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 SEPTEMBER 30, 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 November 12, 2004, the registrant had 209,968,735 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 SEPTEMBER 30, 2004
PAGE
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PART I. FINANCIAL INFORMATION
Item 1. Interim Condensed Consolidated Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets as of September 30, 2004 and June 30, 2004............. 1
Condensed Consolidated Statements of Operations for the three months ended September 30,
2004 and 2003............................................................................ 2
Condensed Consolidated Statements of Cash Flows for the three months ended
September 30, 2004 and 2003.............................................................. 3
Notes to Interim Condensed Consolidated Financial Statements................................. 4
Item 2. Management's Discussion and Analysis or Plan of Operation................................. 13
Item 3. Controls and Procedures................................................................... 23
PART II. OTHER INFORMATION
Item 5. Other Information........................................................................ 23
Item 6. Exhibits.................................................................................. 24
Signatures......................................................................................... 24
PART I. FINANCIAL INFORMATION
ITEM 1. INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, JUNE 30,
2004 2004
------------ ------------
ASSETS (NOTE 2)
Current assets:
Cash and cash equivalents .......................................... $ 21,550 $ 590,196
Restricted cash held in escrow (Note 6) ............................ 50,696 25,293
Accounts receivable, net (Note 11) ................................. 511,524 495,460
Inventories, net (Note 4) .......................................... 754,367 749,304
Prepaid expenses ................................................... 26,203 164,912
------------ ------------
Total current assets .......................................... 1,364,340 2,025,165
Deferred financing costs, net (Notes 6 and 7) ......................... 419,210 609,467
Patent rights, net .................................................... 440,002 480,002
Property and equipment, net ........................................... 294,832 339,207
Other ................................................................. 94,436 158,336
------------ ------------
Total assets .................................................. $ 2,612,820 $ 3,612,177
============ ============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable ................................................... $ 1,324,132 $ 940,889
Accrued liabilities (Note 5) ....................................... 774,918 827,795
Capital lease obligations .......................................... 36,494 28,148
Notes payable (Note 6) ............................................. 967,932 1,169,031
------------ ------------
Total current liabilities ..................................... 3,103,476 2,965,863
Capital lease obligations ............................................. 2,975 5,880
Convertible notes, principal face amounts of $5,637,000 and $6,036,376,
respectively (Note 7) .............................................. 3,269,450 2,703,961
------------ ------------
Total liabilities ............................................. 6,375,901 5,675,704
------------ ------------
Commitments and contingencies (Notes 6, 7, 10 and 11)
Stockholders' deficit (Note 8):
Preferred stock, $.001 par value; 15,000,000 shares authorized; none
issued or outstanding ............................................ -- --
Common stock, $.001 par value; 750,000,000 shares authorized;
199,268,735 and 181,341,686 issued and outstanding, respectively 199,269 181,342
Additional paid-in capital ......................................... 55,195,371 54,425,383
Accumulated deficit ................................................ (59,157,721) (56,670,252)
------------ ------------
Total stockholders' deficit ................................... (3,763,081) (2,063,527)
------------ ------------
Total liabilities and stockholders' deficit ................... $ 2,612,820 $ 3,612,177
============ ============
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
------------------------------
SEPTEMBER 30, SEPTEMBER 30,
2004 2003
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Net sales ....................................................... $ 885,138 $ 625,475
Cost of sales ................................................... 652,806 427,136
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Gross profit .......................................... 232,332 198,339
------------- -------------
Operating expenses:
Sales and marketing ........................................... 588,964 131,918
General and administrative .................................... 697,322 697,851
Product research and development .............................. 10,620 3,468
Depreciation and amortization ................................. 93,003 79,313
Loss on disposal of equipment ................................. -- 87,756
------------- -------------
Total operating expenses .................................. 1,389,909 1,000,306
------------- -------------
Loss from operations .................................. (1,157,577) (801,967)
------------- -------------
Non-operating income (expenses):
Interest income ............................................... -- 2,007
Interest and financing expenses (Notes 6 and 7) ............... (174,770) (199,636)
Amortization of discount on convertible notes (Note 7) ........ (964,865) (387,672)
Amortization of deferred financing costs (Notes 6 and 7) ....... (190,257) (57,583)
Gain on unexercised option and purchase agreement (Note 9) .... -- 250,000
------------- -------------
Total non-operating expenses, net ......................... (1,329,892) (392,884)
------------- -------------
Net loss .............................................. $ (2,487,469) $ (1,194,851)
============= =============
Net loss per common share - basic and diluted (Note 3). $ (0.01) $ (0.01)
============= =============
Weighted average shares outstanding - basic and diluted
(Note 3) ............................................ 195,170,614 95,989,741
============= =============
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
THREE MONTHS ENDED
------------------------------
SEPTEMBER 30, SEPTEMBER 30,
2004 2003
------------- -------------
OPERATING ACTIVITIES:
Net loss ............................................................ $(2,487,469) $(1,194,851)
Non-cash items:
Depreciation/amortization of property, equipment and patent rights 93,003 79,313
Loss on disposal of equipment ..................................... -- 87,756
Amortization of deferred financing costs (Notes 6 and 7) .......... 190,257 57,583
Amortization of discount on convertible notes (Note 7) ............ 964,865 387,672
Provision for doubtful accounts ................................... 255,405 20,520
Increase (decrease) in inventory valuation allowance .............. 6,410 (22,719)
Other ............................................................. -- (15,357)
Net changes in assets and liabilities:
Accounts receivable ............................................... (271,469) (137,315)
Inventories ....................................................... (11,473) 306,578
Prepaid expenses .................................................. 138,709 (314,668)
Accounts payable .................................................. 676,333 (792,778)
Accrued liabilities ............................................... 42,572 106,516
Deferred income ................................................... -- (250,000)
Change in non-current assets ...................................... 63,900 57,817
----------- -----------
Net cash used in operating activities ........................ (338,957) (1,623,933)
----------- -----------
FINANCING ACTIVITIES:
Proceeds from issuance of convertible notes, net (Note 7) ........... -- 1,513,500
Principal payments of capital lease obligations ..................... (3,187) (112,352)
Principal payments of notes payable ................................. (201,099) (190,540)
Increase in restricted cash equivalent .............................. (25,403) --
----------- -----------
Net cash provided by (used in) financing activities .......... (229,689) 1,210,608
----------- -----------
Net decrease in cash and cash equivalents .............................. (568,646) (413,325)
Cash and cash equivalents at beginning of period ....................... 590,196 1,370,126
----------- -----------
Cash and cash equivalents at end of period ............................. $ 21,550 $ 956,801
=========== ===========
SUPPLEMENTAL SCHEDULE OF CASH ACTIVITIES:
Interest paid in cash .............................................. $ 43,220 $ --
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 7) $ -- $ 3,350,000
Contingent offering proceeds held in escrow (Note 7) ............... $ -- $ 1,553,500
Assets acquired through capital lease obligation .................... $ 8,628 $ --
Issuance of common stock in exchange for:
Conversion of convertible debt and accrued interest (Note 7) ..... $ 407,154 $ 700,000
Payment of accounts payable and accrued expenses ................. $ 380,761 $ --
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 developer and 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 the Company's monitors
enables a patient to readily ascertain the cholesterol-lowering 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
including a substantial accumulated deficit at June 30, 2004 and 2003. In
recognition of such, its independent registered public accountants included an
explanatory paragraph in their report on the Company's consolidated financial
statements for the fiscal years ended June 30, 2004 and 2003, that expressed
substantial doubt regarding the Company's ability to continue as a going
concern.
The Company is addressing its ability to continue as a going concern, as well as
its sales, gross margins and operating expenses, by among other things, the
following:
o During the Company's fiscal year ended June 30, 2004, the
Company completed three private placement offerings of
$6,225,000 in unsecured convertible debentures from which it
received $5,244,592 in net cash proceeds;
o On November 8, 2004, the Company's outstanding note payable
with a financial institution was assigned to a principal
stockholder of the Company. The principal stockholder amended
the terms of the note payable providing additional funding of
$1.5 million with no payments due for 6 months;
o Depleting the remaining inventory of our higher-cost,
predecessor device during fiscal 2004;
o Continuing negotiations with retailers in an effort to
increase its number of distribution outlets;
o Sponsoring a continuing education program to broaden awareness
and educate pharmacists on the benefits of it's products;
o Developing a consumer point-of-sale awareness program for
those patients purchasing certain cholesterol-lowering
prescriptions;
o Conducting marketing activities beginning in October 2003, as
funds were available;
o Continuing to support and monitor the Medicare reimbursement
considerations of the federal government for cholesterol
testing; and
o Continuing to operate with a core staff of only 19 employees
while implementing cost-cutting measures to maintain personnel
levels and administrative costs.
The Company will continue to require additional financing to fund its current
and longer term operating needs, including continuing marketing activities to
build broad public awareness of its cholesterol monitor. The amount of
additional funding needed to support the Company 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 Company's ability to sustain a
long-term marketing campaign and the success of marketing activities 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.
4
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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. 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, 2004.
Reclassifications
Certain amounts in the condensed consolidated financial statements for the prior
period has been reclassified to be consistent with the current period's
presentation.
Net Loss Per Share
Basic and diluted net loss per share has been computed by dividing net loss by
the weighted average number of common shares outstanding during the fiscal year.
At September 30, 2004 and 2003, the Company had stock options, stock warrants
and convertible notes outstanding that could potentially be exercised or
converted into 112,017,441 and 55,986,279 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 notes 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.
5
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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
---------------------------
SEPTEMBER 30, SEPTEMBER 30,
2004 2003
---------------------------
Net loss, as reported ................ $(2,487,469) $(1,194,851)
Add: SFAS No. 123 compensation expense (65,844) (145,870)
----------- -----------
Pro forma net loss ................... $(2,553,313) $(1,340,721)
=========== ===========
Net loss per share:
Basic and diluted - as reported . $ (0.01) $ (0.01)
=========== ===========
Basic and diluted - pro forma .... $ (0.01) $ (0.01)
=========== ===========
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 FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). This interpretation of Accounting
Research Bulletin No. 51, "Consolidated Financial Statements," addresses
consolidation by business enterprises of variable interest entities that possess
certain characteristics. FIN 46 requires that if a business enterprise has a
controlling financial interest in a variable interest entity, the assets,
liabilities, and results of the activities of the variable interest entity must
be included in the consolidated financial statements with those of the business
enterprise. FIN 46 applies immediately to variable interest entities created
after January 31, 2003, and to variable interest entities in which an enterprise
obtains an interest after that date. As the Company has not had, and continues
not to have, any ownership in variable interest entities, the Company's adoption
of FIN 46, as required on January 31, 2003, had no impact on its consolidated
financial statements.
In December 2003, the FASB issued a revision to the interpretation ("FIN No.
46(r)"). FIN No. 46(r) clarifies the application of Accounting Research Bulletin
No. 51 to certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. The provisions of FIN No.
46(r) were adopted by the Company with no material impact to the condensed
consolidated financial statements.
4. INVENTORIES, NET
Inventories, net, consist of the following:
SEPTEMBER 30, JUNE 30,
2004 2004
---------- ----------
Raw materials .................... $ 416,531 $ 444,880
Work in process .................. 105,334 80,814
Finished goods ................... 27,705 176,971
Finished goods at retail locations 232,144 67,576
--------- ---------
781,714 770,241
Less valuation allowance ......... (27,347) (20,937)
--------- ---------
Inventories, net ................. $ 754,367 $ 749,304
========= =========
6
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. ACCRUED LIABILITIES Accrued liabilities consist of the following:
SEPTEMBER 30, JUNE 30,
2004 2004
-------- --------
Accrued royalties payable ........................... $257,535 $257,535
Accrued sales returns, including warranty obligations 242,876 238,064
Accrued interest payable ............................ 191,823 184,784
Accrued wages, benefits and related taxes ........... 73,661 138,759
Accrued other ....................................... 9,023 8,653
-------- --------
Total accrued liabilities ........................... $774,918 $827,795
======== ========
6. NOTE PAYABLE
Effective May 1, 2003, the Company renewed its then expiring 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 accrued interest at 15% and was repaid on March 31, 2004, 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. On March 31, 2004, the financial
institution became 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. As of September 30, 2004,
$50,696 had been retained and was being held in an escrow account. The term loan
is 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. Any principal and accrued interest balances remaining on the term loan
will be due and payable as a lump sum on April 1, 2005. The remaining term loan
may be prepaid at any time, without penalty, at the Company's option. The
outstanding principal balance of this note payable was $967,932 and $1,169,031
at September 30, 2004 and June 30, 2004, respectively.
In consideration for extending the above loans, the Company agreed to pay 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 fiscal 2004 the Company issued 2,593,333 shares of common
stock as partial payment of the annual fee for the May 1, 2004 through April 30,
2005 period and a balance of approximately $24,500 remains payable at September
30, 2004. These annual fees are amortized to deferred financing costs over the
renewal period.
In November 2004, a principal stockholder of the Company entered into an
agreement with the above financial institution, under which the financial
institution assigned to the principal stockholder of the Company all of their
right, title and interest under the note payable. At the time of the assignment,
the outstanding amount due under the note payable was $920,323.
Subsequently, the Company and the new note holder entered into a series of
amendments to the note payable and related loan documents under which the
following terms were modified:
o the aggregate amount of the note was increased from $920,323
to $2,869,740, after giving effect to an original issue
discount in the amount of $449,415;
o $974,709 of the increase was funded November 12, 2004
resulting in net cash proceeds to the Company of $750,000;
o $974,708 of the increase is to be funded by December 31, 2004
(subject to the satisfaction of certain conditions precedent);
7
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
o the new loan balance of $2,869,740 is to be repaid in monthly
installments of $100,000 commencing May 1, 2005, with the
outstanding balance becoming due and payable on February 1,
2006;
o the Company paid a commitment fee to induce the principal
stockholder to enter into the series of amendments in the
amount of $500,000, paid by issuance of a promissory note
(commitment fee note) which is payable on February 1, 2006, in
cash or, at the Company's option, in shares of its common
stock at a 20% discount to market. The commitment fee note is
also convertible at the option of the note holder at a
conversion price of $.05 per, subject to adjustment; and
o the Company agreed to file a registration statement covering
the shares issuable under the commitment fee note.
7. CONVERTIBLE NOTES
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
September 30, 2004. These debentures (i) accrue interest at the prime rate plus
two percent (6.25% at September 30, 2004), (ii) are 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 (limited to
9.99% ownership). 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.
In connection with the Company's issuance of the amended and restated
procmissoty note discussed in Note 6, the conversion rate of the debentures
issued during June 2001 through November 2001 was reduced to $0.05 per share.
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 $0 at September 30,
2004, (i) accrued interest at a fixed rate of 8.0% per annum, which was 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 could 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.
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. 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 convertible debentures issued in September 2003.
In July 2004, the remaining principal balance from the September issuance of
$199,376 and related interest of $7,778 was converted into 2,468,004 shares of
the Company's common stock. As of September 30, 2004, no further convertible
debenture principal or accrued interest remaining outstanding related to the
September 2003 issuance.
8
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
February 2004 Issuances
On February 19, 2004, the Company completed a private placement offering of
$2,775,000 in unsecured convertible debentures from which it received $2,077,592
in net cash proceeds. These debentures, which have an aggregate principal face
amount of $1,797,000 at September 30, 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, or an effective annual
interest rate of 9%, 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. 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 4.99% or more of the
Company's 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 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 4.99% 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
stockholder approval to increase the number of authorized common shares to a
minimum of 500 million shares before April 30, 2004. Stockholder approval to
increase the authorized common shares to 750 million was obtained on April 28,
2004.
Investors in the February 19, 2004, financing were 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. This option expired on October 28, 2004.
The agreements entered into in connection with 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 through
June 10, 2005.
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 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 September 30, 2004.
9
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 $2,367,550 at September 30,
2004.
The remaining $5,637,000 in principal of the Company's outstanding convertible
debentures at September 30, 2004, mature during the Company's fiscal years
ending as follows:
FISCAL YEARS ENDING JUNE 30, PRINCIPAL
----------------------------------------------------------------
2005............................................. $ -
2006............................................. 1,797,000
2007............................................. 3,840,000
-----------
Total principal payments......................... $ 5,637,000
===========
8. STOCKHOLDERS' DEFICIT
General
The Company is restricted under Nevada corporate law from declaring any
dividends to stockholders due to current working capital and stockholders'
deficits.
The Company's stockholders elected to increase its authorized common shares from
100 million to 250 million and 750 million at a special stockholders' meetings
held on December 1, 2003 and April 28, 2004, respectively.
Common Shares Issued In Payment of Accrued Interest and Upon Conversion of
Convertible Note
In July 2004, the Company issued 6,468,004 shares of its common stock to two
institutional investors upon conversion of convertible notes with a principal
face amount of $399,376 and accrued interest of $7,778.
Common Shares Issued for Services
In July 2004, the Company issued 5,589,565 shares to unrelated consultants for
various services previously rendered in the amount of $188,089. The issuance of
these shares was authorized by the Company's Board of Directors on June 22,
2004, and therefore reduced accounts payable.
Also in July 2004, the Company issued 3,499,999 common shares to five directors
currently serving on the Company's Board of Directors. These shares were issued
for past services provided as Board members in the amount of $105,000. The
issuance of these shares was authorized by the Company's Board of Directors on
June 22, 2004, and therefore reduced the accrued liability.
In July 2004, the Company issued 2,369,481 shares of its common stock to certain
employees as payment for $87,671 in compensation expense. The issuance of these
shares was authorized by the Company's Board of Directors on June 22, 2004, and
therefore reduced the accrued liability.
9. 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 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 its
fiscal 2004.
10
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. CONTINGENCIES
General
The Company is periodically involved in litigation and administrative
proceedings primarily arising in the normal course of its business. In the
opinion of management, the Company's gross liability, if any, and without any
consideration given to the availability of indemnification or insurance
coverage, under any pending or existing litigation or administrative proceedings
would not materially affect its financial position, results of operations or
cash flows.
Patent Litigation
The Company is the plaintiff in patent infringement litigation, in which the
Company alleges willful patent infringement. The defendants have brought a
number of counterclaims, including antitrust, unfair competition, tortious
interference with business relations and patent misuse, and have asserted
unspecified general damages. In May 2003, the District Court ruled against our
assertion of patent infringement. The Company timely filed a Notice of Appeal to
the Court of Appeals for the Federal Circuit and in August 2004, the Court of
Appeals reversed the District Court's ruling and remanded the matter back to the
District Court for a new hearing. Following the remand, the Company returned to
settlement negotiations with the defendant. Pursuant to these negotiations, the
parties have now entered into a Letter of Intent requiring the parties to
negotiate in good faith an agreement that would, among other things, resolve the
litigation through a license under the patent. A final agreement has not yet
been reached, and the litigation remains pending before the Idaho District
Court. Should the District Court not rule in our favor and/or we are unable to
successfully negotiate a settlement including royalties to be received, we would
be required to impair our patent, and as such, we would write down the patent to
its net realizable value through a charge to amortization expense.
Royalty Obligation Dispute on Proprietary Optics Technology
The Company licensed the use of proprietary optics technology previously
utilized in its predecessor cholesterol monitor from a principal vendor in
exchange for payment of a royalty to the vendor for each monitor manufactured
with the optics technology. Beginning in October 2002, the Company developed and
began utilizing its own proprietary optics technology in its current cholesterol
monitor. In October 2002, the Company ceased accruing and paying the royalty
obligation as the Company viewed the re-engineered optics technology used in its
current cholesterol monitor as being proprietary to the Company. The vendor
asserted in a letter to the Company that the subject optics technology was, in
their opinion, still subject to royalties under the licensing agreement.
Negotiations have continued throughout fiscal 2004 and remain ongoing as of this
date to resolve the royalty obligation dispute. The Company has accrued $257,535
as of September 30, 2004 and June 30, 2004, and believes that any reasonably
likely incremental royalty obligation resulting from these negotiations would
not be material to our consolidated financial statements.
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 required the Company to make minimum
annual purchases and required certain compensating payments in the event the
Company fails to meet the minimum purchase requirements. As the Company has not
met these minimum purchase commitments, the vendor increased the price of the
test strips by 10% for fiscal 2004. Should the Company continue to not meet
these minimum purchase requirements, the vendor could require the Company to
make additional compensating payments. The dollar amount of such future
payments, if any, is currently indeterminable.
Purchase Commitments Under Marketing Contract
In February 2004, the Company entered into a marketing contract, which
contractually obligated the Company to purchase a minimum number of radio
advertising spots through January 7, 2005. As of September 30, 2004, the Company
had $473,248 of purchase obligations remaining under this contract.
11
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. SUBSEQUENT EVENTS
In November 2004, a principal stockholder of the Company entered into an
agreement with the holder of its note payable, under which the holder assigned
to the principal stockholder all of their right, title and interest under the
note payable. Subsequently, the terms of the note payable and related loan
documents were amended (see Note 6.)
Subsequent to quarter end, the Company ceased its relationship with a major
customer which had accounted for approximately 10% of revenues during fiscal
2004 due to the customers nonpayment of certain invoices due the Company. The
Company has fully reserved for all remaining unpaid invoices due from this
customer as of September 30, 2004.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Certain disclosures in this Quarterly Report on Form 10-QSBinclude 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 our current cholesterol monitor, 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 relatively unestablished product marketplace, consumer
preferences, perceptions and receptiveness with respect to our monitor, our
critical capital raising efforts in an uncertain and volatile economical
environment and any dilutive effect these efforts may have on the market price
of our common stock, our ability to maintain 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 - Business," "Item 6 -
Management's Discussion and Analysis or Plan of Operation," particularly the
discussions under "Substantial Doubt as to our Ability to Continue as a Going
Concern" and "Risks and Uncertainties," and elsewhere in our most recent Annual
Report on Form 10-KSB for the fiscal year ended June 30, 2004, 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.
OVERVIEW
We market a proprietary over-the-counter, total cholesterol-monitoring device
for at-home use by both health-conscious and at-risk consumers ("our cholesterol
monitor"). Our cholesterol monitor 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.").
Our revenue is derived from the sale of our cholesterol monitors, as well as
sales of the dry-chemistry test strips utilized in performing a total
cholesterol test with our cholesterol monitors. 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.
During the first quarter of fiscal 2005 we were successful in the following
areas:
o Increased our net revenue 42% over the same period of the
prior year while maintaining personnel levels and
administrative costs;
o Successfully aired on a national shopping network with our
product being the best selling product in its category for the
24 hour period in which it was presented; and
o Continued to implement our targeted radio advertising campaign
through the middle of September, at which time all media ads
were ceased due to cash flow constraints.
Our primary focus continues to be to increase consumer awareness of the benefits
of our products though increased distribution, educating pharmacists, and
seeking additional funding in order to continue conducting marketing activities.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (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 including a substantial
accumulated deficit at June 30, 2004 and 2003. In recognition of such, our
independent registered public accountants included an explanatory paragraph in
their report on our consolidated financial statements for the fiscal years ended
June 30, 2004 and 2003, that expressed substantial doubt regarding our ability
to continue as a going concern.
We are addressing our ability to continue as a going concern, as well as our
sales, gross margins and operating expenses, by among other things, the
following:
o During our fiscal year ended June 30, 2004, we completed three
private placement offerings of $6,225,000 in unsecured
convertible debentures from which we received $5,244,592 in
net cash proceeds;
o On November 8, 2004, our outstanding note payable with a
financial institution was assigned to a principal stockholder.
The principal stockholder amended the terms of the note
payable providing additional funding of $1.5 million with no
payments due for 6 months;
o Depleting the remaining inventory of our higher-cost,
predecessor device during fiscal 2004;
o Continuing negotiations with retailers in an effort to
increase our number of distribution outlets;
o Sponsoring a continuing education program to broaden awareness
and educate pharmacists on the benefits of our products; o
Developed a consumer point-of-sale awareness program for those
patients purchasing certain cholesterol-lowering
prescriptions;
o Conducting marketing activities beginning in October 2003, as
funds were available;
o Continuing to support and monitor the Medicare reimbursement
considerations of the federal government for cholesterol
testing; and
o Continuing to operate with a core staff of only 19 employees
while implementing cost-cutting measures to maintain personnel
levels and administrative costs.
We will continue to require additional financing to fund our current and
longer-term operating needs, including continuing marketing activities to build
broad public awareness of our cholesterol monitor. 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 sustain a long-term marketing campaign and
the success of marketing activities 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 from which we may not recover.
CONSOLIDATED RESULTS OF OPERATIONS
Our consolidated net sales for the three months ended September 30, 2004
("fiscal 2005 first quarter") were $885,138, an increase of $259,663, or 42%, as
compared to $625,475 for the three months ended September 30, 2003 ("fiscal 2004
first quarter"). This increase in net sales is primarily attributed to
significant increased orders from two existing customers offset by an increase
in the amount of sales returns related to expired test strips. The increase in
orders from one customer is due to the consumer point-of-sale awareness program
for those patients purchasing certain cholesterol-lowering prescriptions. The
second customer is a national television network that featured our products on
several shows during the first quarter of 2005 compared to none during the first
quarter of 2004. The remaining sales increase is due to overall increases in
sales to the majority of our customers due to the advertising campaign that was
conducted through mid-September 2004.
Subsequent to September 30, 2004, we ceased our relationship with a major
customer which had accounted for approximately 10% of revenues during the fiscal
year ended June 30, 2004, due to the major customer's nonpayment of certain
invoices due. We expect this decrease in sales to be offset by the increasing
sales experienced with the national television shopping network and another
significant retailer which recently became a customer of the Company.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (CONTINUED)
CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
We realized a consolidated gross profit of $232,332 for our fiscal 2005 first
quarter, an increase of $33,993, or 17.1%, as compared to a consolidated gross
profit of $198,339 for our fiscal 2004 first quarter. Our resulting consolidated
gross margin was 26.2% for our fiscal 2005 first quarter, as compared to 31.7%
for our fiscal 2004 first quarter. The decrease in gross margin is attributed to
the significant increase in sales to the national television network, which has
a lower gross margin than that of our other retail customers.
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. If
we are unsuccessful in our efforts to timely procure equity or debt financing
sufficient to continue to fund these marketing activities during fiscal 2005,
the likelihood of us achieving broad market awareness and acceptance of our
consumer monitors will be remote.
Our consolidated total operating expenses were $1,389,909 for the fiscal 2005
first quarter, an increase of $389,603, or 38.9%, from the $1,000,306 incurred
during our fiscal 2004 first quarter. As further detailed below, the increase in
operating expenses for our fiscal 2005 first quarter is primarily due to
increased marketing costs related to the radio marketing campaign which we began
in October 2003.
Our consolidated sales and marketing expenses were $588,964 for the fiscal 2005
first quarter, an increase of $457,046, or 346.5%, from the $131,918 incurred
during our fiscal 2004 first quarter. The increase is primarily attributable to
the launch of our radio advertising campaign which continued through the
majority of fiscal 2005 first quarter. There was no such campaign during the
first quarter of fiscal 2004.
Our consolidated general and administrative ("G&A") expenses of $697,322 for the
fiscal 2005 first quarter were comparable to the $697,851 incurred during our
fiscal 2004 first quarter. Although the total general and administrative
expenses are comparable, decreases in royalty expenses, consulting, legal fees
and investor relations fees are offset by an increase in bad debt expense due to
increasing the bad debt allowance for a major customer with whom we ceased our
business relationship as mentioned above.
Our product research and development expenses were $10,620 for the fiscal 2005
first quarter, an increase of $7,152, or 206.2%, from the $3,468 incurred during
our fiscal 2004 first 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 $93,003 for the fiscal
2005 first quarter, an increase of $13,690, or 17.3%, from the $79,313 incurred
during our fiscal 2004 first quarter. This increase primarily was attributable
to increased patent amortization due to a decrease in the remaining estimated
useful life of the patent from six to three years. We decreased the useful life
of the patent due to the uncertainty of the patent litigation and related
negotiations with the plaintiff whereby the parties are negotiating in good
faith an agreement that would, among other things, resolve the litigation
through a license agreement under the patent.
We incurred an $87,756 loss on the disposal of tooling equipment associated with
our predecessor consumer device during the fiscal 2004 first quarter. No such
losses were incurred during the first quarter of fiscal 2005.
Our resulting loss from operations for the fiscal 2005 first quarter was
$1,157,577, an increase of $355,610, or 44.3%, from the $801,967 loss incurred
during our fiscal 2004 first quarter.
Our non-operating income and expenses primarily consist of amortization of
convertible debt discount, interest and financing expenses. Our net
non-operating expenses for the fiscal 2005 first quarter were $1,329,892
(inclusive of $1,219,022 in non-cash charges), an increase of $937,008, or
238.5%, from net non-operating expenses of $392,884 (inclusive of $508,086 in
non-cash charges) in our fiscal 2004 first quarter. The net increase realized
was primarily attributable to increased amortization of convertible debt
discount and an increase in the amortization of deferred financing costs. These
increases are due to the increase in convertible debentures subject to discount
amortization and related financing charges incurred in obtaining these
debentures. Both the discount on the convertible debentures and the related
deferred financing costs are amortized to expense over the life of the
debentures.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (CONTINUED)
CONSOLIDATED RESULTS OF OPERATIONS (CONTINUED)
Primarily as a result of the foregoing, we incurred a net loss of $2,487,469
($0.01 per basic and diluted share) in the fiscal 2005 first quarter as compared
to a net loss of $1,194,851 ($0.01 per basic and diluted share) in our fiscal
2004 first quarter.
CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES
General
We have historically sustained our operations and funded our growth through an
ongoing combination of trade credit arrangements, short-term financings, and
debt and equity issuances. As our working capital requirements generally precede
the realization of sales and related accounts receivable, we routinely draw upon
our existing cash and cash equivalent balances and seek short and long-term
financing to fund our procurement of inventory.
As more extensively discussed in the preceding disclosures entitled "Substantial
Doubt Regarding Our Ability to Continue as a Going Concern," we have incurred
substantial operating and net losses, as well as negative operating cash flows,
since our inception. As a result, we had significant working capital and
stockholders' deficits at June 30, 2004 and 2003. In recognition of such, our
independent registered public accountants have included an explanatory paragraph
in their report on our accompanying consolidated financial statements for the
fiscal years ended June 30, 2004 and 2003, that expresses substantial doubt
regarding our ability to continue as a going concern. It must be noted that any
inability by us to timely procure the balance of the significant long-term
financing we currently seek will likely have material adverse consequences on
our business, and, as a result, on our consolidated financial condition, results
of operations and cash flows.
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.
Capital Lease Obligations
We lease certain equipment under capital leases. The aggregate net carrying
values of the underlying collateralizing assets were approximately $142,781 and
$164,000 at September 30, 2004 and June 30, 2004, respectively.
Our aggregate future obligations under capital lease agreements in existence at
September 30, 2004 are as follows:
FISCAL YEARS ENDING JUNE 30,
---------------------------------------------------------------
2005 (balance thereof)........................... $ 34,262
2006............................................. 7,740
-----------
Total lease payments............................. 42,002
Less imputed interest............................ 2,533
-----------
Present value of net minimum lease payments...... 39,469
Less current maturities.......................... 36,494
-----------
Total long-term capital lease obligation......... $ 2,975
===========
Outstanding Notes Payable
Effective May 1, 2003, we restructured 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
accrued interest at 15% and was repaid on March 31, 2004, 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. On March 31, 2004, the financial institution
became 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. As of September 30, 2004, $50,696 had been
retained and was being held in an escrow account. The term loan is secured and
collateralized by our cash and cash equivalents, accounts receivable, inventory,
property and equipment and
16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (CONTINUED)
CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
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. Any principal and accrued interest balances remaining
on the term loan will be due and payable as a lump sum on April 1, 2005. The
remaining term loan may be prepaid at any time, without penalty, at our option.
The outstanding principal balance of this note payable was $967,932 and
$1,169,031 at September 30, 2004 and June 30, 2004, respectively.
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 fiscal 2004, we issued 2,593,333 shares of common stock as partial
payment of the annual fee for the May 1, 2004 through April 30, 2005 period and
a balance of approximately $24,500 remains payable at September 30, 2004.
In November 2004, a principal stockholder of our Company entered into an
agreement with the above financial institution, under which the financial
institution assigned to the principal stockholder all of their right, title and
interest under the note payable. At the time of the assignment, the outstanding
amount due under the note payable was $920,323.
Subsequently, we and the new note holder entered into a series of amendments to
the note payable and loan documents under which the following terms were
modified:
o the aggregate amount of the note was increased from $920,323
to $2,869,740, after giving effect to an original issue
discount in the amount of $449,415;
o $974,709 of the increase was funded November 12, 2004
resulting in net cash proceeds to us $750,000;
o $974,708 of the increase is to be funded by December 31, 2004
(subject to the satisfaction of certain conditions precedent);
o the new loan balance of $2,869,740 is to be repaid in monthly
installments of $100,000 commencing May 1, 2005, with the
outstanding balance becoming due and payable on February 1,
2006;
o we paid a commitment fee to induce the principal stockholder
to enter into the series of amendments in the amount of
$500,000, paid by issuance of a promissory note (commitment
fee note) which is payable on February 1, 2006, in cash or, at
our option, in shares of our common stock at a 20% discount to
market. The commitment fee note is also convertible at the
option of the note holder at a conversion price of $.05 per,
subject to adjustment; and
o we agreed to file a registration statement covering the shares
issuable under the commitment fee note.
Currently Outstanding Convertible Debt Obligations
From June 2001 through November 2001, we issued unsecured convertible
debentures, $3,840,000 of which remains outstanding with one debenture holder at
September 30, 2004. These debentures (i) accrue interest at the prime rate plus
two percent (6.25% at September 30, 2004), (ii) are 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 (limited to 9.99%
ownership). 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.
In connection with the issuance of the amended and restated procmissoty note
discussed above, the conversion rate of the debentures issued during June 2001
through November 2001 was reduced to $0.05 per share.
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 $0 at September 30, 2004, (i) accrued
interest at a fixed rate of 8.0% per annum, which was payable at our 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
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (CONTINUED)
CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
share of the Company's common stock at $0.2144 per share. 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.
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 could 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.
In July 2004, the remaining principal balance from the September issuance of
$199,376 and related interest of $7,778 was converted into 2,468,004 shares of
our common stock. As of September 30, 2004, no further convertible debenture
principal or accrued interest remaining outstanding related to the September
2003 issuance.
The remaining principal balance from the September issuance of $199,376 at June
30, 2004 was subsequently converted during the first quarter of fiscal 2005,
resulting in no further convertible debenture principal or interest related to
the September 2003 issuance outstanding as of this date.
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. After conversions, these debentures have an aggregate principal face
amount of $1,797,000 at September 30, 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. 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 stockholder approval to
increase the number of authorized common shares to a minimum of 500 million
shares before April 30, 2004. Stockholder approval to increase the number of
authorized common shares to 750 million was obtained on April 28, 2004.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (CONTINUED)
CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
Investors in the February 19, 2004, financing were 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. This option expired on October 28, 2004.
The agreements entered into in connection with 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 through June 10, 2005.
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 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 September 30, 2004.
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 $2,367,550 and $3,332,415 at
September 30, 2004 and June 30, 2004, respectively.
The remaining $5,637,000 in principal of the Company's outstanding convertible
debentures at September 30, 2004, mature during the Company's fiscal years
ending as follows:
FISCAL YEARS ENDING JUNE 30, PRINCIPAL
---------------------------------------------------------------
2005............................................. $ -
2006............................................. 1,797,000
2007............................................. 3,840,000
------------
Total principal payments......................... $ 5,637,000
============
Off-Balance Sheet Liabilities
Under SEC regulations, we are required to disclose our 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. An off-balance sheet arrangement means
a transaction, agreement or contractual arrangement to which any entity that is
not consolidated with us is a party, under which we have:
o Any obligation under certain guarantee contracts;
o Any retained or contingent interest in assets transferred to an
unconsolidated entity or similar arrangement that serves as credit,
liquidity or market risk support to that entity for such assets;
o Any obligation under a contract that would be accounted for as a
derivative instrument, except that it is both indexed to our stock and
classified in stockholder's equity in our statement of financial
position; and
o Any obligation arising out of a material variable interest held by us
in an unconsolidated entity that provides financing, liquidity, market
risk or credit risk support to us, or engages in leasing, hedging or
research and development services with us.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (CONTINUED)
CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
As of the date of this report, we do not have any off-balance sheet arrangements
that we are required to disclose pursuant to these regulations. In the ordinary
course of business, we enter into operating lease commitments, purchase
commitments and other contractual obligations. These transactions are recognized
in our financial statements in accordance with generally accepted accounting
principles in the United States.
Contractual Obligations
The following table sets forth our contractual obligations as of September 30,
2004:
Contractual Obligations Payments Due by Period
------------------------------------------- -----------------------------------------------------------------
Less than 3-5 More than
Total 1 year 1-3 Years Years 5 Years
------------- ------------ ------------ --------- -----------
Long Term Debt (1) $ 6,604,932 $ 967,932 $ 5,637,000 (2) $ - $ -
Capital Lease Obligations 39,469 36,494 2,975 - -
Operating Lease Obligations
69,367 43,282 18,252 7,833 -
Purchase Obligations 473,248 473,248 (3) - - -
------------- ------------ ------------ --------- -----------
Total $ 7,187,016 $ 1,520,956 $ 5,658,227 $ 7,833 $ -
============= ============ ============ ========= ===========
(1) Amounts do not include interest to be paid.
(2) Consists of convertible debentures that are convertible into shares of
common stock at the option of the debenture holder at conversion rates of
$0.05 as of the date of this filing.
(3) Consists of purchase commitments made under a contract for our targeted
radio advertising campaign. Although we are contractually obligated to
continue the radio advertising campaign through January 7, 2005, due to
cash flow constraints we ceased placing media ads in mid-September 2004.
Unless the advertising agent is able to find substitute sponsors for our
committed advertising spot times, we may be required to pay for the
remaining obligation of $473,248 in addition to the $391,000 accrued at
September 30, 2004.
Consolidated Cash Flows
Our operating activities utilized $338,957 in cash and cash equivalents during
the fiscal 2005 first quarter, a decrease of $1,284,976, or 79.1%, from the
$1,623,933 in cash and cash equivalents utilized during our fiscal 2004 first
quarter. On a comparative quarter-to-quarter basis, our lower utilization
substantially reflects the positive cash flow effects of adding back increased
non-cash charges, increased accounts payable and accrued liabilities after
considering non-cash items, and decreased prepaid expenses. Partially offsetting
the preceding was our increased net loss and the negative cash flow effects of
increased accounts receivable and inventories.
There were no cash flow effects from investing activities during the quarters
ended September 30, 2004 or 2003.
Our financing activities utilized $229,689 in cash and cash equivalents during
the fiscal 2005 first quarter, a $1,440,297 or 119.0% increase compared to the
$1,210,608 in cash and cash equivalents provided by financing activities during
our fiscal 2004 first quarter. Our fiscal 2005 first quarter reflects repayments
made on our note payable and capital leases, as well as, an increase in
restricted cash and cash equivalents. Our 2004 fiscal first quarter reflects the
receipt of the non-escrowed portion of the net cash proceeds received from our
issuance of convertible notes being slightly offset by principal payments on our
outstanding capital lease obligations and notes payable.
As a result of the foregoing, our cash and cash equivalents decreased by
$568,646 to $21,550 at September 30, 2004 as compared with $590,196 at June 30,
2004.
Planned Capital Expenditures
We have no significant planned capital expenditures for fiscal 2005.
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (CONTINUED)
OTHER MATTERS
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 previous fiscal
year 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.
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 September 30, 2004, we believe that the prime rate would have to
significantly increase for the resulting adverse impact on our interest expense
to be material to our expected results of operations for fiscal 2005, 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 and we have not
used, nor do we contemplate using, any derivative financial instruments.
Critical Accounting Policies
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires us to make certain estimates and assumptions that affect the reported
amounts and timing of revenue and expenses, the reported amounts and
classification of assets and liabilities, and disclosure of contingent assets
and liabilities. Our actual results have differed, and will likely continue to
differ, to some extent from our initial estimates 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 generate revenue primarily from sales
of our cholesterol monitors and dry-chemistry test strips
utilized in our cholesterol monitors. 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. In certain instances, shipments made to a retail
customer may not transfer risk of ownership at the time of
shipment, in which case, the revenue is not recognized until
the time risks of ownership transfer, generally when the
product is sold by the retailer to a consumer.
o Sales Returns Allowance. We record an allowance for sales
returns and for warranty repairs at the time revenue is
recognized. Our estimates of an appropriate allowance for
sales returns is based upon historical returns as a percentage
of sales, as well as future expectations on returns of test
strips based upon the length of time from their expiration
date at the time of sale. Management reviews the adequacy of
the allowance on a quarterly basis, however the nature of
these estimates are inherently subjective causing actual
results to vary from our estimated outcome, thereby requiring
us to make future adjustments to our net sales and results of
operations.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (CONTINUED)
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. Management reviews the
adequacy of the allowance on a quarterly basis by reviewing
the accounts receivable aging and considering the historical
default rates of customers with past due receivables. 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 Inventory Obsolescence Allowance. Our inventories, which
primarily consist of component parts and assembled cholesterol
monitors, are stated at the lower of first-in, first-out cost
or market. Obsolete inventory has historically consisted of
component parts no longer utilized in the current model of our
cholesterol monitor, as well as, expired dry-chemistry test
strips or excess test strips with short-term expiration dates
that will likely not be sold prior to expiration. Management
considers the above factors in our quarterly review of the
inventory obsolescence allowance. Our estimates of an
appropriate inventory obsolescence allowance is 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. Our long-lived assets consist
primarily of various patents for technology utilized in our
cholesterol monitors, as well as, currently unutilized
technology for the measurement of cholesterol in its component
parts. On a quarterly basis, we evaluate the value of our
patents for impairment by comparing our estimates of related
future cash flows, on an undiscounted basis, to its net book
value. Factors considered by management in its review of the
value of patents include the status of current litigation
surrounding our most significant patent, likelihood of
development or sale of the patent (if unutilized), and likely
cash flows from royalties to be received from others for use
of the patented technology. 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. Our
estimates of an asset's related future cash flows are
inherently subjective and actual results could vary from our
estimated outcome, including expected outcomes of the current
litigation surrounding our most significant patent. In August
2004, the Court of Appeals ruled in our favor and remanded the
matter back to the District Court for a new hearing. Should
the courts not rule in our favor, we would most likely be
required to reduce the valuation of this patent which could
have a material impact on our consolidated financial
statements.
Legal Contingencies
We, 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 "Business - 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 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. In August 2004, the Court of Appeals reversed the District Court's
ruling and remanded the matter back to the District Court for a new hearing.
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION (CONTINUED)
OTHER MATTERS (CONTINUED)
Following the remand, the parties returned to settlement negotiations. Pursuant
to these negotiations, the parties have now entered into a Letter of Intent
requiring the parties to negotiate in good faith an agreement that would, among
other things, resolve the litigation through a license under U.S. Patent No.
3,135,716. A final agreement has not yet been reached, and the litigation
remains pending before the Idaho District Court.
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 District Court 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.
ITEM 3. CONTROLS AND PROCEDURES
As of September 30, 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 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. OTHER INFORMATION
ITEM 5. OTHER INFORMATION
In November 2004, a principal stockholder of our Company entered into an
agreement with the holder of our note payable, under which the holder assigned
to the principal stockholder all of their right, title and interest under the
note payable. At the time of the assignment, the outstanding amount due under
the note payable was $920,323.
Subsequently, we and the new note holder entered into a series of amendments to
the note payable and related loan documents under which the following terms were
modified:
o the aggregate amount of the note was increased from $920,323
to $2,869,740, after giving effect to an original issue
discount in the amount of $449,415;
o $974,709 of the increase was funded November 12, 2004
resulting in net cash proceeds to us $750,000;
o $974,708 of the increase is to be funded by December 31, 2004
(subject to the satisfaction of certain conditions precedent);
o the new loan balance of $2,869,740 is to be repaid in monthly
installments of $100,000 commencing May 1, 2005, with the
outstanding balance becoming due and payable on February 1,
2006;
o we paid a commitment fee to induce the principal stockholder
to enter into the series of amendments in the amount of
$500,000, paid by issuance of a promissory note (commitment
fee note) which is payable on February 1, 2006, in cash or, at
our option, in shares of our common stock at a 20% discount to
market. The commitment fee note is also convertible at the
option of the note holder at a conversion price of $.05 per,
subject to adjustment; and we agreed to file a registration
statement covering the shares issuable under the commitment
fee note.
ITEM 6. EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
10.1 Amended and Substituted Promissory note dated November 12, 2004 in
favor of RAB Special Situations LP (1)
10.2 Amended and Restated Loan and Security Agreement dated November 12,
2004 with RAB Special Situations LP (2)
10.3 Amendment Agreement dated November 12, 2004 with RAB Special
Situations LP (3)
10.4 Convertible Term Note dated November 12, 2004 in favor of RAB Special
Situations LP (4)
10.5 Registration Rights Agreement dated November 12, 2004 with RAB
Special Situations LP (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.**
32.1 Certification of Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.**
32.2 Certification of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.**
- ------------------------------------
** Filed herewith.
(1) Filed as Exhibit 10.1 to our Current Report on Form 8-K filed with the
Securities and Exchange on November 15, 2004 and incorporated herein by
reference.
(2) Filed as Exhibit 10.2 to our Current Report on Form 8-K filed with the
Securities and Exchange on November 15, 2004 and incorporated herein by
reference.
(3) Filed as Exhibit 10.3 to our Current Report on Form 8-K filed with the
Securities and Exchange on November 15, 2004 and incorporated herein by
reference.
(4) Filed as Exhibit 10.4 to our Current Report on Form 8-K filed with the
Securities and Exchange on November 15, 2004 and incorporated herein by
reference.
(5) Filed as Exhibit 10.5 to our Current Report on Form 8-K filed with the
Securities and Exchange on November 15, 2004 and incorporated herein by
reference.
23
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Post Falls,
State of Idaho, on this 15th day of November 2004.
LIFESTREAM TECHNOLOGIES, INC.
By: /s/ Nikki Nessan
Nikki Nessan
Chief Financial and Accounting Officer
24