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 MARCH 31, 2004
[ ] 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 May 13, 2004, the registrant had 161,325,276 shares of its $.001 par value
common stock outstanding.
Transitional Small Business Disclosure Format: Yes [ ] No [X ]
LIFESTREAM TECHNOLOGIES, INC.
INDEX TO
QUARTERLY REPORT ON FORM 10-QSB
FOR THE FISCAL QUARTER ENDED MARCH 31, 2004
PAGE
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PART I. OUR FINANCIAL INFORMATION
Item 1. Our Interim Condensed Consolidated Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets as of March 31, 2004, and June 30, 2003................. 1
Condensed Consolidated Statements of Operations for the three and nine months ended
March 31, 2004, and March 31, 2003.......................................................... 2
Condensed Consolidated Statements of Cash Flows for the nine months ended March 31, 2004,
and March 31, 2003.......................................................................... 3
Notes to Condensed Consolidated Financial Statements.......................................... 4
Item 2. Our Management's Discussion and Analysis.................................................. 13
Item 3. Our Controls and Procedures............................................................... 23
PART II. OUR OTHER INFORMATION
Item 1. Our Legal Proceedings..................................................................... 24
Item 2. Our Changes in Securities and Use of Proceeds............................................. 24
Item 3. Our Defaults Upon Senior Securities....................................................... 25
Item 4. Our Submission of Matters to a Vote of Security Holders................................... 25
Item 5. Our Other Information..................................................................... 25
Item 6. Our Exhibits and Reports on Form 8-K...................................................... 25
Signatures......................................................................................... 26
i
PART I. OUR FINANCIAL INFORMATION
ITEM 1. OUR INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, JUNE 30,
2004 2003
----------- -----------
ASSETS (NOTE 2)
Current assets:
Cash and cash equivalents ................................................. $ 1,483,070 1,370,126
Accounts receivable, net .................................................. 639,636 269,398
Inventories, net (Note 4) ................................................. 1,048,440 1,612,590
Prepaid expenses .......................................................... 656,129 38,506
----------- -----------
Total current assets ................................................. 3,827,275 3,290,620
Deferred financing costs, net ................................................ 909,590 422,897
Patent rights, net ........................................................... 500,738 562,945
Property and equipment, net .................................................. 395,156 647,527
Note receivable - officer (Note 5) ........................................... 38,728 38,728
Other ........................................................................ 143,232 115,208
----------- -----------
Total assets ......................................................... $ 5,814,719 $ 5,077,925
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) (NOTE 2)
Current liabilities:
Accounts payable .......................................................... $ 795,633 $ 2,173,720
Accrued liabilities (Note 6) .............................................. 606,086 766,047
Capital lease obligations ................................................. 35,280 147,964
Notes payable (Note 7) .................................................... 900,000 900,000
Deferred income (Note 10) ................................................. -- 250,000
----------- -----------
Total current liabilities ............................................ 2,336,999 4,237,731
Capital lease obligations .................................................... 8,661 42,754
Notes payable (Note 7) ....................................................... 517,535 1,069,932
Convertible debentures, principal face amounts of $6,936,376 and $5,270,000,
respectively (Note 8) ..................................................... 2,290,297 2,386,082
----------- -----------
Total liabilities .................................................... 5,153,492 7,736,499
----------- -----------
Commitments and contingencies (Notes 8 and 11)
Stockholders' equity (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; 159,475,276 and 92,894,590 issued and
outstanding, respectively ............................................... 159,475 92,895
Additional paid-in capital ................................................ 53,366,446 39,511,226
Accumulated deficit ....................................................... (52,864,694) (42,262,695)
----------- -----------
Total stockholders' equity (deficit) ................................. 661,227 (2,658,574)
----------- -----------
Total liabilities and stockholders' equity (deficit) ................. $ 5,814,719 $ 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 NINE MONTHS ENDED
---------------------------------- ----------------------------
MARCH 31, MARCH 31, MARCH 31, MARCH 31,
2004 2003 2004 2003
--------------- --------------- ---------------- ---------
Net sales ............................................. $ 627,014 $ 649,093 $ 2,039,540 $ 3,711,642
Cost of sales ......................................... 688,909 454,818 1,774,580 2,472,729
------------- ------------ ------------- ------------
Gross profit (loss) ................................... (61,895) 194,275 264,960 1,238,913
------------- ------------ ------------- ------------
Operating expenses:
Sales and marketing ............................. 474,361 315,301 1,319,747 778,715
General and administrative ...................... 678,681 860,116 2,042,610 2,495,719
Product research and development ................ 19,593 20,622 47,584 292,687
Depreciation and amortization ................... 76,838 106,469 232,971 348,141
Loss on disposal of equipment ................... -- -- 87,756 --
------------- ------------ ------------- ------------
Total operating expenses .............................. 1,249,473 1,302,508 3,730,668 3,915,262
------------- ------------ ------------- ------------
Loss from operations .................................. (1,311,368) (1,108,233) (3,465,708) (2,676,349)
------------- ------------ ------------- ------------
Non-operating income (expenses):
Interest income .................................. 3,555 13,877 6,795 15,877
Interest and financing expenses (Notes 7 and 8) .. (2,222,959) (325,309) (2,890,791) (1,056,781)
Amortization of convertible debt discount (Note 8) (3,101,620) (320,218) (4,484,839) (960,655)
Gain on unexercised option and purchase agreement
(Note 10) ................................... -- -- 250,000 --
Other, net ....................................... (8,744) (13,624) (17,456) (15,886)
------------- ------------ ------------- ------------
Total non-operating expenses, net ..................... (5,329,768) (645,274) (7,136,291) (2,017,445)
------------- ------------ ------------- ------------
Net loss .............................................. $ (6,641,136) $ (1,753,507) $ (10,601,999) $ (4,693,794)
============= ============ ============= ============
Net loss per share - Basic and diluted (Note 3) ....... $ (0.05) $ (0.06) $ (0.09) $ (0.18)
============= ============ ============= ============
Weighted average number of shares - Basic and diluted
(Note 3) ........................................... 146,490,616 29,422,009 114,952,123 26,790,935
============= ============ ============= ============
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
NINE MONTHS ENDED
MARCH 31, MARCH 31,
2004 2003
------------ -----------
OPERATING ACTIVITIES:
Net loss ............................................................ $(10,601,999) $(4,693,794)
Non-cash items:
Depreciation and amortization ..................................... 232,971 348,141
Loss on disposal of equipment ..................................... 87,756 --
Amortization of deferred financing costs (Notes 7 and 8) .......... 515,715 270,300
Amortization of discount on convertible debentures (Note 8) ....... 4,484,839 960,655
Provision for doubtful accounts ................................... 40,188 98,632
Increase (reduction) in inventory valuation allowance ............. 362,757 (3,178)
Beneficial conversion feature of convertible debt (Note 8) ........ 1,728,889 --
Issuances of compensatory common stock, options and warrants for
employee and non-employee services .............................. 325,975 184,002
Other ........................................................... (15,357) --
Net changes in assets and liabilities:
Accounts receivable ............................................... (410,426) (581,576)
Inventories ....................................................... 201,393 299,969
Prepaid expenses .................................................. (617,623) 89,782
Accounts payable .................................................. (1,378,087) 1,387,706
Accrued liabilities ............................................... 543,939 387,961
Deferred income ................................................... (250,000) 250,000
Other non-current assets .......................................... 91,976 (2,544)
------------ -----------
Net cash used in operating activities ........................ (4,657,094) (1,003,944)
------------ -----------
NVESTING ACTIVITIES:
Capital expenditures ................................................ (6,149) (16,407)
------------ -----------
Net cash used in investing activities ........................ (6,149) (16,407)
------------ -----------
INANCING ACTIVITIES:
Proceeds from issuance of convertible debentures, net (Note 8) .... 5,244,592 --
Proceeds from issuances of common stock ........................... 230,769 550,000
Proceeds from borrowings under line of credit agreement ........... -- 59,587
Principal payments of capital lease obligations ................... (146,777) (1,486)
Principal payments of notes payable (Note 7) ...................... (552,397) (27,247)
Principal payments of convertible debentures and other debt ....... -- (750,000)
Redemption of restricted certificate of deposit ................... -- 600,000
------------ -----------
Net cash provided by financing activities .................... 4,776,187 430,854
------------ -----------
Net increase (decrease) in cash and cash equivalents ................... 112,944 (589,497)
Cash and cash equivalents at beginning of period ....................... 1,370,126 589,854
------------ -----------
Cash and cash equivalents at end of period ............................ $ 1,483,070 $ 357
============ ===========
SUPPLEMENTAL SCHEDULE OF CASH ACTIVITIES:
Interest paid in cash .............................................. $ 205,156 $ 337,370
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) .. $ 6,247,000 $ --
Issuance of common stock in exchange for conversion of convertible
debt and accrued interest (Note 9) ................................ $ 5,284,524 $ --
Issuance of common stock in exchange for financing costs (Note 7) .. $ 120,000 $ --
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 flow, 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.
In order to address its ability to continue as a going concern, the Company has
initiated or completed the following financing activities:
o 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 (See Note 8);
o On February 19, 2004, the Company completed an additional private
placement offering of $2,775,000 in unsecured convertible debentures
from which it received $2,077,592 in net cash proceeds. In connection
with this transaction, participating warrant holders agreed to
exercise outstanding warrants held by them. As of March 31, 2004, the
Company had received approximately $231,000 in net proceeds from the
exercise of these warrants and expects to receive approximately
$240,000 in net cash proceeds upon exercise of the remaining
outstanding warrants (See Note 8);
o On March 1, 2004, the Company received $100,000 in net proceeds from
the issuance of an unsecured convertible debenture in the principal
amount of $122,000 (See Note 8);
o On April 28, 2004, the Company's shareholders elected to increase its
authorized common shares to 750 million shares for use in future
financing transactions; and
o The Company granted investors in the February 19, 2004 financing, the
option to purchase up to an additional $1,220,000 of convertible
debentures and warrants through October 28, 2004, with terms and
conditions substantially identical to those in the original February
2004 transaction.
With respect to its sales, gross margins and operating expenses, the
Company:
o 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 of approximately 45%
before reductions for inventory obsolescence allowances on expired
test strips;
o Depleted its remaining inventory of its higher-cost, predecessor
device subsequent to March 31, 2004;
o Continued negotiations with a major retailer, as well as smaller
retailers, to sell its current consumer device;
o Developed a continuing education program to be implemented over the
next 6 months to broaden awareness and educate pharmacists on the
benefits of the product;
o Developed a consumer point-of-sale awareness program for those
patients purchasing certain cholesterol-lowering prescriptions, which
will be tested during May and June 2004;
o Continued to conduct the radio advertising marketing activities it
began in October 2003;
o Continued to support and monitor the Medicare reimbursement
considerations of the federal government for cholesterol testing;
o Continued to operate with a core staff of only 19 employees; and
o Continued to implement cost-cutting measures, the most significant of
which continues to be the elimination of consultants and research and
development costs.
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)
The Company will continue to require additional financing to fund its
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 awareness to consumers and
pharmacists.
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 flow 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)
Reclassifications
Certain amounts in the condensed consolidated financial statements for the prior
periods have been reclassified to be consistent with the current period's
presentation.
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 March 31, 2004 and 2003, the Company had stock options, stock
warrants and convertible debentures outstanding that could potentially be
exercised or converted into 129,826,267 and 19,590,107 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 NINE MONTHS ENDED
---------------------------- -----------------------------
MARCH 31, MARCH 31, MARCH 31, MARCH 31,
2004 2003 2004 2003
----------- ----------- ------------ -----------
Net loss, as reported ................... $(6,641,136) $(1,753,507) $(10,601,999) $(4,693,794)
Add: SFAS No. 123 compensation expense... $ (54,722) $ (54,722) $ (712,356) $ (954,415)
----------- ----------- ------------ -----------
Pro forma net loss ...................... $(6,695,858) $(1,808,229) $(11,314,355) $(5,648,209)
=========== =========== ============ ===========
Net loss per share:
Basic and diluted - as reported .... $ (0.05) $ (0.06) $ (0.09) $ (0.18)
=========== =========== ============ ===========
Basic and diluted - pro forma ....... $ (0.05) $ (0.06) $ (0.10) $ (0.21)
=========== =========== ============ ===========
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
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)
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) were adopted by the Company with no
material impact to the 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 September 30, 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:
MARCH 31, 2004 JUNE 30, 2003
----------- -----------
Raw materials .......................... $ 1,194,713 $ 1,203,877
Work in process ........................ 150,181 63,861
Finished goods ......................... 440,999 719,548
----------- -----------
1,785,893 1,987,286
Less valuation allowance ............... (737,453) (374,696)
----------- -----------
Inventories, net ....................... $ 1,048,440 $ 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:
MARCH 31, 2004 JUNE 30, 2003
-------------- -------------
Accrued sales returns, including warranty obligations .......... $227,833 $103,947
Accrued royalties payable ...................................... 157,649 104,104
Accrued wages, benefits and related taxes ...................... 83,952 79,672
Accrued interest payable ....................................... 77,313 472,413
Accrued other .................................................. 59,339 5,911
-------- --------
Total accrued liabilities ...................................... $606,086 $766,047
======== ========
7. NOTES 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. The advance loan was repaid in full on March 31, 2004. The
remaining term 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 cash and cash equivalents, 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. During the quarter ended March 31, 2004, the Company issued
1,000,000 shares of common stock as partial payment of the $100,000 annual fee
for the May 1, 2004 through April 30, 2005 period.
8. CONVERTIBLE DEBENTURES
June through November 2001 Issuances
From June 2001 through November 2001, the Company issued unsecured convertible
debentures, $3,840,000 of which remains outstanding with one debenture holder at
March 31, 2004. These debentures (i) accrue interest at the prime rate plus two
percent (6.0% at March 31, 2004), (ii) are currently convertible at the option
of the holder 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 holder may not convert its debentures to the extent
that conversion would result in the holder's beneficial ownership of 9.99% or
more of the Company's then outstanding common shares. The holder of these
debentures has a one-time right to convert a portion of the debentures after the
closing of any subsequent private offering at less than $0.10 per common share.
The holder exercised this right during the third quarter of 2004 and converted
$180,000 of principal and $60,000 of accrued interest at $0.05 resulting in
$240,000 of additional expense upon conversion related to the beneficial
conversion feature. 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.
8
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. CONVERTIBLE DEBENTURES (CONTINUED)
September 2003 Issuances
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 $199,376 at March
31, 2004, (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. The debentures were convertible at the option of the
holders at a stated rate of $0.13 per share and were 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. Holders may not convert their debentures or exercise their
warrants to the extent that conversion or exercise would result in the Holders'
beneficial ownership of 4.99% or more 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 required 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 debentures remain outstanding. The agreement further stipulates that no
debenture may be prepaid without the consent of the holder and that each
debenture holder had a right of first refusal to participate in any new
financing transaction consented to through April 21, 2004.
On January 13, 2004, the Company entered into an exchange agreement with each
holder of its convertible debentures that were issued in September 2003. Under
the exchange agreement, each debenture holder agreed 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. Holders may not convert
their debentures to the extent that conversion would result in the holders'
beneficial ownership of 4.99% or more of the Company's then outstanding common
shares. Accrued but unpaid interest of $149,659 related to these debentures 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 of
$149,659. 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 $1,488,889 of
additional financing expense related to the beneficial conversion features of
the exchange and amortized to expense $2,667,676 of previously existing debt
discount related to the convertibles debentures issued in September 2003.
February 2004 Issuances
On February 19, 2004, the Company completed a private placement offering of
$2,775,000 in unsecured convertible debentures from which we received $2,077,592
in net cash proceeds. These debentures, which have an aggregate principal face
amount of $2,775,000 at March 31, 2004, become due and payable on February 19,
2006. The purchase price for the convertible debentures 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 and are
being amortized to deferred financing costs over the term of the debentures. The
debentures are convertible at a conversion price of $0.05 per share (66% of the
average of the five 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 participating warrant holders agreed to exercise
outstanding warrants held by them to the extent such exercise would not result
in any participant's beneficial ownership of 4.9% or more of the Company's then
outstanding common shares.
9
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. CONVERTIBLE DEBENTURES (CONTINUED)
Participants in the February 19, 2004 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 19, 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. 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. Holders may not convert debentures or
exercise warrants to the extent that conversion or exercise would result in the
holders' beneficial ownership of 4.9% or more of the Company's then outstanding
common shares.
On March 22, 2004, the Company filed a registration statement with the United
States Securities and Exchange Commission ("SEC") registering the resale of the
common shares underlying the debentures and warrants issued on February 19,
2004, which became effective April 5, 2004. The Company also agreed to seek
shareholder approval to increase the number of authorized common shares to a
minimum of 500 million shares before April 30, 2004. Shareholder approval to
increase the authorized common shares to 750 million was obtained on April 28,
2004. 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.
Investors in the February 19, 2004, financing have been granted the option to
purchase up to an additional $1,220,000 of convertible debentures and warrants
with terms and conditions substantially identical to those applicable to the
February 19, 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 of the February 19, 2004, transaction 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.
March 2004 Issuance
In March 2004, the Company issued an unsecured convertible debenture in the
amount of $122,000 from which it received $100,000 in net proceeds after an
original issue discount of $22,000. The Company also issued 732,000 of
detachable stock purchase warrants in connection with this transaction. The
convertible debenture and common stock purchase warrants have identical terms
and conditions to those issued on February 19, 2004. The principal balance
outstanding for this debenture was $122,000 at March 31, 2004.
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 $4,646,079 and $2,883,918 at
March 31, 2004, and June 30, 2003, respectively.
10
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. CONVERTIBLE DEBENTURES (CONTINUED)
The remaining $6,936,376 in principal of the Company's outstanding convertible
debentures at March 31, 2004, mature during the Company's fiscal years ending as
follows:
FISCAL YEARS ENDING JUNE 30, PRINCIPAL
------------------------------------------------------------
2006....................................... $ 2,897,000
2007....................................... 4,039,376
-------------
Total principal payments................... $ 6,936,376
9. STOCKHOLDERS' EQUITY (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.
The Company's shareholders elected to increase its authorized common shares from
250 million to 750 million at a special shareholders' meeting held on April 28,
2004.
Common Shares Issued In Payment of Accrued Interest and Upon Conversion of
Convertible Debenture 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
related accrued but unpaid interest of $149,659. Additionally, we 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 (See Note 8).
In March 2004 we issued 4,800,000 shares of common stock upon conversion of
debenture principal in the amount of $180,000 and related accrued interest of
$60,000.
Common Shares Issued Upon Exercise of Common Stock Purchase Warrants
In February 2004, we issued 4,615,384 shares of our common stock to two
institutional investors upon exercise of 4,615,384 common stock purchase
warrants resulting in approximately $231,000 net cash proceeds.
Common Shares Issued for Services
On January 7, 2004, we issued 975,669 restricted shares of our common stock to
certain of our employees as payment for $117,080 in compensation expense.
On January 9, 2004, we issued 1,000,000 restricted shares of our common stock to
a financing company in partial settlement of a $100,000 loan renewal fee (See
Note 7).
On January 21, 2004, we issued 250,000 restricted shares of our common stock to
an investment-banking firm in exchange for investment banking services and
research coverage.
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.
11
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 flow.
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. Because the Company did not meet the calendar
2002 minimum sales threshold set forth in the agreement, this supplier began
prospectively assessing a 10% price surcharge in exchange for agreeing to
maintain U.S. exclusivity. This surcharge was based on the Company's revised
sales forecasts for the duration of the agreement. Should the Company fail to
meet these sales forecasts, the supplier may impose a more significant price
surcharge as a condition to further maintaining U.S. exclusivity. The dollar
amount of such future amounts, if any, is currently indeterminable.
12
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.
13
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 flow, 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
regarding our ability to continue as a going concern.
In order to address our ability to continue as a going concern, we have
initiated or completed the following financing activities:
o 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;
o On February 19, 2004, we completed an additional private placement
offering of $2,775,000 in unsecured convertible debentures from which
we received $2,077,592 in net cash proceeds. In connection with this
transaction, participating warrant holders agreed to exercise
outstanding warrants held by them. As of March 31, 2004, we had
received approximately $231,000 in net proceeds from the exercise of
these warrants and expect to receive approximately $240,000 in net
cash proceeds upon exercise of the remaining outstanding warrants;
o On March 1, 2004, we received $100,000 in net proceeds from the
issuance of an unsecured convertible debenture in the principal amount
of $122,000;
o On April 28, 2004, our shareholders elected to increase our authorized
common shares to 750 million shares for use in future financing
transactions; and
o We granted to investors in the February 19, 2004 financing, the option
to purchase up to an additional $1,220,000 of convertible debentures
and warrants through October 28, 2004, with terms and conditions
substantially identical to those in the original February 2004
transaction.
With respect to our sales, gross margins and operating expenses, we have:
o 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 of approximately 45%
before reductions for inventory obsolescence allowances on expired
test strips;
o Depleted our remaining inventory of our higher-cost, predecessor
device subsequent to March 31, 2004;
o Continued negotiations with a major retailer, as well as smaller
retailers, to sell our current consumer device;
o Developed a continuing education program to be implemented over the
next 6 months to broaden awareness and educate pharmacists on the
benefits of our product;
o Developed a consumer point-of-sale awareness program for those
patients purchasing certain cholesterol-lowering prescriptions, which
will be tested during May and June 2004;
o Continued to conduct the radio advertising marketing activities we
began in October 2003, primarily targeted radio advertising;
o Continued to support and monitor the Medicare reimbursement
considerations of the federal government for cholesterol testing;
o Continued to operate with a core staff of only 19 employees; and
o Continued to implement cost-cutting measures, the most significant of
which continues to be the elimination of consultants and research and
development costs.
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 our ability to continue conducting marketing activities and the success of
these campaigns on increasing awareness to consumers and pharmacists.
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 flow will likely be materially adversely impacted, the
effects
14
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
SUBSTANTIAL DOUBT REGARDING OUR ABILITY TO CONTINUE AS A GOING CONCERN
(CONTINUED)
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.
OUR CONSOLIDATED RESULTS OF OPERATIONS
Our consolidated net sales for the fiscal quarter ended March 31, 2004 ("fiscal
2004 third quarter"), were $627,014, a decrease of $22,079, or 3.4%, as compared
to $649,093 for the fiscal quarter ended March 31, 2003 ("fiscal 2003 third
quarter"). For the nine months ended March 31, 2004 ("first nine months of
fiscal 2004"), our consolidated net sales were $2,039,540, a decrease of
$1,672,102, or 45%, as compared to $3,711,642 for the nine months ended March
31, 2003 ("first nine months of fiscal 2003"). 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 the three and nine
months ended March 31, 2004, gross sales of our consumer monitors decreased
approximately 6% and 49%, respectively, whereas gross sales of our related
consumer test strips increased 39% and 6%, respectively from the comparative
prior periods. Gross sales of smart cards and other accessories decreased
approximately 15% and 17% for the three and nine months ended March 31, 2004,
respectively from the comparative prior periods.
We primarily attribute the decrease in our consolidated net sales for our fiscal
2004 third quarter as compared to the third quarter of 2003 to increased sales
returns for test strips sold with a short-term expiration date. Without the
effect of this increase in returns, gross sales for the third quarter of 2004
were $46,026 or 5.9% higher than the third quarter of 2003. The decrease in our
consolidated net sales for the first nine months of fiscal 2004 from the first
nine months of fiscal 2003 is attributable 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 loss of $61,895 for our fiscal 2004 third
quarter, a decrease of $256,170, or 131.9%, as compared to a consolidated gross
profit of $194,275 for our fiscal 2003 third quarter. For the first nine months
of our fiscal 2004, our consolidated gross profit was $264,960, a decrease of
$973,953, or 78.6%, as compared to a consolidated gross profit of $1,238,913 for
our fiscal 2003 first nine months. Our resulting gross margins were (9.9)% and
13.0% for our fiscal 2004 third quarter and first nine months, respectively, as
compared to 29.9% and 33.4% for our fiscal 2003 third quarter and first nine
months, respectively. We primarily attribute these significant decreases in our
gross profits and margins to the increase in the inventory obsolescence
allowance by $199,476 and $362,757 for the fiscal 2004 third quarter and first
nine months, respectively. The increase in the inventory obsolescence allowance
is due to our decision to suspend sales of test strips expiring in May and
September 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 and September 2004 expiration dates. 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 $1,249,473 (inclusive of
$193,919, in non-cash charges) for our fiscal 2004 third quarter, a decrease of
$53,035, or 4.1%, from the $1,302,508 (inclusive of $161,308 in non-cash
charges) incurred during our fiscal 2003 third quarter. For our fiscal 2004
first nine months, our total operating expenses were $3,730,668 (inclusive of
$437,451 in non-cash charges), a decrease of $184,594, or 4.7%, from the
$3,915,262 (inclusive of $477,304 in non-cash charges) incurred during our
fiscal 2003 first nine months. As further detailed below, the decrease in
operating expenses for our fiscal 2004 third quarter is due to decreased general
and administrative expenses resulting from continued cost-cutting measures
primarily related to professional and consulting services, as well as reduced
salaries expense from operating with fewer employees. This decrease is offset by
increased marketing costs related to the radio marketing campaign beginning in
October 2003.
15
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
OUR CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
Our consolidated sales and marketing expenses were $474,361 for our fiscal 2004
third quarter, an increase of $159,060, or 50.5%, from the $315,301 incurred
during our fiscal 2003 third quarter. For the nine months ended March 31, 2004,
our sales and marketing expenses were $1,319,747, an increase of $541,032, or
69.5%, from the $778,715 incurred during the nine months ended March 31, 2003.
These expense increases primarily were derived from the launch of our radio
advertising campaign in October 2003, which continued throughout the fiscal 2004
third quarter. This substantial increase is offset by a decrease in salaries
expense due to staffing reductions, commissions due to decreased sales and
curtailed travel to and participation in trade shows. Our sales and marketing
expenses will continue to increase for our fiscal 2004 fourth 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 $678,681 for
our fiscal 2004 third quarter, a decrease of $181,435, or 21.1%, from the
$860,116 incurred during our fiscal 2003 third quarter. For the nine months
ended March 31, 2004, our G&A expenses were $2,042,610, a decrease of $453,109,
or 18.2%, from the $2,495,719 incurred during the nine months ended March 31,
2003. The decrease for the third quarter of fiscal 2004 as compared to the third
quarter of 2003 is due to lower professional fees, decreased bad debt expense,
and decreased expenses related to being listed on the American Stock Exchange in
2003 as opposed to trading over the counter during 2004. These decreases were
offset by increased compensation expense related to the issuance of restricted
stock to employees and increased insurance costs. The decrease in G&A expenses
for the nine months ended March 31, 2004 as compared to the nine months ended
March 31, 2003 is 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 staffing reductions, as well as, decreased bad debt, rent,
utilities, telecommunications and travel expenses. Slightly offsetting the
preceding were increased costs for investor relations and costs incurred in
connection with a shareholders' meeting related to the increase in our
authorized common shares, increased insurance costs 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.
Our product research and development expenses were $19,593 for our fiscal 2004
third quarter, a decrease of $1,029, or 5.0%, from the $20,622 incurred during
our fiscal 2003 third quarter. For the nine months ended March 31, 2004, our
product research and development expenses were $47,584, a decrease of $245,103,
or 83.8%, from the $292,687 incurred during the nine months ended March 31,
2003. The three month period was substantially the same, while the decrease in
the nine month period primarily was attributable to reductions in salaries,
benefits, and product design costs 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 $76,838 for our fiscal
2004 third quarter, a decrease of $29,631, or 27.8%, from the $106,469 incurred
during our fiscal 2003 third quarter. For our fiscal 2004 first nine months, our
non-cash depreciation and amortization expenses were $232,971, a decrease of
$115,170, or 33.1%, from the $348,141 incurred during our fiscal 2003 first nine
months. These decreases are primarily attributable to certain equipment that
became fully depreciated during fiscal 2003.
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 third quarter was $1,311,368, an increase of $203,135, or 18.3%, from the
$1,108,233 incurred during our fiscal 2003 third quarter. For the nine months
ended March 31, 2004, our loss from operations was $3,465,708, an increase of
$789,359, or 29.5%, from the $2,676,349 incurred during the comparable period of
fiscal 2003.
16
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
OUR CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
Our non-operating income and expenses primarily consist of amortization of
convertible debt discount, interest and financing expenses, and other
miscellaneous income and expense items. Our net non-operating expenses were
$5,329,768 (inclusive of $5,252,337 in non-cash charges) in our fiscal 2004
third quarter, as compared to net non-operating expenses of $645,274 (inclusive
of $410,318 in non-cash charges) in our fiscal 2003 third quarter. For the nine
months ended March 31, 2004, our net non-operating expenses were $7,136,291
(inclusive of $7,079,842 in non-cash charges) as compared to $2,017,445
(inclusive of $1,230,954 in non-cash charges) for the nine months ended March
31, 2003. The net increase realized for our fiscal 2004 third quarter and first
nine months primarily was attributable to increased amortization of convertible
debt discount of $2,781,402 and $3,524,184, respectively. The increased
amortization of convertible debt discount is due to the conversion of $3.2
million and $4.6 million of convertible debentures during the 2004 third fiscal
quarter and 2004 first nine months, respectively. The remaining increase in
non-operating income and expenses for the three and nine months ended March 31,
2004 is due to $1,728,889 of expense related to a beneficial conversion feature
recognized as a result of issuing convertible debt at a discount from the stated
conversion rate.
Primarily as a result of the foregoing, we incurred a net loss of $6,641,136
($0.05 per basic and diluted share) in our fiscal 2004 third quarter as compared
to a net loss of $1,753,507 ($0.06 per basic and diluted share) in our fiscal
2003 third quarter. For the nine months ended March 31, 2004, we incurred a net
loss of $10,601,999 ($.09 per basic and diluted share) as compared to a net loss
of $4,693,794 ($0.18 per basic and diluted share) for the nine months ended
March 31, 2003.
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 marketing efforts and 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 flow,
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.
Our Capital Lease Obligations
We lease certain equipment under capital leases. The aggregate net carrying
values of the underlying collateralizing assets were approximately $194,000 and
$285,000 at March 31, 2004, and June 30, 2003, respectively.
17
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
OUR CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Our aggregate future obligations under capital lease agreements in existence at
March 31, 2004, are as follows:
FISCAL YEARS ENDING JUNE 30,
-------------------------------------------------------------
2004 (balance thereof)........................... $ 18,823
2005............................................. 24,308
2006............................................. 6,172
----------
Total lease payments............................. 49,303
Less imputed interest............................ 5,362
----------
Present value of net minimum lease payments...... 43,941
Less current maturities.......................... 35,280
----------
Total long-term capital lease obligation......... $ 8,661
==========
The future aggregate minimum lease payments under operating lease agreements in
existence at March 31, 2004, are as follows:
FISCAL YEARS ENDING JUNE 30,
-------------------------------------------------------------
2004 (balance thereof)........................ $ 25,528
2005.......................................... 25,781
----------
Total minimum operating lease payments........ $ 51,309
==========
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. The
advance loan was repaid in full on March 31, 2004. The remaining term 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 cash
and cash equivalents, 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
agreed to 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. During the quarter ended March 31, 2004,
we issued 1,000,000 shares of common stock as partial payment of the $100,000
annual fee for the May 1, 2004 through April 30, 2005 period.
As a result of the preceding conversion, we no longer have any established
credit facilities in place for future borrowings.
18
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
OUR CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Our Outstanding Convertible Debentures
June through November 2001 Issuances
From June 2001 through November 2001, we issued unsecured convertible
debentures, $3,840,000 of which remains outstanding with one debenture holder at
March 31, 2004. These debentures (i) accrue interest at the prime rate plus two
percent (6.0% at March 31, 2004), (ii) are currently convertible at the option
of the holders into 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. The holder may not convert its debentures to the extent that conversion
would result in the holder's beneficial ownership of 9.99% or more of our then
outstanding common shares. The holder of these debentures has a one-time right
to convert a portion of the debentures after the closing of any subsequent
private offering at less than $0.10 per common share. The holder exercised this
right during the third quarter of 2004 and converted $180,000 of principal and
$60,000 of accrued interest at $0.05 resulting in $240,000 of additional expense
upon conversion related to the beneficial conversion feature. 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.
September 2003 Issuances
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 $199,376 at March 31, 2004, (i)
accrue interest at a fixed rate of 8.0% per annum, which is payable at the our
option in either cash or authorized and unissued shares of our common stock. The
debentures were convertible at the option of the holders at a stated rate of
$0.13 per share and were 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. Holders may not convert
their debentures or exercise their warrants to the extent that conversion or
exercise would result in the holders' beneficial ownership of 4.99% or more 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 required 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 to exchange the principal
amount of its debenture for shares of our common stock, at the rate of $0.09 of
debenture principal per share of common stock. Holders may not convert their
debentures to the extent that conversion would result in the Holders' beneficial
ownership of 4.99% or more of our then outstanding common shares. Accrued but
unpaid interest of $149,659 related to these debentures 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 of $149,659. Additionally, we
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
we recognized approximately $1,489,000 of additional financing expense related
to the beneficial conversion features of the exchange and amortized to expense
approximately $2,668,000 of previously existing debt discount related to the
convertibles debentures issued in September 2003.
February 2004 Issuances
On February 19, 2004, we completed a private placement offering of $2,775,000 in
unsecured convertible debentures from which we received $2,077,592 in net cash
proceeds. These debentures, which have an aggregate principal face amount of
19
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
OUR CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
$2,775,000 at March 31, 2004, become due and payable on February 19, 2006. The
purchase price for the convertible debentures 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 and are being amortized to
deferred financing costs over the term of the debentures. The debentures are
convertible at a conversion price of $0.05 per share (66% of the average of the
five 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 our common stock. In connection with this transaction
participating warrant holders agreed to exercise outstanding warrants held by
them to the extent such exercise would not result in any particants' beneficial
ownership of 4.9% or more of our then outstanding common shares.
Participants in the February 19, 2004 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 19, 2004. The warrants can be
exercised over a nineteen-month period and have an exercise price of $0.065 per
share of our common stock, subject to adjustment upon the occurrence of events
substantially identical to those provided for in the debentures. We have the
right to call the warrants in the event that the average closing price of our
common stock exceeds 200% of the exercise price for a consecutive 20-day trading
period. Holders may not convert debentures or exercise warrants to the extent
that conversion or exercise would result in the holders' beneficial ownership of
4.9% or more of our then outstanding common shares.
On March 22, 2004, we filed a registration statement with the United States
Securities and Exchange Commission ("SEC") registering the resale of the common
shares underlying the debentures and warrants issued on February 19, 2004, which
became effective April 5, 2004. We also agreed to seek shareholder approval to
increase the number of authorized common shares to a minimum of 500 million
shares before April 30, 2004. Shareholder approval to increase the number of
authorized common shares to 750 million was obtained on April 28, 2004. We 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.
Investors in the February 19, 2004, financing have been granted the option to
purchase up to an additional $1,220,000 million in convertible debentures and
warrants with terms and conditions substantially identical to those applicable
to the February 19, 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. We 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 of the February 19, 2004, transaction requires that we
obtain the unanimous approval of the debenture holders prior to the occurrence
of certain events including stock dividends, subdivisions, combinations and
reclassifications of our 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.
March 2004 Issuance
In March 2004, we issued an unsecured convertible debenture in the amount of
$122,000 from which we received $100,000 in net proceeds after an original issue
discount of $22,000. We also issued 732,000 of detachable stock purchase
warrants in connection with this transaction. The convertible debenture and
common stock purchase warrants have identical terms and conditions to those
issued on February 19, 2004. The principal balance outstanding for this
debenture was $122,000 at March 31, 2004.
20
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
OUR CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
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 debentures. The
aggregate unamortized debt discount amounted to $4,646,079 and $2,883,918 at
March 31, 2004, and June 30, 2003, respectively. The remaining principal of our
outstanding convertible debentures at March 31, 2004, of $6,936,376 matures
during our fiscal years ending as follows:
FISCAL YEARS ENDING JUNE 30, PRINCIPAL
--------------------------------------------------------------
2006............................................. $ 2,897,000
2007............................................. 4,039,376
-----------
Total Principal Payments......................... $ 6,936,376
===========
Our Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements that have or are reasonably likely to
have a current or future effect on our financial condition, changes in financial
condition, revenues or expenses, results of operations, liquidity, capital
expenditures or capital resources that are material to investors.
Our Consolidated Cash Flows
Our operating activities utilized $4,657,094 in cash and cash equivalents during
our fiscal 2004 first nine months, an increase of $3,653,150, or 363.9%, from
the $1,003,944 in cash and cash equivalents utilized during our fiscal 2003
first nine months. On a comparative fiscal period-to-period basis, our
substantially higher utilization primarily reflects the $5,908,205 increase in
our net loss as well as the utilization of cash to decrease accounts payable by
$1,378,087 during the first nine months of fiscal 2004 compared to a positive
cash flow from the increase in accounts payable of $1,378,706 during the first
nine months of fiscal 2003. The substantial decrease in accounts payable is due
to utilization of funds received from financing activities to pay vendors. Our
higher utilization also reflects the negative cash flow effects of increased
prepaid expenses resulting from prepayments made on a substantial marketing
contract and decreased deferred income. Partially offsetting these negative cash
flow effects were the positive cash flow effects of increased non-cash charges
primarily related to increased amortization of discount on convertible
debentures resulting from substantial issuances of convertible debt and
conversions of convertible debt during the nine months ended March 31, 2004,
increased deferred financing costs resulting from commission paid on several
financing transactions during the nine months ended March 31, 2004, as well as
beneficial conversion feature expense related to the discounted conversion of
convertible debt.
Our investing activities utilized $6,149 in cash and cash equivalents during our
fiscal 2004 first nine months, a decrease of $10,258, or 62.5%, from the $16,407
in cash and cash equivalents utilized during our fiscal 2003 first nine months.
Our decreased utilization is attributable to lower capital expenditures as a
result of continued cost-cutting measures implemented to decrease cash outflows.
Our financing activities provided $4,776,187 in cash and cash equivalents during
our fiscal 2004 first nine months, an increase of $4,345,333, or 1008.5%, from
the $430,854 in cash and cash equivalents provided during our fiscal 2003 first
nine months. Our fiscal 2004 increase reflects the receipt of the $5,244,592 net
cash proceeds received from our issuance of convertible debentures and $230,769
proceeds received from our issuance of stock from exercise of warrants (both of
which have been previously discussed) being offset by increased principal
payments on our outstanding capital lease obligations and notes payable. In
contrast, our fiscal 2003 first nine months reflected principal payments on
outstanding convertible debentures and other debt, being offset by the cash
inflow from the redemption of a previously restricted certificate of deposit.
21
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
OUR CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
As a result of the foregoing, our unrestricted cash and cash equivalents
increased by $112,944 to $1,483,070 at March 31, 2004, from $1,370,126 at June
30, 2003. Our working capital increased by $2,437,387 to $1,490,276 at March 31,
2004, from a deficiency of $947,111 at June 30, 2003.
Our Planned Capital
Expenditures We have no significant planned capital expenditures for fiscal
2004.
OUR OTHER MATTERS
Our Seasonal and Inflationary Influences
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 nine
months 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 interest-bearing 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 March 31, 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 revenues 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 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.
22
ITEM 2. OUR MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED)
OUR OTHER MATTERS (CONTINUED)
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 and
were assigned an appeal number of 03-1630. All briefs were timely filed,
argument was heard on May 7, 2004, and the appeal was submitted for decision on
that date. We expect to receive the appellate decision within several months.
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.
Should the Court of Appeals not rule in our favor, we may be unsuccessful in
collecting future royalties from parties utilizing this technology and as a
result, may reduce the net realizable value requiring a write down of the patent
on our consolidated financial statements. Settlement discussions are at a
standstill but may resume at any time.
ITEM 3. OUR CONTROLS AND PROCEDURES
As of March 31, 2004, the Company carried out an evaluation, under the
supervision and with the participation of the Company's management, including
its Chief Executive Officer and its Chief Financial Officer, of the design and
operation of the Company's disclosure controls and procedures. Based on this
evaluation, the Company's Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures are effective
for gathering, analyzing and disclosing the information the Company is required
to disclose in the reports it files under the Securities
23
Exchange Act of 1934, within the time periods specified in the SEC's rules and
forms. There have been no significant changes in the Company's internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of this evaluation and through the date of the filing of this form
10-QSB.
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 and
were assigned an appeal number of 03-1630. All briefs were timely filed,
argument was heard on May 7, 2004, and the appeal was submitted for decision on
that date. We expect to receive the appellate decision within several months.
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.
Should the Court of Appeals not rule in our favor, we may be unsuccessful in
collecting future royalties from parties utilizing this technology and as a
result, may reduce the net realizable value requiring a write down of the patent
on our consolidated financial statements. Settlement discussions are at a
standstill but may resume at any time.
ITEM 2. OUR CHANGES IN SECURITIES AND USE OF PROCEEDS
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 quarter ended March 31, 2004.
In each of these transactions, the investor(s) (a) had access to business and
financial information about us, (b) was an accredited invesor and/or had such
experience in business and financial matters so that it was able to evaluate the
risks and merits of an investment in us, (c) acknowledged that the securities
were not registered under the Securities Act of 1933 and could not be
transferred except in compliance with applicable securities laws, and (d)
received securities bearing a legend describing the restrictions referred to in
clause (c) above. Unless otherwise noted, no placement agent or broker dealer
participated in the transaction and no commissions or similar compensation was
paid.
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 to exchange the principal
amount of its debenture for shares of our common stock, at the rate of $0.09 of
debenture principal per share of common stock. Holders may not exchange their
debentures to the extent that exchange would result in the holders' beneficial
ownership of 4.99% or more of our then outstanding common shares. Accrued but
unpaid interest of $149,659 related to these debentures 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 applied to
$175,000 of principal previously converted by a debenture holder to the $0.09
rate stated in the Exchange Agreement.
On January 7, 2004, we issued 975,669 restricted shares of our common stock to
certain of our employees as payment for $117,080 in compensation expense.
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ITEM 2. OUR CHANGES IN SECURITIES AND USE OF PROCEEDS (CONTINUED)
On January 9, 2004, we issued 1,000,000 restricted shares of our common stock to
a financing company in partial settlement of a $100,000 renewal fee.
On January 21, 2004, we issued 250,000 restricted shares of our common stock to
an investment-banking firm in exchange for investment banking services and
research coverage.
On February 19, 2004, we completed a private placement offering of $2,775,000 in
unsecured convertible debentures to four institutional investors from which we
received $2,077,592 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 our common stock. In
connection with this transaction participating warrant holders agreed to
exercise outstanding warrants held by them to the extent such exercise would not
result in any participants' beneficial ownership of 4.9% of our then outstanding
common shares. We paid $181,968 in commissions to a placement agent in
connection with this financing transaction.
In February 2004 we issued 4,615,384 shares of our common stock to two
institutional investors upon exercise of 4,615,384 common stock purchase
warrants from which we received approximately $231,000 in net cash proceeds. We
paid approximately $9,000 to the placement agent of the February 19, 2004
private placement offering as a warrant exchange fee in connection with these
exercises.
In March 2004 we issued 4,800,000 shares of common stock upon conversion of
debenture principal in the amount of $180,000 and accrued interest of $60,000.
In March 2004 we issued an additional $122,000 of convertible debentures from
which we received $100,000 in net proceeds after an original issue discount of
$22,000. We also issued 732,000 of detachable stock purchase warrants in
connection with this transaction. The convertible debentures and common stock
purchase warrants have identical terms and conditions to those issued on
February 19, 2004 discussed above.
ITEM 3. OUR DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. OUR SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OUR OTHER INFORMATION
Effective April 5, 2004, Brett Sweezy, our Chief Financial Officer, terminated
his employment with us due to his involvement with a new business venture. Mr.
Sweezy will continue to provide services to the Company on a consulting basis
through June 30, 2004. Nikki Nessan, V.P. of Finance, has been designated as
interim Chief Accounting and Financial Officer until such time that a new Chief
Financial Officer is hired.
ITEM 6. OUR EXHIBITS AND REPORTS ON FORM 8-K
During the period covered by this report, we filed no current report on Form
8-K, except that on March 1, 2004, we filed a report of Form 8-K reporting our
completion of a $2,775,000 private placement of convertible debentures.
EXHIBIT INDEX
10.1 Securities Purchase Agreement dated February 19, 2004 (1)
10.2 Form of Convertible Debenture due February 19, 2006 (2)
10.3 From of Common Stock Purchase Warrant dated February 19, 2004 (3)
10.4 Registration Rights Agreement dated February 19, 2004 (4)
10.5 Exchange Agreement dated January 12, 2004 (5)
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.
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32.1 Certification of Chief Executive Officer pursuant to Section 906 of the
LIFESTREAM Sarbanes-Oxley Act of TECHNOLOGIES, 2002. INC.
32.2 Certification of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
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(1) Incorporated by reference to exhibit 99.2 to our Current Report on Form 8-K
filed with the Securities and Exchange Commission on March 1, 2004.
(2) Incorporated by reference to exhibit 99.3 to our Current Report on Form 8-K
filed with the Securities and Exchange Commission on March 1, 2004.
(3) Incorporated by reference to exhibit 99.4 to our Current Report on Form 8-K
filed with the Securities and Exchange Commission on March 1, 2004.
(4) Incorporated by reference to exhibit 99.5 to our Current Report on Form 8-K
filed with the Securities and Exchange Commission on March 1, 2004.
(5) Incorporated by reference to exhibit 10.14 to our Registration Statement on
Form SB-2 filed with the Securities and Exchange Commission on March 22,
2004.
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 14th day of May, 2004.
LIFESTREAM TECHNOLOGIES, INC.
By: /s/ Nikki Nessan
----------------
Nikki Nessan
Chief Financial and Accounting Officer
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