UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL QUARTER ENDED DECEMBER 31, 2003
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
LIFESTREAM TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
COMMISSION FILE NUMBER 000-29058
NEVADA 82-0487965
--------------------------- ---------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
510 Clearwater Loop, Suite 101, Post Falls, ID 83854
(Address of principal executive offices)
(208) 457-9409
(Registrant's telephone number, including area code)
Check whether the issuer (1) 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 February 20, 2004, the registrant had 150,059,892 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 DECEMBER 31, 2003
PAGE
----
PART I. OUR FINANCIAL INFORMATION
Item 1. Our Interim Condensed Consolidated Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets as of December 31, 2003 and June 30, 2003............... 1
Condensed Consolidated Statements of Operations for the three and six months ended
December 31, 2003, and December 31, 2002.................................................... 2
Condensed Consolidated Statements of Cash Flows for the six months ended December 31, 2003 ...
and December 31, 2002.............................................................................. 3
Notes to Interim Condensed Consolidated Financial Statements.................................. 4
Item 2. Our Management's Discussion and Analysis.................................................. 12
Item 3. Our Controls and Procedures............................................................... 21
PART II. OUR OTHER INFORMATION
Item 1. Our Legal Proceedings..................................................................... 21
Item 2. Our Changes in Securities and Use of Proceeds............................................. 21
Item 3. Our Defaults Upon Senior Securities....................................................... 22
Item 4. Our Submission of Matters to a Vote of Security Holders................................... 22
Item 5. Our Other Information..................................................................... 22
Item 6. Our Exhibits and Reports on Form 8-K...................................................... 22
Signatures......................................................................................... 23
i
PART I. OUR FINANCIAL INFORMATION
ITEM 1. OUR INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
DECEMBER 31, JUNE 30,
2003 2003
------------ ------------
ASSETS (NOTE 2)
Current assets:
Cash and cash equivalents ................................................. $ 364,026 $ 1,370,126
Accounts receivable, net .................................................. 698,374 269,398
Inventories, net (Note 4) ................................................. 987,760 1,612,590
Prepaid expenses .......................................................... 635,753 38,506
------------ ------------
Total current assets ................................................. 2,685,913 3,290,620
Deferred financing costs, net ................................................ 492,529 422,897
Patent rights, net ........................................................... 521,474 562,945
Property and equipment, net .................................................. 446,794 647,527
Note receivable - officer (Note 5) ........................................... 38,728 38,728
Other ........................................................................ 48,232 115,208
------------ ------------
Total assets ......................................................... $ 4,233,670 $ 5,077,925
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable .......................................................... $ 794,476 $ 2,173,720
Accrued liabilities (Note 6) .............................................. 584,309 766,047
Capital lease obligations ................................................. 43,166 147,964
Notes payable (Note 7) .................................................... 900,000 900,000
Deferred income (Note 10) ................................................. -- 250,000
------------ ------------
Total current liabilities ............................................ 2,321,951 4,237,731
Capital lease obligations .................................................... 11,208 42,754
Note payable (Note 7) ........................................................ 677,865 1,069,932
Convertible debentures, principal face amounts of $7,195,000 and $5,270,000,
respectively (Note 8) ..................................................... 2,344,301 2,386,082
------------ ------------
Total liabilities .................................................... 5,355,325 7,736,499
------------ ------------
Commitments and contingencies (Notes 8 and 11)
Stockholders' deficit (Note 9):
Preferred stock, $.001 par value; 15,000,000 shares authorized; none issued
or outstanding .......................................................... -- --
Common stock, $.001 par value; 250,000,000 and 100,000,000 shares
authorized, respectively; 113,179,212 and 92,894,590 issued and
outstanding, respectively ............................................... 113,179 92,895
Additional paid-in capital ................................................ 44,988,724 39,511,226
Accumulated deficit ....................................................... (46,223,558) (42,262,695)
------------ ------------
Total stockholders' deficit .......................................... (1,121,655) (2,658,574)
------------ ------------
Total liabilities and stockholders' deficit .......................... $ 4,233,670 $ 5,077,925
============ ============
The accompanying notes are an integral part of these
condensed consolidated financial statements.
1
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED SIX MONTHS ENDED
-------------------------------- --------------------------------
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
2003 2002 2003 2002
------------- ------------- ------------- -------------
Net sales ............................................. $ 787,052 $ 1,930,113 $ 1,412,526 $ 3,062,549
Cost of sales ......................................... 658,536 1,103,038 1,085,672 2,017,911
------------- ------------- ------------- -------------
Gross profit .......................................... 128,516 827,075 326,854 1,044,638
------------- ------------- ------------- -------------
Operating expenses:
Sales and marketing ............................. 713,468 248,416 845,386 463,414
General and administrative ...................... 666,514 699,542 1,363,928 1,635,603
Product research and development ................ 24,523 94,736 27,991 272,065
Depreciation and amortization ................... 76,820 121,215 156,133 241,672
Loss on disposal of equipment ................... -- -- 87,756 --
------------- ------------- ------------- -------------
Total operating expenses .............................. 1,481,325 1,163,909 2,481,194 2,612,754
------------- ------------- ------------- -------------
Loss from operations .................................. (1,352,809) (336,834) (2,154,340) (1,568,116)
------------- ------------- ------------- -------------
Non-operating income (expenses):
Interest income .................................. 1,232 983 3,240 2,001
Interest and financing expenses (Notes 7 and 8) .. (418,530) (352,106) (675,749) (731,472)
Amortization of convertible debt discount (Note 8) (995,547) (320,218) (1,383,219) (640,436)
Gain on unexercised option and purchase
agreement (Note 10) ............................ -- -- 250,000 --
Other ............................................ (358) (1,599) (795) (2,263)
------------- ------------- ------------- -------------
Total non-operating expenses, net ..................... (1,413,203) (672,940) (1,806,523) (1,372,170)
------------- ------------- ------------- -------------
Net loss .............................................. $ (2,766,012) $ (1,009,774) $ (3,960,863) (2,940,286)
============= ============= ============= =============
Net loss per share - Basic and diluted (Note 3) ....... $ (0.03) $ (0.04) $ (0.04) $ (0.12)
============= ============= ============= =============
Weighted average number of shares - Basic and diluted
(Note 3) ........................................... 102,553,484 26,027,563 99,271,612 25,503,962
============= ============= ============= =============
The accompanying notes are an integral part of these
condensed consolidated financial statements
2
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2003 2002
----------- -----------
OPERATING ACTIVITIES:
Net loss .......................................................... $(3,960,863) $(2,940,286)
Non-cash items:
Depreciation and amortization ................................... 156,133 241,672
Loss on disposal of equipment ................................... 87,756 --
Amortization of deferred financing costs (Notes 7 and 8) ........ 213,368 180,200
Amortization of discount on convertible debentures (Note 8) ..... 1,383,219 640,436
Provision for (recovery of) doubtful accounts ................... 32,726 (29,991)
Increase (reduction) in inventory valuation allowance ........... 163,281 (3,178)
Other ........................................................... (15,357) --
Issuances of compensatory common stock, options and warrants for
employee and non-employee services ............................ 183,898 74,324
Net changes in assets and liabilities:
Accounts receivable ............................................. (461,702) (1,076,707)
Inventories ..................................................... 461,549 500,624
Prepaid expenses ................................................ (597,247) 258
Accounts payable ................................................ (1,379,244) 1,334,595
Accrued liabilities ............................................. 372,503 274,503
Deferred income ................................................. (250,000) 250,000
Other non-current assets ........................................ 66,976 (5,353)
----------- -----------
Net cash used in operating activities ...................... (3,543,004) (558,903)
----------- -----------
INVESTING ACTIVITIES:
Capital expenditures .............................................. (1,685) (16,407)
----------- -----------
Net cash used in investing activities ...................... (1,685) (16,407)
----------- -----------
FINANCING ACTIVITIES:
Proceeds from issuance of convertible debentures, net (Note 8) .... 3,067,000 --
Proceeds from borrowings under line of credit agreement ........... -- 554,391
Principal payments of capital lease obligations ................... (136,344) (3,057)
Principal payments of notes payable (Note 7) ...................... (392,067) --
Principal payments of convertible debentures and other debt ....... -- (468,164)
----------- -----------
Net cash provided by financing activities .................. 2,538,589 83,170
----------- -----------
Net decrease in cash and cash equivalents ............................ (1,006,100) (492,140)
Cash and cash equivalents at beginning of period ..................... 1,370,126 589,854
----------- -----------
Cash and cash equivalents at end of period ........................... $ 364,026 $ 97,714
=========== ===========
SUPPLEMENTAL SCHEDULE OF CASH ACTIVITIES:
Interest paid in cash ............................................ $ 144,903 $ 226,524
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Discount for beneficial conversion feature on convertible notes
and the fair value of accompanying detachable stock warrants
(Note 8).......................................................... $ 3,350,000 $ --
Issuance of common stock in exchange for conversion of convertible
debt and accrued interest (Note 9) ............................. $ 1,979,241 $ --
The accompanying notes are an integral part of these
condensed consolidated financial statements
3
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS AND ORGANIZATIONAL STRUCTURE
Lifestream Technologies, Inc. (the "Company"), a Nevada corporation
headquartered in Post Falls, Idaho, is a marketer of a proprietary total
cholesterol measuring device for at-home use by health conscious consumers and
at-risk medical patients. Through regular monitoring of one's total cholesterol
level, an individual can continually assess their susceptibility to developing
cardiovascular disease. Once diagnosed with an elevated total cholesterol level,
regular at-home testing with one of our devices enables a patient to readily
ascertain the benefits derived from diet modification, an exercise regimen
and/or a drug therapy, thereby reinforcing their continuing compliance with an
effective cholesterol-lowering program.
2. SUBSTANTIAL DOUBT REGARDING THE COMPANY'S ABILITY TO CONTINUE AS A GOING
CONCERN
The Company has incurred substantial operating and net losses, as well as
negative operating cash flows, since its inception. As a result, the Company
continued to have significant working capital and stockholders' deficits at June
30, 2003. In recognition of such, the Company's independent certified public
accountants included an explanatory paragraph in their report on the Company's
consolidated financial statements for the fiscal year ended June 30, 2003 that
expressed substantial doubt regarding the Company's ability to continue as a
going concern.
As more extensively discussed in Note 8, on September 13, 2003, the Company
completed a private placement offering of $3,350,000 in unsecured convertible
debentures from which it received $3,067,000 in net cash proceeds. Also, as more
extensively discussed in Note 12, on February 20, 2004, the Company completed a
private placement offering of $2,775,000 in unsecured convertible debentures
from which it received $2,077,000 in net cash proceeds. The purchase price for
the convertible debentures issued in February 2004 gives effect to an original
issue discount of approximately $500,000, the amount of which was withheld from
the proceeds at the time of the closing of the financing. In connection with
this transaction and subject to a 4.9% beneficial ownership limitation,
following public disclosure of the term and conditions of this financings
participating warrant holders agreed to exercise outstanding warrants held by
them. Upon exercise, the Company will receive an additional $481,000 in net
proceeds . After this offering, the Company has only approximately 1.7 million
authorized common shares remaining available for issuance. Under the terms of
the offering, the Company has agreed to seek shareholder approval to increase
the number of authorized common shares to 500 million shares by April 30, 2004.
Subject to such increase in the number of authorized common shares, investors in
the February 20, 2004 financing have been granted the option to purchase up to
an additional $1.22 million of convertible debentures and warrants with terms
and conditions substantially identical to those in the February 2004
transaction. Any failure by the Company to obtain such approval will limit its
future financing options to the issuance of higher interest-bearing,
non-convertible debt instruments.
The Company will continue to require additional financing to fund the Company's
longer-term operating needs, including its continued conducting of those
marketing activities it deems critical to building broad public awareness of,
and demand for, its current consumer device. The amount of additional funding
needed to support it until that point in time at which it forecasts that its
business will become self-sustaining from internally generated cash flow is
highly dependent upon the ability to continue conducting marketing activities
and the success of these campaigns on increasing sales to consumers.
With respect to its sales and gross margins, the Company introduced its current
consumer device to the retail marketplace in October 2002, from which it has
realized, and expects to continue to realize, a substantially improved gross
margin. Despite such, the Company's consolidated gross margin for the next
fiscal quarter will continue to reflect a blended rate as it attempts to deplete
its remaining inventory of its predecessor device, primarily through smaller,
less prominent, direct marketers. During such time, the Company may continue to
periodically offer related incentives that would adversely impact its
consolidated gross margin, the timing and degree to which is not currently
determinable. However, once its inventory of these predecessor devices is fully
depleted, the Company anticipates a consolidated gross margin of approximately
45% from sales of its current consumer device before reductions for inventory
obsolescence allowances. Additionally, to the extent that it is able to continue
to conduct the meaningful marketing activities it began in October 2003,
primarily targeted radio advertising, the Company believes that the economic and
psychological attractiveness of its current consumer device's lower retail price
point will substantially increase the likelihood of it realizing the significant
sales increases and operating cost leverage it seeks over the longer term.
4
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUBSTANTIAL DOUBT REGARDING THE COMPANY'S ABILITY TO CONTINUE AS A GOING
CONCERN (CONTINUED)
With respect to its operating cost structure, the Company implemented a series
of difficult, yet necessary, cost-cutting measures during its preceding fiscal
year. The most significant of these measures was the elimination of
substantially all non-critical personnel, consultants and infrastructure. The
Company currently operates with a core staff of 19 full-time employees, as
compared to 38 employees at June 30, 2002. Additionally, concurrent with the
completion of all re-engineering activities associated with the development and
refinement of its current consumer device, the Company eliminated substantially
all of its product research and development expenditures as of December 31,
2002. The Company expects that its product research and development needs and
expenditures for the foreseeable future will remain nominal.
It must be noted that, should the Company be unsuccessful in any of the
initiatives or matters discussed above, its business, and, as a result, its
consolidated financial position, results of operations and cash flows will
likely be materially adversely impacted, the effects from which it may not
recover. As such, substantial doubt as to the Company's ability to continue as a
going concern remains as of the date of this report.
3. INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Principles of Consolidation
These 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 transactions
and balances have been eliminated in consolidation.
Fiscal Periods
The Company's fiscal year-end is June 30. References to a fiscal year refer to
the calendar year in which such fiscal year ends.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make certain estimates and assumptions that affect the
reported amounts and timing of revenue and expenses, the reported amounts and
classification of assets and liabilities, and the disclosure of contingent
assets and liabilities. The accounting estimates that require management's most
difficult and subjective judgments include the assessment and valuation of the
patent rights, allowance for doubtful accounts receivable and the sales returns
allowance. These estimates and assumptions are based on the Company's historical
results as well as management's future expectations. The Company's actual
results could vary materially from management's estimates and assumptions.
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 of America 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 annual
consolidated financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted in these interim condensed consolidated 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 most recent Annual Report on Form 10-KSB for the fiscal year ended
June 30, 2003.
5
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Net Loss Per Share
Basic and diluted net loss per share have been computed by dividing net loss by
the weighted average number of common shares outstanding during the fiscal
period. At December 31, 2003 and 2002, the Company had stock options, stock
warrants and convertible debentures outstanding that could potentially be
exercised or converted into 83,304,128 and 21,248,001 additional common shares,
respectively. Should the Company report net income in a future period, net
income per share - diluted will be separately disclosed giving effect to the
potential dilution that could occur under the treasury stock method if these
stock options, stock warrants and convertible debentures were exercised or
converted into common shares.
Stock-Based Compensation
As allowed by Statement of Financial Accounting Standard No. 123, "Accounting
for Stock-Based Compensation" ("SFAS No. 123"), the Company has elected to
retain the compensation measurement principles of Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"), and
its related interpretations for stock options issued to employees. Under APB No.
25, compensation cost is recognized at the measurement date for the amount, if
any, that the quoted market price of the Company's common stock exceeds the
option exercise price. The measurement date is the date at which both the number
of options and the exercise price for each option are known.
No stock-based employee compensation cost is reflected in the Company's reported
net losses, as all options granted had an exercise price equal to or in excess
of the market value of the underlying common stock on the respective dates of
grant. If the Company had accounted for its stock-based employee compensation
under the fair value recognition and measurement principles of SFAS No. 123, the
Company's reported net losses would have been adjusted to the pro forma net loss
amounts presented below:
THREE MONTHS ENDED SIX MONTHS ENDED
------------------------------- -------------------------------
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net loss, as reported .................. $(2,766,012) $(1,009,774) $(3,960,863) $(2,940,286)
Add: SFAS No. 123 compensation expense (511,764) (678,981) (657,634) (899,693)
----------- ----------- ----------- -----------
Pro forma net loss ..................... (3,277,776) (1,688,755) (4,618,497) (3,839,979)
=========== =========== =========== ===========
Net loss per share:
Basic and diluted - as reported ... (0.03) (0.04) (0.04) (0.12)
=========== =========== =========== ===========
Basic and diluted - pro forma ...... (0.03) (0.06) (0.05) (0.15)
=========== =========== =========== ===========
Segment Reporting
The Company's chief operating decision makers consist of members of senior
management that work together to allocate resources to, and assess the
performance of, the Company's business. Senior management currently manages the
Company's business, assesses its performance, and allocates its resources as a
single operating segment.
Recently Adopted Accounting Standards
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest
Entities: ("FIN No. 46"). In December 2003, the FASB issued a revision to the
interpretation ("FIN No. 46(r)"). FIN No. 46(r) clarifies the application of
Accounting Research Bulletin No. 51 to certain entities in which equity
investors do not have the characteristics of a controlling financial interest or
do not have sufficient equity at risk for the entity to finance its activities
without additional subordinated financial support from other parties. The
provisions of FIN No. 46 and FIN No. 46(r) effective as of December 31, 2003,
were adopted by the Company with no material impact to the condensed
consolidated financial statements. The
6
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Recently Adopted Accounting Standards (continued)
remaining provisions of FIN No. 46(r) will be adopted during the third quarter
of fiscal 2004, as applicable, and are not expected to have a material impact to
the Company's condensed consolidated financial statements.
In April 2003, the Financial Accounting Standards Board ("FASB") issued SFAS No.
149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities" ("SFAS No. 149"). SFAS No. 149 amends and clarifies accounting for
derivative instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities under SFAS No. 133. SFAS No. 149
requires that contracts with comparable characteristics be accounted for
similarly and clarifies when a derivative contains a financing component that
warrants special reporting in the statement of cash flows. SFAS No. 149 is
effective for contracts entered into or modified after June 30, 2003, except in
certain circumstances, and for hedging relationships designated after June 30,
2003. The Company adopted SFAS No. 149, as required, on July 1, 2003 with no
impact on the condensed consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." SFAS No. 150
established standards for how an issuer classifies and measures in its statement
of financial position certain financial instruments with characteristics of both
liabilities and equity. The Company adopted SFAS No. 150, as required, on May
31, 2003 for financial instruments entered into or modified after such date,
with no impact on its accompanying consolidated financial statements. The
remaining provisions of SFAS No. 150 are effective beginning with the Company's
fiscal 2004 first quarter ending December 31, 2003 and must be applied
prospectively by reporting the cumulative effect of a change in an accounting
principle for financial instruments created before the issuance date of SFAS No.
150 and still existing at July 1, 2003. The Company adopted these remaining
provisions of SFAS No. 150, as required, with no impact on the condensed
consolidated financial statements.
4. INVENTORIES, NET
Inventories, net, consist of the following:
DECEMBER 31, 2003 JUNE 30, 2003
----------------- -------------
Raw materials .......... $ 1,124,630 $ 1,203,877
Work in process ........ 143,220 63,861
Finished goods ......... 257,887 719,548
----------- -----------
1,525,737 1,987,286
Less valuation allowance (537,977) (374,696)
----------- -----------
Inventories, net ....... $ 987,760 $ 1,612,590
=========== ===========
5. NOTE RECEIVABLE - OFFICER
Through fiscal 2001, the Company's Board of Directors periodically approved the
advancement of funds to the Company's Chief Executive Officer. The underlying
promissory note is unsecured, accrues interest at a stated interest rate of
8.75% per annum and requires bi-weekly repayments of principal and interest
through May 23, 2014. Effective May 1, 2002, the Board of Directors indefinitely
suspended the bi-weekly servicing requirement. On October 15, 2003, the
Company's Board of Directors resolved that all related interest accruals during
fiscal 2004 are to be concurrently offset by equivalent bonus awards to the
Company's Chief Executive Officer.
7
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
DECEMBER 31, 2003 JUNE 30, 2003
----------------- -------------
Accrued sales returns, including warranty obligations $224,333 $103,947
Accrued interest payable ............................ 154,041 472,413
Accrued royalties payable ........................... 135,300 104,104
Accrued wages, benefits and related taxes ........... 49,514 79,672
Accrued other ....................................... 21,121 5,911
-------- --------
Total accrued liabilities ........................... $584,309 $766,047
======== ========
7. NOTE PAYABLE
Effective May 1, 2003, the Company renegotiated its existing revolving credit
facility agreement with a financial institution. Under the new agreement, the
Company's then outstanding balance of $2,197,800 was bifurcated into a
$2,000,000 twenty-four month term loan ("term loan") and a $197,800 advance loan
("advance loan"). The term loan accrues interest at a fixed rate of 15% per
annum and is to be repaid through the financial institution's retention of the
first $75,000 of each month's assigned accounts receivable collections. The
advance loan accrues interest at 15% and is to be repaid through the financial
institution's additional retention of 25% of each month's assigned accounts
receivable collections over and beyond the initial $75,000 in collections
retained to service the term loan. This incremental 25% retention is limited to
$50,000 in any month, with a sub-limit of $25,000 should any month's aggregate
accounts receivable collections be less than $200,000. Any principal and accrued
interest balances remaining on the respective loans will be due and payable as
lump sums on April 1, 2005. Beginning with the date on which the advance loan is
repaid in full, the financial institution will become entitled to retain ten
percent of all subsequently collected accounts receivable, subject to a
limitation of ten percent of the term loan's then outstanding balance, with the
aggregate retentions to be returned to the Company upon its full repayment of
the term loan. Either loan may be prepaid at any time, without penalty, at the
Company's option. As with the original revolving credit facility, both loans are
secured and collateralized by the Company's accounts receivable, inventory,
property and equipment and intellectual property. Should any category of
collateral fall below specified percentages and margins, the financial
institution will be entitled to retain additional accounts receivable
collections sufficient to restore such percentages and margins. In consideration
for extending the above loans, the Company will pay the financial institution an
annual fee of $100,000, beginning on May 1, 2003 and upon each annual
anniversary thereafter on which the term loan remains unpaid. The initial annual
fee was satisfied through the issuance of 1,000,000 shares of the Company's
common stock.
8. CONVERTIBLE DEBENTURES
On September 13, 2003, the Company issued $3,350,000 in unsecured convertible
debentures from which it received $3,067,000 in net cash proceeds. These
debentures, which have an aggregate principal face amount of $3,175,000 at
December 31, 2003, (i) accrue interest at a fixed rate of 8.0% per annum, which
is payable at the Company's option in either cash or authorized and unissued
shares of its common stock, (ii) are currently convertible at the option of the
holders, provided that the Company has sufficient authorized and unissued common
shares, into shares of its common stock at a stated rate of $0.13 per share, and
(iii) become due and payable on September 12, 2006. For every two dollars of
original debenture principal, the holder received a detachable stock purchase
warrant allowing for the purchase over the subsequent two-year period of a share
of the Company's common stock at $0.2144 per share. Any related subsequent
issuances of the Company's common stock are limited to any individual debenture
holder beneficially owning no more than 4.99% of the Company's then outstanding
common shares. A registration statement filed with the United States Securities
and Exchange Commission ("SEC") registering the resale of the preceding
debentures and warrants became effective on December 23, 2003.
An underlying agreement also requires that the Company obtain the unanimous
approval of the debenture holders prior to (i) selling any common shares or
convertible debentures from September 13, 2003 until April 21, 2004 (120 days
after the date on which the SEC declared the registration statement effective)
or (ii) selling any common shares or common share equivalents with anti-dilution
guarantees or declaring a reverse stock split during the period in which any of
these notes remain
8
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. CONVERTIBLE NOTES (CONTINUED)
outstanding. The agreement further stipulates that no debenture may be prepaid
without the consent of the holder and that each debenture holder has a right of
first refusal to participate in any new financing transaction consented to
through April 21, 2004.
From June 2001 through November 2001, the Company issued unsecured convertible
debentures that remain outstanding. These debentures, which have an aggregate
principal face amount of $4,020,000 at December 31, 2003, (i) accrue interest at
the prime rate plus two percent (6.0% at December 31, 2003), (ii) are currently
convertible at the option of the holders into common stock of the Company at a
stated rate of $0.10 per share, and (iii) become due and payable on various
dates between July 1, 2006 and November 20, 2006. The Company has the right to
force conversion of the debentures if the market price of its common stock
exceeds $3.00 per share for 20 consecutive trading days. For every two dollars
of original debenture principal, the holder received a detachable stock purchase
warrant allowing for the purchase of a share of the Company's common stock at
$2.50 per share. All stock purchase warrants related to the June 2001 to
November 2001 issuances expired unexercised as of December 31, 2003.
At the respective dates of issuance, the Company was required under accounting
principles generally accepted in the United States of America to ascertain for
each of the above debenture issuances the fair value of the detachable stock
warrants and resulting beneficial conversion feature. For each debenture
issuance, the aggregate fair value of the detachable warrants and beneficial
conversion features was determined to be equal to the aggregate principal face
amount of the debt proceeds received, and as such, these amounts were recorded
as debt discounts by increasing additional paid-in capital. These debt discounts
are being amortized over the respective lives of the underlying debentures. The
aggregate unamortized debt discount amounted to $4,850,699 and $2,883,918 at
December 31, 2003 and June 30, 2003, respectively. The remaining principal and
discounted amounts of the Company's outstanding convertible debentures at
December 31, 2003 of $7,195,000 and $2,344,301, respectively, mature during the
Company's fiscal year ending June 30, 2007.
9. STOCKHOLDERS' DEFICIT
General
The Company's shareholders elected to increase its authorized common shares from
100 million to 250 million at a special shareholders' meeting held on December
1, 2003.
Common Shares Issued In Payment of Accrued Interest and Upon Conversion of
Convertible debenture
In December 2003, the Company issued 12,378,778 shares of its common stock to
three institutional investors upon conversion of convertible debentures with a
principal face amount totaling $1,175,000 and $104,241 in related accrued
interest.
Common Shares Issued for Services
In October 2003, the Company issued 384,410 shares to a patent attorney in
satisfaction of $82,648 in unpaid legal fees and related accrued interest.
In October 2003, the Company issued 575,000 shares of common stock to a patent
attorney in satisfaction of $36,250 in unpaid legal fees and $50,000 as a
non-refundable retainer for legal services to be rendered.
In October 2003, the Company issued 100,000 shares of common stock to an
independent consultant in final settlement of consulting services rendered by
the consultant in the amount of $45,000. The services consisted of introducing
the Company to prospective investors.
10. OPTION AND PURCHASE AGREEMENT
Pursuant to an option and purchase agreement dated November 20, 2002, the
Company received $250,000 from an unrelated party in exchange for granting them
an option to purchase for an additional $500,000 a non-critical and currently
unutilized technology patent to which the Company claims ownership. The Company
reflected the $250,000 received as deferred income at June 30, 2003. Concurrent
with the July 10, 2003 expiration of this option and purchase agreement, the
Company recognized $250,000 in non-operating income during the first quarter of
fiscal 2004.
9
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. CONTINGENCIES
General
The Company is periodically involved in litigation and administrative
proceedings primarily arising in the normal course of its business. In the
opinion of management, the Company's gross liability, if any, and without any
consideration given to the availability of indemnification or insurance
coverage, under any pending or existing litigation or administrative proceedings
would not materially affect its financial position, results of operations or
cash flows.
Compensating Payment Provision with Principal Vendor
The Company's contract with the supplier of its dry-chemistry total cholesterol
test strips contains a provision that could potentially require the Company to
make certain compensating payments in the event the Company fails to meet
minimum annual sales requirements. The dollar amount of such future amounts, if
any, is currently indeterminable.
12. SUBSEQUENT EVENTS
On January 13, 2004, the Company entered into an Exchange Agreement with each
holder of its convertible debentures that were issued in September 2003 (See
Note 8). Under the Exchange Agreement, each debenture holder agreed, subject to
a 4.99% beneficial ownership limitation, to exchange the principal amount of its
debenture for shares of the Company's common stock, at the rate of $0.09 of
debenture principal per share of common stock. Accrued but unpaid interest on
each debenture was paid at the time of the exchange by the issuance of
additional shares of common stock at the rate of $0.09 per share. Accordingly,
in January 2004 the Company issued 32,427,204 shares of common stock upon
exchange of debenture principal in the amount of $2,975,624 and the payment of
accrued but unpaid interest. Additionally, the Company issued 2,227,807 shares
of common stock to adjust the conversion rate applied to $175,000 of principal
previously converted by a debenture holder to the $0.09 rate stated in the
Exchange Agreement. As a result of the above, in January 2004 the Company
recognized approximately $1.5 million of additional financing expense related to
the beneficial conversion features of the exchange and amortized to expense
approximately $2.7 million of previously existing debt discount related to the
convertibles debentures issued in September 2003.
On February 20, 2004, the Company completed a private placement offering of
$2,775,000 in unsecured convertible debentures from which it received $2,077,000
in net cash proceeds. The purchase price for the convertible debentures issued
in February 2004 gives effect to an original issue discount of approximately
$500,000, the amount of which was withheld from the proceeds at the time of the
closing of the financing. The term of the debentures is two years, and the
debentures are convertible at a conversion price of $0.05 per share (66% of the
average of the 5 consecutive closing bid prices immediately prior to the closing
date of the offering). The conversion price is subject to adjustment upon the
occurrence of certain events including stock dividends, subdivisions,
combinations and reclassifications of the Company's common stock. In connection
with this transaction and subject to a 4.9% beneficial ownership limitation,
following public disclosure of the term and conditions of this financings
participating warrant holders agreed to exercise outstanding warrants held by
them. Upon exercise, the Company will receive an additional $481,000 in net
proceeds.
The participants of the offering received detachable stock purchase warrants
allowing for the purchase of a number of common shares equal to 30% of the
number of shares which could be obtained upon conversion of the debenture
principal outstanding on February 20, 2004. The warrants can be exercised over a
nineteen-month period and have an exercise price of $0.065 per share of the
Company's common stock, subject to adjustment upon the occurrence of events
substantially identical to those provided for in the debentures. Any related
subsequent issuances of the Company's common stock are limited to any individual
shareholder beneficially owning no more than 4.99% of the Company's then
outstanding common shares. The Company has the right to call the warrants in the
event that the average closing price of the Company's common stock exceeds 200%
of the exercise price for a consecutive 20-day trading period.
The Company is required to file a registration statement with the United States
Securities and Exchange Commission ("SEC") registering the resale of the common
shares underlying the preceding debentures and warrants on or before March 20,
2004. Depending upon the occurrence and duration of certain intervening events
to which it has little or no control over, the Company may be required to obtain
the SEC's declaration of effectiveness for this registration statement as early
as July 18, 2004, to which there can be no assurance. Any failure by the Company
to meet the mandated deadlines will constitute a default event, and, as a
result, the debentures holders may demand "repayment." Within the context of any
default, "repayment" is
10
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. SUBSEQUENT EVENTS (CONTINUED)
defined as being the greater of (i) 130% of the aggregate outstanding principal
balance and accrued interest or (ii) a currently indeterminable amount based
upon the aggregate outstanding principal and accrued interest adjusted upwards
in accordance with a formula dependent upon any increase in the market price of
the Company's common stock subsequent to February 20, 2004. The Company has
agreed to seek shareholder approval to increase the number of authorized common
shares to 500 million shares by April 30, 2004. Subject to receipt of such
authorization, the Company will register such number of additional shares as is
necessary to cause the registration of 125% of the common shares underlying the
debentures and warrants then outstanding.
Subject to obtaining shareholder approval to increase the number of authorized
common shares, investors in the February 20, 2004 financing have been granted
the option to purchase up to an additional $1.22 million in convertible
debentures and warrants with terms and conditions substantially identical to
those applicable to the February 20, 2004 transaction. The conversion price for
the second offering will be 66% of the average of the 5 consecutive closing bid
prices immediately prior to the closing date of the private offering, subject to
adjustment upon the occurrence of events substantially identical to those
provided for in the debentures issued in February 2004. Warrants will be issued
similar to the first private offering and the warrant exercise price will be
130% of the set debenture conversion price. The Company will be required to file
a registration statement covering the shares underlying the debentures and
warrants of this secondary offering and will again be subject to certain
penalties if the registration statement is not filed or effective within a
predetermined time.
An underlying agreement requires that the Company obtain the unanimous approval
of the debenture holders prior to the occurrence of certain events including
stock dividends, subdivisions, combinations and reclassifications of the
Company's common stock until less than 20% of the principal remains outstanding
on the debentures. The agreement further stipulates that no debenture may be
prepaid without the consent of the holder and that each debenture holder has a
right of first refusal to participate in any new financing transaction consented
to for a one year period ending after effectiveness of the registration
statement. The Company will also be prohibited from conducting any other
offering activities subsequent to filing the registration statement with the SEC
and through the date on which either the SEC declares it effective or the
Company withdraws it.
Under accounting principles generally accepted in the United States of America,
the Company was required to ascertain the fair value of the detachable stock
warrants and resulting beneficial conversion feature of the convertible
debentures issued on February 20, 2004. The aggregate fair value of the
detachable warrants and beneficial conversion features was determined to be
equal to the aggregate principal face amount of the debt proceeds received, and
as such, these amounts were recorded as debt discounts by increasing additional
paid-in capital. These debt discounts will be amortized over the life of the
underlying debentures.
On January 7, 2004, the Company issued 975,669 shares of restricted common stock
to employees of the Company as payment for $117,080 in compensation expense.
11
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS
Certain disclosures in this Quarterly Report on Form 10-QSB, including the
information incorporated by reference herein, include certain forward-looking
statements within the meaning of the safe harbor protections of Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. Statements that include words such as
"believe," "expect," "should," intend," "may," "anticipate," "likely,"
"contingent," "could," "may," "estimate," or other future-oriented statements,
are forward-looking statements. Such forward-looking statements include, but are
not limited to, statements regarding our business plans, strategies and
objectives, and, in particular, statements referring to our expectations
regarding our ability to continue as a going concern, generate increased market
awareness of, and demand for, our current consumer device, realize improved
gross margins, and timely obtain required financing. These forward-looking
statements involve risks and uncertainties that could cause actual results to
differ from anticipated results. The forward-looking statements are based on our
current expectations and what we believe are reasonable assumptions given our
knowledge of the markets; however, 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 our marketing of a relatively new total
cholesterol monitoring device for consumers in a yet to be established product
marketplace, consumer preferences, perceptions and receptiveness with respect to
our device, our critical capital raising efforts in an uncertain and volatile
economical environment, our ability to maintain an existing relationships with
critical vendors and customers, our cash-preservation and cost-containment
efforts, our ability to retain key management personnel, our inexperience with
advertising, our competition and the potential impact of technological
advancements thereon, the impact of changing economic, political, geo-political
and regulatory environments on our business, the impact on demand for devices
such as ours due to the availability, affordability and coverage terms of
private and public medical insurance, our exposure to product liability claims,
as well as those factors discussed in "Item 1 - Our Business," "Item 6 - Our
Management's Discussion and Analysis," particularly the discussions under
"Substantial Doubt as to our Ability to Continue as a Going Concern" and "Our
Risks and Uncertainties," and elsewhere in our most recent Annual Report on Form
10-KSB for the fiscal year ended June 30, 2003 filed with the United States
Securities and Exchange Commission. Readers are urged to carefully review and
consider the various disclosures made by us in this report, in the
aforementioned Annual Report on Form 10-KSB, and those detailed from time to
time in our reports and filings with the United States Securities and Exchange
Commission that attempt to advise interested parties of the risks and factors
that are likely to affect our business.
Our fiscal year ends on June 30. References to a fiscal year refer to the
calendar year in which such fiscal year ends.
INTRODUCTION
We market a proprietary over-the-counter, total cholesterol monitoring device
for at-home use by both health-conscious and at-risk consumers ("our consumer
device"). Our consumer device enables an individual, through regular at-home
monitoring of their total cholesterol level, to continually assess their
susceptibility to developing cardiovascular disease, the single largest cause of
premature death and permanent disability among adult men and women in the United
States of America ("U.S.").
Once an individual is diagnosed with an elevated total cholesterol level, our
consumer device enables an individual to readily ascertain and track certain
collective benefits being derived from diet modification, an exercise regimen
and drug therapy. By doing so, we believe that an individual's long-term
adherence to an effective cholesterol-lowering program is reinforced.
We introduced our current consumer device to the retail marketplace in October
2002. It is the successor to a consumer device that we first introduced in
January 2001. Our consumer device sales has accounted for substantially all of
our consolidated net sales since fiscal 2001.
Our current base of customers primarily consists of national and regional drug
store chains, and, to a lesser extent, pharmacy-featuring grocery store chains,
specialty catalog and Internet-based direct marketers and independent
pharmacies. To date, our ability to conduct those significant marketing
activities that we deem critical to building broad market awareness of, and
demand for, our consumer device has been severely limited due to financial
constraints. However, subsequent to our most recent fiscal year ended June 30,
2003, we have been successful in obtaining a portion of the long-term financing
we have sought to enable us to begin to move forward with such marketing, as
discussed below.
12
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
SUBSTANTIAL DOUBT REGARDING OUR ABILITY TO CONTINUE AS A GOING CONCERN
We have incurred substantial operating and net losses, as well as negative
operating cash flows, since our inception. As a result, we continued to have
significant working capital and stockholders' deficits at June 30, 2003. In
recognition of such, our independent certified public accountants included an
explanatory paragraph in their report on our consolidated financial statements
for the fiscal year ended June 30, 2003 that expressed substantial doubt as to
our ability to continue as a going concern.
On September 13, 2003, we completed a private placement offering of $3,350,000
in unsecured convertible debentures from which we received $3,067,000 in net
cash proceeds. On February 20, 2004, we completed a private placement offering
of $2,775,000 in unsecured convertible debentures from which we received
$2,077,000 in net cash proceeds. The purchase price for the convertible
debentures issued in February 2004 gives effect to an original issue discount of
approximately $500,000, the amount of which was withheld from the proceeds at
the time of the closing of the financing. In connection with this transaction
and subject to a 4.9% beneficial ownership limitation, following public
disclosure of the terms and conditions of this financings participating warrant
holders agreed to exercise outstanding warrants held by them. Upon exercise, we
will receive an additional $481,000 in net proceeds. After this offering, we
have only approximately 1.7 million authorized common shares remaining available
for issuance. Under the terms of the offering, we have agreed to seek
shareholder approval to increase the number of authorized common shares to 500
million shares by April 30, 2004. Subject to such increase in the number of
authorized common shares, investors in the February 20, 2004 financing have been
granted the option to purchase up to an additional $1.22 million of convertible
debentures and warrants with terms and conditions substantially identical to
those in the February 2004 transaction. Any failure by us to obtain such
approval will limit our future financing options to the issuance of higher
interest-bearing, non-convertible debt instruments.
We will continue to require additional financing to fund our longer-term
operating needs, including our continued conducting of those marketing
activities we deem critical to building broad public awareness of, and demand
for, our current consumer device. The amount of additional funding needed to
support us until that point in time at which we forecast that our business will
become self-sustaining from internally generated cash flow is highly dependent
upon the ability to continue conducting marketing activities and the success of
these campaigns on increasing our sales to consumers.
With respect to our sales and gross margins, we introduced our current consumer
device to the retail marketplace in October 2002, from which we have realized,
and expect to continue to realize, a substantially improved gross margin.
Despite such, our consolidated gross margin for the next fiscal quarter will
continue to reflect a blended rate as we attempt to deplete our remaining
inventory of our predecessor device, primarily through smaller, less prominent,
direct marketers. During such time, we may continue to periodically offer
related incentives that would adversely impact our consolidated gross margin,
the timing and degree to which currently is not determinable. However, once our
inventory of these predecessor devices is fully depleted, we anticipate a
consolidated gross margin of approximately 45% from sales of our current
consumer device before reductions for inventory obsolescence allowance.
Additionally, to the extent that we are able to continue to conduct the
meaningful marketing activities we began in October 2003, primarily targeted
radio advertising, we believe that the economic and psychological attractiveness
of our current consumer device's lower retail price point will substantially
increase the likelihood of us realizing the significant sales increases and
operating cost leverage we seek over the longer term.
With respect to our operating cost structure, we implemented a series of
difficult, yet necessary, cost-cutting measures during our preceding fiscal
year. The most significant of these measures was the elimination of
substantially all non-critical personnel, consultants and infrastructure. We
currently operate with a core staff of 19 critical full-time employees, as
compared to 38 employees at June 30, 2002. Additionally, concurrent with the
completion of all re-engineering activities associated with the development and
refinement of our current consumer device, we eliminated substantially all of
our product research and development expenditures as of December 31, 2002. We
expect that our product research and development needs and expenditures for the
foreseeable future will remain nominal.
It must be noted that, should we be unsuccessful in any of the initiatives or
matters discussed above, our business, and, as a result, our consolidated
financial position, results of operations and cash flows will likely be
materially adversely impacted, the effects from which we may not recover. As
such, substantial doubt as to our ability to continue as a going concern remains
as of the date of this report.
13
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
OUR CONSOLIDATED RESULTS OF OPERATIONS
Our consolidated net sales for the fiscal quarter ended December 31, 2003
("fiscal 2004 second quarter"), were $787,052, a decrease of $1,143,061, or
59.2%, as compared to $1,930,113 for the fiscal quarter ended December 31, 2002
("fiscal 2003 second quarter"). For the six months ended December 31, 2003
("fiscal 2004 first half"), our consolidated net sales were $1,412,526, a
decrease of $1,650,023, or 53.9%, as compared to $3,062,549 for the six months
ended December 31, 2002 ("fiscal 2003 first half"). Consistent with our
continuing principal focus on the retail marketplace, our consumer sales
accounted for in excess of 95% of our consolidated net sales during each of the
above fiscal 2004 and 2003 periods. Monitors consistently accounted for
approximately 60% - 75% of our consumer sales whereas test strips, smart cards
and other accessories collectively accounted for the respective balances. During
our fiscal 2004 second quarter and first half, net sales of our consumer
monitors decreased approximately 58% and 52%, respectively, whereas net sales of
our related consumer test strips increased 20% and 29%, respectively from the
comparative prior periods. Net sales of smart cards and other accessories
decreased approximately 87% and 83% for fiscal 2004 second quarter and fiscal
2004 first half, respectively. Our second-generation consumer monitors, which we
began shipping during October 2002, ultimately accounted for approximately 66%
and 62% of our overall consumer monitor sales during our fiscal 2004 second
quarter and first half, respectively.
We primarily attribute the decrease in our consolidated net sales for our fiscal
2004 second quarter and fiscal 2004 first half to our fulfillment in fiscal 2003
first quarter of a $701,045 initial order from a prominent national drug store
chain and the fulfillment in fiscal 2003 second quarter of an $851,475 initial
order from a prominent national drug store chain. The remaining decrease is due
to increased sales returns allowance for test strips with a short-term
expiration date.
We realized a consolidated gross profit of $128,516 for our fiscal 2004 second
quarter, a decrease of $698,559, or 84.5%, as compared to a consolidated gross
profit of $827,075 for our fiscal 2003 second quarter. For our fiscal 2004 first
half, our consolidated gross profit was $326,854, a decrease of $717,784, or
68.7%, as compared to a consolidated gross profit of $1,044,638 for our fiscal
2003 first half. Our resulting gross margins were 16.3% and 23.1% for our fiscal
2004 second quarter and first half, respectively, as compared to 42.9% and 34.1%
for our fiscal 2003 second quarter and first half, respectively. We primarily
attribute these significant decreases in our gross profits and margins to the
increase in the inventory obsolescence allowance by $186,000 and $163,281 for
the fiscal 2004 second quarter and first half, respectively. The increase in the
inventory obsolescence allowance is due to our decision to suspend sales of test
strips expiring in May 2004 due to the short term in which our consumers would
be able to utilize the test strips. This resulted in the obsolescence of all
test strips with the May 2004 expiration. To a lesser extent, we attribute the
decrease in gross margins to the adverse impacts of offering pricing discounts
and incentives to certain retailers to deplete inventory supplies of our
first-generation consumer monitor.
Our ability to realize consolidated gross profits sufficient to leverage our
ongoing operating expenses, and thus, achieve sustained operating profitability
at an acceptable level, remains highly dependent upon us achieving broad
awareness and acceptance of our monitors among both retailers and consumers.
Should we be unsuccessful in our current efforts to timely procure equity or
debt financing sufficient to fund essential marketing activities, the likelihood
of us achieving the prerequisite broad market awareness and acceptance of our
consumer monitors will be remote.
Our consolidated total operating expenses were $1,481,325 (inclusive of $91,820
in non-cash charges) for our fiscal 2004 second quarter, an increase of
$317,416, or 27.3%, from the $1,163,909 (inclusive of $130,244 in non-cash
charges) incurred during our fiscal 2003 second quarter. For our fiscal 2004
first half, our total operating expenses were $2,481,194 (inclusive of $243,532
in non-cash charges), a decrease of $131,560, or 5.0%, from the $2,612,754
(inclusive of $315,996 in non-cash charges) incurred during our fiscal 2003
first half. As further detailed below, the increase in operating expenses for
our fiscal 2004 second quarter is primarily due to the launch of the radio
advertising campaign in October of 2003.
Our consolidated sales and marketing expenses were $713,468 for our fiscal 2004
second quarter, an increase of $465,052, or 187.2%, from the $248,416 incurred
during our fiscal 2003 second quarter. For our fiscal 2004 first half, our sales
and marketing expenses were $845,386, an increase of $381,972, or 82.4%, from
the $463,414 incurred during our fiscal 2003 first half. These expense increases
primarily were derived from the launch of our radio advertising campaign in
October 2003 which continued throughout the fiscal 2004 second quarter. This
substantial increase is offset by a decrease in salaries expense due to
headcount reductions, commissions due to decreased sales and curtailed travel to
and participation in trade
14
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
OUR CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
shows. Our selling and marketing expenses will significantly increase for our
fiscal 2004 third quarter, and possibly beyond, as we deploy a significant
portion of the proceeds received from our recent financings, as well as from any
future financings, into advertising campaigns.
Our consolidated general and administrative ("G&A") expenses were $666,514 for
our fiscal 2004 second quarter, a decrease of $33,028, or 4.7%, from the
$699,542 incurred during our fiscal 2003 second quarter. For our fiscal 2004
first half, our G&A expenses were $1,363,928, a decrease of $271,675, or 16.6%,
from the $1,635,603 incurred during our fiscal 2003 first half. These expense
decreases were attributable to lower professional service costs due to the
previous completion, contraction or discontinuance of non-critical consulting
engagements and various cost savings realized as a result of administrative and
technical support headcount reductions, including related salaries and benefits,
rent, utilities, telecommunications and travel. Slightly offsetting the
preceding were increased costs for investor relations and a special proxy
related to the increase in our authorized common shares, and increased royalty
fee accruals as a result of ongoing negotiations with a principal vendor from
whom we license the proprietary optics technology utilized in our predecessor
consumer device. Discussions are ongoing with this principal vendor regarding
whether our current consumer device is subject to royalty fees under our
licensing agreement. Although there can be no assurance of such, we believe this
vendor, given our long-standing relationship, will ultimately agree to mutually
acceptable royalty terms.
Our product research and development expenses were $24,523 for our fiscal 2004
second quarter, a decrease of $70,213, or 74.1%, from the $94,736 incurred
during our fiscal 2003 second quarter. For our fiscal 2004 first half, our
product research and development expenses were $27,991, a decrease of $244,074,
or 89.7%, from the $272,065 incurred during our fiscal 2003 first half. This
decrease primarily was attributable to reductions in salaries, benefits, travel
and meeting expenses as the development of our current consumer device was
substantially completed by the end of our fiscal 2003 first quarter. Certain
continuing engineering activities directed at achieving further cost refinements
were also substantially completed during our preceding fiscal 2003 second
quarter. We currently expect that our product research and development needs and
expenditures will be nominal for the foreseeable future.
Our non-cash depreciation and amortization expenses were $76,820 for our fiscal
2004 second quarter, a decrease of $44,395, or 36.6%, from the $121,215 incurred
during our fiscal 2003 second quarter. For our fiscal 2004 first half, our
non-cash depreciation and amortization expenses were $156,133, a decrease of
$85,539, or 35.4%, from the $241,672 incurred during our fiscal 2003 first half.
These decreases primarily are attributable to certain equipment that became
fully depreciated during fiscal 2003. As our planned capital expenditures are
minimal, we currently anticipate that our depreciation and amortization expense
for the remaining half of fiscal 2004 will approximate that incurred during the
fiscal 2004 first half.
We incurred an $87,756 loss on the disposal of tooling equipment associated with
our predecessor consumer device during the fiscal 2004 first quarter. We
currently do not foresee any similar losses for the balance of fiscal 2004.
Primarily as a result of the foregoing, our loss from operations for our fiscal
2004 second quarter was $1,352,809, an increase of $1,015,975, or 301.6%, from
the $336,834 incurred during our fiscal 2003 second quarter. For our fiscal 2004
first half, our loss from operations was $2,154,340, an increase of $586,224, or
37.4%, from the $1,568,116 incurred during our fiscal 2003 first half.
Our non-operating income and expenses primarily consist of interest income,
interest and financing expenses, amortization of convertible debt discount and
other miscellaneous income and expense items. Our net non-operating expenses
were $1,413,203 (inclusive of $1,319,419 in non-cash charges) in our fiscal 2004
second quarter, as compared to net non-operating expenses of $672,940 (inclusive
of $410,318 in non-cash charges) in our fiscal 2003 second quarter. For our
fiscal 2004 first half, our net non-operating expenses were $1,806,523
(inclusive of $1,827,505 in non-cash charges) as compared to $1,372,170
(inclusive of $820,636 in non-cash charges) for our fiscal 2003 first half. The
net increase realized for our fiscal 2004 second quarter and first half
primarily was attributable to increased amortization of convertible debt
discount of $675,329 and $742,783, respectively. The increased amortization of
convertible debt discount is due to the conversion of $1.2 million and $1.4
million of convertible notes during the 2004 second fiscal quarter and 2004
first half, respectively. Due to the substantial portion of convertible debt
converted subsequent to December 31, 2003,
15
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
OUR CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
we expect the amortization of convertible debt discount to increase
significantly during the third quarter of fiscal 2004.
Primarily as a result of the foregoing, we incurred a net loss of $2,766,012
($0.03 per basic and diluted share) in our fiscal 2004 second quarter as
compared to a net loss of $1,009,774 ($0.04 per basic and diluted share) in our
fiscal 2003 second quarter. For our fiscal 2004 first half, we incurred a net
loss of $3,960,863 ($0.04 per basic and diluted share) as compared to a net loss
of $2,940,286 ($0.12 per basic and diluted share) for our fiscal 2003 first
half.
OUR CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES
General
We have historically sustained our operations and funded our growth through an
ongoing combination of trade credit arrangements, short-term financings, and
debt and equity issuances. As our working capital requirements generally precede
the realization of sales and related accounts receivable, we routinely draw upon
our existing cash and cash equivalent balances and seek short and long-term
financing to fund our procurement of inventory.
As more extensively discussed in the preceding disclosures entitled "Substantial
Doubt as to Our Ability to Continue as a Going Concern," we have incurred
substantial operating and net losses, as well as negative operating cash flows,
since our inception. As a result, we had significant working capital and
stockholders' deficits as of our most recently completed fiscal year ended June
30, 2003. In recognition of such, our independent certified public accountants
included an explanatory paragraph in their report on our consolidated financial
statements for our most recently completed fiscal year ended June 30, 2003 that
expressed substantial doubt as to our ability to continue as a going concern.
It must be noted that, should we be unsuccessful in any of the initiatives or
matters discussed in the preceding disclosures entitled "Substantial Doubt as to
Our Ability to Continue as a Going Concern," our business, and, as a result, our
consolidated financial position, results of operations and cash flows will
likely be materially adversely impacted, the effects from which we may not
recover. As such, substantial doubt as to our ability to continue as a going
concern remains as of the date of this report.
Structured Settlement Agreement with Roche, a Principal Vendor to Which We Are
Materially Dependent
On May 22, 2003, we entered into a structured settlement agreement with Roche to
prospectively service and ultimately satisfy $996,921 in overdue accounts
payable to them. Our payment obligations under this agreement were fully
satisfied as of December 31, 2003.
Our Capital Lease Obligations
We lease certain equipment under capital leases. The aggregate net carrying
values of the underlying collateralizing assets were approximately $224,000 and
$285,000 at December 31, 2003 and June 30, 2003, respectively.
Our aggregate future obligations under capital lease agreements in existence at
December 31, 2003 are as follows:
FISCAL YEARS ENDING JUNE 30,
----------------------------
2004 (balance thereof) .................... $29,968
2005 ...................................... 24,308
2006 ...................................... 6,172
-------
Total lease payments ...................... 60,448
Less imputed interest ..................... 6,074
-------
Present value of net minimum lease payments 54,374
Less current maturities ................... 43,166
-------
Total long-term capital lease obligation .. $11,208
=======
16
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
OUR CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Our Outstanding Notes Payable
Effective May 1, 2003, we converted our then expiring revolving credit facility
agreement with a financial institution. Under the new agreement, our then
outstanding balance of $2,197,800 was bifurcated into a $2,000,000 twenty-four
month term loan ("term loan") and a $197,800 advance loan ("advance loan"). The
term loan accrues interest at a fixed rate of 15% per annum and is to be repaid
through the financial institution's retention of the first $75,000 of each
month's assigned accounts receivable collections. The advance loan accrues
interest at 15% and is to be repaid through the financial institution's
additional retention of 25% of each month's assigned accounts receivable
collections over and beyond the initial $75,000 in collections retained to
service the term loan. This incremental 25% retention is limited to $50,000 in
any month, with a sub-limit of $25,000 should any month's aggregate accounts
receivable collections be less than $200,000. Any principal and accrued interest
balances remaining on the respective loans will be due and payable as lump sums
on April 1, 2005. Beginning with the date on which the advance loan is repaid in
full, the financial institution will become entitled to retain ten percent of
all subsequently collected accounts receivable, subject to a limitation of ten
percent of the term loan's then outstanding balance, with the aggregate
retentions to be returned to us upon our full repayment of the term loan. Either
loan may be prepaid at any time, without penalty, at our option. As with the
original revolving credit facility, both loans are secured and collateralized by
our accounts receivable, inventory, property and equipment and intellectual
property. Should any category of collateral fall below specified percentages and
margins, the financial institution will be entitled to retain additional
accounts receivable collections sufficient to restore such percentages and
margins. In consideration for extending the above loans, we will pay the
financial institution an annual fee of $100,000, beginning on May 1, 2003 and
upon each annual anniversary thereafter on which the term loan remains unpaid.
The initial annual fee was satisfied through the issuance of 1,000,000 shares of
our common stock.
As a result of the preceding conversion, we no longer have any established
credit facilities in place for future borrowings.
Our Outstanding Convertible Debentures
On September 13, 2003, we issued $3,350,000 in unsecured convertible debentures
from which we received $3,067,000 in net cash proceeds. These debentures, which
have an aggregate principal face amount of $3,175,000 at December 31, 2003, (i)
accrue interest at a fixed rate of 8.0% per annum, which is payable at our
option in either cash or authorized and unissued shares of our common stock,
(ii) are currently convertible at the option of the holders, provided that we
have sufficient authorized and unissued common shares, into shares of our common
stock at a stated rate of $0.13 per share, and (iii) become due and payable on
September 12, 2006. For every two dollars of original debenture principal, the
holder received a detachable stock purchase warrant allowing for the purchase
over the subsequent two-year period of a share of our common stock at $0.2144
per share. Any related subsequent issuances of our common stock is limited to
any individual debenture holder beneficially owning no more than 4.99% of our
then outstanding common shares. A registration statement filed with the United
States Securities and Exchange Commission ("SEC") registering the resale of the
preceding debentures and warrants became effective on December 23, 2003.
An underlying agreement also requires that we obtain the unanimous approval of
the debenture holders prior to (i) selling any common shares or convertible
debentures from September 13, 2003 until April 21, 2004 (120 days after the date
on which the SEC declared the registration statement effective) or (ii) selling
any common shares or common share equivalents with anti-dilution guarantees or
declaring a reverse stock split during the period in which any of these
debentures remain outstanding. The agreement further stipulates that no
debenture may be prepaid without the consent of the holder and that each
debenture holder has a right of first refusal to participate in any new
financing transaction consented to through April 21, 2004.
On January 13, 2004, we entered into an Exchange Agreement with each holder of
our convertible debentures that were issued in September 2003. Under the
Exchange Agreement, each debenture holder agreed, subject to a 4.99% beneficial
ownership limitation, to exchange the principal amount of its debenture for
shares of our common stock, at the rate of $0.09 of note principal per share of
common stock. Accrued but unpaid interest on each debenture was paid at the time
of the exchange by the issuance of additional shares of common stock at the rate
of $0.09 per share. Accordingly, in January 2004 we issued 32,427,204 shares of
common stock upon exchange of debenture principal in the amount of $2,975,624
and the payment of accrued but unpaid interest. Additionally, we issued
2,227,807 shares of common stock to adjust the conversion rate of $175,000 of
principal previously converted by a debenture holder to the $0.09 rate under the
Exchange Agreement. As a result of the above, in January 2004 we recognized
approximately $1.5 million of additional debt discount expense related to the
beneficial
17
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
OUR CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Our Outstanding Convertible Debentures (continued)
conversion features of the exchange and amortized approximately $2.7 million of
previously existing debt discount related to the convertibles debentures issued
in September 2003.
From June 2001 through November 2001, we issued unsecured convertible debentures
that remain outstanding. These debentures, which have an aggregate principal
face amount of $4,020,000 at December 31, 2003, (i) accrue interest at the prime
rate plus two percent (6.0% at December 31, 2003), (ii) are currently
convertible at the option of the holders into our common stock at a stated rate
of $0.10 per share, and (iii) become due and payable on various dates between
July 1, 2006 and November 20, 2006. We have the right to force conversion of the
debentures if the market price of our common stock exceeds $3.00 per share for
20 consecutive trading days. For every two dollars of original debenture
principal, the holder received a detachable stock purchase warrant allowing for
the purchase of a share of our common stock at $2.50 per share All stock
purchase warrants related to the June 2001 to November 2001 issuances expired
unexercised as of December 31, 2003.
At the respective dates of issuance, we were required under accounting
principles generally accepted in the United States of America to ascertain for
each of the above debenture issuances the fair value of the detachable stock
warrants and resulting beneficial conversion feature. For each debenture
issuance, the aggregate fair value of the detachable warrants and beneficial
conversion features was determined to be equal to the aggregate principal face
amount of the debt proceeds received, and as such, these amounts were recorded
as debt discounts by increasing additional paid-in capital. These debt discounts
are being amortized over the respective lives of the underlying notes. The
aggregate unamortized debt discount amounted to $4,850,699 and $2,883,918 at
December 31, 2003 and June 30, 2003, respectively. The remaining principal and
discounted amounts of our outstanding convertible debentures at December 31,
2003 of $7,195,000 and $2,344,301, respectively, mature during our fiscal year
ending June 30, 2007.
Our Off-Balance Sheet Liabilities
Our off-balance sheet liabilities principally consist of lease payment
obligations incurred under operating leases, which are required to be excluded
from our consolidated balance sheet by generally accepted accounting principles
in the United States of America. Our most significant operating leases pertain
to our corporate facilities. All of our other operating leases pertain to
various equipment and technology. Certain of these operating leases are
noncancellable and contain rent escalation clauses.
The future aggregate minimum lease payments under operating lease agreements in
existence at December 31, 2003 are as follows:
FISCAL YEARS ENDING JUNE 30,
----------------------------
2004 (balance thereof) ............... $52,066
2005 ................................. 22,484
-------
Total minimum operating lease payments $74,550
=======
Our Consolidated Cash Flows
Our operating activities utilized $3,543,004 in cash and cash equivalents during
our fiscal 2004 first half, an increase of $2,984,101, or 533.9%, from the
$558,903 in cash and cash equivalents utilized during our fiscal 2003 first
half. On a comparative fiscal period-to-period basis, our substantially higher
utilization primarily reflects the $1,020,577 increase in our net loss as well
as the utilization of cash to decrease accounts payable by $1,379,244 during the
first half of fiscal 2004 compared to a positive cash flow from the increase in
accounts payable of $1,334,595 during the first half of fiscal 2003. Our higher
utilization also reflects the negative cash flow effects of increased accounts
receivable and prepaid expenses and decreased deferred income. Partially
offsetting these negative cash flow effects were the positive cash flow effects
of increased accrued liabilities and higher overall add-backs for various
non-cash charges related to amortization, depreciation, inducement,
compensation, and other expenses.
Our investing activities utilized $1,685 in cash and cash equivalents during our
fiscal 2004 first half, a decrease of $14,722, or 89.7%, from the $16,407 in
cash and cash equivalents utilized during our fiscal 2003 first half. Our
decreased utilization is attributable to lower capital expenditures.
18
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
OUR CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Our financing activities provided $2,538,589 in cash and cash equivalents during
our fiscal 2004 first half, an increase of $2,455,419, or 2952.2%, from the
$83,170 in cash and cash equivalents provided during our fiscal 2003 first half.
Our fiscal 2004 increase reflects the receipt of the $3,067,000 net cash
proceeds received from our issuance of convertible debentures, as previously
discussed, being slightly offset by principal payments on our outstanding
capital lease obligations and notes payable. In contrast, our fiscal 2003 first
half reflected principal payments on outstanding convertible debentures and
other debt, being slightly offset by borrowings under our then existing
revolving line of credit.
As a result of the foregoing, our unrestricted cash and cash equivalents
decreased by $1,006,100 to $364,026 at December 31, 2003, from $1,370,126 at
June 30, 2003. Our working capital increased by $1,311,073 to $363,962 at
December 31, 2003 from a deficiency of $947,111 at June 30, 2003.
Our Planned Capital Expenditures
Our only significant planned capital expenditure for fiscal 2004 is the purchase
or lease of an additional automated test strip packaging machine with an
estimated cost of $350,000. However, our ultimate need for this machine is
dependent upon us meeting our fiscal 2004 sales target, which correspondingly is
dependent upon us procuring the significant additional equity or debt financing
we currently seek, as previously discussed. To a significantly lesser extent, we
currently anticipate the need to perform certain telecommunications and computer
technology upgrades during fiscal 2004 with an estimated aggregate cost of
$100,000.
OUR OTHER MATTERS
Our Seasonal and Inflationary Influences
Although we remain in the relatively early stages of the national introduction
and roll-out of our consumer monitors to retailers, we have historically
experienced certain seasonal sales influences consistent with our initial
expectations. In particular, we had expected, absent materially adverse economic
or counter-acting events, that our fiscal second quarter ending December 31
would slightly benefit from increased orders by retailers for the holiday
shopping season. This trend was not reflected in the current fiscal quarter and
we remain uncertain as to whether this seasonality will continue in the future.
To date, we have not been materially impacted by inflationary influences.
Our Quantitative and Qualitative Disclosures About Market Risk
We currently are exposed to financial market risks from changes in short-term
interest rates as certain of our outstanding convertible debentures, as
discussed above, have an interest rate that fluctuates with the prime rate.
Based on the aggregate outstanding balance of these convertible debentures at
December 31, 2003 and subsequent conversions of these debentures in January
2004, we believe that the prime rate would have to significantly increase, in
excess of a few hundred basis points, for the resulting adverse impact on our
interest expense to be material to our expected results of operations for fiscal
2004, and possibly beyond. However, should we be successful in procuring the
significant additional financing we currently seek and if such financing were to
be substantially in the form of variable rate debt, then our exposure to these
market risks would increase, possibly significantly.
We currently are not materially exposed to currency market risks. However,
should we in the future enter into significant contracts subjecting us to
foreign currency adjustments or denominated in non-U.S. dollar currencies, then
we would become exposed to these market risks.
We have not used, and currently do not contemplate using, any derivative
financial instruments.
Our Critical Accounting Policies
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires us to make certain estimates and assumptions that affect the reported
amounts and timing of revenue and expenses, the reported amounts and
classification of assets and liabilities, and disclosure of contingent assets
and liabilities. Our actual results have differed, and will likely continue to
differ, to some extent from our initial estimates
19
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
OUR OTHER MATTERS (CONTINUED)
and assumptions. We currently believe that the following significant accounting
policies entail making particularly difficult, subjective or complex judgments
of inherently uncertain matters that, given any reasonably possible variance
therein, would make such policies particularly critical to a materially accurate
portrayal of our historical or reasonably foreseeable financial condition or
results of operations:
o Revenue Recognition. We recognize a sale, including related shipping
and handling income, and the cost of the sale, upon product shipment
provided that all material risks and rewards of ownership are
concurrently transferred from us to our customer, collection of the
related receivable by us is reasonably assured, and we are able to
reliably estimate an appropriate allowance for sales returns based on
our relevent historical product experience and future expectations.
However, our estimates of an appropriate allowance for sales returns is
inherently subjective and actual results could vary from our estimated
outcome, thereby requiring us to make future adjustments to our net
sales and results of operations.
o Allowance for Doubtful Accounts. We record an allowance for doubtful
accounts based on specifically identified amounts that we believe to be
uncollectible and those accounts that are past due beyond a certain
date. However, our estimates of an appropriate allowance for doubtful
accounts are inherently subjective and actual results could vary from
our estimated outcome, thereby requiring us to make future adjustments
to our accounts receivable and results of operations.
o Inventories. Our inventories, which primarily consist of component
parts, assembled devices and related supplies, are stated at the lower
of first-in, first-out cost or market. However, our estimates of market
and an appropriate allowance for inventory obsolescence are inherently
subjective and actual results could vary from our estimated outcome,
thereby requiring us to make future adjustments to our inventories and
results of operations.
o Impairment of Long-Lived Assets. We, on at least a quarterly basis,
evaluate each of our long-lived assets for impairment by comparing our
estimates of related future cash flows, on an undiscounted basis, to
its net book value. If impairment is indicated, we reduce the net book
value to an amount equal to the estimated future cash flows, on an
appropriately discounted basis. However, our estimates of an asset's
related future cash flows are inherently subjective and actual results
could vary from our estimated outcome, thereby requiring us to make
future adjustments to our assets and results of operations.
Our Legal Contingencies
We as a company, including our subsidiaries, are periodically involved in
incidental litigation and administrative proceedings primarily arising in the
normal course of our business. In our opinion, our gross liability, if any, and
without any consideration given to the availability of indemnification or
insurance coverage, under any pending or existing incidental litigation or
administrative proceedings would not materially affect our financial position,
results of operations or cash flows.
Our wholly-owned subsidiary, Lifestream Diagnostics, Inc., is the plaintiff in
patent infringement litigation, Civil Action No. CV00-300-N-MHW, against Polymer
Technology Systems, Inc., et al, currently pending in the United States District
Court for the District of Idaho. The patent-in-suit is Thakore, U.S. Patent No.
3,135,716 (see "Our Business - Our Intellectual Property Rights" for further
details). We allege willful patent infringement and seek Polymer's immediate
discontinuance of the HDL test strip technology currently utilized in their
diagnostic device to which we claim ownership. The defendants have brought a
number of counterclaims, including antitrust, unfair competition, tortious
interference with business relations and patent misuse, and have only asserted
unspecified general damages. The Court conducted a "claim interpretation"
hearing (also called a "Markman" hearing) January 29-30, 2003, and issued a
Memorandum Decision on May 28, 2003 ruling against our assertion of patent
infringement. Based on the Court's claim interpretation decision, the parties
jointly requested entry of a judgment of non-infringement, a stay of the
counterclaims, and a certification that the claim interpretation decision is
ripe for appeal. The Court entered this order on August 21, 2003. We timely
filed a Notice of Appeal to the Court of Appeals for the Federal Circuit, but
have not yet been advised of the Appeal Number. Although we believe that our
claims are well founded in law and fact, and believe that the counterclaims and
defenses alleged by the
20
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
OUR OTHER MATTERS (CONTINUED)
defendants are baseless, the outcome of this litigation cannot be predicted with
certainty. Settlement discussions are at a standstill but may resume at any
time.
ITEM 3. OUR CONTROLS AND PROCEDURES
Under the supervision and with the participation of our Chief Executive Officer
and Chief Financial Officer, we have evaluated the effectiveness of the design
and operation of our disclosure controls and procedures, as defined in Rules
13a-15(e) and 15d--15(e) of the Exchange Act, as of the end of the period
covered by this report. Based on that evaluation, our Chief Executive Officer
and Chief Financial Officer have concluded that these disclosure controls and
procedures are effective to provide reasonable assurance that material
information relating to us and our consolidating subsidiaries is made known to
management, including to the Chief Executive Officer and Chief Financial
Officer, to allow timely decisions regarding required disclosures. There were no
changes in our internal control over financial reporting during our last fiscal
quarter ended December 31, 2003 that have materially affected, or are reasonably
likely to materially affect, our internal controls over financial reporting.
PART II. OUR OTHER INFORMATION
ITEM 1. OUR LEGAL PROCEEDINGS
We as a company, including our subsidiaries, are periodically involved in
incidental litigation and administrative proceedings primarily arising in the
normal course of our business. In our opinion, our gross liability, if any, and
without any consideration given to the availability of indemnification or
insurance coverage, under any pending or existing incidental litigation or
administrative proceedings would not materially affect our financial position,
results of operations or cash flows.
Our wholly-owned subsidiary, Lifestream Diagnostics, Inc., is the plaintiff in
patent infringement litigation, Civil Action No. CV00-300-N-MHW, against Polymer
Technology Systems, Inc., et al, currently pending in the United States District
Court for the District of Idaho. The patent-in-suit is Thakore, U.S. Patent No.
3,135,716 (see "Our Business - Our Intellectual Property Rights" for further
details). We allege willful patent infringement and seek Polymer's immediate
discontinuance of the HDL test strip technology currently utilized in their
diagnostic device to which we claim ownership. The defendants have brought a
number of counterclaims, including antitrust, unfair competition, tortious
interference with business relations and patent misuse, and have only asserted
unspecified general damages. The Court conducted a "claim interpretation"
hearing (also called a "Markman" hearing) January 29-30, 2003, and issued a
Memorandum Decision on May 28, 2003 ruling against our assertion of patent
infringement. Based on the Court's claim interpretation decision, the parties
jointly requested entry of a judgment of non-infringement, a stay of the
counterclaims, and a certification that the claim interpretation decision is
ripe for appeal. The Court entered this order on August 21, 2003. We timely
filed a Notice of Appeal to the Court of Appeals for the Federal Circuit, but
have not yet been advised of the Appeal Number. Although we believe that our
claims are well founded in law and fact, and believe that the counterclaims and
defenses alleged by the defendants are baseless, the outcome of this litigation
cannot be predicted with certainty. Settlement discussions are at a standstill
but may resume at any time.
ITEM 2. OUR CHANGES IN SECURITIES AND USE OF PROCEEDS
On December 23, 2003, our Form SB-2 was declared effective the the Securities
and Exchance Commission.
In reliance upon the registration exemption provisions of Section 4(2) of the
Securites Act of 1933, as amended, and the rules and regulations thereunder, we
issued the following securities during our fiscal 2004 first quarter ended
December 31, 2003.
In December 2003, we issued 12,378,778 shares of its common stock to three
institutional investors upon conversion of convertible debentures with a
principal face amount totaling $1,175,000 and $104,241 in related accrued
interest.
In October 2003, we issued 384,410 shares to a patent attorney in satisfaction
of $82,648 in unpaid legal fees and related accrued interest.
21
ITEM 2. OUR CHANGES IN SECURITIES AND USE OF PROCEEDS (CONTINUED)
In October 2003, we issued 575,000 shares of common stock to a patent attorney
in satisfaction of $36,250 in unpaid legal fees and $50,000 as a non-refundable
flat-fee payment for legal services to be rendered.
In October 2003, we issued 100,000 shares of common stock to an independent
consultant in final settlement of consulting services rendered by the consultant
in the amount of $45,000. The services consisted of introducing us to
prospective investors.
ITEM 3. OUR DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. OUR SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Below are the proxy tabulation results for the matters voted upon at the
Company's Special Meeting of Stockholders held on December 1, 2003:
1. Approval to amend the Company's Articles of Incorporation to increase
the number of authorized shares of common stock from 100,000,000 shares
to 250,000,000 shares:
For: 72,982,396 Against: 150,677 Abstain: 1,371,492
Below are the proxy tabulation results for the matters voted upon at the
Company's Annual Meeting of Stockholders held on December 19, 2003:
1. Election of Neil Luckianow to the Company's Board of Directors
(Class III with term expiring in 2006):
For: 69,356,723 Withhold: 523,088
2. Ratify the appointment of BDO Seidman, LLP as the Company's Independent
Certified Public Accountants for the Fiscal Year Ending June 30, 2004:
For: 69,359,017 Against: 291,138 Abstain: 229,656
ITEM 5. OUR OTHER INFORMATION
Effective October 31, 2003, our common stock began trading on the NASDAQ's
Over-The-Counter Bulletin Board under the ticker symbol "LFTC" and discontinued
trading on the American Stock Exchange.
ITEM 6. OUR EXHIBITS AND REPORTS ON FORM 8-K
We filed no reports on Form 8-K during the quarter ended December 31, 2003.
EXHIBIT INDEX
3.1.1 Certificate of Amendment to Articles of Incorporation of Lifestream
Technologies, Inc. dated December 4, 2003.
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
22
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 23rd day of February, 2004.
LIFESTREAM TECHNOLOGIES, INC.
By: /s/ Brett Sweezy
------------------------------------
Brett Sweezy
Chief Financial and Accounting Officer
23