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 quarterly period ended September 30, 2005
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from _______ to ______
Commission file number 001-16161
LIFESTREAM TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
NEVADA 82-0487965
- ------------------------------- -----------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
510 Clearwater Loop, Suite 101, Post Falls, ID 83854
----------------------------------------------------
(Address of principal executive offices)
(208) 457-9409
--------------
(Issuer's telephone number)
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 [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
APPLICABLE TO CORPORATE ISSUERS
As of November 10, 2005, the registrant had 251,403,735 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, 2005
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Interim Condensed Consolidated Financial Statements (Unaudited):
Condensed Consolidated Balance Sheets as of September 30, 2005 and June 30, 2005 .......... 2
Condensed Consolidated Statements of Operations for the three months ended
September 30, 2005 and 2004 ............................................................ 3
Condensed Consolidated Statements of Cash Flows for the three months ended
September 30, 2005 and 2004 ............................................................ 4
Notes to Interim Condensed Consolidated Financial Statements .............................. 6
Item 2. Management's Discussion and Analysis or Plan of Operation ................................. 20
Item 3. Controls and Procedures ................................................................... 33
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ......................................................................... 34
Item 6. Exhibits .................................................................................. 34
Signatures ........................................................................................ 35
1
PART I. FINANCIAL INFORMATION
ITEM 1. INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
LIFESTREAM TECHNOLOGIES, INC., AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, June 30,
2005 2005
------------- ------------
Current Assets:
Cash and cash equivalents $ 37,224 $ 250,024
Restricted cash held in escrow - -
Accounts receivable, net of allowance for doubtful accounts of
$213,346 and $43,551, respectively 160,258 133,411
Inventories, net 817,981 927,910
Prepaid expenses 82,905 260,133
------------- ------------
Total current assets 1,098,368 1,571,478
Property and equipment, net 98,477 139,780
Patent rights, net of accumulated amortization of $1,839,879 and $1,799,879 280,000 320,000
Deferred financing costs 80,349 194,691
Other 9,236 9,236
------------- ------------
Total assets $ 1,566,430 $ 2,235,185
============= ============
Current Liabilities:
Accounts payable $ 1,230,807 $ 1,057,914
Accrued liabilities 768,509 695,651
Current maturities of convertible notes 3,858,042 1,486,277
Current maturities of notes payable, principal face amount of $2,869,740
September 30, 2005 2,822,952 2,742,145
Current maturities of capital lease obligations 16,558 17,929
------------- ------------
Total current liabilities 8,696,868 5,999,916
Capital lease obligations, less current maturities 1,537 2,656
Convertible notes, principal face amounts of $4,627,000 and $4,709,500,
respectively 465,501 2,631,464
------------- ------------
Total liabilities 9,163,906 8,634,036
Commitments and contingencies
Stockholders' deficit
Preferred stock, $.001 par value; 15,000,000 shares authorized; none issued
or outstanding - -
Common stock, $.001 par value; 750,000,000 shares
authorized; 244,693,735 and 243,043,735 issued and
outstanding, respectively 244,696 243,046
Additional paid-in capital 57,323,644 57,242,794
Accumulated deficit (65,165,816) (63,884,691)
------------- ------------
Total stockholders' deficit (7,597,476) (6,398,851)
------------- ------------
Total liabilities and stockholders' deficit $ 1,566,430 $ 2,235,185
============= ============
The accompanying notes are an integral part of these consolidated financial
statements.
2
LIFESTREAM TECHNOLOGIES, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF LOSS
(UNAUDITED)
Three Months Ended
------------------------------
September 30, September 30,
2005 2004
------------- -------------
Net sales / Loss $ 438,309 $ 885,138
Cost of sales 353,661 652,806
------------- -------------
Gross profit (loss) 84,648 232,332
------------- -------------
Operating expenses
Sales and marketing 101,574 585,614
General and administrative 635,713 707,339
Product research and development 1,062 10,620
Depreciation and amortization 81,303 93,003
------------- -------------
Total operating expense 819,652 1,396,576
------------- -------------
Loss from operations (735,004) (1,164,244)
------------- -------------
Non-operating income (expense):
Interest income 1,233 5
Amortization of note and issue discount (369,109) (964,865)
Interest and financing expenses (63,903) (168,108)
Amortization of deferred financing costs (114,342) (190,257)
------------- -------------
Total non-operating expense, net (546,121) (1,323,225)
------------- -------------
Net loss $ (1,281,125) $ (2,487,469)
------------- -------------
Net loss per common share - basic and diluted $ (0.01) $ (0.01)
============= =============
Weighted average number of common shares
outstanding - basic and diluted 244,603,073 195,170,614
============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
3
LIFESTREAM TECHNOLOGIES, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Three Months Ended
------------------------------
September 30, September 30,
2005 2004
------------- -------------
Cash flow from operating activities:
Net loss $ (1,281,125) $ (2,487,469)
Non-cash items:
Depreciation and amortization of property and equipment and patent
and license rights 81,303 93,003
Amortization of note and issue discount 369,109 964,865
Amortization of deferred financing costs 114,342 190,257
Recovery of doubtful accounts 172,412 255,405
Increase (reduction) in inventory valuation allowance - 6,410
Issuances of compensatory common stock, options and warrants for
employee and non-employee services 115,300 -
Net changes in assets and liabilities:
Accounts receivable (199,259) (271,469)
Inventories 109,929 (11,473)
Prepaid expenses 61,928 138,709
Accounts payable 172,893 676,333
Accrued liabilities 72,858 42,572
Change in other non-current assets - 63,900
------------- -------------
Net cash used in operating activities: (210,310) (338,957)
------------- -------------
Cash flows from financing activities:
Payments on capital lease obligations (2,490) (3,187)
Payments on note payable - (201,099)
Restricted cash equivalent - (25,403)
------------- -------------
Net cash used by financing activities (2,490) (229,689)
------------- -------------
Net decrease in cash and cash equivalents (212,800) (568,646)
Cash and cash equivalents at beginning of year 250,024 590,196
------------- -------------
Cash and cash equivalents at end of year $ 37,224 $ 21,550
============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
4
LIFESTREAM TECHNOLOGIES, INC., AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED)
(CONTINUED)
Three Months Ended
------------------------------
September 30, September 30,
2005 2004
------------- -------------
Supplemental schedule of cash activities:
Interest paid in cash $ - $ 43,220
Supplemental schedule of non-cash financing activities:
Assets acquired through capital lease obligation $ - $ 8,628
Issuance of common stock in exchange for:
Conversion of convertible debt and accrued interest $ 82,500 $ 407,154
Payment of accounts payable and accrued liabilities $ - $ 380,761
The accompanying notes are an integral part of these consolidated financial
statements.
5
LIFESTREAM TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. NATURE OF BUSINESS AND ORGANIZATIONAL STRUCTURE
Lifestream Technologies, Inc., together with its wholly-owned subsidiaries (the
"Company"), is a Nevada corporation headquartered in Post Falls, Idaho, and is a
marketer of a proprietary cholesterol monitor for at-home use by health
conscious consumers and at-risk medical patients. Through regular monitoring of
one's total cholesterol level, an individual can continually assess their
susceptibility to developing cardiovascular disease. Once diagnosed with an
elevated total cholesterol level, regular at-home testing with one of our
cholesterol monitors enables a patient to readily ascertain the benefits derived
from diet modification, an exercise regimen and/or a drug therapy, thereby
reinforcing their continuing compliance with an effective cholesterol-lowering
program. The Company also markets and sells dry-chemistry test strips utilized
with its cholesterol monitor for measuring total cholesterol.
The Company's current base of customers primarily consists of national and
regional drug store chains, the Home Shopping Network and, to a lesser extent,
pharmacy-featuring grocery store chains, specialty catalog and internet-based
direct marketers and independent pharmacies throughout the United States.
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, 2005 and 2004. 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, 2005 and 2004, 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 by, among
other actions, the following:
o The Company developed a consumer point-of-sale awareness program for
those patients purchasing certain cholesterol-lowering
prescriptions, which is currently being tested;
o The Company has conducted and intends to continue to conduct
marketing activities as funds become available, including a
television commercial test which began in January 2005 and was
completed in February 2005. The Company believes that this test
program was an effective method of furthering its product awareness
campaign and will consider pursuing it further as funds are
available;
o The Company continues to support the Medicare reimbursement
considerations of the federal government for cholesterol testing and
monitor the FDA's consideration of over the counter
cholesterol-lowering drugs;
o The Company reduced personnel levels to a core staff of 13 employees
while implementing cost-cutting measures and decreasing
administrative costs.
o On October 19, 2005, the Company obtained $125,000 in short term
financing from a greater than 5% shareholder. See "Note 12.
Subsequent Events - Short Term Financing Arrangement" below for
further details.
o On October 1, 2005, the Company entered into non-exclusive patent
and trademark license agreements with an unrelated company to
utilize a patent covering secured data acquisition, transmission,
storage and analysis systems. See "Note 12. Subsequent Events -
Patent and Trademark License Agreements" below for further details.
On May 1, 2005, June 1, 2005, July 1, 2005, August 1, 2005, September 1, 2005
October 1, 2005 and November 1, 2005, the Company failed to make the required
$100,000 monthly payments of principal on the Company's outstanding promissory
note in the aggregate principal amount of $2,869,740 payable to RAB Special
Situations LP ("Special Situations"). On May 31, 2005, Special Situations
assigned all of its rights under this note to RAB Special Situations (Master)
Fund Limited ("Master Fund"). Under the terms of the note, in the event of a
default in the Company's payment obligations under the note, the entire
principal amount of the note becomes immediately due and payable. The Company's
obligations under the note and related loan agreements are collateralized by a
security
6
interest in substantially all of its assets. After each occurrence of default,
Master Fund verbally advised the Company that it did not intend to assert the
Company's failure to make payment as a default under the note. On July 11, 2005,
September 16, 2005, October 14, 2005 and November 11, 2005, the Company and
Master Fund signed agreements providing that (a) Master Fund has waived any
default arising by reason of the Company's failure to make the May 1, 2005, June
1, 2005, July 1, 2005, August 1, 2005, September 1, 2005, October 1, 2005 and
November 1, 2005, payments under the note, (b) payment of the May 1, 2005, June
1, 2005, July 1, 2005, August 1, 2005, September 1, 2005, October 1, 2005 and
November 1, 2005, installments under the promissory note will become due and
payable on the February 1, 2006 maturity date of the promissory note, (c) all of
the other terms and conditions of the Company's promissory note to Master Fund
remain in full force and effect.
The Company will continue to require additional financing to fund its
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 continue
conducting marketing activities and the success of these campaigns on increasing
awareness to consumers and pharmacists.
The Company currently does not have sufficient operating revenues or cash to
fund operations beyond February 2006. Additionally, the Company has been unable
to meet its debt service obligations and has relied upon waivers and deferrals
from its lenders in order to avoid defaulting on secured loans. Also,
approximately $4,517,000 of both secured and unsecured indebtedness matures in
February 2006. The Company has no current ability to repay this indebtedness.
Absent restructuring of the current indebtedness and/or the receipt of
additional financing, the Company will be in default of its debt repayment
obligations and may be forced to cease operations and its assets may be subject
to foreclosure by both secured and, thereafter, unsecured investors.
The Company's short-term sources of capital are dependent on its ability to
defer its long-term debt payments. The Company generally funds its operations
with a combination of deferring its trade creditors, borrowings under short-term
financing arrangements and through the sale of common equity. Should the Company
be unsuccessful in any of the initiatives or matters discussed above, its
business, and, as a result, its consolidated financial position, results of
operations and cash flow will likely be materially adversely impacted, the
effects from which it may not recover. As such, substantial doubt as to the
Company's ability to continue as a going concern remains as of the date of this
report.
3. INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Principles of Consolidation
These 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 three-month periods, or
fiscal quarters, refer to the quarter ended on the date indicated. References to
a fiscal year refer to the calendar year in which such fiscal year ends.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make certain estimates and assumptions that affect the
reported amounts and timing of revenue and expenses, the reported amounts and
classification of assets and liabilities, and the disclosure of contingent
assets and liabilities. The accounting estimates that require management's most
difficult and subjective judgments include the assessment and valuation of the
patent rights, allowance for doubtful accounts receivable and the sales returns
allowance. These estimates and assumptions are
7
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, 2005.
Reclassifications
Certain amounts in the condensed consolidated financial statements for the prior
period have been reclassified to be consistent with the current period's
presentation.
Net Loss Per Share
Basic and diluted net loss per share have been computed by dividing net loss by
the weighted average number of common shares outstanding during the fiscal
period. At September 30, 2005 and 2004, the Company had stock options, stock
warrants and convertible debentures outstanding that could potentially be
exercised or converted into 106,200,896 and 112,017,441 additional common
shares, respectively. Should the Company report net income in a future period,
diluted net income per share will be separately disclosed giving effect to the
potential dilution that could occur under the treasury stock method if these
stock options, stock warrants and convertible debentures were exercised or
converted into common shares.
Accounting for Stock Based Compensation
As allowed by SFAS No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure - an amendment of FASB Statement No. 123" and by SFAS
No. 123, "Accounting for Stock-Based Compensation" ("SFAS 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 25"), and its related interpretations, for stock options issued to
employees. Under APB No. 25, compensation expense is recognized based upon the
difference, if any, at the measurement date between the market value of the
stock and the option exercise price. The measurement date is the date at which
both the number of options and the exercise price for each option are known. No
stock-based employee compensation cost is reflected in the Company's reported
net losses, as all options granted had an exercise price equal to or in excess
of the market value of the underlying common stock on the respective dates of
grant.
In December 2004, the FASB issued Statement No. 123R, "Share-Based Payment"
("SFAS 123R"), which revises SFAS 123 and supersedes APB 25. As a result, the
pro forma disclosures previously permitted under SFAS 123 will no longer be an
alternative to financial statement recognition. In April 2005, the Securities
and Exchange Commission (the "SEC") announced the adoption of a rule that amends
the compliance date for SFAS 123R. This rule requires companies that are Small
Business Issuers, as defined in Rule 12b-2 of the Securities Exchange Act of
1934, to implement the provisions of SFAS 123R by the first quarter of the
fiscal year beginning after December 15, 2005. Accordingly, the Company is
required to adopt the provisions of SFAS 123R in the first quarter of fiscal
2007. See "Recently Issued Accounting Standards Not Yet Adopted" below for
further details.
8
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, 2005 SEPTEMBER 30, 2004
-------------------------------------------
Net loss, as reported ...................................................... $ (1,281,125) $ (2,487,469)
Total stock-based employee compensation expense determined under fair value
based method for all awards ............................................. (5,986) (65,844)
------------------- ---------------------
Pro forma net loss ......................................................... $ (1,287,111) $ (2,553,313)
=================== =====================
Net loss per share:
Basic and diluted - as reported ......................................... $ (0.01) $ (0.01)
=================== =====================
Basic and diluted - pro forma ........................................... $ (0.01) $ (0.01)
=================== =====================
The fair value of each option grant was estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted average
assumptions:
THREE MONTHS ENDED
-------------------------------------------
SEPTEMBER 30, 2005 SEPTEMBER 30, 2004
-------------------------------------------
Risk-free interest rate .................................................... 3.3% 3.3%
Expected volatility ........................................................ 109.9% 109.9%
Expected life in years ..................................................... 5 - 10 5 - 10
Expected dividends ......................................................... None None
Revenue Recognition
The Company generates revenue primarily from sales of its cholesterol monitors
and dry-chemistry test strips utilized in its cholesterol monitors. The Company
recognizes a sale, including related shipping and handling income, and the cost
of the sale, when each of the criteria established by Staff Accounting Bulletin
104 ("SAB 104") have been met as follows:
o Pervasive evidence of an arrangement exists - The Company requires a
purchase order from its customers for each sale prior to shipment of
product.
o Delivery has occurred - The Company does not recognize revenue until
the product is shipped and all material risks and rewards of
ownership are concurrently transferred to the customer. In limited
instances, the Company may enter into "pay-on-scan" sales
arrangements whereby the risk of ownership does not transfer to the
customer until the customer has sold the product to a third party
(the consumer). In these limited instances, revenue is not
recognized until the Company has been notified by the customer that
the product has been sold to the consumer.
o Seller's price to the buyer is fixed or determinable - The Company
requires the sales price to be detailed on the customers purchase
order, which may not be changed after acceptance.
o Collection of the related receivable is reasonably assured - The
Company must determine that collection of the related account
receivable is reasonably assured prior to recognition of revenue.
The Company makes estimates to allow for an appropriate allowance
for uncollectible receivables, as well as for sales returns expected
from its customers.
9
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.
To date, the Company's products have been principally marketed to customers
residing within the United States of America. Net sales realized from customers
residing in other geographic markets were less than 1% of consolidated net sales
in the first three months of fiscal 2005 and 2004.
Recently Adopted Accounting Standards
In November 2004, the FASB issued Statement of Financial Accounting Standards
No. 151 - Inventory Costs ("SFAS No. 151"), which amends the provisions of
Chapter 4 of Accounting Research Bulletin No. 43 - "Inventory Pricing". SFAS No.
151 requires that certain production costs, such as idle facility expense,
freight, handling costs, and spoilage be charged as a current period expense.
Under the previous accounting principles, these costs were charged to current
period expense only under certain circumstances. SFAS No. 151 also requires that
fixed production overhead be allocated based on normal production capacity. The
Company adopted SFAS No. 151 effective for its fiscal 2006 first quarter, as
required, with no material impact on its consolidated financial statements.
Recently Issued Accounting Standards Not Yet Adopted
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment," ("SFAS
123R") which revises FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation." ("SFAS 123") and supersedes Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees," ("APB 25"). SFAS 123R
requires a public entity to measure the cost of employee services received in
exchange for an award of equity instruments (including grants of employee stock
options) based on the grant-date fair value of the award (with limited
exceptions). That cost will be recognized over the period during which an
employee is required to provide service in exchange for the award--the requisite
service period (usually the vesting period). The pro forma disclosures
previously permitted under SFAS 123 will no longer be an alternative to
financial statement recognition. See "Accounting for Stock Based Compensation"
above for the pro forma net income and earnings per share amounts for the three
month periods ended September 30, 2005 and 2004, as if the Company had used a
fair-value based method similar to the methods required under SFAS 123R to
measure compensation expense for employee stock-based compensation awards. The
provisions of SFAS 123R are effective for the first quarter of the fiscal year
beginning after December 15, 2005. Accordingly, the Company is required to adopt
SFAS 123R in its first quarter of fiscal 2007. The Company is currently
evaluating the provisions of SFAS 123R. The impact on net income on a quarterly
basis is expected to be comparable to the amounts presented above under the
caption "Accounting for Stock Based Compensation". However, the impact on net
income may vary depending upon a number of factors including, but not limited
to, the price of the Company's stock and the number of stock options the Company
grants.
In May 2005, the FASB issued Statement No. 154, "Accounting Changes and Error
Corrections--a replacement of APB Opinion No. 20 and FASB Statement No. 3"
("SFAS 154"). This Statement replaces APB Opinion No. 20, "Accounting Changes",
and FASB Statement No. 3, "Reporting Accounting Changes in Interim Financial
Statements", and changes the requirements for the accounting for and reporting
of a change in accounting principle. SFAS 154 applies to all voluntary changes
in accounting principle. It also applies to changes required by an accounting
pronouncement in the unusual instance that the pronouncement does not include
specific transition provisions. When a pronouncement includes specific
transition provisions, those provisions should be followed. SFAS 154 is
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. Consequently, the Company will adopt the
provisions of SFAS 154 in its first quarter of fiscal 2007. Management currently
believes that adoption of the provisions of SFAS No. 154 will not have a
material impact on the Company's consolidated financial statements.
10
4. ALLOWANCE FOR DOUBTFUL ACCOUNTS RECEIVABLE
The following schedules set forth the activity in the Company's allowance for
doubtful accounts receivable for the following periods:
SEPTEMBER 30, 2005 JUNE 30, 2005
------------------ -----------------
Balance, beginning of year .......................... $ 43,551 $ 298,398
Additions to allowance .............................. 169,795 255,404
Deductions, net of recoveries ....................... - (510,251)
------------------ -----------------
Balance, end of year ................................ $ 213,346 $ 43,551
================== =================
5. INVENTORIES, NET
Inventories, net, consist of the following:
SEPTEMBER 30, 2005 JUNE 30, 2005
-------------------- ----------------
Raw materials ................................................ $ 217,223 $ 214,328
Work in process .............................................. 7,274 14,496
Finished goods ............................................... 170,445 167,408
Finished goods at retail locations ........................... 468,185 576,824
-------------------- ----------------
363,127 973,056
Less valuation allowance ..................................... (45,146) (45,146)
-------------------- ----------------
Inventories, net ............................................. $ 817,981 $ 927,910
==================== ================
6. ACCRUED LIABILITIES
Accrued liabilities consist of the following:
SEPTEMBER 30, 2005 JUNE 30, 2005
-------------------- ----------------
Accrued royalties payable .................................... $ 257,535 $ 257,535
Accrued sales returns, including warranty obligations ........ 223,457 222,790
Accrued interest payable 249,744 186,531
Accrued wages, benefits and related taxes .................... 33,695 25,517
Accrued other ................................................ 4,078 3,278
-------------------- ----------------
Total accrued liabilities .................................... $ 768,509 $ 695,651
==================== ================
7. NOTE PAYABLE
On May 1, 2003, the Company renewed its then expiring revolving credit facility
agreement with a financial institution. Under the renewed agreement, the
Company's then outstanding balance of $2,197,800 was bifurcated into a
$2,000,000 twenty-four month term loan and a $197,800 advance loan. In
consideration for renewing the revolving credit facility agreement, 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 remained 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 period May 1, 2004
through April 30, 2005 and a balance of approximately $24,500 remained payable
at June 30, 2004. These annual fees were amortized to deferred financing costs
over the renewal period.
In November 2004, Special Situations entered into an agreement with the above
financial institution, under which the financial institution assigned to Special
Situations all of their rights, title and interest under the note payable. At
the time of the assignment, the outstanding amount due under the note payable
was $920,323. On May 31, 2005, Special Situations, assigned all of its rights
under this note to Master Fund, a beneficial owner of approximately 9.99% of our
common stock as of September 30, 2005. Restricted funds held in escrow by the
financial institution served as additional collateral under the terms of the
note payable and were used to partially pay down the then outstanding loan
balance prior to assignment to the stockholder.
11
Subsequently, the Company entered into a series of amendments to the note
payable and related loan documents under which Special Situations modified the
following terms:
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 $449,417;
o $974,709 of the increase was funded November 12, 2004 resulting in
net cash proceeds to us of $750,000;
o $974,708 of the increase was funded December 15, 2004 resulting in
an additional $750,000 in net cash proceeds;
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.
See below for details regarding the Company's failure to make the
required $100,000 monthly installments;
o the Company paid a commitment fee to induce the assignee 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 share, subject to adjustment;
o On May 10, 2005, the United States Securities and Exchange
Commission ("SEC") declared effective the registration statement
that the Company filed covering the resale of shares issuable under
the commitment fee note; and
o the note payable continues to be secured by substantially all of the
Company's assets.
The original issue discount of $449,417 was determined based on an annual
interest rate of 15% over the term of the note payable and was recorded as a
deferred financing cost. This deferred financing cost is being amortized using
the interest method over the life of the amended note payable, is reflected as
"amortization of deferred financing costs" on the Company's consolidated
statement of operations and totaled $80,808 and $321,819 during the fiscal 2006
first quarter and fiscal 2005, respectively.
On May 1, 2005, June 1, 2005, July 1, 2005, August 1, 2005, September 1, 2005,
October 1, 2005 and November 1, 2005, the Company failed to make the required
$100,000 monthly payments of principal on the Company's outstanding promissory
note in the aggregate principal amount of $2,869,740 payable to Special
Situations. On May 31, 2005, Special Situations assigned all of its rights under
this note to Master Fund. Under the terms of the note, in the event of a default
in the Company's payment obligations under the note, the entire principal amount
of the note becomes immediately due and payable. The Company's obligations under
the note and related loan agreements are collateralized by a security interest
in substantially all of its assets. After each occurrence of default, Master
Fund verbally advised the Company that it did not intend to assert the Company's
failure to make payment as a default under the note. On July 11, 2005, September
16, 2005, October 14, 2005 and November 11, 2005, the Company and Master Fund
signed agreements providing that (a) Master Fund has waived any default arising
by reason of the Company's failure to make the May 1, 2005, June 1, 2005, July
1, 2005, August 1, 2005, September 1, 2005, October 1, 2005 and November 1,
2005, payments under the note, (b) payment of the May 1, 2005, June 1, 2005,
July 1, 2005, August 1, 2005, September 1, 2005, October 1, 2005 and November 1,
2005, installments under the promissory note will become due and payable on the
February 1, 2006 maturity date of the promissory note, (c) all of the other
terms and conditions of the Company's promissory note to Master Fund remain in
full force and effect.
8. CONVERTIBLE DEBENTURES
June through November 2001 Issuances
From June 2001 through November 2001, the Company issued unsecured convertible
debentures, $2,980,000 of which remains outstanding with one debenture holder
(Master Fund) at September 30, 2005. These debentures (i) accrue interest at the
prime rate plus two percent (8.75% at September 30, 2005), (ii) are convertible
at the option of the holder into common stock of the Company at a stated rate of
$0.05 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 had a one-time right to convert a portion of the debentures
after the closing of any subsequent private offering at less than $0.05 per
common share (limited to 9.99% ownership). The holder exercised this right
during the third quarter of fiscal 2004 and converted $180,000 of principal and
$60,000 of accrued interest at $0.05 resulting in $240,000 of additional expense
upon conversion
12
related to the beneficial conversion feature. The Company has
the right to force conversion of the debentures if the market price of its
common stock exceeds $3.00 per share for 20 consecutive trading days.
In connection with the Company's issuance of the amended and restated promissory
note discussed in Note 7, the conversion rate of the debentures issued during
June 2001 through November 2001 was reduced from $0.10 to $0.05 per share
resulting in a $72,600 expense related to the beneficial conversion feature
during the second quarter of fiscal 2005.
September 2003 Issuances
On September 13, 2003, the Company issued $3,350,000 in unsecured convertible
debentures to eight investors from which it received $3,067,000 in net cash
proceeds. The debentures (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, (ii) were convertible at the option of the
holders at a stated rate of $0.13 per share, and (iii) 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 SEC registering the resale of
the preceding debentures and warrants became effective on December 23, 2003. On
September 30, 2005, 6,346,155 detachable stock purchase warrants expired. There
are no remaining detachable stock purchase warrants associated with the
September 2003 convertible debenture issuances.
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 $89,659 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 $89,659.
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.
During the first quarter of fiscal 2005, the following conversions of the above
outstanding convertible debentures occurred:
PRINCIPAL # SHARES ISSUED
AMOUNT PRIOR TO UNAMORTIZED DISCOUNT PRINCIPAL AND/OR CONVERSION UPON
CONVERSION DATE CONVERSION PRIOR TO CONVERSION INTEREST CONVERTED RATE CONVERSION
- ---------------------------------------------------------------------------------------------------------
7/9/2004 $ 199,376 $ 117,762 $ 207,154 $ 0.09 2,468,004
There are no further convertible debenture principal or accrued interest
balances remaining outstanding related to the September 2003 issuance.
February 2004 Issuances
On February 19, 2004, the Company completed a private placement offering of
$2,775,000 in unsecured convertible debentures with four investors (all of which
also participated in the September 2003 private placement discussed above) from
which it received $2,077,592 in net cash proceeds. 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. The original issue discount was recorded as a reduction to the
convertible debt balance on the Company's consolidated balance sheet and is
being amortized using the effective interest method to "amortization of
convertible debt discount" on the
13
Company's consolidated statement of operations over the term of the debentures.
The $2,775,000 of convertible debentures are convertible at a conversion price
of $0.05 per share, or 55.5 million common shares as of February 19, 2004. 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. These
debentures have an aggregate principal face amount of $1,025,000 at September
30, 2005 and become due and payable on February 19, 2006.
During the three months ending September 30, 2005 and 2004, the following
conversions of the above outstanding convertible debentures occurred:
PRINCIPAL UNAMORTIZED # SHARES ISSUED
AMOUNT PRIOR DISCOUNT PRIOR PRINCIPAL AND/OR CONVERSION UPON
CONVERSION DATE TO CONVERSION TO CONVERSION INTEREST CONVERTED RATE CONVERSION
- -------------------------------------------------------------------------------------------------
7/10/2004 $ 1,875,000 $ 1,596,088 $ 200,000 $ 0.05 4,000,000
------------------ ----------------
Total $ 200,000 4,000,000
------------------ ----------------
7/7/2005 $ 1,107,500 $ 200,082 $ 82,500 $ 0.05 1,650,000
------------------ ----------------
Total $ 82,500 1,650,000
================== ================
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 could be
exercised over a nineteen-month period and had 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 had 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. As of September 30, 2005, 16,649,999 detachable stock purchase
warrants expired. The are no remaining detachable stock purchase warrants
associated with the February 2004 convertible debenture issuances.
On March 22, 2004, the Company filed a registration statement with the 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
required 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 had a right of first
refusal to participate in any new equity financing transaction undertaken
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
14
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 June 30, 2005. On October 1,
2005, 732,000 detachable stock purchase warrants expired. The are no remaining
detachable stock purchase warrants associated with the March 2004 convertible
debtenture issuance.
November 2004 Issuance
As discussed above in "Note 7. Note Payable", in November 2004, the Company paid
a commitment fee to induce Special Situations to enter into a series of
amendments to an existing note payable. On May 31, 2005, Special Situations
assigned all of its rights under this note to Master Fund. The commitment fee of
$500,000 was paid through the issuance of a convertible promissory note (the
commitment fee note) which is payable on February 1, 2006, in cash or, at the
Company's option, in shares of the Company's common stock at a 20% discount to
market. The commitment fee is also convertible at the option of the note holder
at a conversion price of $.05 per share, subject to adjustment. The $500,000
commitment fee is included in deferred financing costs and is being amortized
over the life of the amended note payable. On May 10, 2005, the United States
Securities and Exchange Commission ("SEC") declared effective the registration
statement that the Company filed covering the resale of shares issuable under
the commitment fee note.
The remaining $4,627,000 in principal of our outstanding convertible debentures
at September 30, 2005, matures during our fiscal years ending as follows:
FISCAL YEARS ENDING JUNE 30, PRINCIPAL NET OF DISCOUNT
------------------------------------------------------------
2006 (remaining) ........... $ 1,647,000 $ 1,549,150
2007 ....................... 2,980,000 2,774,385
-----------------------------
Total principal payments ... $ 4,627,000 $ 4,323,543
=============================
The following tables summarize the principal balance, unamortized debt discount,
original issue discount and net carrying value of each of the above debt
issuances as reported on the consolidated balance sheet, as well as, the related
amortization of convertible notes discount, amortization of deferred financing
costs, and interest and financing costs for each of the above convertible debt
issuances as reported on the consolidated statements of loss as of September 30,
2005 and 2004:
THREE MONTHS ENDING SEPTEMBER 30, 2005 THREE MONTHS ENDING SEPTEMBER 30, 2004
-------------------------------------------------------- --------------------------------------------------------
NET CARRYING NET CARRYING
VALUE OF VALUE OF
PRINCIPAL BALANCE OF UNAMORTIZED DEBT CONVERTIBLE PRINCIPAL BALANCE OF UNAMORTIZED DEBT CONVERTIBLE
DEBT ISSUANCE CONVERTIBLE DEBT AND ISSUE DISCOUNT DEBENTURES CONVERTIBLE DEBT AND ISSUE DISCOUNT DEBENTURES
- ------------------------------------------------------------------------- --------------------------------------------------------
2001 Issuances $ 2,980,000 $ 205,615 $ 2,774,385 $ 3,840,000 $ 1,237,476 $ 2,602,524
September 2003 - - - - - -
February 2004 1,025,000 87,429 937,571 1,675,000 1,236,719 438,281
March 2004 122,000 10,413 111,587 122,000 90,160 31,840
November 2004 500,000 - 500,000 - - -
-------------------------------------------------------- --------------------------------------------------------
$ 4,627,000 $ 303,457 $ 4,323,543 $ 5,637,000 $ 2,564,355 $ 3,072,645
======================================================== ========================================================
AMORTIZATION OF AMORTIZATION OF INTEREST AND AMORTIZATION OF AMORTIZATION OF INTEREST AND
CONVERTIBLE NOTES DEFERRED FINANCING FINANCING CONVERTIBLE NOTES DEFERRED FINANCING FINANCING
DEBT ISSUANCE DISCOUNT COSTS EXPENSES DISCOUNT COSTS EXPENSES
- ------------------------------------------------------------------------- --------------------------------------------------------
2001 Issuances $ 142,921 $ 16,782 $ 63,213 $ 328,549 $ 44,097 $ 62,098
September 2003 - - - 128,542 11,600 -
February 2004 134,124 7,278 - 577,635 36,689 -
March 2004 11,256 - - 28,010 - -
November 2004 - 90,282 - - - -
-------------------------------------------------------- --------------------------------------------------------
$ 288,301 $ 114,342 $ 63,213 $ 1,062,736 $ 92,386 $ 62,098
======================================================== ========================================================
15
The following table summarizes the principal balance, unamortized debt discount,
original issue discount and net carrying value of each of the above debt
issuances as reported on the consolidated balance sheet as of June 30, 2005:
FISCAL YEAR ENDING JUNE 30, 2005
------------------------------------------------------
NET CARRYING
VALUE OF
PRINCIPAL BALANCE OF UNAMORTIZED DEBT CONVERTIBLE
DEBT ISSUANCE CONVERTIBLE DEBT AND ISSUE DISCOUNT DEBENTURES
- ----------------------------------------------------------------------
2001 Issuances $ 2,980,000 $ 348,536 $ 2,631,464
September 2003 - - -
February 2004 1,107,500 221,553 885,947
March 2004 122,000 21,670 100,330
November 2004 500,000 - 500,000
------------------------------------------------------
$ 4,709,500 $ 591,759 $ 4,117,741
======================================================
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 using the effective interest method over the respective
lives of the underlying debentures, the amortization of which is included in
"amortization of convertible debt discount" on the consolidated statement of
loss. The aggregate unamortized debt discount and original issue discount
amounted to $303,457, $591,759 and $2,564,355 at September 30, 2005, June 30,
2005 and September 30, 2004, respectively.
The remaining debt and issue discount of $303,457 related to the Company's
outstanding convertible debentures at September 30, 2005, is expected to
amortize to expense during the Company's fiscal years ending as follows:
DISCOUNT
FISCAL YEARS ENDING JUNE 30, AMORTIZATION
--------------------------------------------
2006 (remaining) ............. $ 97,842
2007 ......................... 205,615
------------
Total discount amortization .. $ 303,457
============
9. STOCKHOLDERS' DEFICIT
General
The Company is restricted under Nevada corporate law from declaring any
dividends to shareholders due to current working capital and stockholders'
deficits.
The Company's shareholders elected to increase its authorized common shares from
100 million to 250 million and from 250 million to 750 million at two special
shareholders' meetings held on December 1, 2003 and April 28, 2004,
respectively.
16
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.
In August 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 $87,672 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.
In June 2005, the Company issued 625,000 shares of its common stock to its
former Chief Operating Officer and current interim member of its Board of
Directors in exchange for consulting services in the amount of $7,500. The
consulting services have been provided and the associated expenses were
recognized as of September 30, 2005.
Common Shares Issued In Payment of Accrued Interest and Upon Conversion of
Convertible Note
In July 2005, the Company issued 1,650,000 shares of its common stock to an
institutional investor upon conversion of convertible debentures with a
principal amount of $82,500.
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.
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 was the plaintiff in patent infringement litigation, in which the
Company alleged willful patent infringement. The defendants brought a number of
counterclaims, including antitrust, unfair competition, tortious interference
with business relations and patent misuse, and had 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. In November 2004, the Company
entered into an agreement with the defendant, resulting in termination of the
lawsuit. In connection with the settlement agreement, the Company granted the
defendant a license to utilize its patent in the professional market and allowed
for the possibility of a supply agreement with the defendant to supply the
Company with dry-chemistry test strips used in the Company's current cholesterol
monitor. If no supply agreement is reached, the license will become fully paid
and unencumbered after December 31, 2007, however if a supply agreement is
reached with the defendant, the license terminates on August 4, 2012, upon
expiration of the patent. As such, we reduced the estimated useful life of our
patent from six to three years as the supply agreement is not currently being
negotiated.
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
17
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 are currently ongoing and the Company has recorded a
liability in the amount of $257,535, which it believes is necessary for full and
final settlement of this matter based on the latest negotiations. The Company
believes that any incremental royalty obligation resulting from these
negotiations would not be material to the Company's expected future consolidated
financial statements, however no assurances can be given.
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 requires the Company to make minimum
annual purchases and requires 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%. 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.
Terminated Agreement for Sale of Intellectual Property
Effective February 1, 2005, we entered into an Intellectual Property and Capital
Interest Agreement ("Agreement") with an unrelated third party, which provided
for the future assignment of certain patent applications to the purchaser. In
connection with the assignment, we agreed to allow our president and chief
executive officer, Christopher Maus, to assist the purchaser in the initial
phases of product development and rollout. On March 1, 2005, Mr. Maus entered
into an employment agreement with the purchaser whereby Mr. Maus would serve as
Chairman of the Board and consultant to the purchaser for a period of two years
ending March 1, 2007. The purchaser was unable to complete its first round of
financing by July 31, 2005, and, as required by the Agreement, the Agreement
automatically terminated and was not extended by the parties. Further, the
employment agreement that Mr. Maus entered into with the purchaser also expired
due to the purchaser's inability to complete its first round of financing.
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. Due to cash flow constraints, the
Company ceased placing media ads in September 2004, and has recorded a liability
in the amount of $300,000 on its consolidated financial statements.
Notice of Arbitration from TheSubway.com
In January 2005, the Company was served with a Notice of Arbitration from
TheSubway.com, Inc. ("Subway"), a former consultant to the Company regarding an
outstanding invoice of $75,000 for various public relations and marketing
services to be undertaken by Subway. In June 2005, the Company and Subway
entered into a settlement agreement pursuant to which the Company agreed to pay
Subway $60,000 in the form of common shares of the Company to be registered with
the SEC. The agreement states that the Company was to complete the registration
process for the common shares issuable to Subway by September 1, 2005. The
Company did not complete the registration process by that agreed upon date, and,
as a result, Subway has the right to declare the settlement agreement in default
and to reschedule the hearing before arbitration. Additionally, this reinstated
Subway's claim for $75,000. On November 2, 2005, the Company informed Subway
that it will not oppose entry of an arbitration award in the amount of $60,000.
Accordingly, the Company has recorded a liability in the amount of $60,000 on
its consolidated financial statements for the fiscal period ended September 30,
2005.
11. RITE AID MERCHANDISE RETURN
During the first quarter of fiscal 2005, the Company contacted Rite Aid
regarding non-payment of certain invoices due to the Company and the Company was
notified that Rite Aid did not intend to pay the invoices until their in-house
inventory levels of the Company's products reduced. The Company ceased any
future shipments to Rite Aid, as they had continued to reorder the Company's
products. Upon further discussions with Rite Aid the Company ceased its supply
relationship. On July 13, 2005, the Company reached an agreement with Rite Aid
that stipulates that all remaining merchandise held by Rite Aid would be
returned to the Company. The Company recorded the impact of this agreement on
June 30, 2005.
18
12. SUBSEQUENT EVENTS
Short Term Financing Arrangment
On October 19, 2005, the Company obtained $125,000 in short term financing from
a greater than 5% shareholder. Pursuant to the unwritten terms of the agreement,
the Company is required to make two principal and interest payments of $70,000
each on dates that are contingent upon the Company's receipt of certain accounts
receivable balances. The Company anticipates that the total payments of $140,000
will be made in the fiscal 2006 second quarter.
Patent and Trademark License Agreements
On October 1, 2005, the Company entered into a non-exclusive patent license
agreement with an unrelated company to utilize a patent covering secured data
acquistion, transmission, storage and analysis systems. This patent license
agreement has an initial period of three full calendar years plus the remaining
portion of the present calendar year. This patent license agreement will
automatically extend for subsequent one calendar year periods provided that it
has not been terminated. This patent license agreement stipulates that the
Company will receive 2.5% of the net sales revenue earned by the licensing
company.
Also, on October 1, 2005, the Company entered into a non-exclusive trademark
license agreement with an unrelated company to utilize the trade name "Personal
Health Card". This trademark license agreement has an initial period of three
full calendar years plus the remaining portion of the present calendar year.
This trademark license agreement will automatically extend for subsequent one
calendar year periods provided that it has not been terminated. This trademark
license agreement stipulates that the Company will receive 0.5% of the net sales
revenue earned by the licensing company.
Common Shares Issued Upon Conversion of Convertible Debt
Subsequent to September 30, 2005, the Company issued 7,960,000 shares of its
common stock to three institutional investors upon conversion of convertible
debentures with a principal amount of $398,000.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Certain disclosures in this Quarterly Report on Form 10-QSB include certain
forward-looking statements within the meaning of the safe harbor protections of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. Statements that include words such
as "believe," "expect," "should," intend," "may," "anticipate," "likely,"
"contingent," "could," "may," "estimate," or other future-oriented statements,
are forward-looking statements. Such forward-looking statements include, but are
not limited to, statements regarding our business plans, strategies and
objectives, and, in particular, statements referring to our expectations
regarding our ability to continue as a going concern, generate increased market
awareness of 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 economic
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, 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, 2005, 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 three-month periods, or fiscal
quarters, refer to the quarter ended on the date indicated. 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, the Home Shopping
Network 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 contacted Rite Aid regarding
non-payment of certain invoices due to us and were notified that Rite Aid did
not intend to pay the invoices until their in-house inventory levels of our
products reduced. We ceased any future shipments to Rite Aid, as they had
continued to reorder our products. Upon further discussions with Rite Aid we
ceased our supply relationship.
Our primary focus continues to be to increase consumer awareness of the benefits
of our products through increased distribution, development of new products,
educating pharmacists, and the use of lower-cost marketing
20
campaign tests while seeking additional funding in order to continue conducting
more significant marketing activities.
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, 2005 and 2004. 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, 2005 and 2004, that expressed substantial doubt regarding our ability
to continue as a going concern.
We are addressing our ability to continue as a going concern by, among other
actions, the following:
o We developed a consumer point-of-sale awareness program for those
patients purchasing certain cholesterol-lowering prescriptions,
which is currently being tested;
o We have conducted and intend to continue to conduct marketing
activities as funds become available, including a television
commercial test which began in January 2005 and was completed in
February 2005. We believe that this test program was an effective
method of furthering our product awareness campaign and will
consider pursuing it further as funds are available;
o We continue to support the Medicare reimbursement considerations of
the federal government for cholesterol testing and monitor the FDA's
consideration of over the counter cholesterol-lowering drugs;
o We reduced personnel levels to a core staff of only 13 employees
while implementing cost-cutting measures and decreasing
administrative costs.
o On October 19, 2005, we obtained $125,000 in short term financing
from a greater than 5% shareholder. See "Note 12. Subsequent Events
- Short Term Financing Arrangement" in our consolidated financial
statements for further details.
o On October 1, 2005, we entered into non-exclusive patent and
trademark license agreements with an unrelated company to utilize a
patent covering secured data acquisition, transmission, storage and
analysis systems. See "Note 12. Subsequent Events - Patent and
Trademark License Agreements" in our consolidated financial
statements for further details.
On May 1, 2005, June 1, 2005, July 1, 2005, August 1, 2005, September 1, 2005,
October 1, 2005 and November 1, 2005, we failed to make the required $100,000
monthly payments of principal on our outstanding promissory note in the
aggregate principal amount of $2,869,740 payable to Special Situations. On May
31, 2005, RAB Special Situations LP ("Special Situations") assigned all of its
rights under this note to RAB Special Situations (Master) Fund Limited ("Master
Fund"). Under the terms of the note, in the event of a default in our payment
obligations under the note, the entire principal amount of the note becomes
immediately due and payable. Our obligations under the note and related loan
agreements are collateralized by a security interest in substantially all of our
assets. After each occurrence of default, Master Fund verbally advised us that
it did not intend to assert our failure to make payment as a default under the
note. On July 11, 2005, September 16, 2005, October 14, 2005 and November 11,
2005, our company and Master Fund signed agreements providing that (a) Master
Fund has waived any default arising by reason of our failure to make the May 1,
2005, June 1, 2005, July 1, 2005, August 1, 2005, September 1, 2005, October 1,
2005 and November 1, 2005, payments under the note, (b) payment of the May 1,
2005, June 1, 2005, July 1, 2005, August 1, 2005, September 1, 2005, October 1,
2005 and November 1, 2005, installments under the promissory note will become
due and payable on the February 1, 2006 maturity date of the promissory note,
(c) all of the other terms and conditions of our promissory note to Master Fund
remain in full force and effect.
We will continue to require additional financing to fund our 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 continue conducting marketing activities and the success of
these campaigns on increasing awareness to consumers and pharmacists.
21
We currently do not have sufficient operating revenues or cash to fund
operations beyond February 2006. Additionally, we have been unable to meet our
debt service obligations and have relied upon waivers and deferrals from our
lenders in order to avoid defaulting on secured loans. Also, approximately
$4,516,000 of both secured and unsecured indebtedness matures in February 2006.
We have no current ability to repay this indebtedness. Absent restructuring of
the current indebtedness and/or the receipt of additional financing, we will be
in default of our debt repayment obligations and may be forced to cease
operations and our assets may be subject to foreclosure by both secured and,
thereafter, unsecured investors.
Our short-term sources of capital are dependent on our ability to defer our
long-term debt payments. We generally fund our operations with a combination of
deferring our trade creditors, borrowings under short-term financing
arrangements and through the sale of common equity. Should we be unsuccessful in
any of the initiatives or matters discussed above, our business, and, as a
result, our consolidated financial position, results of operations and cash
flows will likely be materially adversely impacted, the effects from which we
may not recover. As such, substantial doubt as to our ability to continue as a
going concern remains as of the date of this Report.
CONSOLIDATED RESULTS OF OPERATIONS
Our consolidated net sales for the three months ended September 30, 2005
("fiscal 2006 first quarter") were $438,309, a decrease of $446,828, or 50.5%,
as compared to $885,138 for the three months ended September 30, 2004 ("fiscal
2005 first quarter"). This decrease in net sales is primarily attributable to
significantly decreased orders from two existing customers: CVS Corporation and
the Home Shopping Network. Merchandise returns from CVS Corporation exceeded net
sales during the fiscal 2006 first quarter resulting in a negative net sales
amount of $(20,953), a decrease of $270,106 as compared with net sales of
$249,153 during the fiscal 2005 first quarter. Net sales from the Home Shopping
Network decreased $98,477 to $104,580 in the fiscal 2006 first quarter from
$203,058 in the comparable period last year. We attribute the decrease in sales
to the Home Shopping Network to the timing of when they placed their orders for
our merchandise. Additionally, we experienced an overall decrease in sales from
the majority of our customers. We attribute this overall decrease in net sales
to the radio advertising campaign we conducted through mid-September 2004. Due
to a lack of adequate funding, no similar advertising campaign was conducted
during the fiscal 2006 first quarter. While we believe that these advertising
campaigns have had a positive effect on revenues, unless we are able to secure
additional financing, we will be unable to reinstitute these advertising
campaigns.
These negative impacts were partially offset by increased net sales from
Walgreen Co. We have a sales arrangement with Walgreen Co. known commonly known
as "Pay-on-Scan" whereby a sale is completed at the time a Walgreen Co. customer
purchases our product at a Walgreen Co. retail store. We have estimated that
sales to Walgreen Co. approximated $155,236 during the fiscal 2006 first quarter
as compared with none during the fiscal 2005 first quarter. We have fully
reserved an allowance for doubtful accounts against the net sales amount of
$155,236 due to the fact that Walgreen Co. has not communicated to us that it
agrees with this sales figure.
During the fiscal 2006 first quarter we received merchandise returns from Rite
Aid in the retail sales amount of $149,836. We had recorded a reserve for these
returns of $400,408 at June 30, 2005 in conjunction with an agreement we reached
with Rite Aid. Consequently, the financial impact of the returned merchandise
during the fiscal 2006 first quarter was included in our financial statements as
of June 30, 2005. See "Note 11. Rite Aid Merchandise Return" in our consolidated
financial statements for further details. The absence of Rite-Aid as a customer
may adversely impact upon our future revenues.
We realized a consolidated gross profit of $84,648 for our fiscal 2006 first
quarter, a decrease of $147,684, or 63.6%, as compared to a consolidated gross
profit of $232,332 for our fiscal 2005 first quarter. Our resulting consolidated
gross margin was 19.3% for our fiscal 2006 first quarter, as compared to 26.2%
for our fiscal 2005 first quarter. The decrease in our gross profit dollars is
primarily attributable to the significant decrease in our net sales discussed
above. The decrease in our consolidated gross margin is primarily due to our
inability to leverage certain overhead and labor costs due to the decrease in
our net sales.
22
Our ability to realize consolidated gross profits sufficient to meet 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 marketing activities during fiscal 2006, the
likelihood of us achieving broad market awareness and acceptance of our consumer
monitors will be remote.
Our consolidated total operating expenses were $819,652 for the fiscal 2006
first quarter, a decrease of $576,924, or 41.3%, from the $1,396,576 incurred
during our fiscal 2005 first quarter. As further detailed below, the decrease in
operating expenses for our fiscal 2006 first quarter is primarily due to the
cessation of a significant radio advertising campaign which we began in October
2003 and ended in mid-September 2004. The lack of funding to continue our
advertising campaigns will likely have an adverse affect on future revenues.
Our consolidated sales and marketing expenses were $101,574 for the fiscal 2006
first quarter, a decrease of $484,040, or 82.7%, from the $585,614 incurred
during our fiscal 2005 first quarter. This decrease is primarily attributable to
the cessation of a significant radio advertising campaign which we began in
October 2003 and ended in mid-September 2004. There was no such campaign during
the first quarter of fiscal 2005.
Our consolidated general and administrative ("G&A") expenses were $635,713 for
the fiscal 2006 first quarter, a decrease of $71,626, or 10.1%, compared to the
$707,339 incurred during our fiscal 2005 first quarter. This decrease is
primarily attributable to:
o an increase in bad debt expense of approximately $220,000 during our
fiscal 2005 first quarter related to our cessation of our business
relationship with Rite Aid; and
o a reduction in employee expenses of $103,147 primarily related to
our reducing personnel levels. Our core staff decreased to 13
employees at the end of the fiscal 2006 first quarter compared with
a core staff of 24 at the end of the fiscal 2005 first quarter.
Partially offsetting these decreases was:
o an increase in bad debt expense of $155,236 related to our estimated
"Pay-on-Scan" sales to Walgreen Co. as discussed above;
o an increase of $115,300 in expense associated with issuing stock in
exchange for consulting services during the fiscal 2006 first
quarter; and
o an increase of $60,000 related to our not opposing TheSubway.com,
Inc.'s entry of an arbitration award in this amount. See "Note 10.
Contingencies - Notice of Arbitration from TheSubway.com".
Product research and development expenses were insignificant in both the fiscal
2005 and 2004 first quarters.
Our non-cash depreciation and amortization expenses were $81,303 during the
fiscal 2006 first quarter, a decrease of $11,700, or 12.6%, from the $93,003
incurred during our fiscal 2005 first quarter. This decrease is primarily due to
several assets becoming fully depreciated since the end of the fiscal 2005 first
quarter.
Our resulting loss from operations for the fiscal 2006 first quarter was
$735,004, an improvement of $429,240, or 36.9%, compared with the loss from
operations incurred during our fiscal 2005 first quarter of $1,164,244.
Our non-operating income and expenses primarily consist of amortization of
convertible debt and issuance discount, interest and financing expenses. Our net
non-operating expenses for the fiscal 2006 first quarter were $546,121(inclusive
of $483,451 in non-cash charges), a decrease of $777,104, or 58.7%, from net
non-operating expenses of $1,323,225 (inclusive of $1,219,022 in non-cash
charges) in our fiscal 2005 first quarter. This decrease is primarily attributed
a decrease of $595,756 in amortization of debt and issue discount due to a
decrease in the amount of convertible debentures that were converted during the
period, as well as the overall decrease in the debt and issue discount balance
to be amortized.
23
Primarily as a result of the foregoing, we incurred a net loss of $1,281,125
($0.01 per basic and diluted share) in the fiscal 2006 first quarter as compared
to a net loss of $2,487,469 ($0.01 per basic and diluted share) in our fiscal
2005 first quarter.
CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES
General
We have historically sustained our operations and funded our growth through a
combination of deferring our trade creditors, borrowings under short-term
financing arrangements and through the sale of common equity and debt. We expect
to continue to require additional equity or debt financings as our source of
capital. At September 30, 2005 we had a working capital deficit of $7,130,438
and an accumulated deficit of $65,165,816. We currently do not have sufficient
operating revenues or cash to fund operations and have had significant working
capital and stockholders' deficits as of our most recently completed fiscal
years ending June 30, 2005 and 2004. In recognition of such, our independent
registered public accountants included an explanatory paragraph in their report
on our consolidated financial statements for our most recently completed fiscal
years ended June 30, 2005 and 2004, which expresses substantial doubt regarding
our ability to continue as a going concern. During the balance of fiscal 2006 we
have obligations totaling approximately $4,517,000 which become due, including
$2,869,740 owed Master Fund which is due on February 1, 2006 for which
substantially all of our assets serve as collateral. Should we be unsuccessful
in any of the initiatives or matters discussed in the preceding disclosures
entitled "Substantial Doubt Regarding 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
regarding our ability to continue as a going concern remains as of the date of
this Report, in which event we may be required to cease some or all of our
operations in which event investors could lose their investment in our company.
Our financial statements do not include any adjustments that may be necessary in
the event we are unable to continue as a going concern.
We currently do not have sufficient operating revenues or cash to fund
operations beyond Februrary 2006. Additionally, we have been unable to meet our
debt service obligations and have relied upon waivers and deferrals from our
lenders in order to avoid defaulting on secured loans. Also, approximately
$4,517,000 of both secured and unsecured indebtedness matures in February 2006.
We have no current ability to repay this indebtedness. Absent restructuring of
the current indebtedness and/or the receipt of additional financing, we will be
in default of our debt repayment obligations and may be forced to cease
operations and our assets may be subject to foreclosure by both secured and,
thereafter, unsecured investors.
Our Capital Lease Obligations
We lease certain equipment under capital leases. The aggregate net carrying
values of the underlying collateralizing assets were approximately $2,500 and
$75,000 at September 30, 2005, and June 30, 2005, respectively.
Our aggregate future obligations under capital lease agreements in existence at
September 30, 2005, are as follows:
FISCAL YEARS ENDING JUNE 30,
------------------------------------------------------------------
2006 ................................................. $ 15,491
2007 ................................................. 3,590
---------
Total lease payments ................................. 19,081
Less imputed interest ................................ 986
---------
Present value of net minimum lease payments .......... 18,095
Less current maturities .............................. 16,558
---------
Total long-term capital lease obligation ............. $ 1,537
=========
24
Our Outstanding Note Payable
Effective May 1, 2003, we renewed our then expiring revolving credit facility
with a then outstanding balance of $2,197,800 with a financial institution. Any
principal and accrued interest balances remaining on the term loan were due and
payable as a lump sum on April 1, 2005. In November 2004, Special Situations,
entered into an agreement with the above financial institution, under which the
financial institution assigned to Special Situations all of their rights, title
and interest under the note payable. At the time of the assignment, the
outstanding amount due under the note payable was $920,323. Restricted funds
held in escrow by the financial institution served as additional collateral
under the terms of the note payable and were used to partially pay down the then
outstanding loan balance prior to assignment to Special Situations. On May 31,
2005, Special Situations, assigned all of its rights under this note to Master
Fund, a beneficial owner of approximately 9.99% of our common stock as of
September 30, 2005.
Subsequently, we entered into a series of amendments to the note payable and
related loan documents under which Master Fund modified the following terms:
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 $449,417;
o $974,709 of the increase was funded November 12, 2004 resulting in
net cash proceeds to us of $750,000;
o $974,708 of the increase was funded December 15, 2004 resulting in
an additional $750,000 in net cash proceeds;
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.
See below for details regarding our failure to make the required
$100,000 monthly installments;
o we paid a commitment fee to induce the assignee 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 share, subject to adjustment;
o On May 10, 2005, the United States Securities and Exchange
Commission ("SEC") declared effective the registration statement
that we filed covering the resale of shares issuable under the
commitment fee note; and
o the note payable continues to be secured by substantially all of our
assets.
The original issue discount of $449,417 was determined based on an annual
interest rate of 15% over the term of the note payable and was recorded as a
deferred financing cost. This deferred financing cost is being amortized over
the life of the amended note payable and is reflected as "amortization of
deferred financing costs" on our consolidated statement of loss.
On May 1, 2005, June 1, 2005, July 1, 2005, August 1, 2005, September 1, 2005,
October 1, 2005 and November 1, 2005, we failed to make the required $100,000
monthly payments of principal on our outstanding promissory note in the
aggregate principal amount of $2,869,740 payable to Special Situations. On May
31, 2005, Special Situations assigned all of its rights under this note to
Master Fund. Under the terms of the note, in the event of a default in our
payment obligations under the note, the entire principal amount of the note
becomes immediately due and payable. Our obligations under the note and related
loan agreements are collateralized by a security interest in substantially all
of our assets. After each occurrence of default, Master Fund verbally advised us
that it did not intend to assert our failure to make payment as a default under
the note. On July 11, 2005, September 16, 2005, October 14, 2005 and November
11, 2005, our company and Master Fund signed agreements providing that (a)
Master Fund has waived any default arising by reason of our failure to make the
May 1, 2005, June 1, 2005, July 1, 2005, August 1, 2005, September 1, 2005,
October 1, 2005 and November 1, 2005, payments under the note, (b) payment of
the May 1, 2005, June 1, 2005, July 1, 2005, August 1, 2005, September 1, 2005,
October 1, 2005 and November 1, 2005, installments under the promissory note
will become due and payable on the February 1, 2006 maturity date of the
promissory note, (c) all of the other terms and conditions of our promissory
note to Master Fund remain in full force and effect.
25
We have no current ability to repay this indebtedness. Absent restructuring of
the current indebtedness and/or the receipt of additional financing, we may be
forced to cease operations and our assets may be subject to foreclosure by
investors.
Outstanding Convertible Debentures
June through November 2001 Issuances
From June 2001 through November 2001, we issued unsecured convertible
debentures, $2,980,000 of which remains outstanding with one debenture holder
(Master Fund) at September 30, 2005. These debentures (i) accrue interest at the
prime rate plus two percent (8.75% at September 30, 2005), (ii) are convertible
at the option of the holder into shares our common stock at a stated rate of
$0.05 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 had a one-time right to convert a portion of the debentures after the
closing of any subsequent private offering at less than $0.05 per common share
(limited to 9.99% ownership). The holder exercised this right during the third
quarter of fiscal 2004 and converted $180,000 of principal and $60,000 of
accrued interest at $0.05 resulting in $240,000 of additional expense upon
conversion related to the beneficial conversion feature. We have the right to
force conversion of the debentures if the market price of our common stock
exceeds $3.00 per share for 20 consecutive trading days. We have no current
ability to repay this indebtedness. Absent restructuring of the current
indebtedness and/or the receipt of additional financing, we may be forced to
cease operations and our assets may be subject to foreclosure by investors.
In connection with our issuance of the amended and restated promissory note
discussed in "Note 7. Note Payable" in our consolidated financial statements,
the conversion rate of the debentures issued during June 2001 through November
2001 was reduced from $0.10 to $0.05 per share resulting in a $72,600 expense
related to the beneficial conversion feature during the second quarter of fiscal
2005.
September 2003 Issuances
On September 13, 2003, we issued $3,350,000 in unsecured convertible debentures
to eight investors from which we received $3,067,000 in net cash proceeds. The
debentures (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 our
common stock, (ii) were convertible at the option of the holders at a stated
rate of $0.13 per share, and (iii) were due and payable on September 12, 2006.
For every two dollars of original debenture principal, the holder received a
detachable stock purchase warrant allowing for the purchase over the subsequent
two-year period of a share of our common stock at $0.2144 per share. Holders
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 our then outstanding common shares. A registration statement
filed with the SEC registering the resale of the preceding debentures and
warrants became effective on December 23, 2003. As of September 30, 2005,
6,346,155 detachable stock purchase warrants expired. There are no remaining
detachable stock purchase warrants associated with the September 2003
convertible debenture issuances.
On January 13, 2004, we 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 our common stock, at the rate of $0.09 of
debenture principal per share of common stock. Accrued but unpaid interest of
$89,659 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 $89,659. 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
$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.
26
There are no further convertible debenture principal or accrued interest
balances remaining outstanding related to the September 2003 issuance.
February 2004 Issuances
On February 19, 2004, we completed a private placement offering of $2,775,000 in
unsecured convertible debentures with four investors (all of which also
participated in the September 2003 private placement discussed above) from which
we received $2,077,592 in net cash proceeds. 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. The original issue discount was recorded as a reduction to the
convertible debt balance on our consolidated balance sheet and is being
amortized using the effective interest method to "amortization of convertible
debt discount" on our consolidated statement of loss over the term of the
debentures. The $2,775,000 of convertible debentures are convertible at a
conversion price of $0.05 per share, or 55.5 million common shares as of
February 19, 2004. 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
participant's beneficial ownership of 4.99% or more of our then outstanding
common shares. These debentures have an aggregate principal face amount of
$1,025,000 at September 30, 2005 and become due and payable on February 19,
2006. We have no current ability to repay this indebtedness. Absent
restructuring of the current indebtedness and/or the receipt of additional
financing, we may be forced to cease operations and our assets may be subject to
foreclosure by investors.
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 could be
exercised over a nineteen-month period and had 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 had 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
4.99% or more of our then outstanding common shares. As of September 30, 2005,
16,649,999 detachable stock purchase warrants expired. There are no remaining
detachable stock purchase warrants associated with the February 2004 convertible
debenture issuances.
On March 22, 2004, we filed a registration statement with the 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 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
required 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 had a right of first refusal to participate in
any new equity financing transaction undertaken through June 10, 2005.
27
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, 2005 On October 1, 2005, 732,000 detachable stock
purchase warrants expired. The are no remaining detachable stock purchase
warrants associated with the March 2004 convertible debtenture issuance. We have
no current ability to repay this indebtedness. Absent restructuring of the
current indebtedness and/or the receipt of additional financing, we may be
forced to cease operations and our assets may be subject to foreclosure by
investors.
November 2004 Issuance
As discussed above in "Note 7. Note Payable" in our consolidated financial
statements, in November 2004, we paid a commitment fee to induce Special
Situations to enter into a series of amendments to an existing note payable. On
May 31, 2005, Special Situations assigned all of its rights under this note to
Master Fund. The commitment fee of $500,000 was paid through the issuance of a
convertible promissory note (the 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 is also convertible at the option of
the note holder at a conversion price of $.05 per share, subject to adjustment.
The $500,000 commitment fee is included in deferred financing costs and is being
amortized over the life of the amended note payable. On May 10, 2005, the United
States Securities and Exchange Commission ("SEC") declared effective the
registration statement that we filed covering the resale of shares issuable
under the commitment fee note. We have no current ability to repay this
indebtedness. Absent restructuring of the current indebtedness and/or the
receipt of additional financing, we may be forced to cease operations and our
assets may be subject to foreclosure by investors.
The remaining $4,627,000 in principal of our outstanding convertible debentures
at September 30, 2005, matures during our fiscal years ending as follows:
FISCAL YEARS ENDING JUNE 30, PRINCIPAL NET OF DISCOUNT
------------------------------------------------------------------
2006 ............................ $ 1,647,000 $ 1,549,150
2007 ............................ 2,980,000 2,774,385
------------------------------
Total principal payments ........ $ 4,627,000 $ 4,323,543
==============================
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 using the effective interest method over the respective
lives of the underlying debentures, the amortization of which is included in
"amortization of convertible debt discount" on the consolidated statement of
loss. The original debt discount and related amortization expense for each of
the above convertible debenture issuances are as follows:
AMORTIZATION EXPENSE FOR THE
THREE MONTHS ENDED
---------------------------
ORIGINAL DEBT SEPTEMBER SEPTEMBER
ISSUANCE DATE DISCOUNT 30, 2005 30, 2004
- --------------- ------------- ------------ ------------
June-Nov. 2001 $ 5,211,200 $ 142,921 $ 328,549
September 2003 3,350,000 - 128,542
February 2004 2,775,000 100,007 484,437
March 2004 122,000 11,903 23,337
------------- ------------ ------------
$ 11,458,200 $ 254,831 $ 964,865
============= ============ ============
28
The remaining debt discount of $290,485 related to our outstanding convertible
debentures and note payable at September 30, 2005, is expected to amortize to
expense during our fiscal years ending as follows:
DISCOUNT
FISCAL YEARS ENDING JUNE 30, AMORTIZATION
---------------------------------------------------
2006 (remaining) ................... $ 84,871
2007 ............................... 205,615
------------
Total discount amortization ........ $ 290,485
============
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.
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,
2005:
Contractual Obligations Payments Due by Period
- ------------------------------------------ --------------------------------------------------
Less than More than
Total 1 year 1-3 Years 3-5 Years 5 Years
----------- ------------ ----------- --------- ---------
Note Payable $ 2,869,740 $ 2,869,740 $ - $ - $ -
Convertible Debt (1) (2) 4,627,000 4,127,000 500,000 - -
Capital Lease Obligations (3) 19,081 17,512 1,569 - -
Operating Lease Obligations 35,198 12,384 13,668 9,146 -
Interest Obligations (4) 224,191 175,869 48,322 - -
----------- ------------ ----------- --------- ---------
Total $ 7,775,210 $ 7,202,505 $ 563,559 $ 9,146 $ -
=========== ============ =========== ========= =========
(1) Amounts do not include interest to be paid.
(2) Convertible into shares of common stock at the option of the debenture
holder at conversion rates of $0.05 per share.
(3) Includes imputed interest
(4) Interest obligation on convertible debt is based on an interest rate of
8.75% on the three tranches that comprise the $2,980,000 at various
maturity dates.
29
Consolidated Cash Flows
Our operating activities utilized $210,310 in cash and cash equivalents during
the fiscal 2006 first quarter, an improvement of $128,647, or 38.0%, from the
$338,957 in cash and cash equivalents utilized during our fiscal 2005 first
quarter. On a comparative quarter-to-quarter basis, our lower utilization
substantially reflects the positive cash flow effects of reduced net loss and,
to a lesser extent, decreased accounts receivable. The decreased net loss is
primarily attributable to decreased amortization of debt and issue discount. The
decrease in accounts receivable is primarily related to reduced net sales.
Partially offsetting the preceding were the negative cash flow effects of
decreased amortization of note and issue discount and decreased accounts
payable. The decrease in amortization of debt and issue discount is due to a
decrease in the amount of convertible debentures that were converted during the
period, as well as the overall decrease in the debt and issue discount balance
to be amortized. The decrease in accounts payable is related to reduced
operating activities.
There were no cash flow effects from investing activities during the quarters
ended September 30, 2005 or 2004.
Our financing activities utilized $2,490 in cash and cash equivalents during the
fiscal 2006 first quarter, a decrease of $227,199 or 98.9% compared to the
$229,689 in cash and cash equivalents used by financing activities during our
fiscal 2005 first quarter. Our fiscal 2006 first quarter consists of repayments
on our capital leases. 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.
As a result of the foregoing, our cash and cash equivalents decreased by
decreased to $37,224 at September 30, 2005 as compared with $250,024 at June 30,
2005.
Planned Capital Expenditures
We have no significant planned capital expenditures for fiscal 2006.
OTHER MATTERS
Seasonal and Inflationary Influences
To date we have not been materially impacted by seasonal or 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, 2005, 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 2006, 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:
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
30
and handling income, and the cost of the sale, when each of the criteria
established by Staff Accounting Bulletin 104 ("SAB 104") have been met as
follows:
o Pervasive evidence of an arrangement exists - We require a
purchase order from our customers for each sale prior to
shipment of product.
o Delivery has occurred - We do not recognize revenue until the
product is shipped and all material risks and rewards of
ownership are concurrently transferred to the customer. In
limited instances, we may enter into "pay-on-scan" sales
arrangements whereby the risk of ownership does not transfer
to the customer until the customer has sold the product to a
third party (the consumer). In these limited instances,
revenue is not recognized until we have been notified by the
customer that the product has been sold to the consumer.
o Seller's price to the buyer is fixed or determinable - We
require the sales price to be detailed on the customers
purchase order, which may not be changed after acceptance.
o Collection of the related receivable is reasonably assured -
We must determine that collection of the related account
receivable is reasonably assured prior to recognition of
revenue. We make estimates to allow for an appropriate
allowance for uncollectible receivables, as well as for sales
returns expected from our customers.
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.
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.
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.
31
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 any litigation surrounding a 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 any future royalties to be received under a settlement
agreement allowing an unrelated third party to utilize our patent under a
royalty agreement.
Recently Adopted Accounting Standards
In November 2004, the FASB issued Statement of Financial Accounting Standards
No. 151 - Inventory Costs ("SFAS No. 151"), which amends the provisions of
Chapter 4 of Accounting Research Bulletin No. 43 - "Inventory Pricing". SFAS No.
151 requires that certain production costs, such as idle facility expense,
freight, handling costs, and spoilage be charged as a current period expense.
Under the previous accounting principles, these costs were charged to current
period expense only under certain circumstances. SFAS No. 151 also requires that
fixed production overhead be allocated based on normal production capacity. We
adopted SFAS No. 151 effective for our fiscal 2006 first quarter, as required,
with no material impact on our consolidated financial statements.
Recently Issued Accounting Standards Not Yet Adopted
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment," ("SFAS
123R") which revises FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation." ("SFAS 123") and supersedes Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees," ("APB 25"). SFAS 123R
requires a public entity to measure the cost of employee services received in
exchange for an award of equity instruments (including grants of employee stock
options) based on the grant-date fair value of the award (with limited
exceptions). That cost will be recognized over the period during which an
employee is required to provide service in exchange for the award--the requisite
service period (usually the vesting period). The pro forma disclosures
previously permitted under SFAS 123 will no longer be an alternative to
financial statement recognition. See "Note 3. Interim Condensed Consolidated
Financial Statements - Accounting for Stock Based Compensation" in our
consolidated financial statements for the pro forma net income and earnings per
share amounts for the three month periods ended September 30, 2005 and 2004, as
if the Company had used a fair-value based method similar to the methods
required under SFAS 123R to measure compensation expense for employee
stock-based compensation awards. The provisions of SFAS 123R are effective for
the first quarter of the fiscal year beginning after December 15, 2005.
Accordingly, we are required to adopt SFAS 123R in our first quarter of fiscal
2007. We are currently evaluating the provisions of SFAS 123R. The impact on net
income on a quarterly basis is expected to be comparable to the amounts
presented in "Note 3. Interim Condensed Consolidated Financial Statements -
Accounting for Stock Based Compensation" in our consolidated financial
statements. However, the impact on net income may vary depending upon a number
of factors including, but not limited to, the price of our stock and the number
of stock options we grant.
In May 2005, the FASB issued Statement No. 154, "Accounting Changes and Error
Corrections--a replacement of APB Opinion No. 20 and FASB Statement No. 3"
("SFAS 154"). This Statement replaces APB Opinion No. 20, "Accounting Changes",
and FASB Statement No. 3, "Reporting Accounting Changes in Interim Financial
Statements", and changes the requirements for the accounting for and reporting
of a change in accounting principle. SFAS 154 applies to all voluntary changes
in accounting principle. It also applies to changes required by an accounting
pronouncement in the unusual instance that the pronouncement does not include
specific transition provisions. When a pronouncement includes specific
transition provisions, those provisions should be followed. SFAS 154 is
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. Consequently, we will adopt the provisions of
SFAS 154 in our first quarter of fiscal 2007. We currently believe that adoption
of the provisions of SFAS No. 154 will not have a material impact on our
consolidated financial statements.
32
Legal Contingencies
We as a company, including our subsidiaries, are periodically involved in
incidental litigation and administrative proceedings primarily arising in the
normal course of our business. In our opinion, our gross liability, if any, and
without any consideration given to the availability of indemnification or
insurance coverage, under any pending or existing incidental litigation or
administrative proceedings would not materially affect our financial position,
results of operations or cash flows.
ITEM 3. CONTROLS AND PROCEDURES
As of September 30, 2005, 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.
33
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We as a company, including our subsidiaries, are periodically involved in
incidental litigation and administrative proceedings primarily arising in the
normal course of our business. In our opinion, our gross liability, if any, and
without any consideration given to the availability of indemnification or
insurance coverage, under any pending or existing incidental litigation or
administrative proceedings would not materially affect our financial position,
results of operations or cash flows.
In January 2005, we were served with a Notice of Arbitration from TheSubway.com,
Inc. ("Subway"), a former consultant to us regarding an outstanding invoice of
$75,000 for various public relations and marketing services to be undertaken by
Subway. In June 2005, our company and Subway entered into a settlement agreement
pursuant to which we agreed to pay Subway $60,000 in the form our common shares
to be registered with the SEC. The agreement states that we were to complete the
registration process for the common shares issuable to Subway by September 1,
2005. We did not complete the registration process by that agreed upon date,
and, as a result, Subway has the right to declare the settlement agreement in
default and to reschedule the hearing before arbitration. Additionally, this
reinstated Subway's claim for $75,000. On November 2, 2005, we informed Subway
that we will not oppose entry of an arbitration award in the amount of $60,000.
Accordingly, we have recorded a liability in the amount of $60,000 on our
consolidated financial statements for the fiscal period ended September 30,
2005.
ITEM 6. EXHIBITS
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer *
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer *
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
34
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Dated: November 21, 2005
LIFESTREAM TECHNOLOGIES, INC.
By: /s/ Christopher Maus
----------------------------
Christopher Maus
Chairman of the Board of Directors,
President and Chief Executive Officer
(Principal Executive Officer)
By: /s/ Matt Colbert
------------------------
Matt Colbert
Vice President of Finance and Interim
Chief Finance Officer (Principal
Financial and Accounting Officer)
35
EXHIBIT INDEX
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
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