2005, the Company owed approximately $76,000 to
Phildius, Kenyon and Scott that represents the Company's payroll
tax and fringe benefit obligation for Peter Phildius and Douglas
Scott, officers of the Company, for the past thirty-six months.
Avitar, Inc. and Subsidiaries
Consolidated Balance Sheet
March 31, 2006
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 42,633
Accounts receivable, net of reserve of $9,000 509,434
Inventories 424,883
Prepaid expenses and other current assets 129,226
-----------
Total current assets 1,106,176
PROPERTY AND EQUIPMENT, net 314,331
GOODWILL 138,120
OTHER ASSETS 528,477
------------
Total Assets $ 2,087,104
============
LIABILITIES, PREFERRED STOCK AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Notes payable (Note 5) $ 167,007
Convertible notes payable (Note 5) 650,000
Accounts payable 555,901
Accrued expenses 955,150
Deferred income 16,100
Current portion of long-term capital leases 15,598
Current portion of deferred lessor incentive 13,400
Fair value of warrants (Note 11) 89,435
Fair value of embedded derivatives (Note 11) 1,055,941
------------
Total current liabilities 3,518,532
------------
LONG-TERM DEBT, LESS CURRENT PORTION (Note 5) 1,848,309
LONG-TERM CAPITAL LEASES, LESS CURRENT PORTION 6,971
DEFERRED LESSOR INCENTIVE, LESS CURRENT PORTION 43,550
------------
Total liabilities 5,417,362
------------
REDEEMABLE CONVERTIBLE AND CONVERTIBLE PREFERRED
STOCK (Note 6) 2,920,649
------------
COMMITMENTS
STOCKHOLDERS' DEFICIT:
Series B convertible preferred stock, $.01 par value; authorized
5,000,000 shares; 5,689 shares issued and outstanding 58
Common Stock, $.01 par value; authorized 100,000,000 shares;
4,419,344 shares issued and outstanding 44,193
Additional paid-in capital 49,141,698
Accumulated deficit (55,436,856)
------------
Total stockholders' deficit (6,250,907)
------------
Total Liabilities, Preferred Stock and Stockholders' Deficit $ 2,087,104
============
See accompanying notes to consolidated financial statements.
Avitar, Inc. and Subsidiaries
Consolidated Statements of Operations
(Unaudited)
---------------------------------------------------------
THREE MONTHS ENDED MARCH 31, SIX MONTHS ENDED MARCH 31,
---------------------------------------------------------
2006 2005 2006 2005
------------ ------------ ------------ ------------
(As Restated) (As Restated)
SALES $ 1,297,266 $ 955,223 $ 2,204,536 $ 1,991,263
------------ ------------ ------------ ------------
OPERATING EXPENSES
Cost of sales 900,121 714,610 1,559,114 1,430,619
Selling, general and administrative expenses 1,018,392 1,031,620 2,056,999 1,964,282
Research and development expenses 109,248 183,306 238,954 379,749
------------ ------------ ------------ ------------
Total operating expenses 2,027,761 1,929,536 3,855,067 3,774,650
------------ ------------ ------------ ------------
LOSS FROM OPERATIONS (730,495) (974,313) (1,650,531) (1,783,387)
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE)
Interest expense and financing costs (175,851) (23,183) (389,086) (36,369)
Other income (expense), net (128,640) 711,321 (7,298) 190,691
------------ ------------ ------------ ------------
Total other income (expense), net (304,491) 688,138 (396,384) 154,322
------------ ------------ ------------ ------------
LOSS FROM CONTINUING OPERATIONS (1,034,986) (286,175) (2,046,915) (1,629,065)
------------ ------------ ------------ ------------
DISCONTINUED OPERATIONS
Income from the disposal of USDTL - - 120,000 -
------------ ------------ ------------ ------------
Income from discontinued operations - - 120,000 -
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
NET LOSS $(1,034,986) $ (286,175) $(1,926,915) $(1,629,065)
============ ============ ============ ============
BASIC AND DILUTED LOSS PER SHARE FROM CONTINUING
OPERATIONS (Note 9) $ (0.25) $ (0.11) $ (0.51) $ (1.00)
BASIC AND DILUTED INCOME PER SHARE FROM DISCONTINUED
OPERATIONS (Note 9) - - 0.03 -
------------ ------------ ------------ ------------
BASIC AND DILUTED LOSS PER SHARE (Note 9) $ (0.25) $ (0.11) $ (0.48) $ (1.00)
============ ============ ============ ============
WEIGHTED AVERAGE
NUMBER OF COMMON SHARES OUTSTANDING 4,381,414 2,964,149 4,211,563 2,780,826
============ ============ ============ ============
See accompanying notes to consolidated financial statements.
Avitar, Inc. and Subsidiaries
Consolidated Statement of Stockholders' Deficit
Six Months Ended March 31, 2006
(Unaudited)
Preferred Stock Common Stock Total
..................... ........................
Additional Accumulated Stockholders'
Shares Amount Shares Amount paid-in capital deficit Deficit
- ---------------------------------------------- --------- ------------ ---------- ------------ ------------ ------------
Balance at September 30, 2005 5,689 $ 58.00 3,813,189 $ 38,132 $ 48,860,657 $(53,504,524)$(4,605,677)
Conversion of Series E preferred stock - - 509,162 5,091 229,171 - 234,262
Payment of convertible preferred stock
dividend for Series A preferred stock - - - - - (5,417) (5,417)
Sale of common stock - - 6,083 61 2,779 2,840
Conversion of Series C preferred stock - - 90,910 909 49,091 50,000
Net loss - - - - - (1,926,915) (1,926,915)
- ---------------------------------------------- --------- ------------ ---------- ------------ ------------ ------------
Balance at March 31, 2006 5,689 $ 58 4,419,344 $ 44,193 $ 49,141,698 $(55,436,856)$(6,250,907)
- --------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
Avitar, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
SIX MONTHS ENDED MARCH 31,
-----------------------
2006 2005
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(1,926,915) $(1,629,065)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation and amortization 81,151 77,538
Amortization of debt discount and deferred financing 259,398 11,506
Amortization of deferred rent expense - 62,384
Amortization of deferred lessor incentive 6,700 -
(Income) expense from changes in value of embedded derivatives
and warrants 8,524 (189,546)
Changes in operating assets and liabilities:
Accounts receivable 68,697 153,756
Inventories (49,967) (202,157)
Prepaid expenses and other current assets 74,164 2,759
Other assets (4,858) 698
Accounts payable and accrued expenses 103,497 (60,529)
Deferred revenue (150) (13,950)
----------- -----------
Net cash used in operating activities (1,379,759) (1,786,606)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (85,957) (21,725)
----------- -----------
Net cash used in investing activities (85,957) (21,725)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds (repayment) of notes payable and long-term debt (119,437) 206,506
Sales of redeemable preferred stock, common stock and warrants 2,840 1,162,575
Net proceeds from issuance of convertible long-term debt 1,380,000 -
Redemption of Series A redeemable convertible preferred stock (150,000)
Payment of cash dividend on Seires A redeemable convertible preferred stock (5,417) -
----------- -----------
Net cash provided by financing activities1,107,986 1,369,081
----------- -----------
NET DECREASE IN CASH AND CASH EQUIVALENTS (357,730) (439,250)
CASH AND CASH EQUIVALENTS, beginning of the period 400,363 508,876
----------- -----------
CASH AND CASH EQUIVALENTS, end of the period $ 42,633 $ 69,626
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during period:
Income taxes $ - $ -
Interest $ 23,317 $ 16,986
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
FINANCING ACTIVITIES:
During the six months ended March 31, 2006, 224,712 shares of Series
E redeemable convertible preferred stock were converted into
509,162 shares of common stock.
During the six months ended March 31, 2006, 8,333 shares of Series C
convertible preferred stock were converted into 90,910 shares of
common stock.
During the six months ended March 31, 2005, 958 shares of Series A
redeemable convertible preferred stock were converted into 264,118
shares of common stock.
During the six months ended March 31, 2005, 1500 shares of Series A
convertible preferred stock were converted into 343,464 shares of
common stock.
During the six months ended March 31, 2005, 11,749 shares of common
were issued as payment of dividends for Series A convertible and
redeemable convertible preferred stock.
During the six months ended March 31, 2005, warrants to purchase $ 12,673
5,000 shares of common stock were issued in connection with
the issuance of notes payable.
During the six months ended March 31, 2005, 21,515 shares $ 125,000
of common stock were issued as payment of investor and placement
agent fees in connection with SEDA financing.
See accompanying notes to consolidated financial statements.
AVITAR, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
===============================================================================
1. BASIS OF PRESENTATION
Avitar, Inc. (the "Company" or "Avitar") through its wholly-owned
subsidiary Avitar Technologies, Inc. ("ATI") develops, manufactures,
markets and sells diagnostic test products and proprietary hydrophilic
polyurethane foam disposables fabricated for medical, diagnostics, dental
and consumer use. During the first half of FY2006, the Company continued
the development and marketing of innovative point of care oral fluid drugs
of abuse tests, which use the Company's foam as the means for collecting
the oral fluid sample. Through its wholly owned subsidiary, BJR Security,
Inc. (`BJR"), the Company provides specialized contraband detection and
education services.
The Company's one for fifty (1 for 50) reverse split of its common
stock that was authorized by the Company's shareholders at their annual
meeting held on January 18, 2006 became effective at 5:00 PM on February
17, 2006. Accordingly, the numbers of common stock shares and related
calculations presented herein reflect the results of the reverse split for
current and prior reporting periods.
In December 2003, the Company sold the business and net assets,
excluding cash, of its wholly owned subsidiary, United States Drug Testing
Laboratories, Inc. ("USDTL") which operated a certified laboratory and
provided specialized drug testing services primarily utilizing hair and
meconium as the samples. In November 2005, the Company negotiated an
agreement with the new owners of USDTL to settle all outstanding matters
related to the sale of USDTL (see Note 3). Therefore, USDTL is considered a
discontinued operation and this report reflects the continued operations of
the Company. Due to the current financial condition at Avitar, the Company
may consider selling assets and/or operations, including BJR. However, at
the present time, there can be no assurances that the Company would be
successful in these efforts.
During the audit for Fiscal 2005, the Company was advised by its
independent registered public accounting firm that the method used to
account for sales of certain convertible preferred stock and convertible
notes was not in accordance with the requirements of Emerging Issues Task
Force ("EITF") Issue No. 00-19 "Accounting for Derivative Financial
Instruments Indexed To and Potentially Settled In, a Company's Own Stock".
As a result, management determined that certain previously issued financial
statements should not be relied upon. The consolidated financial statements
included herein reflect the correct method to account for the issuance of
various securities and the derivative features embedded therein.
The accompanying consolidated financial statements of the Company have
been prepared in accordance with generally accepted accounting principles
for interim financial information, the instructions to Form 10-QSB and
Regulation S-B (including Item 310(b) thereof). Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
the Company's management, all adjustments (consisting only of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three and six month periods ended March
31, 2006 are not necessarily indicative of the results that may be expected
for the full fiscal year ending September 30, 2006. The accompanying
consolidated financial statements should be read in conjunction with the
audited financial statements of the Company for the fiscal year ended
September 30, 2005. The Company's consolidated financial statements have
been presented on the basis that it is a going concern, which contemplates
the realization of assets and the satisfaction of liabilities in the normal
course of business. The Company has suffered recurring losses from
operations and has a stockholders' deficit as of March 31, 2006 of
$6,250,907. The Company raised net proceeds aggregating approximately
$2,498,000 during the year ended September 30, 2005 from the sale of stock
and warrants. In addition, the Company raised gross proceeds of $900,000
from short-term convertible notes and $1,000,000 from long-term convertible
notes. During the first half of FY2006, the Company raised gross proceeds
of $1,500,000 from long-term convertible notes and received $120,000 from
the settlement agreement related to the sale of USDTL described above and
in Note 3. Subsequent to March 31, 2006, the Company raised gross proceeds
of $500,000 from the final installment of the long-term convertible note
financing agreement executed in September 2005. The Company is working with
placement agents and investment fund mangers to obtain additional equity
financing. Based upon cash flow projections, the Company believes the
anticipated cash flow from operations and most importantly, the expected
net proceeds from future equity financings will be sufficient to finance
the Company's operating needs until the operations achieve profitability.
There can be no assurances that forecasted results will be achieved or that
additional financing will be obtained. The financial statements do not
include any adjustments relating to the recoverability and classification
of asset amounts or the amounts and classification of liabilities that
might be necessary should the Company be unable to continue as a going
concern.
2. INVENTORIES
At March 31, 2006, inventories consist of the following:
Raw Materials $244,419
Work-in-Process 80,223
Finished Goods 100,241
Total $424,883
3. DISCONTINUED OPERATIONS
On December 16, 2003, the Company consummated a sale of USDTL's
business and net assets, excluding cash. Under the terms of that sale, the
buyer must pay the Company 10% of certain annual revenues in excess of
$1,500,000, less any amounts due from the Company for the purchase of
services from the buyer. In November 2005, the Company negotiated an
agreement with the new owners of USDTL to settle all outstanding matters
related to the sale of USDTL. Under the terms of this settlement, the
Company received an immediate lump sum payment of $120,000 rather than
waiting for the 10 to 14 years that the Company believed it would take to
collect the entire $500,000 from uncertain future revenues of USDTL. The
accompanying financial statements reflect USDTL as a discontinued
operation. The following is a summary of the results of its operations for
the three months and six months ended March 31, 2006 and 2005:
Three Months Six Months
Ended March 31, Ended March 31,
--------------------------------------------
2006 2005 2006 2005
---- ---- ---- ----
Sales $ - $ - $ - $ -
Operating expenses - - - -
Other income (expense) - - 120,000 -
--------- -------- --------- ----------
Income from discontinued operations$ $ - - $ 120,000 $ -
========= ======== ========= ==========
4. MAJOR CUSTOMERS
Customers in excess of 10% of total sales are:
Three Months Ended March 31, Six Months Ended March 31,
2006 2005 2006 2005
--------- ---------- ---------- -----------
Customer A $ 310,756 $ 308,375 $ 532,586 $ 562,161
At March 31, 2006, accounts receivable from this major customer
totaled approximately $163,579.
5. NOTES PAYABLE AND SHORT AND LONG-TERM CONVERTIBLE NOTES PAYABLE
In September 2005, October 2005 and February 2006, the Company
executed notes payable with AJW Partners, LLC, AJW Offshore, Ltd., AJW
Qualified Partners, LLC and New Millennium Capital Partners II, LLC in the
total principal amount of $2,500,000 which are payable at maturity in
September 2008, October 2008 and February 2009, respectively. Interest on
these notes is at 8% per annum and is payable quarterly in cash or the
Company's common stock at the option of the Company. The Company issued
warrants to purchase 100,000 shares of common stock at $12.50 per share for
five years in connection with these notes. In addition, the entire
principal plus any accrued and unpaid interest associated with these notes
is convertible, at the holder's option, into the Company's common stock at
a conversion price of 65% of the average of the three lowest intraday
trading prices of the common stock for the twenty trading days preceding
the date that the holders elect to convert. A discount to debt totaling
$765,756 ($708,750 for the fair value of the conversion feature of these
notes and $57,006 for the fair value of the warrants issued in connection
with these notes) was recorded during FY2005 and the first half of FY2006
and is being amortized over the term of the notes. The unamortized discount
was $651,691 as of March 31, 2006. Fees of approximately $340,000 incurred
in connection with securing these loans were recorded as a deferred
financing charge. The collateral pledged by the Company to secure these
notes includes all assets of the Company. A liability of approximately
$765,800 was recorded for the fair value of the warrants issued in
connection with the $2,500,000 of notes and the conversion feature, which
was increased to its market value of approximately $918,000 at March 31,
2006.
From April to August 2005, the Company executed convertible notes with
an individual in the total principal amount of $650,000 with interest at
10%. Each note has a maturity date of six months from the date of the note
and is payable in ten monthly installments plus accrued interest commencing
on the maturity date of the note. The Company issued warrants to purchase
13,000 shares of common stock at $1.65 to $4.95 per share for three (3)
years in connection with these notes. In addition, the entire principal
plus accrued interest associated with these notes is convertible into the
Company's common stock at a conversion price of the lesser of the closing
price of the common stock on the date of the loan or 85% of the average
closing price of the common stock for the five (5) trading days preceding
the notice of conversion. In no event shall the conversion price be lower
than 50% of the closing price of the common stock on the date of the loan.
A discount to debt totaling $172,930 ($156,800 for the value of the
conversion feature of these notes and $16,130 for the value of the warrants
issued in connection with these notes) was recorded during FY2005 and is
being amortized over the term of the notes. The discount was totally
amortized as of March 31, 2006. A liability of approximately $173,000 was
recorded for the fair value of the warrants issued in connection with the
$650,000 of notes and the conversion feature which was reduced to its
market value of $4,248 at March 31, 2006.
6. CONVERTIBLE AND REDEEMABLE CONVERTIBLE PREFERRED STOCK
In April and June 2005, the Company raised net proceeds of
approximately $1,335,000 from the sale of 1,500,000 shares of Series E
Redeemable Convertible Preferred Stock with a face value of $1,500,000 and
Warrants to purchase 3,000 shares of the Company's common stock. The
$1,500,000 of Series E Preferred Stock are convertible into Common Stock at
the lesser of $4.00 per share or 80% of the average of the three lowest
closing bid prices for the ten trading days immediately prior to the notice
of conversion, subject to adjustments and limitations, and the Warrants are
exercisable at $4.20 per share for a period of three years. The warrants
issued in connection with the sale of 1,500,000 shares of preferred stock
and the conversion feature resulted in a deemed dividend of $1,087,000
being recorded and included in the earnings per share calculation for the
year ended September 30, 2005. A liability of approximately $1,087,000 was
recorded for the original fair value of the warrants issued in connection
with the sale of the 1,500,000 shares of preferred stock and the conversion
feature which was reduced to its market value of approximately $167,000 at
March 31, 2006. As of March 31, 2006, 724,351 shares of this preferred
stock had been converted into 735,556 shares of common stock and 775,649
were outstanding. Upon the occurrence of specific events, the holders of
the Series E Redeemable Convertible Preferred Stock are entitled to redeem
these shares under certain provisions of the agreement covering the
purchase of the preferred stock. Accordingly, this security was not
classified as permanent equity.
In December 2004, the Company sold 1,285 shares of Series A Redeemable
Convertible Preferred Stock and Warrants to purchase 12,000 shares of
common stock for which it received net proceeds of approximately
$1,160,000. The Series A Redeemable Convertible Preferred Stock, with a
face value of $1,285,000, is convertible into common stock at the lesser of
$6.00 per share or 85% of the average of the three lowest closing bid
prices, as reported by Bloomberg, for the ten trading days immediately
prior to the notice of conversion subject to adjustments and floor prices.
The warrants are exercisable at $6.30 per share. The warrants issued in
connection with the sale of 1,285 shares of preferred stock and the put
right and the conversion feature resulted in a deemed dividend of
$1,058,260 being recorded and included in the earnings per share
calculation for the year ended September 30, 2005. A liability of
approximately $1,058,260 was recorded for the original fair value of the
warrants issued in connection with the sale of the 1,285 shares of
preferred stock and the conversion feature, which was $3,830 at March 31,
2006. As of March 31, 2006, 1,135 shares of this preferred stock had been
converted into 452,156 shares of common stock and the remaining 150 shares
of Series A redeemable convertible preferred stock, with a face value of
$150,000, were redeemed by the Company in October 2005 for $155,415 which
included accrued dividends of $5,417.
28,608 shares of the Series C convertible preferred stock with a face
value of $145,000 and 2,000 shares of the 6% Convertible preferred stock
with a face value of $2,000,000 are carried at face value on the balance
sheet outside permanent equity as the Company cannot be sure it has
adequate authorized shares for their conversion as of March 31, 2006.
7. COMMON AND PREFERRED STOCK
During the six months ended March 31, 2006, the Company issued 509,162
shares of common stock to holders who converted 224,351 shares of Series E
redeemable convertible preferred stock, 90,910 shares of common stock to a
holder who converted 8,333 shares of Series C convertible preferred stock
and 6,083 shares of common stock to employees who purchased shares through
the Company's Employee Stock Purchase Plan. Dividends for all preferred
stock amounted to $82,153 for the six months ended March 31, 2006 and the
total amount of unpaid and undeclared dividends was $324,039.
8. GOODWILL
As of September 30, 2005, the Company's goodwill was composed of
$138,120 associated with the acquisition of BJR in 2001. In accordance with
SFAS No. 142, the Company evaluated the goodwill related to the BJR
acquisition and determined that no adjustment to the goodwill balance of
$138,120 was deemed necessary since September 30, 2005.
9. LOSS PER SHARE
The following data show the amounts used in computing earnings per share:
Three Months Six Months
Ended March 31, Ended March 31,
2006 2005 2006 2005
------------ ----------- ------------ ------------
Loss from continuing operations $(1,034,986) $ (286,175) $(2,046,915) $(1,629,065)
Less:
Preferred Stock Dividends 39,718) (31,415) (82,153) (81,679)
Deemed dividends in connection
with Series A preferred
stock sales - (-) (-) (1,058,260)
----------- --------- ----------- -----------
Loss attributable to common
stockholders from
continuing operations (1,074,704) (17,590) (2,129,068) (2,769,004)
Add:
Income (loss) from discontinued
operation - - 120,000 (-)
----------- --------- ----------- -----------
Net loss attributable to common
stockholders used in basic and
diluted EPS $(1,074,704) $ (317,590) $(2,009,068) $(2,769,004)
=========== ========= =========== ===========
Weighted average number of
common shares outstanding 4,381,414 2,964,149 4,211,563 2,780,826
=========== ========= =========== ===========
Loss per share applicable to common
stockholders before discontinued
operations $(0.25) $(0.11) $(0.51) $(1.00)
Impact of discontinued operations - - .03 -
----------- --------- ----------- -----------
Basic and diluted loss per share
applicable to common
stockholders $(0.25) $(0.11) $(0.48) $(1.00)
=========== ========= =========== ===========
10. STOCK OPTIONS
The Company accounts for its stock-based compensation plans using the
intrinsic value method in accordance with the provisions of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and complies with the disclosure
provisions of SFAS No. 123, Accounting for Stock- Based Compensation, and SFAS
No. 148, Accounting for Stock-Based Compensation- Transition and Disclosure. No
stock-based employee compensation cost was reflected in net loss for the
quarters and six months ended March 31, 2006 or 2005, as all options granted
under those plans had an exercise price equal to the fair market value of the
underlying common stock on the date of grant.
The following table illustrates, in accordance with the provisions of SFAS No.
148, Accounting for Stock-Based Compensation - Transition and Disclosure, the
effect on net loss and loss per share if the Company had applied the fair value
recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation,
to stock-based employee compensation.
Three Months Ended March 31, Six Months Ended March 31,
2006 2005 2006 2005
----------- ----------- ------------ ------------
Net loss $(1,034,986) $ (286,175) $ (1,926,915) $ (1,629,065)
Add: stock based
employee compensation
expense included in reported net loss,
net of tax - - - -
Deduct: total stock based employee
compensation expense determined
under the fair value based method for
all awards, net of tax (30,742) (37,450) (61,337) (67,145)
----------- ----------- ------------ -----------
Pro forma net loss $(1,065,728) $ (323,625) $ (1,988,252) $(1,696,210)
=========== =========== ============ ===========
Loss per share:
Basic and diluted - as reported $ (.24) $ (.11) $ (.47) $ (.61)
Basic and diluted - pro forma (.24) (.11) (.47) (.61)
In determining the pro forma amounts above, the Company estimated the fair value
of each option granted using the Black-Scholes option pricing model with the
following weighted-average assumptions:
March 31 2006 2005
Risk free interest rate 4.3% 3.8%
Expected dividend yield - -
Expected lives 5-9 years 5-9 years
Expected volatility 80% 80%
Options granted during the quarter and six months ended March 31, 2006 totaled
7,000 while the options granted for the three and six months ended March 31,
2005 amounted to 42,274. The weighted average fair value of options granted
during the six months ended March 31, 2006 and 2005 was $.42 and $3.50,
respectively.
11. DERIVATIVES
The Company has issued and outstanding convertible debt and certain
convertible equity instruments with embedded derivative features. The Company
analyzes these financial instruments in accordance with SFAS No. 133 and EITF
Issue Nos. 00-19 and 05-02 to determine if these hybrid contracts have embedded
derivatives which must be bifurcated. In addition, free-standing warrants are
accounted for as equity or liabilities in accordance with the provisions of EITF
Issue No. 00-19. As of March 31, 2006, the Company could not be sure it had
adequate authorized shares for the conversion of all outstanding instruments due
to certain conversion rates which vary with the fair value of the Company's
common stock and therefore all embedded derivatives and freestanding warrants
are recorded at fair value, marked-to-market at each reporting period, and are
carried on separate lines of the accompanying balance sheet. If there is more
than one embedded derivative, their value is considered in the aggregate.
12. SUBSEQUENT EVENTS
Subsequent to March 31, 2006, the Company executed additional notes payable
with AJW Partners, LLC, AJW Offshore, Ltd., AJW Qualified Partners, LLC and New
Millennium Capital Partners II, LLC in the total principal amount of $500,000.
The gross proceeds of $500,000 received from these notes represent the final
installments of the $3,000,000 long-term convertible note financing agreement
executed by the Company in September 2005. The prior installments of this
financing are described in Note 5. As part of the final closing of the
$3,000,000 long-term convertible note financing, the Company received the
remainder of the gross proceeds although there was no effective registration
statement for the resale of the common stock into which the notes could be
converted. An effective registration statement was a condition to such funding.
In consideration for such funding without the effective registration statement,
on May 4, 2006 the Company agreed to cancel all warrants theretofore issued to
AJW Partners, LLC, AJW Offshore, Ltd., AJW Qualified Partners, LLC and New
Millennium Capital Partners II, LLC and in lieu thereof issued 3 million
warrants in the aggregate to the same parties in the same proportions, but
exercisable for 7 years at $1.25 per share instead of 5 years at $12.50 per
share. The reduced exercise price still substantially exceeded the market price
of the common stock, which had closed at $0.30 on May 3, 2004.
13. RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment"
("SFAS 123R"), which replaces SFAS 123, "Accounting for Stock-Based
Compensation," and supersedes APB Opinion no. 25, "Accounting for Stock Issued
to Employees." SFAS 123R requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the financial
statements based on their fair values. The effective date for entities that file
as a small business issuer is as of the beginning of the first annual reporting
period that begins on or after December 15, 2005 Therefore, under the current
rules, the Company will be required to adopt SFAS 123R in the first quarter of
fiscal 2007.
Under SFAS 123R, pro forma disclosures previously permitted will no longer
be an alternative to financial statement recognition. The Company must determine
the appropriate fair value model to be used for valuing share-based payments to
employees, the amortization method for compensation cost and the transition
method to be used at the date of adoption. The transition methods include
modified prospective and retrospective adoption options. Additionally, SFAS 123R
clarifies the timing for recognizing compensation expense for awards subject to
acceleration of vesting on retirement and also specifies the treatment of excess
tax benefits associated with stock compensation.
In March 2005, the SEC issued Staff Accounting Bulletin No. 107 ("SAB 107")
regarding the SEC's interpretation of SFAS 123R and the valuation of share-based
payments for public companies. Avitar is evaluating the requirements of SFAS
123R and SAB 107 and expects that the adoption of SFAS 123R will have a material
impact on Avitar's consolidated results of operations and earnings per share.
The Company has not yet determined the method of adoption or the effect of
adopting SFAS 123R, and it has not determined whether the adoption will result
in amounts that are similar to the current pro forma disclosures under SFAS 123.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs" ("SFAS
151"), an amendment of Accounting Research Bulletin ("ARB") No. 43, Chapter 4,
"Inventory Pricing". SFAS 151 amends previous guidance regarding treatment of
abnormal amounts of idle facility expense, freight, handling costs, and
spoilage. This statement requires that those items be recognized as current
period charges regardless of whether they meet the criterion of "so abnormal"
which was the criterion specified in ARB No. 43. In addition, this Statement
requires that allocation of fixed production overheads to the cost of the
production be based on normal capacity of the production facilities. This
pronouncement was effective for the Company beginning October 1, 2005. The
adoption of SFAS 151 by the Company did not have a material impact on its
consolidated results of operations and financial condition.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections" ("SFAS 154") which replaces APB Opinions No. 20 "Accounting
Changes" and SFAS No. 3, "Reporting Accounting Changes in Interim Financial
Statements" An Amendment of APB Opinion No. 28. SFAS 154 provides guidance on
the accounting for and reporting of accounting changes and error corrections. It
establishes retrospective application, or the latest practicable date, as the
required method for reporting a change in accounting principle and the reporting
of a correction of an error. SFAS 154 is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005 and
is required to be adopted by Avitar in the first quarter of fiscal 2007. The
Company is currently evaluating the effect that the adoption of SFAS 154 will
have on its consolidated results of operations and financial condition, but does
not expect it will have a material impact.