25
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Quarter Ended March 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 000-29058
LIFESTREAM TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
NEVADA 82-0487965
------ ----------
(State of other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
510 CLEARWATER LOOP, SUITE 101, POST FALLS, IDAHO 83854
(Address of principal executive offices)
(208) 457-9409
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days: YES [X] NO [ ]
As of May 11, 2001, the registrant had 20,255,114 shares of its $.001 par value
common stock outstanding.
Transitional Small Business Disclosure Format: YES [ ] NO [X]
LIFESTREAM TECHNOLOGIES, INC.
INDEX TO
QUARTERLY REPORT ON FORM 10-QSB
FOR THE FISCAL QUARTER ENDED MARCH 31, 2001
PART I. FINANCIAL INFORMATION
Page
Item 1. Condensed Consolidated Financial Statements
(unaudited)
Condensed Consolidated Balance Sheets at March 31, 2001 and June 30, 2000 ................ 2
Condensed Consolidated Statements of Operations for the three and nine month periods ended
March 31, 2001 and March 31, 2000 ...................................................... 3
Condensed Consolidated Statements of Cash Flows for the three and nine month periods ended
March 31, 2001 and March 31, 2000 ...................................................... 4
Notes to Interim Condensed Consolidated Financial Statements ............................. 5
Item 2. Management's Discussion and Analysis ............................................ 10
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ............................................................... 23
Item 2. Changes in Securities and Use of Proceeds ....................................... 23
Item 3. Defaults Upon Senior Securities ................................................. 23
Item 4. Submission of Matters to a Vote of Security Holders ............................. 23
Item 5. Other Information ............................................................... 23
Item 6. Exhibits and Reports on Form 8-K ................................................ 23
This report may contain forward-looking statements that involve certain risks
and uncertainties. When used in this discussion, the words "anticipate,"
"believe," "estimate," "expect," and similar expressions as they relate to the
Company or its management are intended to identify such forward-looking
statements. The Company's actual results could differ materially from the
results anticipated in these forward-looking statements as a result of certain
factors set forth under "Management's Discussion and Analysis - Risk Factors"
and elsewhere in this report.
1
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION
ITEM 1. INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited)
March 31, June 30,
2001 2000
----------- -------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 107,574 $ 1,059,637
Accounts receivable 443,062 13,786
Inventories 2,367,039 445,767
Prepaid expenses 37,136 8,419
------------ ------------
Total current assets 2,954,811 1,527,609
Equipment and leasehold improvements, net 1,028,565 480,308
Software technology, net 1,109,414 1,591,083
Patent and license rights, net 1,218,591 1,312,113
Note receivable - Officer 93,974 18,836
Other assets 34,185 16,380
------------ ------------
Total assets $ 6,439,540 $ 4,946,329
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,645,687 $ 158,036
Accrued liabilities 252,536 90,037
Deferred revenue 422,982 --
Current maturities of capital lease obligations 100,753 30,186
Current maturities of note payable 547,301 36,330
------------ ------------
Total current liabilities 2,969,259 314,589
Capitalized lease obligations, less current maturities 105,235 20,216
Notes payable, less current maturities 39,357 69,632
Convertible debt 1,090,000 50,000
------------ ------------
Total liabilities 4,203,851 454,437
------------ ------------
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value, 5,000,000 shares authorized,
no shares issued or outstanding -- --
Common stock, $.001 par value, 50,000,000 shares authorized,
20,255,114 and 19,210,304 issued and outstanding, respectively 20,255 19,210
Additional paid-in capital 19,456,217 17,445,275
Accumulated deficit (17,240,783) (12,972,593)
------------ ------------
Total stockholders' equity 2,235,689 4,491,892
------------ ------------
Total liabilities and stockholders' equity $ 6,439,540 $ 4,946,329
============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended Nine Months Ended
-------------------------- --------------------------
March 31, March 31,
2001 2000 2001 2000
-------------------------- --------------------------
Net sales $ 518,702 $ 34,311 $ 597,809 $ 115,366
Cost of sales 393,513 47,166 482,404 119,090
----------- ----------- ----------- -----------
Gross profit (loss) 125,189 (12,855) 115,405 (3,724)
Operating expenses:
Sales and marketing 229,048 143,135 767,183 334,093
General and administrative 515,035 406,665 1,592,417 927,770
Professional services 218,719 441,180 703,245 576,498
Product research and development 92,744 185,791 331,177 358,118
Depreciation and amortization 303,005 259,616 852,657 655,441
----------- ----------- ----------- -----------
Loss from operations (1,233,362) (1,449,242) (4,131,274) (2,855,644)
Interest, net, and other (47,422) 733,263 (136,916) 400,210
----------- ----------- ----------- -----------
Net loss $(1,280,784) $ (715,979) $(4,268,190) $(2,455,434)
=========== =========== =========== ===========
Net loss per share - Basic $ (0.06) $ (0.04) $ (0.22) $ (0.16)
=========== =========== =========== ===========
Net loss per share - Diluted $ (0.06) $ (0.04) $ (0.22) $ (0.16)
=========== =========== =========== ===========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Nine Months Ended
-----------------------------
March 31, March 31,
2001 2000
----------- ------------
OPERATING ACTIVITIES:
Net loss $(4,268,190) $(2,455,434)
Non cash items:
Depreciation and amortization 852,657 655,441
Provision for inventory obsolescence 2,864 --
Issuances of common stock and common stock options for services 619,482 630,558
Issuance of common stock with convertible debt -- 270,000
Contingently issuable common stock -- (719,120)
Net change in current assets and liabilities, net of business acquired:
Accounts receivable (429,276) 5,124
Inventories (1,924,136) (267,824)
Prepaid expenses (28,717) 30,099
Accounts payable 1,487,651 29,590
Accrued liabilities 162,499 (213,415)
Deferred revenue 422,982 --
Increase in other non-current assets (17,805) (69,059)
----------- -----------
Net cash used in operating activities (3,119,989) (2,104,040)
----------- -----------
INVESTING ACTIVITIES:
Purchase of equipment and leasehold improvements (756,625) (132,911)
Software technology (69,098) --
Advances to officer, net (75,138) 867
Cash in business acquired -- 78
----------- -----------
Net cash used in investing activities (900,861) (131,966)
----------- -----------
FINANCING ACTIVITIES:
Proceeds from capital lease obligations incurred 266,780 --
Principal payments on capital lease obligations (111,194) (18,086)
Proceeds from issuances of notes payable 500,000 --
Principal payments on notes payable (19,304) (527,038)
Proceeds from issuances of convertible debt 1,040,000 540,000
Proceeds from sales of common stock 1,157,000 3,858,000
Proceeds from exercises of stock options 235,505 30,482
----------- -----------
Net cash provided by financing activities 3,068,787 3,883,358
----------- -----------
Net (decrease) increase in cash and cash equivalents (952,063) 1,647,352
Cash and cash equivalents, beginning 1,059,637 81,656
----------- -----------
Cash and cash equivalents, ending $ 107,574 $ 1,729,008
=========== ===========
SUPPLEMENTAL CASH FLOW DATA:
Cash paid for interest $ 30,734 $ 23,880
Issuances of common stock in exchange for:
Business acquired -- 1,798,142
Financing costs 98,435 428,748
Conversion of debt 0 270,000
The accompanying notes are an integral part of these condensed consolidated
financial statements
4
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Interim Condensed Consolidated Financial Statements
Nature of Operations and Basis of Presentation
Lifestream Technologies, Inc. (the "Company"), a Nevada corporation, is a
healthcare information technology company primarily focused on developing and
marketing secure, Internet-based medical solutions through the use of
proprietary smart card-enabled medical diagnostic devices. The Company's current
product line consists of a professional-use cholesterol monitor and an
over-the-counter, consumer-use cholesterol monitor. Both monitors measure total
cholesterol levels in the blood and have received market clearances from the
United States Food and Drug Administration ("FDA").
These interim condensed consolidated financial statements include the operations
of the Company and its two wholly owned subsidiaries, Lifestream Diagnostics,
Inc. and Secured Interactive Technologies, Inc. All material intercompany
accounts and transactions have been eliminated in consolidation.
Fiscal Periods
References to a fiscal year refer to the calendar year in which such fiscal year
ends. The Company's fiscal year ends on June 30th.
Preparation of Interim Condensed Consolidated Financial Statements
These interim condensed consolidated financial statements have been prepared by
the Company's management, without audit, in accordance with accounting
principles generally accepted in the United States and, in the opinion of
management, contain all adjustments (consisting of only normal recurring
adjustments) necessary to present fairly the Company's consolidated financial
position, results of operations and cash flows for the periods presented.
Certain information and note disclosures normally included in consolidated
annual financial statements prepared in accordance with accounting principles
generally accepted in the United States have been condensed or omitted in these
consolidated interim financial statements, although the Company believes that
the disclosures are adequate to make the information presented not misleading.
The consolidated financial position, results of operations and cash flows for
the interim periods disclosed herein are not necessarily indicative of future
financial results. These interim condensed consolidated financial statements
should be read in conjunction with the annual consolidated financial statements
and the notes thereto included in the Company's latest Annual Report on Form
10-KSB for the fiscal year ended June 30, 2000.
Use of Estimates
The preparation of interim condensed consolidated financial statements in
conformity with accounting principles generally accepted in the United States
requires management to make certain estimates and assumptions that affect the
reported amounts of assets, liabilities, revenues and expenses and disclosure of
contingent assets and liabilities at the date of the interim condensed
consolidated financial statements. Actual results could differ from those
estimates.
Reclassifications
Certain amounts in the consolidated financial statements for the prior fiscal
year periods have been reclassified to be consistent with the current fiscal
year's presentation.
5
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
1. Interim Condensed Consolidated Financial Statements (continued)
Revenue Recognition
The Company recognizes sales and the related cost of sales upon product
shipment, provided that all material risks and rewards of ownership are
concurrently transferred from the Company to its customer, collection of the
related receivable is reasonably assured, and management is able to reliably
estimate an appropriate allowance for related sales returns based on relevent
historical product experience and future expectations.
Recently Adopted Accounted Standards
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standard No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 requires that every
derivative instrument (including certain derivative instruments embedded in
other contracts) be recorded in the balance sheet as either an asset or
liability measured at its fair value and that subsequent changes in fair value
be recognized currently in earnings unless specific hedge accounting criteria
are met. In June 1999, the FASB issued Statement of Financial Accounting
Standard No. 137, "Accounting for Derivative Instruments and Hedging Activities
- - Deferral of the Effective Date of FASB Statement No. 133" delaying the
effective date of SFAS No. 133. In June 2000, the FASB issued Statement of
Financial Accounting Standard No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities" amending certain accounting and
reporting standards of SFAS No. 133. The Company adopted the provisions of SFAS
No. 133, as amended, effective July 1, 2000 for its fiscal 2001 financial
statements. As the Company was not a party to any derivative instruments, the
cumulative effect of adoption did not have a material impact on the Company's
financial statements.
Recently Issued Accounting Standards and SEC Staff Accounting Bulletins Not Yet
Adopted
In December 1999, the United States Securities and Exchange Commission released
Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements". SAB 101 provides interpretive guidance on the proper recognition,
presentation and disclosure of revenues in financial statements. The Company
will adopt SAB 101, as required, in its consolidated financial statements for
the fourth quarter of fiscal 2001. However, as the Company believes that its
current revenue recognition policies comply with accounting principles generally
accepted in the United States and the related interpretive guidance set forth in
SAB 101, the adoption of SAB 101 is not expected to have a material impact on
the Company's consolidated financial statements.
In May 2000, the Emerging Issues Task Force ("EITF") issued EITF 00-14,
"Accounting for Certain Sales Incentives" ("EITF 00-14"). Under the provisions
of EITF 00-14, for sales incentives that will not result in a loss on the sale
of product or service, a vendor should recognize the "cost" of the sales
incentive at the latter of the date the related revenue is recorded by the
vendor or the date the sales incentive is offered. The reduction to or refund of
the selling price of the product or service resulting from any cash sales
incentive should be classified as a reduction of revenue. In April 2001, the
EITF delayed the effective date of EITF 00-14. The Company will adopt EITF
00-14, as required, in its consolidated financial statements for the third
quarter of fiscal 2002 with restatement of all comparative prior period
financial statements. The adoption of EITF 00-14 is not expected to have a
material impact on the Company's consolidated financial statements.
6
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Recently Issued Accounting Standards and SEC Staff Accounting Bulletins Not Yet
Adopted (continued)
In July 2000, the EITF issued EITF 00-10, "Accounting for Shipping and Handling
Fees and Costs" ("EITF 00-10"). Under the provisions of EITF 00-10, amounts
billed to a customer in a sale transaction related to shipping and handling
represent revenues earned for the goods provided and should be classified as
sales revenue. The provisions of EITF 00-10 prohibit the netting of related
shipping and handling costs against sales revenue and require disclosure of the
dollar amount of any significant shipping and handling costs excluded from cost
of sales. In September 2000, the EITF made an addition to the final consensus
reached at the July 2000 meeting requiring that the income statement
classification of any significant shipping and handling costs also be disclosed
pursuant to APB Opinion No. 22, "Disclosure of Accounting Policies." The Company
will adopt EITF 00-10, as required, in its consolidated financial statements for
the fourth quarter of fiscal 2001 with restatement of all comparative prior
period financial statements. As the Company includes shipping and handling
revenues within net sales and related shipping and handling costs within cost of
sales, the adoption of EITF 00-10 will not have a material impact on the
Company's consolidated financial statements.
In April 2001, the EITF issued EITF 00-25, "Accounting for Consideration from a
Vendor to a Retailer in Connection with the Purchase or Promotion of the
Vendor's Products" ("EITF 00-25"). Under the provisions of EITF 00-25, it is
presumed, in the absence of persuasive evidence to the contrary, that
consideration from a vendor to a purchaser of the vendor's products should be
charecterized as a reduction of revenue when recognized in the vendor's income
statement. This presumption is overcome and the consideration should be
charecterized as a cost incurred if, the vendor receives, or will receive, an
identifiable benefit (i.e., goods or services) in return for the consideration
and the vendor can reasonably estimate the fair value of the benefit. The
Company will adopt EITF 00-25, as required, in its consolidated financial
statements for the third quarter of fiscal 2002 with restatement of all
comparative prior period financial statements. The adoption of EITF 00-25 is not
expected to have a material impact on the Company's consolidated financial
statements.
2. Financial Condition and Liquidity
On January 1, 1999, the Company commenced revenue-generating operations related
to its professional-use cholesterol monitor and ceased being a development-stage
company. In March 1999, the Company recognized its first revenues from sales of
its professional-use cholesterol monitor. However, shortly thereafter, the
Company's management elected to curtail the marketing of its professional-use
cholesterol monitor and instead deploy the Company's limited capital resources
into the development of an over-the-counter, consumer-use cholesterol monitor
for which management envisioned, and continues to envision, significantly larger
market and revenue potential. On July 25, 2000, the Company received the
prerequisite FDA market clearance for its over-the-counter, consumer-use
cholesterol monitor thereby allowing it to proceed with production and
marketing. In November 2000, the Company began fulfilling initial purchase
orders received from a limited number of high-profile, national and regional
retailers for its consumer-use cholesterol monitor. To date, the Company has
been successful in obtaining additional purchase orders from certain of these
retailers as well as in obtaining initial and repeat purchase orders from a
number of other high-profile national and regional retailers. The Company has
also begun to once again actively market its professional-use cholesterol
monitor. However, despite the Company's marketing successes to date, it must be
noted that the Company's ability to broadly market and efficiently produce its
cholesterol monitors will continue to be severely constrained should it be
unsuccessful in its ongoing capital raising efforts - See Liquidity and Capital
Resources below. As such, there can be no assurance that the revenue-generating
potential the Company's management perceives for its cholesterol monitors will
ever be realized.
7
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
2. Financial Condition and Liquidity (continued)
The Company has incurred significant operating and net losses since its
inception and, as a result, has a substantial accumulated deficit at March 31,
2001. The Company continues to actively pursue measures aimed at improving its
current liquidity and capital resource positions. These actions include seeking
new sources of capital or funding to allow the Company to continue marketing and
producing its cholesterol monitors.
Between September 13, 2000 and March 31, 2001, the Company obtained $500,000 in
unsecured financing from a financial institution with which a member of its
Board of Directors ("Director") is affiliated and to which he provided a
personal guarantee. These borrowings accrue interest at the financial
institution's prevailing prime rate plus two percent, with all outstanding
principal and interest due and payable on or before September 13, 2001. The
Director may elect at any time to repay all outstanding principal and accrued
interest on the Company's behalf, and to the extent that an appropriate
conversion price can be mutually agreed upon, he may subsequently convert the
assumed debt and interest balance into common shares of the Company. There are
no related covenants or restrictions.
Between February 12, 2001 and March 5, 2001, the Company also obtained
$1,000,000 in financing from one of its existing principal investors
("Investor") in exchange for a convertible note payable. The note accrues
interest, payable monthly, at the prevailing prime rate plus two percent and is
secured by all the assets of the Company, other than its accounts receivable.
The principal balance is due no later than March 5, 2003 and the Investor may
demand earlier repayment should the Company be successful in obtaining
sufficient unrestricted capital or funding from other sources. The Investor may
also at any time elect to convert all or part of the outstanding principal
balance into common shares of the Company at a stated conversion price of $1.00
per common share with attached warrants at $2.50 per share.
There can be no assurances that the Company will ultimately be successful in any
of its ongoing capital-raising efforts or in the execution of its overall
business plan. Any failure by the Company to raise sufficient funds in a timely
manner or to effectively execute its business plan will have a material adverse
impact on its business, results of operations, liquidity and cash flows.
3. Inventories
Inventories consist of supplies, component parts, dry chemistry test strips and
assembled devices. Inventories are stated at lower of cost (first-in, first-out
method) or market. Inventories consist of the following:
March 31, June 30,
2001 2000
---------------- ---------------
Raw materials $1,427,333 $421,397
Work in process 353,282 54,792
Finished goods 586,424 9,313
---------------- ---------------
2,367,039 485,502
Less; Provision for inventory obsolescence 0 39,735
--------------- ---------------
Total inventories $2,367,039 $445,767
================ ===============
8
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO THE INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Loss Per Share
The following is a reconciliation of the number of common shares used in the
computations of net loss per basic and diluted share. Net loss per basic common
share is computed by dividing net loss by the weighted average number of common
shares outstanding for the period. Net loss per diluted common share is the same
as net loss per basic common share as the effects that could occur if securities
or other contracts to issue common stock (e.g., stock options, stock warrants
and convertible debt) were exercised or converted into common stock would be
anti-dilutive:
Three Months Ended Nine Months Ended
----------------------------------------------------------------------
March 31, March 31, March 31, March 31,
2001 2000 2001 2000
----------------------------------------------------------------------
Net loss ($1,280,784) ($ 715,979) ($ 4,268,190) ($2,455,434)
======================================================================
Average shares outstanding used to
determine net loss per basic common
share 20,202,536 17,957,124 19,782,089 15,401,059
Net effect of dilutive stock options
based on the treasury stock method - - - -
using average market price (1)
----------------------------------------------------------------------
Average shares used to determine net
loss per diluted common share 20,202,536 17,957,124 19,782,089 15,401,059
======================================================================
(1) Excluded anti-dilutive shares issuable through stock options, stock
warrants and convertible debt were 1,452,429 and 2,883,962 for the
three months ended March 31, 2001 and March 31, 2000, respectively, and
2,650,962 and 1,377,429 for the nine months ended March 31, 2001 and
March 31, 2000, respectively.
9
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS
The following discussion includes certain forward-looking statements within the
meaning of the federal securities laws. Such forward-looking statements include,
but are not limited to, statements regarding our current business strategies,
objectives and plans that involve risks and uncertainties. When used in this
discussion, the words "anticipate," "believe," "estimate," "expect," and similar
expressions are intended to identify such forward-looking statements. These
forward-looking statements are based on our current expectations and our actual
performance, results and achievements could differ materially from those
expressed in, or implied by, these forward-looking statements. Factors, within
and beyond our control, that could cause or contribute to such differences
include, among others, the following: those associated with developing and
marketing medical diagnostic devices, including technological advancements and
innovations, identifying, recruiting and retaining highly qualified personnel,
consumer receptivity and preferences, availability, affordability and coverage
terms of private and public medical insurance, political and regulatory
environments and general economic and business conditions; competition; success
of capital-raising, operating, marketing and growth initiatives; development and
operating costs; advertising and promotional efforts; brand awareness; the
existence or absence of adverse publicity; changes in business strategies or
development plans; quality and experience of management; availability, terms and
deployment of capital; business abilities and judgment of personnel; labor and
employee benefit costs; as well as those factors discussed elsewhere in this
Form 10-QSB and in our most recent Form 10-KSB for the fiscal year ended June
30, 2000 filed with the United States Securities and Exchange Commission.
References to a fiscal year refer to the calendar year in which such fiscal year
ends. Our fiscal year ends on June 30th.
Our Company Overview
We are a healthcare information technology company primarily focused on
developing and marketing secure, Internet-based medical solutions through the
use of proprietary smart card-enabled medical diagnostic devices. Our current
diagnostic product line consists of two easy-to-use, hand-held, smart
card-enabled cholesterol monitors, one specifically designed for facility-use by
professional medical service providers and one specifically designed for at home
use by at-risk cholesterol patients and health conscious consumers. Both
monitors share certain core technological capabilities, primarily being the
ability to measure total cholesterol levels in the blood with proven clinical
laboratory accuracy in approximately three minutes and the ability to
cumulatively store the resulting cholesterol test results on an integrated smart
card. Using a complimentary feature unique to our professional-use monitor, the
medical professional operator can additionally input via the monitor's keypad
eight other cardiac risk factors (e.g., gender, age, weight, tobacco use, etc.)
identified by the Framingham Heart Disease Epidemiological Study ("Framingham
Study") and determine the cardiac condition of the patient.
Both of our monitors have also been developed to ultimately take advantage of
our proprietary Internet technology, Privalink TM, which currently is in beta
testing. Once fully developed and available, our Privalink TM system will allow
for the cholesterol test results and any other patient medical data stored on
the smart card to be encryptically downloaded via the Internet to a secured
website we currently have under construction. This value-added capability will
allow both patients and their authorized medical providers to use the Internet
to conveniently retrieve this stored medical data, along with related scientific
literature, thereby promoting effective communication and coordination between
physician, pharmacist and patient. Although there can be no assurance of such,
we currently anticipate that our PrivalinkTM system, initially with a limited
number of basic capabilities, will become available, on a user fee or
subscription basis, on or about September 30, 2001.
In its "2000 Heart and Stroke Statistical Update", the American Heart
Association ("AHA") estimates that approximately 40 million American adults have
"high" total blood cholesterol levels (240 and higher milligrams per deciliter)
and approximately 60 million other Americans have "borderline-high" cholesterol
levels (200 - 239 milligrams per deciliter). The AHA, as well as the Framingham
Study, have identified elevated blood cholesterol as a primary contributor to
coronary heart disease ("CHD"), the single largest killer of American males and
females, as well as other forms of cardiovascular disease. Of the estimated
600,000 CHD-related deaths in the United States ("U.S.") during 1997, the AHA
estimates that about 225,000 died without ever being hospitalized and, in 50% of
the men and 63% of the women who died suddenly of CHD, there were no previous
symptoms of CHD. The AHA also sights CHD as the leading cause of premature,
permanent disability in the U.S. labor force, accounting for 19% of disability
allowances by the Social Security Administration. The AHA also estimates that
CHD prevention and treatment costs alone exceed $100 billion annually with more
than 750,000 new patients entering cholesterol-lowering drug therapy programs
each month.
10
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Our Company Overview (continued)
Because of the recognized medical importance of managing cholesterol and
preventing CHD, the National Cholesterol Education Program ("NCEP") was formed
to educate consumers and professionals about the importance of knowing an
individual's cholesterol level and to establish guidelines for the detection,
evaluation and treatment of high cholesterol in adults. To detect cholesterol
risk and aid in therapy compliance, the NCEP recommends a whole blood total
cholesterol test at least once every five years, and if cholesterol levels are
categorized as high, every three months.
Medical professionals have traditionally been the only source for cholesterol
testing and such testing has typically been performed with a bench top analyzer
requiring a considerable sample of whole blood and generally taking 24 to 48
hours to produce results. Although some bench top analyzers have more recently
evolved to utilize dry chemistry strip technology, such as that utilized in our
monitors, thereby eliminating the previously required and critical segregation
of red blood cells from serum/plasma for an accurate result, they continue to
require relatively large amounts of whole blood in precise measurements and
generally require a minimum of five minutes, excluding the time required for
blood drawing and centrifugation, to produce results. Additionally, as the cost
of a single bench top analyzer can approach $2,000, the resulting patient test
costs can also be a deterrent to routine cholesterol monitoring.
Accordingly, our efforts to date primarily have focused on meeting what we
perceive to be a continuing widespread need in the professional and consumer
markets for a more affordable, timely and convenient means of accurately testing
for blood cholesterol levels. We believe that our professional-use and
over-the-counter, consumer-use cholesterol monitors meet this widespread need,
providing easier to operate, more cost-effective and faster results-producing
alternatives to traditional bench top analyzers for use in routine cholesterol
testing, monitoring and treatment programs. We believe that the potential
societal benefits of our monitors will be earlier detection of high cholesterol
levels by at-risk individuals, more timely interventions by medical
professionals, more actively engaged and informed patients, and ultimately,
reductions in cholesterol-related disabilities and deaths.
Both our professional-use and over-the-counter, consumer-use cholesterol
monitors have received market clearances from the U.S. Food and Drug
Administration ("FDA") and meet all NCEP guidelines for precision. Both monitors
operate on the power of a single nine-volt battery and are compact, lightweight
and portable. Either monitor can be easily and discreetly carried in a medical
bag, purse or briefcase. To perform a cholesterol test on either monitor, the
operator merely sticks the finger using a reusable lance device equipped with a
disposable lancet and deposits a single drop of blood on a dry chemistry strip.
The strip then initiates a chroma-graphic reaction with lipoprotein to produce a
color change in direct proportion to the quantity of total cholesterol in the
blood sample. The resulting color change is "read" by the monitor's integrated
photometry system and converted electronically to a quantitative digital
read-out that is displayed within three minutes on an integrated easy-to-read,
liquid crystal display ("LCD") screen. Ongoing test results may be stored on an
integrated, encryption-based smart card thereby maintaining a complete history
of test results. We believe that there are no other hand-held, quantitative
cholesterol monitoring systems that are easier to use, more accurate and quicker
in obtaining results. Our professional-use cholesterol monitor was introduced
into the marketplace in March 1999 and currently has a suggested retail price of
$299.95. We recently introduced our over-the-counter, consumer-use cholesterol
monitor into the marketplace in November 2000 with a suggested retail price of
$129.95. The users of our monitors must additionally purchase our dry chemistry
test strips, which have a suggested retail price of $19.95 for a box of six
single-use test strips.
11
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Our Company Overview (continued)
Our overriding corporate objective is to ultimately establish our proprietary
cholesterol monitors and complimentary PrivalinkTM system as the consumer
standard of care for personal health and wellness and the medical industry
standard for virtual patient record storage and retrieval. We plan to achieve
our objective by:
>> Achieving and maintaining market leadership through innovative product
introductions and extensions
>> Leveraging what we believe to be our superior technological
capabilities
>> Accelerating our penetration of targeted markets through key strategic
marketing alliances
>> Aggressively targeting the consumer channel with the continued
introduction of our FDA-approved, Over-The-Counter, Consumer-Use
Cholesterol Monitor
>> Obtaining and promoting independent third party endorsements by leading
healthcare authorities
>> Developing and introducing other proprietary, Internet-enabled medical
diagnostic devices to allow consumers to better manage their health
>> Positioning our products as the preferred tools for personal health
management of chronic diseases
We have recently employed a number of professionals with extensive backgrounds
in the medical products industry that we believe will assist us in executing our
business plan. In addition, we recently renegotiated our existing license and
supply agreement with Roche. The new agreement became effective January 1, 2001
and has a four-year term with an additional one-year option to renew. Provided
that we meet certain minimum purchase requirements, Roche will continue to
supply us with dry chemistry test strips for our cholesterol monitors but with
more favorable licensing fees, strip pricing and payment terms. In the absence
of a material breach of contract, the agreement also provides that Roche will
not market any competing cholesterol monitors in the United States.
12
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Our Results of Operations
On January 1, 1999, we commenced revenue-generating operations related to our
professional-use cholesterol monitor and ceased being a development-stage
company. In March 1999, we recognized our first revenues from sales of our
professional-use cholesterol monitor. However, shortly thereafter, we elected to
curtail the marketing of our professional-use cholesterol monitor and instead
deploy our limited capital resources into the development of an
over-the-counter, consumer-use cholesterol monitor for which we envisioned, and
continues to envision, significantly larger market and revenue potential. On
July 25, 2000, we received the prerequisite FDA market clearance for our
over-the-counter, consumer-use cholesterol monitor thereby allowing us to
proceed with production and marketing. In November 2000, we began fulfilling
initial purchase orders received from a limited number of high-profile, national
and regional retailers for our consumer-use cholesterol monitor. To date, we
have been successful in obtaining additional purchase orders from certain of
these retailers as well as in obtaining initial and repeat purchase orders from
a number of other high-profile national and regional retailers. We have also
begun to once again actively market our professional-use cholesterol monitor.
However, despite our marketing successes to date, it must be noted that our
ability to broadly market and efficiently produce our cholesterol monitors will
continue to be severely constrained should we be unsuccessful in our ongoing
capital raising efforts - See Liquidity and Capital Resources below. As such,
there can be no assurance that the revenue-generating potential we perceive for
our cholesterol monitors will ever be realized.
Our net sales for the three months ended March 31, 2001 ("the fiscal 2001 third
quarter") were $518,702, as compared to only $34,311 for the three months ended
March 31, 2000 ("the fiscal 2000 third quarter"). For the nine months ended
March 31, 2001 ("the first nine months of fiscal 2001"), our net sales were
$597,809 as compared to only $115,366 for the nine months ended March 31, 2000
("the first nine months of fiscal 2000"). The vast majority of our fiscal 2001
net sales were derived from sales of our recently debuted over-the-counter,
consumer-use cholesterol monitor, whereas all of our fiscal 2000 net sales were
derived from sales of our professional-use cholesterol monitor. At March 31,
2001, our balance sheet reflects deferred revenue of $422,982 that represents
shipments of our over-the-counter, consumer-use cholesterol monitor to a
national retailer for which we have deferred revenue recognition pursuant to
Statement of Financial Accounting Standards No. 48 "Revenue Recognition When
Right of Returns Exist". These revenues will be recognized at such time as we
accumulate historical product returns experience sufficient to enable us to
reliably estimate and correspondingly record an accrual for related product
returns.
Cost of sales includes direct labor, material and overhead, including product
shipping and handling costs. Our cost of sales for the fiscal 2001 third quarter
and first nine months were $393,513 and $482,404, respectively, as compared to
$47,166 and $119,090 for the fiscal 2000 third quarter and first nine months,
respectively. Our resulting gross margins were 24.1% and 19.3% for the fiscal
2001 third quarter and first nine months, respectively, as compared to gross
margins of (37.5)% and (3.2)% for the fiscal 2000 third quarter and first nine
months, respectively. Limited unit sales of our cholesterol monitors to date and
introductory wholesale pricing discounts granted to achieve market penetration
with retailers have resulted in reductions to our targeted gross revenues and
margins. Our ability to realize significantly improved gross margins in the
future remains contingent upon our cholesterol monitors receiving broader market
exposure and acceptance which, in turn, will enable us to realize improved
prices and realize various economies of scale. In addition, we are currently
pursuing a number of initiatives aimed at reducing our component costs, and
thereby reducing our overall manufacturing cost per monitor.
Our total operating expenses were $1,358,551 for the fiscal 2001 third quarter,
a decrease of $77,836, or 5.4%, from the $1,436,387 incurred during the fiscal
2000 third quarter. Our total operating expenses were $4,246,679 for the first
nine months of fiscal 2001, an increase of $1,394,759, or 48.9%, from the
$2,851,920 incurred during the first nine months of fiscal 2000. These
increases, as further detailed below, primarily are attributable to various
costs incurred in connection with developing and marketing of our recently
debuted over-the-counter, consumer-use cholesterol monitor.
13
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Our Results of Operations (continued)
Our sales and marketing expenses were $229,048 for the fiscal 2001 third
quarter, an increase of $85,913, or 60.0%, from the $143,135 incurred during the
fiscal 2000 third quarter. For the first nine months of fiscal 2001, our sales
and marketing expenses were $767,183, an increase of $433,090, or 129.6%, from
the $334,093 incurred during the first nine months of fiscal 2000. Both fiscal
2001 increases primarily are attributable to various incremental costs being
incurred in connection with marketing our recently debuted over-the-counter,
consumer-use cholesterol monitor, including additional sales, marketing and
customer service personnel, trade show attendance and participation,
advertising, and point-of-sale promotional materials.
Our general and administrative expenses were $515,035 for the fiscal 2001 third
quarter, an increase of $108,370, or 26.7%, from the $406,665 incurred during
the fiscal 2000 third quarter. For the first nine months of fiscal 2001, our
general and administrative expenses were $1,592,417 (inclusive of $151,680) in
non-cash charges), an increase of $664,647, or 71.6%, from the $927,770
(inclusive of $60,270) in non-cash charges) incurred during the first nine
months of fiscal 2000. Both fiscal 2001 increases primarily are attributable to
various incremental corporate infrustructure costs necessary to support our
increased sales and marketing activities, including additional management,
technical and administrative support personnel, increased telecommunications,
and additional leased space for our packaging operations. To a lesser extent,
the fiscal 2001 periods also reflect increased Board of Directors fees and
investor relations costs, including certain incremental costs incurred in
connection with the listing of our common stock on the American Stock Exchange
beginning in October 2000 - Ticker Symbol "KFL".
Our professional service expenses were $218,719 (inclusive of $93,834 in
non-cash charges) for the fiscal 2001 third quarter, a decrease of $222,461, or
50.4%, from the $441,180 (inclusive of $287,000 in non-cash charges) incurred
during the fiscal 2000 third quarter. For the first nine months of fiscal 2001,
our professional service expenses were $703,245 (inclusive of $302,210 in
non-cash charges), an increase of $126,747, or 22.0%, from the $576,498
(inclusive of $302,000 in non-cash charges) incurred during the first nine
months of fiscal 2000. The decrease for the fiscal 2001 third quarter primarily
is attributable to the comparative fiscal 2000 third quarter including
significant, non-cash stock compensation to an investor relations consultant.
The increase for the first nine months of fiscal 2001 primarily is attributable
to incremental legal fees incurred in connection with new patent filings and
patent enforcement litigation, and, to a lesser extent, increased recruiting,
consulting, accounting and public relations fees.
Our product research and development expenses were $92,744 (inclusive of $17,500
in non-cash charges) for the fiscal 2001 third quarter, a decrease of $93,047,
or 50.1%, from the $185,791 incurred during the fiscal 2000 third quarter. For
the first nine months of fiscal 2001, our product research and development
expenses were $331,177 (inclusive of $27,133 in non-cash charges), a decrease of
$26,941, or 7.5%, from the $358,118 incurred during the first nine months of
fiscal 2000. Both fiscal 2001 decreases primarily are attributable to the fiscal
2000 third quarter including substantial, non-recurring clinical trials costs
for our over-the-counter, consumer-use cholesterol monitor. Partially offsetting
the decrease for the first nine month of fiscal 2001 are various product
development costs incurred in completing our recently debuted over-the-counter,
consumer-use cholesterol monitor.
Our non-cash depreciation and amortization expenses were $303,005 for the fiscal
2001 third quarter, an increase of $43,389, or 16.7%, from the $259,616 incurred
during the fiscal 2000 third quarter. For the first nine months of fiscal 2001,
our non-cash depreciation and amortization expenses were $852,657, an increase
of $197,216, or 30.1%, from the $655,441 incurred during the first nine months
of fiscal 2000. The increase for the fiscal 2001 third quarter primarily is
attributable to recently acquired packaging equipment and leasehold
improvements. The increase for the first nine months of fiscal 2001 additionally
reflects amortization of software technology acquired in our September 3, 1999
acquisition of Secured Interactive Technologies, Inc.
14
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Our Results of Operations (continued)
Primarily as a result of the foregoing, our losses from operations for the
fiscal 2001 third quarter and first nine months were $1,233,362 and $4,131,274,
respectively. This compares to our losses from operations for the fiscal 2000
third quarter and first nine months of $1,449,242 and $2,855,644, respectively.
Our non-operating expenses and income primarily consist of interest income,
interest expense and other miscellaneous income and expense items. Our net
non-operating expense was $47,422 for the fiscal 2001 third quarter as compared
to net non-operating income of $733,263 (inclusive of $664,960 in net non-cash
income) for the fiscal 2000 third quarter. For the first nine months of fiscal
2001, our net non-operating expense was $136,916 (inclusive of $92,341 in
non-cash charges) as compared to net non-operating income of $400,210 (inclusive
of $598,712 in net non-cash income) for the first nine months of fiscal 2000.
The comparative fiscal 2000 periods reflect substantial non-cash, non-operating
income as a result of our incremental reversing of an $867,000 liability
recognized at June 30, 1999 for the entire potential cost of an inducement made
to convertible promissory note holders to exercise their common stock conversion
rights. As the closing market price of our common stock at each subsequent
fiscal quarter-end continued to increase, and ultimately exceed, the price
guarantee provided to these individuals, we were required by U.S. generally
accepted accounting principles to correspondingly adjust the potential cost of
the inducement at each fiscal quarter-end. At March 31, 2000, the originally
recorded liability of $867,000 was fully reversed. Partially offsetting these
reversals during the first nine months of fiscal 2000 were other non-cash,
financing costs incurred in inducing certain individuals with common shares to
provide us with short-term financing necessary to extinguish a note payable
which had become due. Absent these non-cash items, the fiscal 2001 periods
reflect increased interest expense as a result of generally increased debt
levels.
We incurred a net loss of $1,280,784 ($0.06 per basic and diluted share) for the
fiscal 2001 third quarter as compared to a net loss of $715,979 ($0.04 per basic
and diluted share) for the fiscal 2000 third quarter. For the first nine months
of fiscal 2001, we incurred a net loss of $4,268,190 ($0.22 per basic and
diluted share) as compared to a net loss of $2,455,434 ($0.16 per basic and
diluted share) for the first nine months of fiscal 2000.
Our Liquidity and Capital Resources
The Company has incurred significant operating and net losses since its
inception and, as a result, has a substantial accumulated deficit at March 31,
2001. We continue to actively pursue measures aimed at improving the Company's
current liquidity and capital resource positions. These actions include seeking
new sources of capital or funding to allow us to continue marketing and
producing our cholesterol monitors.
Between September 13, 2000 and March 31, 2001, we obtained $500,000 in unsecured
financing from a financial institution with which a member of our Board of
Directors ("Director") is affiliated and to which he provided a personal
guarantee. These borrowings accrue interest at the financial institution's
prevailing prime rate plus two percent, with all outstanding principal and
interest due and payable on or before September 13, 2001. The Director may elect
at any time to repay all outstanding principal and accrued interest on the
Company's behalf, and to the extent that an appropriate conversion price can be
mutually agreed upon, he may subsequently convert the assumed debt and interest
balance into common shares of the Company. There are no related covenants or
restrictions.
Between February 12, 2001 and March 5, 2001, we also obtained $1,000,000 in
financing from one of our existing principal investors ("Investor") in exchange
for a convertible note payable. The note accrues interest, payable monthly, at
the prevailing prime rate plus two percent and is secured by all the assets of
the Company, other than its accounts receivable. The principal balance is due no
later than March 5, 2003 and the Investor may demand earlier repayment should we
successful in obtaining sufficient unrestricted capital
15
ITEM 2. OUR MANAGEMENT'SDISCUSSION AND ANALYSIS (continued)
Our Liquidity and Capital Resources (continued)
or funding from other sources. The Investor may also at any time elect to
convert all or part of the outstanding principal balance into common shares of
the Company at a stated conversion price of $1.00 per common share.
There can be no assurances that we will ultimately be successful in any of our
ongoing capital-raising efforts or in the execution of our overall business
plan. Any failure by us to raise sufficient funds in a timely manner or to
effectively execute our business plan will have a material adverse impact on the
Company's business, results of operations, liquidity and cash flows.
Our operating activities consumed $3,119,989 in cash and cash equivalents during
the first nine months of fiscal 2001, an increase of $1,015,949, or 48.3%, from
the $2,104,040 in cash and cash equivalents consumed during the first nine
months of fiscal 2000. The increased consumption rate for the first nine months
of fiscal 2001 primarily is attributable to our increased net loss coupled with
the negative cash flow effects of increased inventories, accounts receivable,
prepaid expenses and non-current other assets. Partially offsetting these
negative cash flow effects were the positive cash flow effects of increased
accounts payable, deferred revenue and accrued liabilities, as well as the
adding back of increased non-cash depreciation and amortization. Our operating
cash flow for the comparative first nine months of fiscal 2000 also reflects the
net positive effect of the non-cash, non-operating income and expense items
previously discussed in Management's Discussion and Analysis - Results of
Operations. We have historically financed our operations through the issuance of
common stock and debt securities.
Our investing activities utilized $900,861 in cash and cash equivalents during
the first nine months of fiscal 2001, an increase of $768,895, or 582.6%, from
the $131,966 in cash and cash equivalents utilized during the first nine months
of fiscal 2000. The increased utilization during first nine months of fiscal
2001 primarily is attributable to investments in packaging equipment, computer
hardware and software, and leasehold improvements, and, to a significantly
lesser extent, advances to an officer.
Our financing activities provided $3,068,787 in cash and cash equivalents during
the first nine months of fiscal 2001, a decrease of $814,571, or 21.0%, from the
$3,883,358 in cash and cash equivalents provided by financing activities during
the first nine months of fiscal 2000. The decrease in cash and cash equivalents
provided by financing activities during the first nine months of fiscal 2001
primarily is attributable to decreased proceeds from sales of common stock.
Partially offsetting these decreased cash flows were the positive cash flow
effects of increased proceeds from issuances of convertible debt and notes
payable, exercises of stock options and, to a lesser extent, increased capital
lease obligations.
As a result of the foregoing, we had cash and cash equivalents of $107,574 and
$1,059,637 at March 31, 2001 and June 30, 2000, respectively. Our working
capital was ($14,448) and $1,213,020 at March 31, 2001 and June 30, 2000,
respectively.
We currently have no material commitments for capital equipment. We anticipate
that any capital equipment needs for the foreseeable future will be met through
operating leases.
16
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Our Other Matters
Seasonal and Inflationary Influences
We currently are not materially impacted by seasonal or inflationary influences.
Quantitative and Qualitative Disclosures About Market Risk
We currently are not exposed to financial market risks from changes in foreign
currency exchange rates and are only modestly impacted by changes in interest
rates. However, in the future, we may enter into transactions denominated in
non-U.S. currencies or increase the level of our borrowings, which could
increase our exposure to these market risks. We have not used, and currently do
not contemplate using, any derivative financial instruments.
Recently Issued Accounting Standards and SEC Staff Accounting Bulletins Not Yet
Adopted
In December 1999, the United States Securities and Exchange Commission released
Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements". SAB 101 provides interpretive guidance on the proper recognition,
presentation and disclosure of revenues in financial statements. The Company
will adopt SAB 101, as required, in its consolidated financial statements for
the fourth quarter of fiscal 2001. However, as the Company believes that its
current revenue recognition policies comply with accounting principles generally
accepted in the United States and the related interpretive guidance set forth in
SAB 101, the adoption of SAB 101 is not expected to have a material impact on
the Company's consolidated financial statements.
In May 2000, the Emerging Issues Task Force ("EITF") issued EITF 00-14,
"Accounting for Certain Sales Incentives" ("EITF 00-14"). Under the provisions
of EITF 00-14, for sales incentives that will not result in a loss on the sale
of product or service, a vendor should recognize the "cost" of the sales
incentive at the latter of the date the related revenue is recorded by the
vendor or the date the sales incentive is offered. The reduction to or refund of
the selling price of the product or service resulting from any cash sales
incentive should be classified as a reduction of revenue. In April 2001, the
EITF delayed the effective date of EITF 00-14. The Company will adopt EITF
00-14, as required, in its consolidated financial statements for the third
quarter of fiscal 2002 with restatement of all comparative prior period
financial statements. The adoption of EITF 00-14 is not expected to have a
material impact on the Company's consolidated financial statements.
In July 2000, the EITF issued EITF 00-10, "Accounting for Shipping and Handling
Fees and Costs" ("EITF 00-10"). Under the provisions of EITF 00-10, amounts
billed to a customer in a sale transaction related to shipping and handling
represent revenues earned for the goods provided and should be classified as
sales revenue. The provisions of EITF 00-10 prohibit the netting of related
shipping and handling costs against sales revenue and require disclosure of the
dollar amount of any significant shipping and handling costs excluded from cost
of sales. In September 2000, the EITF made an addition to the final consensus
reached at the July 2000 meeting requiring that the income statement
classification of any significant shipping and handling costs also be disclosed
pursuant to APB Opinion No. 22, "Disclosure of Accounting Policies." The Company
will adopt EITF 00-10, as required, in its consolidated financial statements for
the fourth quarter of fiscal 2001 with restatement of all comparative prior
period financial statements. As the Company includes shipping and handling
revenues within net sales and related shipping and handling costs within cost of
sales, the adoption of EITF 00-10 will not have a material impact on the
Company's consolidated financial statements.
In April 2001, the EITF issued EITF 00-25, "Accounting for Consideration from a
Vendor to a Retailer in Connection with the Purchase or Promotion of the
Vendor's Products" ("EITF 00-25"). Under the
17
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Our Other Matters (continued)
Recently Issued Accounting Standards and SEC Staff Accounting Bulletins Not Yet
Adopted (continued) provisions of EITF 00-25, it is presumed, in the absence of
persuasive evidence to the contrary, that consideration from a vendor to a
purchaser of the vendor's products should be charecterized as a reduction of
revenue when recognized in the vendor's income statement. This presumption is
overcome and the consideration should be charecterized as a cost incurred if,
the vendor receives, or will receive, an identifiable benefit (i.e., goods or
services) in return for the consideration and the vendor can reasonably estimate
the fair value of the benefit. The Company will adopt EITF 00-25, as required,
in its consolidated financial statements for the third quarter of fiscal 2002
with restatement of all comparative prior period financial statements. The
adoption of EITF 00-25 is not expected to have a material impact on the
Company's consolidated financial statements.
Risk Factors
History of Operating Losses and Need For Additional Capital/Funding To Fully
Execute Our Business Plan. On January 1, 1999, we commenced revenue-generating
operations related to our professional-use cholesterol monitor and ceased being
a development-stage company. In March 1999, we recognized our first revenues
from sales of our professional-use cholesterol monitor. However, shortly
thereafter, we elected to curtail the marketing of our professional-use
cholesterol monitor and instead deploy our limited capital resources into the
development of an over-the-counter, consumer-use cholesterol monitor for which
we envisioned, and continue to envision, significantly larger market and revenue
potential. On July 25, 2000, we received the prerequisite FDA market clearance
for our over-the-counter, consumer-use cholesterol monitor thereby allowing us
to proceed with production and marketing. In November 2000, we began fulfilling
initial purchase orders received from a limited number of high profile, national
and regional retailers for our consumer-use cholesterol monitor. To date, we
have been successful in obtaining additional purchase orders from certain of
these retailers as well as in obtaining initial and repeat purchase orders from
a number of other high-profile national and regional retailers. We have also
begun to once again actively market our professional-use cholesterol monitor.
However, despite our marketing successes to date, it must be noted that our
ability to broadly market and efficiently produce our cholesterol monitors will
continue to be severely constrained should we be unsuccessful in our ongoing
capital raising efforts - See Liquidity and Capital Resources. As such, there
can be no assurance that the revenue-generating potential we perceive for our
cholesterol monitors will ever be realized.
The Company has incurred significant operating and net losses since its
inception and, as a result, has a substantial accumulated deficit at March 31,
2001. We continue to actively pursue measures aimed at improving the Company's
current liquidity and capital resource positions. These actions include seeking
new sources of capital or funding to allow us to continue marketing and
producing our cholesterol monitors.
Between September 13, 2000 and March 31, 2001, we obtained $500,000 in unsecured
financing from a financial institution with which a member of our Board of
Directors ("Director") is affiliated and to which he provided a personal
guarantee. These borrowings accrue interest at the financial institution's
prevailing prime rate plus two percent, with all outstanding principal and
interest due and payable on or before September 13, 2001. The Director may elect
at any time to repay all outstanding principal and accrued interest on the
Company's behalf, and to the extent that an appropriate conversion price can be
mutually agreed upon, he may subsequently convert the assumed debt and interest
balance into common shares of the Company. There are no related covenants or
restrictions.
Between February 12, 2001 and March 5, 2001, we also obtained $1,000,000 in
financing from one of our existing principal investors ("Investor") in exchange
for a convertible note payable. The note accrues interest, payable monthly, at
the prevailing prime rate plus two percent and is secured by all the assets of
the
18
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Risk Factors (continued)
History of Operating Losses and Need For Additional Capital/Funding To Fully
Execute Our Business Plan (continued). Company, other than its accounts
receivable. The principal balance is due no later than March 5, 2003 and the
Investor may demand earlier repayment should we successful in obtaining
sufficient unrestricted capital or funding from other sources. The Investor may
also at any time elect to convert all or part of the outstanding principal
balance into common shares of the Company at a stated conversion price of $1.00
per common share.
There can be no assurances that we will ultimately be successful in any of our
ongoing capital-raising efforts or in the execution of our overall business
plan. Any failure by us to raise sufficient funds in a timely manner or to
effectively execute our business plan will have a material adverse impact on the
Company's business, results of operations, liquidity and cash flows.
We have incurred significant operating and net losses since our inception and,
as a result, have a substantial accumulated deficit at March 31, 2001. We
recently began fulfilling initial purchase orders received from a limited number
of high-profile, national retailers for our over-the-counter, consumer-use
cholesterol monitor which we believe has a significantly larger market and
revenue potential than our professional-use cholesterol monitor. However, our
ability to broadly market and efficiently produce our cholesterol monitors has
been and continues to be severely constrained by our limited capital resources.
As such, there can be no assurance that the revenue-generating potential we
perceive for our cholesterol monitors will ever be realized.
Limited Marketing Experience and Uncertain Market Acceptance of Products. While
certain members of our management team have significant and relevant marketing
experience in healthcare diagnostics, as a company we have limited experience
marketing our professional-use or consumer-use cholesterol monitors.
Additionally, we are currently working with third party representatives to
engage medical product distributors to market our cholesterol monitors. While we
have engaged one distributor directly, our third party representatives have only
held preliminary discussions with a limited number of distributors to date. It
is possible that we will be unsuccessful in retaining suitable distributors for
our professional-use product. Additionally, there can be no assurance that these
distributors will be successful in introducing and marketing our monitors in the
professional marketplace. In the consumer market, we are approaching the
traditional consumer retail channel, via internal sales personnel and
traditional independent manufacturer representatives. While we have had initial
success in achieving agreements with certain national and regional retailers, we
have no assurance that the balance of our distribution efforts will match our
early success. Additionally, achieving adequate distribution does not
necessarily guarantee consumer purchase of our consumer cholesterol monitor.
Finally, although our initial marketing plan does not focus on such, it should
be noted that we have no experience as a company in marketing our products in
foreign countries.
Lack of Assembly Experience and Dependence on Certain Sources of Supply. We have
limited experience to date in assembling our professional-use cholesterol
monitor and minimal experience in assembling our over-the-counter, consumer-use
cholesterol monitor. Prior to any significant increase in the current production
of our cholesterol monitors, we will have to select and qualify various sources
of supply and remain able to manufacture in compliance with regulatory
requirements, in sufficient quantity, with appropriate quality and at acceptable
costs. There also can be no assurance that we would be able to pass through any
incremental costs incurred to our customers. We are also highly dependent upon
Roche and LRE as the sole supplier of the diagnostic modules, dry chemistry test
strips and calibration keys required for our cholesterol monitors. Should any
party be unable to meet its respective continuing obligations under the
contract, we will be forced to either find another suitable supplier for these
critical items or make substantial capital and personnel investments to allow us
to internally produce these critical items. Although we believe that suitable
alternative sources are available for our other components, any
19
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Risk Factors (continued)
Lack of Assembly Experience and Dependence on Certain Sources of Supply
(continued). interruptions in our supply of components or raw materials would
likely have at least a short-term material adverse effect on our business,
financial position, results of operations and cash flows.
Dependence on Key Personnel. We believe that our future success is highly
dependent upon the continued services of Christopher Maus, our Chairman, Chief
Executive Officer and President. We believe that the loss of Mr. Maus' services
would likely have a material adverse effect on our business, results of
operations, liquidity and cash flows. We currently maintain a key man life
insurance policy on the life of Mr. Maus in the amount of $5,000,000. There can
be no assurances that we would be able to replace Mr. Maus in the event his
services become unavailable or that the proceeds from the above insurance policy
would sufficiently compensate us for the loss of Mr. Maus' services.
We are also highly dependent upon the principal members of our current
management team. Furthermore, our successful recruiting and retaining of certain
additional key personnel will be critical to our future success. Although we
believe that we have been successful to date in recruiting and retaining skilled
and experienced management, marketing and scientific personnel, there can be no
assurance that we will continue to be successful in recruiting and retaining key
personnel on acceptable terms, particularly given the current intensely
competitive environment for highly-qualified and experienced individuals.
Competition. The development and marketing of medical products is intensely
competitive. There are other companies that are currently marketing, or are
seeking to market, diagnostic products that compete with our professional-use
and over-the-counter, consumer-use cholesterol monitors. Some of these competing
products have received the prerequisite FDA marketing clearances for competing
with our monitors. Furthermore, several companies offering products similar to
ours have substantially greater financial, marketing and technological resources
than we currently have. As such, there can be no assurance that our products
will be able to successfully compete with these existing or future products. Our
cholesterol monitors compete, and will continue to compete, with established
medical laboratories that have traditionally performed most blood analysis.
Certain of our laboratory competitors currently offer services that may be
perceived by some individuals as being priced lower than the costs of utilizing
our cholesterol monitors. We also cannot currently provide the same range of
tests provided by these laboratories. In addition, certain health care providers
may choose not to change their established means for such tests or make the
necessary capital investment to purchase our products. We also face competition
in the alternate-site market from makers of bench top multi-test blood analyzers
and other point-of-care blood analyzers.
While we believe that our products will be able to successfully compete with
clinical laboratories, bench top multi-test analyzers and other point-of-care
blood analyzers on the basis of ease of use, portability, the ability to conduct
tests without a skilled technician, cost effectiveness and quality of results,
there can be no assurance that we will be able to compete successfully. Blood
analysis is a well-established field in which there are a number of competitors
that have substantially greater financial resources and larger, more established
marketing, sales and service organizations than we currently have. As such,
there can be no assurance that our products will be competitive with the
existing or future products or services of our competitors.
Other companies having a significant presence in the professional market for
diagnostic screening and therapeutic monitoring, such as Abbott Laboratories,
Clinical Diagnostic Systems (a division of Johnson & Johnson) and Boehringer
Mannheim GmbH (a subsidiary of Roche Holdings Ltd.), have developed or are
developing analyzers designed for preventive care testing. These competitors
have substantially greater financial, technical, research and other resources
and larger, more established marketing, sales, distribution and service
organizations. However, we believe that we currently have a competitive
advantage due to the
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ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Risk Factors (continued)
Competition (continued). design and cardiac risk factor analysis capabilities of
our professional-use cholesterol monitor as a hand-held, quantitative,
affordable and regulatory approved instrument. However, there can be no
assurance that our professional-use cholesterol monitor will be able to compete
with these other analyzers and testing devices or that our competitors will not
succeed in obtaining further government approvals or in developing or marketing
technologies or products that are more commercially attractive than our current
or future products.
Government Regulation. In the past, we have been successful in obtaining all
required U.S. regulatory approvals, however, the process of obtaining marketing
clearances or approvals can be costly and time-consuming and there can be no
assurance that further clearances or approvals will be granted to us with
respect to any future products or that FDA review will not involve delays
adversely affecting the marketing and sale of any new products developed by us.
Moreover, our current approvals as well as any future approvals remain subject
to continual review and the subsequent discovery of previously unknown problems
may result in certain marketing restrictions or a complete withdrawal of the
product from the market. We also remain subject to FDA regulations with respect
to various other matters, including our manufacturing practices, record-keeping
and reporting. For instance, the FDA requires the integration of their quality
system into any facility it registers as a "medical device facility". The
quality system requirement ("QSR") encompasses product development ("GDP") and
manufacturing, customer service, incident reporting and labeling control
("GMP"). Our assembly facility in Post Falls, Idaho is registered with the FDA
and operates under the quality provisions of the FDA as well as under those of
the ISO-9001 quality system. Our assembly facility as well as our production
processes will remain subject to periodic audits on an ongoing basis by the FDA.
In addition, the use of our products may be regulated by various state agencies.
Although we believe that we will be able to comply with all applicable
regulations of the FDA, including QSR, GMP and GDP guidelines, current FDA
regulations and state regulations depend heavily on administrative
interpretations. As such, there can be no assurance that future interpretations
made by the FDA or other regulatory bodies, with possible retroactive effect,
will not adversely affect our business, results of operations, liquidity and
cash flows.
Although our primary marketing focus for the foreseeable future will be the
domestic U.S. market, we anticipate eventually attempting to market our products
overseas. Regulatory requirements pertaining to cholesterol monitors, as well as
other medical diagnostic devices, vary widely from country to country and can
range from simple product registrations to detailed submissions such as those
required by the U.S. FDA. There can be no assurance that we will be successful
in obtaining the requisite regulatory clearances in any foreign market.
Potential Impact of Medicare Reimbursement Regulations. Third party payers can
affect the pricing and the relative attractiveness of our products by regulating
the maximum amount of reimbursement they will provide for blood testing
services. For example, the reimbursement of fees for blood testing services for
Medicare patients in the hospital is included under Medicare's prospective
payment system diagnosis-related group regulations. If the reimbursement amounts
for blood testing services are decreased in the future, it may decrease the
amount which physicians and hospitals are able to charge Medicare patients for
such services and consequently the price we can charge for our products.
Dependence on and Protection of Patents and Proprietary Technology. Our
commercial success is dependent, in part, upon our trade secrets, know-how,
patents and other proprietary rights. There can be no assurance that our current
and pending patents will not be challenged by third parties, invalidated or
designed around, or that they will provide protection that has commercial
significance. There can also be no assurance that any current or future patent
applications will result in the actual issuance of a patent. Litigation, which
would likely be costly and time-consuming, may be necessary to protect our
intellectual property. The invalidation of any of our current or future patents
could permit increased competition, with
21
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (continued)
Risk Factors (continued)
Dependence on and Protection of Patents and Proprietary Technology (continued).
potential material adverse effects on our business, results of operations,
liquidity and cash flows. In addition, there can be no assurance that our
technological applications will not infringe upon the patents or proprietary
rights of others or that licenses that might be required for our processes or
products will be available to us on commercially reasonable terms, if at all.
Furthermore, there can be no assurance that others may not develop or acquire
trade secrets or know-how similar to ours.
Product Liability and Insurance; Possible Exposure to Claims. The clinical
testing, marketing and manufacturing of our products necessarily involves the
risk of product liability. Although we maintain product liability insurance, the
amount and scope of any current and future insurance coverage may not be
adequate to protect us in the event of a product liability claim.
Continuing Research and Development Expenditures. We anticipate that we will
continue to expend significant funds on our research and product development
efforts. There can be no assurance that these costs will ultimately be recovered
through the successful development, introduction and marketing of resulting
products.
Limited Market for Our Common Shares. Our common stock is currently traded on
the American Stock Exchange and currently experiences limited trading volume on
any given day. This limited liquidity may adversely affect the ability of a
shareholder to sell their shares in the secondary market.
22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Other than patent enforcement litigation initiated by the Company against a
competitor, there are no material legal proceedings presently pending to which
Lifestream Technologies, Inc. or either of its two subsidiaries are party or of
which any of their properties are the subject.
Item 2. Changes in Securities and Use of Proceeds
The Company relied on Section 4(2) of the 1933 Act as the basis for an exemption
from the registration requirements of the 1933 Act for the issuance of the
following restricted shares.
In January 2001, we issued 7,003 common shares to a public relations consultant
in exchange for services valued at $13,237.
In March 2001, we issued (i) 55,000 common shares to a legal firm in exchange
for services valued at $57,500, and (ii) 17,500 common shares to a consultant in
exchange for services valued at $17,500.
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
There were no reports filed on Form 8-K during the three months ended March 31,
2001.
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SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized, in
the City of Post Falls, State of Idaho, on this 15th day of May 2001.
LIFESTREAM TECHNOLOGIES, INC.
By: /s/ Brett Sweezy
--------------------------------------
Brett Sweezy
Chief Financial and Accounting Officer
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