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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-QSB
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Mark One
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended September 30, 2003
OR
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
Commission file number 0-25022
QT 5, Inc.
(Name of Small Business Issuer in Its Charter)
Delaware 72-1148906
(State Or Other Jurisdiction Of (I.R.S. Employer
Incorporation Or Organization) Identification No.)
5655 Lindero Canyon Road, Suite 120, Westlake Village, California 91362
(Address Of Principal Executive Offices) (Zip Code)
818-338-1500
(Issuer's Telephone Number, Including Area Code)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 |_|
Transitional Small Business Disclosure Format: Yes |_| No |X|
The total number of shares of the registrant's Common Stock, par value $.15
per share, outstanding on November 10, 2003 was 46,614,457
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QT 5, Inc.
Index to Form 10-QSB
Page
Part I-- FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheet at September 30, 2003 (Unaudited) 2
Consolidated Statements of Operations for the Three Months
Ended September 30, 2003 and 2002 3
Consolidated Statements of Cash Flows for the Three Months Ended
September 30, 2003 and 2002 4
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis 15
Item 3. Controls and Procedures 18
Part II-- OTHER INFORMATION
Item 1. Legal Proceedings 18
Item 2. Change in Securities and Use of Proceeds 18
Item 3. Defaults Upon Senior Securities 19
Item 4. Submission of Matters to a Vote of Securities Holders 19
Item 5. Other Information 19
Item 6. Exhibits and Reports on Form 8-K 19
1
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
QT 5, Inc.
Consolidated Balance Sheet
September 30,
2003
------------
(Unaudited)
ASSETS
Current assets:
Cash $ 33,528
Accounts receivable, net of allowance for doubtful
accounts of $10,000 358,083
Inventories 188,628
Deferred costs 78,628
Prepaid royalties 137,035
Prepaid insurance 474,459
Other prepaid expenses 100,799
Notes receivable 139,500
------------
Total current assets 1,510,660
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Property and equipment, net of accumulated depreciation
of $6,496 28,882
Patent, net of accumulated amortization of $4,411 45,589
Deferred financing cost, net of accumulated amortization
of $27,066 732,872
Other assets 9,595
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Total assets $ 2,327,598
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 778,400
Accrued salaries 503,645
Installment financing payable 422,374
Deferred revenue 264,165
Lease liability 156,400
Deferred rent expense 8,381
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Total current liabilities 2,133,365
Convertible debentures payable, net of unamortized
debt discount of $964,384 35,616
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Total liabilities 2,168,981
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Commitments and contingencies
Stockholders' equity (deficit):
Common stock; $0.15 par value; 100,000,000 shares
authorized; 45,272,029 shares issued and
outstanding 6,790,804
Additional paid-in capital 5,629,318
Prepaid consulting expense (81,126)
Accumulated deficit (12,180,379)
------------
Total stockholders' equity (deficit) 158,617
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$ 2,327,598
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See accompanying notes to unaudited consolidated financial statements.
2
QT 5, Inc.
Consolidated Statements of Operations
For the Three Months
Ended September 30,
-------------------------------
2003 2002
------------ ------------
(Unaudited) (Unaudited)
Revenue $ 145,467 $ --
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Costs and expenses:
Cost of sales 80,521 --
General and administrative 1,742,010 318,537
------------ ------------
Loss from operations (1,677,064) (318,537)
Other expense:
Interest expense (297,040) --
Other (20,499) --
------------ ------------
Net loss $ (1,994,603) $ (318,537)
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Basic and diluted net loss per
common share $ (0.05) $ (0.02)
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Basic and diluted weighted
average shares outstanding 42,865,278 13,801,500
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See accompanying notes to unaudited consolidated financial statements.
3
QT 5, Inc.
Consolidated Statements of Cash Flows
For the Three Months
Ended September 30,
-----------------------------
2003 2002
----------- -----------
(Unaudited) (Unaudited)
Cash flows from operating activities
Net loss $(1,994,603) $ (318,537)
Adjustments to reconcile net loss to net cash
used in operating activities:
Provision for loss on doubtful accounts
receivable 10,000 --
Depreciation and amortization 1,724 1,618
Amortization of debt discount and deferred
financing cost 62,682 --
Loss on issuance of shares for settlement
of accounts payable 20,499 --
Interest expense on issuance of shares for
settlement of note payable to a related party 202,500 --
Stocks and options issued for services 577,320 --
Changes in operating assets and liabilities:
Accounts receivable (272,857) --
Inventories (100,065) --
Deferred costs (57,077) --
Prepaid expenses and other assets (123,985) --
Accounts payable and accrued expenses 641,146 (56,076)
Deferred revenue 177,981 --
Deferred rent expense (2,519) (301)
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Net cash used in operating activities (857,254) (373,296)
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Cash flows used in investing activities
Purchases of property and equipment -- (8,451)
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Cash flows from financing activities
Proceeds from sale of stock 150,000 --
Payments on notes payable to related parties (67,500) --
Payments on notes payable (215,000) --
Payments on installment financing (9,534) --
Proceeds from convertible debentures, net of
cash costs of $147,000 853,000 --
Proceeds from notes payable to related
parties 112,500 50,000
Capital contribution -- 300,000
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Net cash provided by financing
activities 823,466 350,000
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Net decrease in cash (33,788) (31,747)
Cash, beginning of period 67,316 62,391
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Cash, end of period $ 33,528 $ 30,644
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See accompanying notes to unaudited consolidated financial statements.
4
QT 5, Inc.
Consolidated Statements of Cash Flows (continued)
For the Three Months
Ended September 30,
------------------------------
2003 2002
------------ ------------
(Unaudited) (Unaudited)
Supplemental disclosure of cash flow information:
Installment financing payable and prepaid
insurance recorded for insurance premium
financed $ 431,908 $ --
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Common stock issued as prepaid consulting
services $ 9,240 $ --
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Amortization of prepaid consulting expense $ 357,071 $ --
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Debt discount recognized related to
convertible debentures $ 1,000,000 $ --
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Common stock issued for settlement of
accounts payable $ 129,434 $ --
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Common stock issued for settlement of
note payable to a related party $ 112,500 $ --
============ ============
Common stock issued in connection with
deferred financing cost $ 16,000 $ --
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Warrant issued in connection with deferred
financing cost $ 596,938 $ --
============ ============
See accompanying notes to unaudited consolidated financial statements.
5
QT 5, Inc.
Notes to Unaudited Consolidated Financial Statements
September 30, 2003
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BACKGROUND AND ORGANIZATION
On April 7, 2002, the Company entered into an Agreement for the Assignment of
Patent Rights to U.S. Patent No. 6,268,386 (the "Agreement") relating to the
formulation of nicotine beverages (the "Nico Patent"). The Agreement was
effective only upon the execution and delivery of the assignment of patent. The
assignment of patent was executed and delivered on June 26, 2002. The Company's
first nicotine water-based product is NICOWater(TM). In acquiring the patent,
the Company re-allocated its resources from focusing on the licensing and joint
developing of medical testing devices and other pharmaceutical products to
successfully launching its nicotine product line. In May 2003, the Company
commenced shipping NICOWater(TM), its water-based homeopathic nicotinum
(nicotine) product, designed to relieve the symptoms of tobacco cravings.
The Company's future plans include continuing its efforts to license small
medical device(s) and pharmaceutical products together with its development of
such products for the professional and retail consumer markets. Although the
Company is not currently marketing any products other than its nicotine-based
line of products, the Company has, in October 2003, acquired a license for
certain intellectual property rights and related associated research and
development efforts and FDA approvals on an H.I.V. test kit, in-vitro drug test
kit and a cardiac pulmonary test kit (see Note 11).
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared by the management of the Company pursuant to the rules and regulations
of the Securities and Exchange Commission and in accordance with accounting
principles generally accepted in the United States of America for interim
financial information. The information furnished herein reflects all adjustments
(consisting of normal recurring accruals and adjustments) which are, in the
opinion of management, necessary to fairly represent the financial position and
operating results for the respective periods. Certain information and footnote
disclosures normally present in the annual financial statements prepared in
accordance with accounting principles generally accepted in the United States of
America have been omitted pursuant to such rules and regulations. It is
suggested that these unaudited condensed consolidated financial statements be
read in conjunction with the audited consolidated financial statements and notes
thereto for the year ended June 30, 2003, included in the Company's Annual
Report on Form 10-KSB filed with the Securities and Exchange Commission on
September 23, 2003. The results of the three months ended September 30, 2003 are
not necessarily indicative of the results to be expected for the full year
ending June 30, 2004.
PRINCIPLES OF CONSOLIDATION
The accompanying condensed consolidated financial statements include the
accounts of QT 5, Inc. and its wholly owned subsidiary. All significant
intercompany transactions and balances have been eliminated in consolidation.
GOING CONCERN
The accompanying unaudited condensed consolidated financial statements have been
prepared in conformity with accounting principles generally accepted in the
United States of America, which contemplate continuation of the Company as a
going concern. The Company incurred a net loss of $1,994,603 and only had
$145,467 of revenue during the three months ended September 30, 2003, and had a
cash balance of $33,528 at September 30, 2003. In addition, the Company had an
accumulated deficit of $12,180,379 and negative working capital of $622,705 and
is involved in a legal dispute relating to its patent rights for its only
revenue-generating product (see Note 8) at September 30, 2003. Management
recognizes that the Company must generate additional resources for the eventual
achievement of sustained profitable operations. The Company's success is
dependent upon numerous items, including the successful development of effective
marketing strategies to customers in a competitive market coupled with faster
service and a variety of options, and the successful outcome of the legal
dispute. The Company's new product line entered the market in May 2003 and
management believes that this product will have a significant effect on future
profitability. In August 2003, management successfully obtained additional
capital through a $2 million sale and issuance of 6% convertible debentures,
from which the Company received initial gross proceeds of $1 million and an
additional $200,000 advance against the second $1 million, the balance of which
is scheduled to be paid following the effective date of a
6
registration statement (which was filed with the Securities and Exchange
Commission on October 2, 2003) covering the common stock underlying the
debentures and related warrants. The Company is in the final stage of
negotiations for an accounts receivable financing facility. However, no
assurance can be given that an accounts receivable financing and the balance of
the convertible debenture funding will be consummated as contemplated or will
generate sufficient cash to satisfy the Company's need for additional capital or
that other debt or equity financing will be available to the Company on
satisfactory terms.
These factors, among others, raise substantial doubt about the Company's ability
to continue as a going concern. The accompanying condensed consolidated
financial statements do not include any adjustments relating to the
recoverability and classification of asset carrying amounts or the amount and
classification of liabilities that might result from the outcome of these
uncertainties.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the respective reporting period. Actual results could differ from those
estimates. Significant estimates made by management are, among others, the
realizability of inventories, deferred costs, prepaid royalties and long-lived
assets, collectibility of receivables, and the valuation allowance on deferred
tax assets.
CONCENTRATION OF CREDIT RISK
The financial instrument which potentially subjects the Company to concentration
of credit risk is cash. The Company maintains cash balances at certain high
quality financial institutions, and at times such balances may exceed the
Federal Deposit Insurance Corporation $100,000 insurance limit. As of September
30, 2003, there was no uninsured cash balance.
The Company extends credit to its customers and performs ongoing credit
evaluations of such customers. The Company does not obtain collateral to secure
its accounts receivable. At September 30, 2003, the Company recorded $264,165 of
accounts receivable as deferred revenue, as the payment terms are contingent
upon customer sell-through of product and therefore collectibility is not
reasonably assured.
IMPAIRMENT OF LONG-LIVED ASSETS
Long-lived assets and certain identifiable intangibles to be held and used by an
entity are reviewed by the management of the Company for impairment whenever
events or changes in circumstances indicate that the carrying value of an asset
may not be recoverable. As of September 30, 2003, management of the Company
believes that no impairment has been indicated. There can be no assurances,
however, that market conditions will not change or demand for the Company's
products will develop which could result in impairment of long-lived assets in
the future.
INCREASE IN AUTHORIZED SHARES AND CHANGE IN PAR VALUE
On October 8, 2003, the Company filed a Definitive Form 14C with the Securities
and Exchange Commission stating that the Company's Board of Directors and
shareholders of record as of the close of business on September 22, 2003,
holding a majority of the total number of outstanding shares, have consented to
increase the number of shares of authorized common stock from 100,000,000 to
300,000,000. The par value of each such common stock shall be $0.001 per share.
The Company filed the Certificate of Amendment of Certificate of Incorporation
with the Secretary of the State of Delaware, in accordance with federal security
laws, on November 3, 2003, and will reflect these changes in its December 31,
2003 consolidated financial statements.
REVENUE RECOGNITION
The Company recognizes revenue at the time of shipment of its products to
customers. The Company is still in its initial stages of selling the new product
line to customers or distributors as of September 30, 2003. Pursuant to Staff
Accounting Bulletin No. 101, the Company deferred $264,165 of its sales and
corresponding $78,628 cost of sales to certain distributors in the accompanying
condensed consolidated balance sheet as the payment terms are contingent upon
customer sell-through of product and therefore collectibility of these
receivables is not reasonably assured.
7
ADVERTISING
The Company expenses the cost of advertising when incurred as general and
administrative expense. Advertising expense was approximately $139,000 and
$54,000 for the three months ended September 30, 2003 and 2002, respectively.
STOCK-BASED COMPENSATION
The Company uses the intrinsic value method of accounting for stock-based
compensation to employees in accordance with Accounting Principles Board Opinion
("APB") No. 25, "Accounting for Stock Issued to Employees." The Company accounts
for non-employee stock-based compensation under Statement of Financial
Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation." At September 30, 2003, the Company has two stock-based employee
compensation plans, which are described more fully in Note 7. During the three
months ended September 30, 2003 and 2002, no compensation expense was recognized
in the accompanying consolidated statements of operations for options or
warrants issued to employees pursuant to APB 25, as all options or warrants
granted in fiscal 2003 under those plans had exercise prices equal to the market
value of the underlying common stock on the date of grant. The following table
illustrates the effect on net loss and loss per share if the Company had applied
the fair value recognition provisions of SFAS No. 123, to stock-based
compensation:
Three Months Ended September 30,
--------------------------------
2003 2002
----------- -----------
Net loss as reported $(1,994,603) $ (318,537)
Deduct:
Total stock-based employee compensation
expense under APB 25 0 0
Add:
Total stock-based employee compensation
under fair value based method for all
awards, net of related tax effects (111,185) 0
----------- -----------
Pro forma net loss $(2,105,788) $ (318,537)
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Basic and diluted loss per share - as reported $ (0.05) $ (0.02)
=========== ===========
Basic and diluted loss per share - pro forma $ (0.05) $ (0.02)
=========== ===========
INCOME TAXES
The Company recognizes deferred tax liabilities and assets for the expected
future tax consequences of events that have been recognized in the Company's
financial statements or tax returns. Under this method, deferred tax assets and
liabilities are determined based on the difference between the financial
statement carrying amounts and tax bases of assets and liabilities at each
period end based on enacted tax laws and statutory tax rates applicable to the
periods in which the differences are expected to affect taxable income. A
valuation allowance is provided for significant deferred tax assets when it is
more likely than not that such assets will not be recovered.
LOSS PER SHARE
Basic loss per share is computed by dividing loss available to common
stockholders by the weighted-average number of common shares outstanding.
Diluted loss per share is computed similar to basic loss per share except that
the denominator is increased to include the number of additional common shares
that would have been outstanding if the potential common shares had been issued
and if the additional common shares were dilutive. All potentially dilutive
shares, 55,385 and 0 as of September 30, 2003 and 2002, respectively, have been
excluded from dilutive loss per share, as their effect would be anti-dilutive
for the three-month periods ending September 30, 2003 and 2002.
COMPREHENSIVE INCOME
Comprehensive income is not presented in the Company's condensed consolidated
financial statements since the Company did not have any items of comprehensive
income in any period presented.
8
SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION
As the Company operates in one segment, the Company has not made segment
disclosures in the accompanying condensed consolidated financial statements.
ACCOUNTING PRONOUNCEMENTS
In May 2003, the Financial Accounting Standards Board ("FASB")issued SFAS No.
150, "Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity." SFAS No. 150 establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). SFAS No. 150 is effective for financial instruments entered into
or modified after May 31, 2003, and otherwise is effective at the beginning of
the first interim period beginning after June 15, 2003. It is to be implemented
by reporting the cumulative effect of a change in an accounting principle for
financial instruments created before the issuance date of SFAS No. 150 and still
existing at the beginning of the interim period of adoption. Restatement is not
permitted. The Company does not expect the adoption of SFAS No. 150 to have a
material impact on its financial position, cash flows or results of operations.
NOTE 2 - NOTES RECEIVABLE
On January 1, 2003, the Company entered into promissory notes receivable in the
total amount of $199,500 with two former stockholders of Moneyzone.com, Inc.
("Moneyzone"), an entity that the Company merged with and into in January 2003.
These notes accrue interest at a rate of 4% per annum and are payable on January
1, 2004. The notes were entered into as consideration for a contingent liability
and assumed defense costs relating to Moneyzone's lease liability resulting from
abandoned office space (see Note 8) and other remaining accounts payable of
Moneyzone assumed in the merger. Pursuant to the terms of the notes, the amount
of the notes shall be automatically adjusted to the amount of actual liability
and defense costs incurred by the Company related to the litigation, and shall
also be reduced by any amounts of Moneyzone's outstanding accounts payable which
the Company does not actually pay within one year or which are forgiven or
negotiated to lower amount. These notes are secured by 399,000 shares of the
Company's common stock owned by former stockholders. The remaining balance of
notes receivable as of September 30, 2003 is $139,500.
NOTE 3 - PATENT AND ROYALTY FEE
On April 7, 2002, the Company entered into the Agreement relating to the
formulation of nicotine beverages (see Note 1). The Agreement was effective only
upon the execution and delivery of the assignment of patent. The assignment of
patent was executed and delivered on June 26, 2002. In consideration thereof,
the Company issued 133,000 shares of its common stock valued at $50,000 (or
$0.376 per share, which was management's estimate of the fair market value of
its common stock on the date the patent was assigned). The cost of the patent is
being amortized over the patent's remaining useful life of 17 years. In
addition, the Company agreed to pay the original patent holder royalties of
$1.20 per case, quarterly, for every case sold (consisting of 24 bottles per
case) of the Company's products which utilize the patent, for the remaining life
of the patent. The royalty payments will begin on the first day of the calendar
quarter commencing at such time as the Company makes a first distribution. The
Company has agreed to the following performance goals: (1) during the first year
following the first distribution, the Company will sell a minimum of 500,000
cases of the patented product, and (2) during any year thereafter for the
duration of the Agreement, the Company will sell a minimum of 1,000,000 cases of
the patented product each year. In June 2002, the Company prepaid royalties
through the issuance of 399,000 shares of its stock valued at $150,000 (or
$0.376 per share which was management's estimate of the fair market value of its
common stock on the date the shares were issued) in lieu of meeting the minimum
performance requirement of the first year. This amount will be amortized to
expense at the rate of $1.20 per case sold.
The Company has filed for arbitration to resolve a dispute involving the parties
of this Agreement (see Note 8). The arbitration hearing has been scheduled to
commence in December 2003. During the three months ended September 30, 2003, the
Company recorded $12,965 of royalty expense in the accompanying condensed
consolidated statements of operations.
9
NOTE 4 - INSTALLMENT FINANCING PAYABLE
The Company financed its product liability insurance premiums totaling $431,908
in August 2003. The principal amounts bear interest at 7.85% per annum and are
payable in equal monthly installments totaling $46,930 through May 1, 2004.
NOTE 5 - NOTES PAYABLE
In June 2003 the Company entered into a Settlement Agreement and Mutual General
Releases with certain third party note holders and related parties, mutually
releasing all parties from any and all claims arising out of or related to
certain convertible promissory notes and bridge loan (the "Previous Notes"), and
executed and delivered new Secured Notes and Security Agreements (the "New
Notes") in the aggregate principal amount of $265,000. The New Notes superseded
the Previous Notes, bearing interest at the rate of 12% per annum with the
entire amount, including principal and accrued interest, due and payable on
December 1, 2003. The New Notes were secured by a pledge and first and second
priority security interest in all of the tangible and intangible assets of the
Company, and included certain non-financial covenants and events of default,
among other items, such as the Company's failure to ship in any calendar month
at least 10,000 cases of NICOWater(TM) and generate gross sales of at least
$280,000 from the sale of NICOWater(TM) in any month.
In August 2003, the Company prepaid the notes payable and notes payable to
related parties in the entire principal amounts of $215,000 and $50,000,
respectively, plus accrued interest of $5,760 for an aggregate amount of
$270,760 and has received full collateral releases from the noteholders.
NOTE 6 - CONVERTIBLE DEBENTURES
On August 22, 2003, the Company entered into a Securities Purchase Agreement
with certain investors pursuant to which the Company issued 6% convertible
debentures in the total principal amount of $2,000,000. The first payment of
$1,000,000 in gross proceeds was provided at the first closing, as defined, and
an additional amount up to $1,000,000 will be funded at the second closing, as
defined. The debenture is payable on August 22, 2006. The interest of 6% per
annum is payable quarterly in cash or shares of the Company's common stock, at
the option of the Company, plus an additional interest of 15% per annum will
accrue daily if all accrued interest is not paid in full when due. The debenture
is convertible at the option of the holder into shares of the Company's common
stock at $0.075 with a forced conversion option by the Company if certain
closing prices are attained, as defined. The Company is required to register the
shares that might be issued under the agreement and is subject to liquidated
damages if agreed upon timetables are not met, as defined. In connection with
the Securities Purchase Agreement, the Company also issued warrants to purchase
13,333,333 shares of the Company's common stock at an exercise price of $0.075
per share (see Note 7). In connection with the issuance of detachable warrants
and the beneficial conversion feature of the debentures, the Company has
recorded a debt discount of $1,000,000 and is amortizing the discount using the
effective interest method through August 2006. During the three months ended
September 30, 2003, the Company recorded interest expense related to the
amortization of the debt discount of $35,616.
On August 19, 2003, the Company also issued warrants to purchase 2,666,667
shares of the Company's common stock as part of the commission fee in connection
with the convertible debentures. The warrants have an exercise price of $0.075
per share and expire in five years. The Company recorded the value of the
warrant of $596,938 as an issuance cost, and accordingly, such amount is
included in the deferred financing cost in the accompanying condensed
consolidated balance sheet. During the three months ended September 30, 2003,
the Company incurred other issuance costs totaling $147,000 and an additional
$16,000 related to the issuance of the Company's common stock for finders fees
(see Note 7), which were all recorded as deferred financing cost in the
accompanying condensed consolidated balance sheet. The Company is amortizing the
deferred financing cost using the effective interest method through August 2006
and recorded interest expense related to the amortization of the deferred
financing cost of $35,616 during the three months ended September 30, 2003.
NOTE 7 - STOCKHOLDERS' DEFICIT
COMMON STOCK
In July 2003, the Company issued 1,000,000 shares of common stock for cash of
$150,000 and a warrant to purchase 1,000,000 shares of the Company's common
stock (see further discussion in the Warrants section below) to a third party.
In July 2003, the Company issued 270,430 shares of the Company's common stock
under the 2003 Plan, valued at $81,130 (or $0.30 per share, which is the fair
market value of the stock on the date of issuance), to a consultant for services
performed.
10
In August 2003, the Company issued 206,000 shares of the Company's common stock
under the 2003 Plan, valued at $48,320 (or $0.23 per share, (which is the fair
market value of the stock on the dates of issuance), to two consultants for
services performed and to be performed in the future. The Company recorded
$9,240 of prepaid consulting expense related to the future services to be
performed.
In August 2003, the Company issued 283,590 shares of the Company's common stock
under the 2003 Plan, valued at $79,405 (or $0.28 per share, which is the fair
market value of the stock on the date of issuance), for settlement of accounts
payable. The Company recorded a loss on settlement of accounts payable of
$19,142 in other expense in the accompanying condensed consolidated statements
of operations for the three months ended September 30, 2003.
In August 2003, the Company issued 1,500,000 shares of its restricted common
stock to one of its shareholders in full payment of a non-interest bearing
demand promissory note of $112,500 dated July 25, 2003 (see Note 9). Based on
the estimated fair value of the stock issued, the Company recognized interest
expense of $202,500 in the accompanying consolidated statements of operations
during the three months ended September 30, 2003.
In August 2003, the Company issued 127,171 shares of its restricted common stock
to one of its shareholders valued at $26,706 (or $0.21 per share, which is the
weighted average fair market value on the dates the services were performed) for
consulting services performed.
In September 2003, the Company issued 420,773 shares of the Company's common
stock under the 2003 Plan for consulting services rendered, valued at $73,333
(or $0.17 per share, which is the fair market value of the stock on the date of
issuance).
In September 2003, the Company issued 542,513 shares of the Company's common
stock under the 2003 Plan, valued at $70,527 (or $0.13 per share, which is the
fair market value of the stock on the date of issuance), for settlement of
accounts payable. The Company recorded a loss on settlement of accounts payable
of $1,357 in other expense in the accompanying condensed consolidated statement
of operations for the three months ended September 30, 2003.
During the three months ended September 30, 2003, the Company amortized $357,071
of prepaid consulting expense which is being amortized over the respective
service periods.
In September 2003, the Company committed to issue 100,000 shares of the
Company's common stock valued at $16,000 (or $0.16 per share) to a third party
for finders fees related to the convertible debentures, which was recorded as
part of deferred financing costs (see Note 6).
Certain common stock purchase agreements with certain investors include a
provision in which if for a period of six months from the purchase of shares the
Company's common stock closing price for 5 consecutive trading days will be
below $0.15 per share, the Company will issue to the investors additional
shares, whereby the number of shares purchased and the additional shares,
multiplied by $0.10 would be equal to the aggregate purchase price paid. As of
September 30, 2003, the aggregate purchase price paid by these investors totaled
$310,000 and no additional shares were required to be issued. However, the
Company's common stock closing price fell below $0.15 per share for the 5
consecutive trading days ended October 3, 2003, requiring the Company to issue
an additional 1,033,334 shares of common stock to those investors. Such shares
represent the maximum number of shares required to be issued by the Company
under the provisions of these common stock purchase agreements and were issued
in the quarter ended December 31, 2003 (see Note 11).
STOCK OPTIONS
The Company has a stock option plan (the "2000 Plan"), as amended, that
authorized the issuance of options and shares to acquire up to 2,533,330
registered shares of common stock to officers, employees, directors and
consultants. On February 12, 2003, the Company increased the number of
registered shares reserved for issuance pursuant to the 2000 Plan amendment to
4,233,330 shares. The 2000 Plan allows for the issuance of either incentive
stock options (which can only be granted to employees) and non-qualified stock
options, pursuant to Section 422 of the Internal Revenue Code. Options vest at
the discretion of the Board of Directors as determined at the grant date, but no
longer than a ten-year term. Under the 2000 Plan, the exercise price shall not
be less than fair market value on the date of grant for the incentive stock
options, and not less than 50% of the fair market value on the date of grant for
non-qualified stock options. The number of options under the 2000 Plan available
for grant at September 30, 2003 was 2,655,830.
On April 21, 2003, the Company adopted an incentive equity stock plan (the "2003
Plan") that authorized the issuance of up to 10,000,000 shares of common stock
in the form of options, rights to purchase common stock and stock bonuses, of
which 5,000,000 shares were registered on April 25, 2003 and 5,000,000 shares
were registered on June 25, 2003. The 2003 Plan allows for the issuance of
incentive
11
stock options (which can only be granted to employees), non-qualified stock
options, stock awards, or stock bonuses pursuant to Section 422 of the Internal
Revenue Code. Options vest at the discretion of the Board of Directors as
determined at the grant date, but no longer than a ten-year term. Under the 2003
Plan, the exercise price shall not be less than fair market value on the date of
grant for the incentive stock options, and not less than 85% of the fair market
value on the date of grant for non-qualified stock options. The number of
options under the 2003 Plan available for grant at September 30, 2003 was
3,528,861.
No options were issued or outstanding during the three months ended September
30, 2003.
Warrants
From time to time, the Company issues warrants pursuant to various employment,
consulting and third party agreements.
During the three months ending September 30, 2003, the Company:
(i) issued a warrant to purchase 1,000,000 shares of the Company's common stock
at $0.50 per share to a third party. The warrant expires in 5 years and vests
immediately. The common stock purchase warrant agreement also includes a right
by the Company to call any or all shares of the common stock issued under
warrant agreement from the warrant holder for (i) $2.00 per share for the first
500,000 shares and (ii) $3.00 per share for the remaining 500,000 shares through
July 9, 2004. This call right can by exercised by the Company only if the
Company's common stock has a closing price above the call price for 5
consecutive trading days prior to execution of the call right.
(ii) issued a warrant to purchase 750,000 restricted shares of the Company's
common stock at $0.24 per share (the fair market value of the stock on the date
of grant) to one of its officers in connection with his employment agreement and
recorded $0 of compensation expense as the warrant had an exercise price equal
to the market value of the underlying common stock on the date of grant.
(iii) issued, pursuant to the Securities and Purchase Agreement and in
connection with the convertible debenture financing (see Note 6), warrants to
purchase one share of the Company's common stock for every two shares underlying
the debentures (or 13,333,333 shares of the Company's common stock as of
September 30, 2003) at $0.075 per share (below the fair market value on the date
of grant), expiring in five years. The fair value of the warrants was recorded
as a deferred financing cost (see Note 6).
(iv) issued a warrant to purchase 2,666,667 shares of the Company's common stock
as part of the commission fee in connection with the convertible debenture
financing (see Note 6). The warrant has an exercise price of $0.075 per share
(below the fair market value on the date of grant), expires in five years, and
is valued at $596,938 using the Black-Scholes option pricing model.
Certain common stock purchase warrant agreements issued prior to the quarter
ended September 30, 2003 with certain investors include a right by the Company
to call any or all shares of the common stock issued under warrant agreement
from the warrant holder for (i) $2.00 per share for the first 950,000 shares and
(ii) $3.00 per share for the remaining 950,000 shares through June 9, 2004. This
call right can by exercised by the Company only if the Company's common stock
has a closing price above the call price for 7 consecutive trading days prior to
execution of the call right.
NOTE 8 - COMMITMENTS AND CONTINGENCIES
EMPLOYMENT AGREEMENT
In August 2003, the Company entered into an employment agreement with one of its
officers. The agreement is for a five-year term through July 31, 2008 and
provides for a base salary of $250,000 per annum through October 1, 2003,
$300,000 per annum through October 1, 2004, and an increase of at least 10%
annually until the termination date. The agreement also provides for a sign-up
bonus of $75,000 payable over a seven month period, annual net profit bonus of
1.25% of the Company's net income, issuance of incentive stock options, and
warrant to issue 750,000 shares of the Company's common stock at $0.24 per share
(fair market value of the stock on the date of grant). Additionally, the
agreement provides for a payment of $500,000 upon sale or merger of the Company,
and severance payment of one year of base salary.
LITIGATION
On November 15, 2002, Fidelity Mortgage, Inc. ("Fidelity") filed a lawsuit
against the Company alleging that the Company breached a sublease with Fidelity.
Fidelity is seeking $156,400 in damages plus interest, costs and attorneys'
fees. The Company is in the process defending this
12
litigation and has recorded a liability of $156,400 in the accompanying
consolidated balance sheet.
As of May 6, 2003, the Company has been responding to what the Company believes
are unfounded allegations regarding the assignment of patent rights agreement
between the patent inventor and the Company. The Company took affirmative action
to speedily resolve the dispute by filing for arbitration on June 6, 2003. The
Company believes that the patent inventor's claims lack any merit. Commencement
of the arbitration hearing has been scheduled for December 2003. The Company
intends to vigorously pursue its claims in the arbitration. Nevertheless,
arbitration is uncertain, and the Company may not prevail in the arbitration and
can express no opinion as to its ultimate outcome.
In October 2003, two individuals filed a lawsuit against the Company in
connection with a consulting agreement and a common stock warrant purchase
agreement they allegedly entered into with the Company. Attorneys for the
Company have responded disavowing the validity of referenced agreements and the
Company intends to have any and all claims in connection with the lawsuit
dismissed.
The Company is, from time to time, involved in various legal and other
proceedings which arise in the ordinary course of operating its business. In the
opinion of management, the amount of ultimate liability, if any, with respect to
these actions will not materially affect the consolidated financial position or
results of operations of the Company.
INDEMNITIES AND GUARANTEES
During the normal course of business, the Company has made certain indemnities
and guarantees under which it may be required to make payments in relation to
certain transactions. These indemnities include certain agreements with the
Company's officers, under which the Company may be required to indemnify such
person for liabilities arising out of their employment relationship. The
duration of these indemnities and guarantees varies and, in certain cases, is
indefinite. The majority of these indemnities and guarantees do not provide for
any limitation of the maximum potential future payments the Company could be
obligated to make. Historically, the Company has not been obligated to make
significant payments for these obligations and no liabilities have been recorded
for these indemnities and guarantees in the accompanying consolidated balance
sheet.
NOTE 9 - RELATED PARTY TRANSACTIONS
During the three months ended September 30, 2002, the Company recorded expense
of approximately $135,000 related to various related parties, including officers
and /or stockholders of the Company, for consulting and other administrative
services and expenses. No such expenses were incurred during the three months
ended September 30, 2003, mainly because these related parties became employees
of the Company under employment agreements.
Also, during the three months ended September 30, 2003, the Company issued
127,171 shares of its common stock to a stockholder for consulting services
valued at $26,706.
In July 2003, the Company entered into a non-interest bearing promissory note
for $112,500 with one of its shareholders, which was due on demand. In August
2003, the Company issued 1,500,000 shares of its restricted common stock to the
shareholder for a full payment of this promissory note. Based on the estimated
fair value of the stock issued, the Company recognized interest expense of
$202,500 during the three months ended September 30, 2003 in the accompanying
condensed consolidated statements of operations.
In November 2002, the Company entered into a non-interest bearing note, due on
demand, for a purchase of certain office furniture from one of its officers for
$17,500. The Company repaid this note in full in August 2003.
13
NOTE 10 - BASIC AND DILUTED LOSS PER COMMON SHARE
The following is a reconciliation of the numerators and denominators of the
basic and diluted loss per common share computations for the three months ended
September 30, 2003 and 2002:
2003 2002
------------ ------------
Numerator for basic and diluted loss per
common share - net loss $ (1,994,603) $ (318,537)
============ ============
Denominator for basic and diluted loss per
common share - weighted average shares $ 42,865,278 $ 13,801,500
============ ============
Basic and diluted loss per common share $ (0.05) $ (0.02)
============ ============
NOTE 11 - SUBSEQUENT EVENTS
In October 2003, the Company received an advance of $200,000 against the
$1,000,000 due at the second funding of the convertible debenture financing (see
Note 6). Consideration for this advance, among other items, included reducing
the exercise price of the stock purchase warrants issued pursuant to the
original Securities Purchase Agreement and a warrant to purchase 2,666,667
shares of the Company's common stock issued as part of the commission fee in
connection with the convertible debenture financing (see Note 6) from $0.075 to
$0.01. In addition, the Company granted to the convertible debenture purchasers
a continuing security interest in substantially all of the Company's assets and
agreed to refrain from issuing shares or granting options to the Company's
employees, officers or directors in excess of 50,000 shares per month for a
period of 12 months, without the prior written consent of the convertible
debenture purchasers. So long as we are in compliance with our obligations under
the debentures, the convertible debenture purchasers agreed to subordinate their
security interests to a potential future factor lien as may be required for the
Company to factor its accounts receivable.
In October 2003, the Company finalized a License Agreement which grants to the
Company exclusive rights, worldwide, to sell and distribute all of the
licensor's products including, but not limited to, intellectual property rights
and related associated research and development efforts and FDA approvals on an
H.I.V. test kit, in-vitro drug test kit and a cardiac pulmonary test kit. In
consideration for the License Agreement, the Company released 3,260,760
previously issued shares of its common stock from escrow. The term of the
License Agreement is one year, although so long as the Company meets certain
proposed sales projections, the agreement will be extended for four additional
one-year terms. After this period, if neither party terminates the License
Agreement, it will be extended for an additional five-year term. The term of the
License Agreement will become effective four months after all required
regulatory clearances have been obtained for certain of the licensed products
and after the licensor has obtained a manufacturer to manufacture the products
in accordance with the terms of the License Agreement, which requires the
manufacturing to be at or below a certain price for the various products. The
Company will determine and record the value of the License Agreement in its
quarter ending December 31, 2003.
The Company issued 1,033,334 shares of common stock to certain investors in
connection with certain provisions in common stock purchase agreements (see Note
7). Such shares represent the maximum number of shares required to be issued by
the Company under the provisions of these common stock purchase agreements.
In November 2003, the Company issued 109,094 registered shares and is committed
to issue additional 218,187 registered shares of the Company's common stock
under the 2003 Plan, valued at $32,728 (or $0.10 per share, which is the fair
market value of the stock on the date of issuance), for settlement of accrued
legal fees. The Company will record a loss on settlement of accounts payable of
$6,545 in other expense in the consolidated statement of operations in the
quarter ending December 31, 2003.
In November 2003, the Company issued 200,000 registered shares and is committed
to issue an additional 550,000 registered shares of the Company's common stock,
valued at $60,000 (or $0.08 per share, which is the fair market value of the
stock) to a consultant for services performed. As of September 30, 2003, the
Company recorded accrued consulting fees of $40,000 in accounts payable and
accrued expenses in the accompanying condensed consolidated balance sheet
related to these consulting services performed during the three months ended
September 30, 2003.
14
Item 2. Management's Discussion and Analysis or Plan of Operation
General Overview
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the unaudited consolidated balance
sheet as of September 30, 2003, and the unaudited consolidated statements of
operations and cash flows for the three months ended September 30, 2003, and the
related notes thereto.
The Company cautions readers that important facts and factors described in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations and elsewhere in this document sometimes have affected, and in the
future could affect, the Company's actual results, and could cause the Company's
actual results during fiscal 2004 and beyond to differ materially from those
expressed in any forward-looking statements made by, or on behalf of, the
Company.
As reported in the Independent Auditors' Report on our June 30, 2003 financial
statements, the Company has incurred losses from operations that raised
substantial doubt about our ability to continue as a going concern.
GOING CONCERN
We recognize that we must generate additional revenue in order to eventually
reach a level of sustained profitable operations. We are dependent on the
development of effective marketing strategies for our products to customers in a
competitive market coupled with the timeliness of the delivery of our products.
We anticipate expanding the distribution of NICOWater (TM) which we belive will
generate increased revenue to the Company. In addition, we believe that new
product releases will have a significant effect on future profitability. Our
plans also include obtaining additional working capital through accounts
receivable financing. However, no assurances can be made that we will attain
profitability and that the additional working capital will be available when
needed or on terms acceptable to us. As of May 6, 2003, the Company has been
responding to what the Company believes are unfounded allegations regarding the
assignment of patent rights agreement between the patent inventor and the
Company. The Company took affirmative action to speedily resolve the dispute by
filing for arbitration on June 6, 2003. The Company believes that the patent
inventor's claims lack any merit. Commencement of the arbitration hearing has
been scheduled for December 2003. The Company intends to vigorously pursue its
claims in the arbitration. Nevertheless, arbitration is uncertain, and the
Company may not prevail in the arbitration and can express no opinion as to its
ultimate outcome.
These factors, among others, raise substantial doubt regarding our ability to
continue as a going concern. The accompanying consolidated financial statements
do not include any adjustments relating to the recoverability and classification
of asset carrying amounts or the amount and classification of liabilities that
might result from the outcome of these uncertainties.
Critical Accounting Policies
In preparing our financial statements, we make estimates, assumptions and
judgments that can have a significant effect on our revenues, income/loss from
operations, and net income/net loss, as well as on the value of certain assets
on our balance sheet. We believe that there are several accounting policies that
are critical to an understanding of our historical and future performance as
these policies affect the reported amounts of revenues, expenses, and
significant estimates and judgments applied by management. While there are a
number of accounting policies, methods and estimates affecting our financial
statements, policies that are particularly significant are stock-based
compensation and revenue recognition. In addition, please refer to Note 1 to the
accompanying condensed consolidated financial statements for further discussion
of our significant accounting policies.
STOCK-BASED COMPENSATION. The Company accounts for non-employee stock-based
compensation under Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting For Stock-Based Compensation." SFAS No. 123 defines a fair value
based method of accounting for stock-based compensation. However, SFAS No. 123
allows an entity to continue to measure compensation cost related to stock and
stock options issued to employees using the intrinsic method of accounting
prescribed by Accounting Principles Board Opinion No. 25, as amended ("APB 25"),
"Accounting for Stock Issued to Employees." Under APB 25, compensation cost, if
any, is recognized over the respective vesting period based on the difference,
on the date of grant, between the fair value of the Company's common stock and
the grant price. Entities electing to remain with the accounting method of APB
25 must make pro forma disclosures of net income and earnings per share, as if
the fair value method of accounting defined in SFAS No. 123 had been applied.
The Company has elected to account for its stock-based compensation to employees
under APB 25.
REVENUE RECOGNITION. We recognize revenue at the time of shipment of our
products to customers. We are still in our initial stages of selling our new
product line to customers or distributors
15
as of September 30, 2003. Pursuant to Staff Accounting Bulletin No. 101, we
deferred sales and the related costs to certain distributors as the payment
terms are contingent upon customer sell-through of product, and therefore
collectibility is not reasonably assured.
RESULTS OF OPERATIONS
Although we believe that we are making progress, our first quarter revenues
reflect a slower entrance and expansion into the marketplace with our initial
product, NICOWater(TM), than had been anticipated. We currently distribute our
product through regional distributors and regional and national pharmaceutical
chains however, we continue to require substantial additional funding for sales
and marketing, general business overhead and the continuing research and
development of products. There can be no assurance that our operations will be
profitable or that we will be able to obtain financing when we need it or, if we
obtain financing, that such financing will have terms satisfactory to us. Our
products, to the extent that they may be deemed medical devices or biologics,
are governed by the Federal Food, Drug and Cosmetics Act and by the regulations
of various state and foreign governmental agencies. There can be no assurance
that we will maintain or obtain the appropriate regulatory approvals required to
market our products.
During the three months ended September 30, 2003, we had revenues of $145,467
and incurred a net loss of $1,994,603, compared to no revenue and a net loss of
$318,537 during the three months ended September 30, 2002. Additional shipments
to certain pharmacies in the amount of $264,165 during the current three-month
period are not included as revenue and have been reflected as deferred revenue
in our September 30, 2003 balance sheet. The three-month period ended September
30, 2002 was part of our development stage activities.
Cost of sales for the three-month period ended September 30, 2003 was $80,521
compared to $0 during the development stage three-month period ended September
30, 2002. General and administrative expenses for the three months ended
September 30, 2003 were $1,742,010, compared to $318,537 for the three months
ended September 30, 2002. The increase in expenses of $1,423,473 for the current
three month period were due substantially to non-cash medical, marketing and
other advisory consulting fees of $577,320, legal and accounting fees of
$163,860, salaries and commissions of $347,419, insurance of $150,528 and other
operating expenses of approximately $184,346. During the three-month period
ended September 30, 2003, we issued 1,024,374 shares of common stock for
medical, marketing and other advisory consulting services pursuant to consulting
agreements. On the date of issuance the fair market value of the common stock
was $229,489, of which $9,240 was prepaid consulting expense to be amortized
over the respective service periods. During the three months ended September 30,
2003 and 2002, we recorded interest expense of $94,540 and $0, respectively,
representing accrued interest and amortization of a discount on convertible
debentures.
LIQUIDITY AND CAPITAL RESOURCES
Our capital requirements, particularly as they relate to the acquisition,
introduction and launch of our products and our continued testing and
improvement of our products, have been and will continue to be significant. Our
future cash requirements and the adequacy of available funds will depend on many
factors, including costs of acquiring new products, costs to bring new products
to market, the pace at which we are able to launch NICOWater(TM) or other
products we may acquire, whether or not a market develops for NICOWater(TM) or
for any other product we acquire and, if a market develops, the pace at which it
develops.
While we have recently begun to earn revenues from the sale of NICOWater(TM),
the revenues we have generated to date are not sufficient to fund our
operations. In August 2003, we obtained additional capital to roll-out our
product by issuing $2 million of 6% convertible debentures. We received gross
proceeds of $1 million from this financing in August 2003 and an advance of
$200,000 against the additional $1 million in October 2003. We will receive the
remaining $800,000 in gross proceeds following the effective date of a
registration statement we filed with the Securities and Exchange Commission
registering the common stock underlying the debentures, although there is no
assurance that the registration statement will ever be declared effective. In
addition, we are currently negotiating a credit facility for accounts receivable
financing. However, there is no assurance that we will obtain the accounts
receivable financing. Even if we obtain the accounts receivable financing and we
receive all the proceeds from the placement of our convertible debentures, there
is no assurance that we will not need additional capital to become profitable.
During the next 12 months, if we do not have sufficient capital to fund our
operations, we would have to seek capital through an offering of our securities
or from additional loans. We cannot guarantee that financing will be available
to us, on acceptable terms or at all. If we do not earn revenues sufficient to
support our business and we fail to obtain other financing, either through an
offering of our securities or by obtaining additional loans, we may be unable to
maintain our operations.
We had $33,528 in cash, $358,083 in accounts receivable, $188,628 in inventories
and $712,293 in prepaid expenses at September 30, 2003. Included in prepaid
expenses is $137,035 in royalties
16
net of earned royalty offsets pursuant to the agreement for the assignment of
patent rights, $100,000 prepayment for the production of in-store display racks
for NICOWater(TM) and $474,459 of prepaid product liability and workers
compensation insurance. An additional $81,126 of prepaid expense, representing
consulting services to be rendered in subsequent periods pursuant to consulting
agreements for which the Company issued shares of common stock, is reflected as
a reduction of stockholders' equity. Also reflected are two promissory notes
receivable in the net amount of $139,500 representing consideration for the
assumption of a lease liability. Deferred costs in the amount of $78,628
represent the cost of sales attributable to the $264,165 of product shipments
that are reflected as deferred revenue.
Current liabilities in the amount of $2,133,365 include accounts payable and
accrued expenses of $778,400, of which $289,290 are attributable to legal
expenses. Also included are accrued salaries of $503,645, an installment
financing payable of $422,374, a lease liability of $156,400 related to assumed
pre-merger Moneyzone liabilities and deferred rent of $8,381. Convertible
debentures payable in the amount of $35,616 represent the initial gross
$1,000,000 funding, net of unamortized debt discount of $964,384, related to our
placement of convertible debentures having a face value of $2,000,000. Deferred
revenue in the amount of $264,165 represents shipments to certain pharmacies
during the current three-month period designated as consigned sales and not
included as revenue. We had negative working capital in the amount of $622,705
at September 30, 2003.
During the three months ended September 30, 2003, our net cash position
decreased by $33,788 from a beginning balance of $67,316 as of June 30, 2003. As
of September 30, 2002, we had cash of $30,644. During the three months ended
September 30, 2003, we had a loss from operations of $1,677,064. We had no cash
flows from investing activities and net cash flows provided by financing
activities were $823,466. During this period, our operating activities utilized
net cash of $857,254.
Also during the three months ended September 30, 2003, our trade accounts
payable and accrued expenses increased by $641,146, due primarily to our
transition from a development stage to an operating company, and our notes
payable decreased by $282,500, due to our utilization of the convertible
debenture funding, as compared to a decrease of $56,076 and an increase of
$350,000, respectively, during the same period in 2002.
The Company does not currently have any material commitments for capital
expenditures in the short term other than those expenditures incurred in the
ordinary course of business.
Since inception, our operating and investing activities have used all cash
generated from our financing activities. We anticipate continued revenues from
sales of our products, however, we will have an ongoing need to raise additional
capital to meet working capital requirements in order to fund the growth and
development of the business.
SIGNIFICANT EVENTS DURING THE CURRENT THREE-MONTH PERIOD
Transition To Operating Company
We have transitioned from a development stage enterprise to an operating company
and have only recently begun to generate revenues from sales of our initial
product NICOWater(TM). All losses accumulated from inception through our last
fiscal year ended June 30, 2003 have been considered as part of our development
stage activities. Although we anticipate increased revenue, we will require
substantial additional financing for sales and marketing, general business
overhead, continuing research and development and obtaining regulatory approval
for and the commercialization of products. There can be no assurances that our
operations will be profitable or that we will be able to obtain sufficient
additional financings when they are needed, or that such financings will be
obtainable on terms satisfactory to us. Our products, to the extent they may be
deemed medical devices or biologics, are governed by the Federal Food, Drug and
Cosmetics Act and by the regulations of various state and foreign governmental
agencies. There can be no assurance that we will maintain or obtain the
appropriate regulatory approvals required to market our products.
INCREASE IN AUTHORIZED COMMON SHARES
On October 8, 2003, we filed a Definitive Form 14C with the Securities and
Exchange Commission stating that our Board of Directors and shareholders of
record as of the close of business on September 22, 2003 holding a majority of
the total number of outstanding shares consented to increase the number of
shares of authorized common stock from 100,000,000 to 300,000,000. The par value
of each such share of common stock was changed to $0.001 per share. The
Certificate of Amendment of Certificate of Incorporation has been filed with the
Secretary of the State of Delaware.
17
ITEM 3. CONTROLS AND PROCEDURES.
The Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's President and
the Chief Financial Officer, of the effectiveness of the design and operation of
the Company's disclosure controls and procedures as of the end of the period
covered by this report. Based on that evaluation, the President and the Chief
Financial Officer concluded that the Company's disclosure controls and
procedures are effective to ensure that information required to be disclosed by
the Company in the reports that it files or submits under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the
time periods specified in the Security and Exchange Commission's rules and
forms.
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect internal controls subsequent to the date
of their evaluation.
Forward Looking Statements
This report contains "forward-looking statements" within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. These forward-looking statements are based on our management's beliefs
as well as assumptions and information currently available to us. When used in
this report, the words "believe," "expect," "anticipate," "estimate" and similar
expressions are intended to identify forward-looking statements. These
statements are subject to risks, uncertainties and assumptions, including,
without limitation, the risks and uncertainties concerning our recent
reorganization, our present financial condition, the availability of additional
capital as and when required, general economic conditions and the risks and
uncertainties discussed in the section titled "Management's Discussion and
Analysis of Financial Condition and Results of Operation". Should one or more of
these risks or uncertainties materialize, or should underlying assumptions prove
incorrect, actual results may vary materially from those anticipated, estimated,
or projected. We caution you not to place undue reliance on any forward-looking
statements, all of which speak only as of the date of this report. You should
refer to and carefully review the information in future documents we file with
the Securities and Exchange Commission.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
As of May 6, 2003, the Company has been responding to what the Company believes
are unfounded allegations regarding the assignment of patent rights agreement
between the patent inventor and the Company. The Company took affirmative action
to speedily resolve the dispute by filing for arbitration on June 6, 2003. The
Company believes that the patent inventor's claims lack any merit. Commencement
of the arbitration hearing has been scheduled for December, 2003. The Company
intends to vigorously pursue its claims in the arbitration. Nevertheless,
arbitration is uncertain, and the Company may not prevail in the arbitration and
can express no opinion as to its ultimate outcome.
In October 2003, the Company was served by Thomas A. Slamecka and Michael T.
Pieniazek in the Circuit Court of Cook County, Illinois with a Summons and
Complaint in connection with a consulting agreement and a common stock warrant
purchase agreement entered into with the Company. The plaintiffs allege that the
services were provided, and have asked the Court to order the Company to issue
the common stock. Other than attorney's fees and costs, the plaintiffs have not
asked for monetary damages. Attorneys for the Company have responded disavowing
the validity of the agreements. The Company intends to vigorously defend this
action.
Item 2. Changes in Securities and Use of Proceeds.
Certain common stock purchase agreements with certain investors include a
provision in which, if for a period of six months from the purchase of shares
the Company's common stock closing price for 5 consecutive trading days falls
below $0.15 per share, the Company will issue to the investors additional
shares, whereby the number of shares purchased and the additional shares,
multiplied by $0.10 would be equal to the aggregate purchase price paid. As of
September 30, 2003, the aggregate purchase price paid by these investors totaled
$310,000 and no additional shares were required to be issued. However, the
Company's common stock closing price fell below $0.15 per share for the 5
consecutive trading days ended October 3, 2003, requiring the Company to issue
an additional 1,033,334 shares of common stock to those certain investors. Such
shares will be issued upon receipt by the Company of verification by the
Secretary of State of Delaware that the Company's filing of a Certificate of
Amendment of Certificate of Incorporation increasing the Company's authorized
common stock to 300,000,000 shares was accepted by the Secretary of State. These
securities are exempt from registration pursuant to Section 4 (2) of
18
the Securities Act of 1933.
In July 2003, the Company issued 1,000,000 shares of its common stock for cash
of $150,000 and a warrant to purchase 1,000,000 shares of the Company's common
stock to William J. Ritger, an accredited individual. The warrant term is five
years and the exercise price is $0.50 per share. These securities were issued
pursuant to an exemption from registration provided by Section 4 (2) of the
Securities Act of 1933.
In August 2003, the Company issued 1,500,000 shares of its common stock to SBI
USA LLC, one of its shareholders in full payment of a non-interest bearing
demand promissory note of $112,500 dated July 25, 2003. These securities were
issued pursuant to an exemption from registration provided by Section 4 (2) of
the Securities Act of 1933.
In August 2003, the Company issued 127,171 shares of its common stock to SBI USA
LLC, one of its shareholders, in exchange for services rendered. The value of
the services received was determined by the Board of Directors to be $26,706 (or
$0.21 per share), which was the weighted average fair market value of the common
stockon the dates the services were performed. These securities were issued
pursuant to an exemption from registration provided by Section 4 (2) of the
Securities Act of 1933.
In August 2003, the Company committed to issue 100,000 shares of its common
stock as a finder's fee to Shai Stern in connection with the convertible
debenture financing. The value of the common stock was determined by the Board
of Directors to be $0.08 per share. These securities were issued pursuant to an
exemption from registration provided by Section 4 (2) of the Securities Act of
1933.
In August 2003, the Company entered into a Securities Purchase Agreement with
certain accredited institutional investors pursuant to which the Company issued
6% convertible debentures in the total principal amount of $2,000,000. The
debentures are due to be paid on August 22, 2006. The debentures are convertible
at the option of the holders into shares of the Company's common stock at $0.075
with a forced conversion option by the Company if certain closing prices are
attained. In connection with the Securities Purchase Agreement, we also issued
warrants to purchase 13,333,333 shares of the Company's common stock at an
exercise price of $0.075 per share to these investors. The warrant exercise
price was reduced to $0.01 in October 2003. The term of the warrants is five
years. These securities were issued pursuant to an exemption from registration
provided by Rule 506 of Regulation D promulgated under the Securities Act of
1933.
In August 2003, we also issued a warrant to HPC Capital Management to purchase
2,666,667 shares of the Company's common stock as part of the commission fee
paid in connection with the placement of the convertible debentures. The warrant
had an exercise price of $0.075 per share, which was reduced to $0.01 per share
in October 2003, and expires in five years. These securities were issued
pursuant to an exemption from registration provided by Section 4 (2) of the
Securities Act of 1933.
In August 2003, the Company issued a warrant to purchase 750,000 shares of the
Company's common stock at $0.24 per share (the fair market value of the stock on
the date of grant) to Norman A. Kunin, the Company's Chief Financial Officer in
connection with his employment agreement. The term of the warrant is five years.
These securities were issued pursuant to an exemption from registration provided
by Section 4 (2) of the Securities Act of 1933.
ITEM 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
On October 8, 2003 the Company filed a Definitive Form 14C with the Securities
and Exchange Commission stating that the Company's Board of Directors and
shareholders of record as of the close of business on September 22, 2003 holding
a majority of the total number of outstanding shares had consented to increase
the number of shares of authorized common stock from 100,000,000 to 300,000,000.
The par value of each such share of common stock was reduced to $0.001 per
share. The Certificate of Amendment of Certificate of Incorporation was filed
with the Secretary of the State of Delaware on November 3, 2003.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
19
2.1 Agreement and Plan of Merger, dated as of June 28, 1999, by and among the
registrant, EBonlineinc.com, Inc., and John D. Brasher, Jr., incorporated by
reference to our Current Report on Form 8-K (File No. 000-25022), dated as of
July 15, 1999.
2.2 Amendment No. 1 to the Agreement and Plan of Merger, dated as of June 28,
1999, by and among the registrant, EBonlineinc.com, Inc., and John D. Brasher,
Jr., incorporated by reference to our Current Report on Form 8-K (File No.
000-25022), dated as of July 15, 1999.
2.3 Letter Agreement between MoneyZone.com and Global Capital Partners Inc.
dated as of March 7, 2001, incorporated by reference to our Current Report on
Form 8-K (File No. 000-25022), dated as of March 7, 2001.
2.4 Agreement and Plan of Merger, dated as of July 15, 2002, by and among the
registrant and QuickTest 5, Inc., incorporated by reference to Exhibit 10.2 of
our Schedule 14C (File No. 000-25022), filed with the Commission on December 11,
2002 (the "Schedule 14C").
2.5 Certificate of Merger, dated as of January 9, 2003, between the registrant
and Quicktest 5, Inc., incorporated by reference to Exhibit 10.1 of the Schedule
14C.
3.1 Certificate of Incorporation, dated as of April 4, 1989, incorporated by
reference to Registration Statement on Form 10-SB (File No. 0-25022), dated as
of October 27, 1994.
3.2 Certificate of Amendment to Certificate of Incorporation, dated as of
November 8, 1990, incorporated by reference to Registration Statement on Form
10-SB (File No. 0-25022), dated as of October 27, 1994.
3.3 Certificate of Amendment to Certificate of Incorporation, dated as of
October 26, 1994, incorporated by reference to Registration Statement on Form
10-SB (File No. 0-25022), dated as of October 27, 1994.
3.4 Certificate of Increase in Number of Authorized Shares of Common Stock,
dated as of July 8, 1996, amending the Certificate of Incorporation,
incorporated by reference to our Annual Report on Form 10-KSB (File No.
000-25022), dated as of March 30, 2000.
3.5 Certificate of Amendment to Certificate of Incorporation, dated as of March
12, 1997, incorporated by reference to our Annual Report on Form 10-KSB (File
No. 000-25022), dated as of March 30, 2000.
3.6 Certificate of Amendment to Certificate of Incorporation, dated as of March
20, 1998, incorporated by reference to our Annual Report on Form 10-KSB (File
No. 000-25022), dated as of April 14, 1998.
3.7 Certificate of Amendment to Certificate of Incorporation, dated as of March
31, 1998, incorporated by reference to our Annual Report on Form 10-KSB (File
No. 000-25022), dated as of April 14, 1998.
3.8 Certificate of Amendment to Certificate of Incorporation, dated as of July
8, 1999, incorporated by reference to our Annual Report on Form 10-KSB (File No.
000-25022), dated as of March 30, 2000.
3.9 Certificate of Amendment to Certificate of Incorporation, dated as of July
22, 1999, incorporated by reference to our Annual Report on Form 10-KSB (File
No. 000-25022), dated as of March 30, 2000.
3.10 Certificate of Amendment to Certificate of Incorporation, dated as of
December 17, 1999, incorporated by reference to our Annual Report on Form 10-KSB
(File No. 000-25022), dated as of March 30, 2000.
3.11 Certificate of Amendment to Certificate of Incorporation, dated as of
November 3, 2003, filed herewith.
3.12 By-Laws of MoneyZone.com, Inc., incorporated by reference to Registration
Statement on Form 10-SB (File No. 0-25022), dated as of October 27, 1994.
4.1 Form of Registration Rights Agreement, dated as of October 1, 1999, by and
among EBonlineinc.com, and each of the investors listed on Exhibit A thereto,
incorporated by reference to our Annual Report on Form 10-KSB (File No.
000-25022), dated as of March 30, 2000.
4.2 Convertible Debenture Purchase and Exchange Agreement dated as of September
15, 2000, incorporated by reference to our Current Report on Form 8-K (File No.
000-25022), dated as of
20
September 15, 2000.
4.3 6% Convertible and Exchangeable Debenture, incorporated by reference to our
Current Report on Form 8-K (File No. 000-25022), dated as of September 15, 2000.
4.4 Common Stock Purchase Warrant, incorporated by reference to our Current
Report on Form 8-K (File No. 000-25022), dated as of September 15, 2000.
4.5 Registration Rights Agreement, incorporated by reference to our Current
Report on Form 8-K (File No. 000-25022), dated as of September 15, 2000.
4.6 Registration Rights Agreement by and among registrant and NDMS Investments,
L.P. and NDMS Investments, L.P. assignees incorporated by reference to our
Annual Report on Form 10-KSB (File No. 000-25022) dated as of April 15, 2003.
4.7 $150,000 Promissory Note dated September 30, 2002, between the registrant
and NDMS Investments, L.P. incorporated by reference to our Annual Report on
Form 10-KSB (File No. 000-25022) dated as of April 15, 2003.
4.8 Amendment No. 1 to $150,000 Promissory Note dated February 28, 2003
incorporated by reference to our Annual Report on Form 10-KSB (File No.
000-25022) dated as of April 15, 2003.
4.9 Registration Rights Agreement dated September 30, 2002, between the
registrant and NDMS Investments, L.P. incorporated by reference to our Annual
Report on Form 10-KSB (File No. 000-25022) dated as of April 15, 2003.
10.1 Employment Agreement dated August 4, 2003 between the registrant and Norman
Kunin, incorporated by reference to our Annual Report on Form 10-KSB (File No.
000-25022) dated as of September 19, 2003.
10.2 Common Stock Purchase Warrant dated August 4, 2003 issued to Norman A.
Kunin, incorporated by reference to our Annual Report on Form 10-KSB (File No.
000-25022) dated as of September 19, 2003.
10.3 Securities Purchase Agreement dated August 19, 2003 between the registrant
and various holders of the registrant's convertible debentures, incorporated by
reference to our Annual Report on Form 10-KSB (File No. 000-25022) dated as of
September 19, 2003.
10.4 Registration Rights Agreement dated August 19, 2003 between the registrant
and various holders of the registrant's convertible debentures, incorporated by
reference to our Annual Report on Form 10-KSB (File No. 000-25022) dated as of
September 19, 2003.
10.5 Warrant dated August 19, 2003 between the registrant and various holders of
the registrant's convertible debentures, incorporated by reference to our Annual
Report on Form 10-KSB (File No. 000-25022) dated as of September 19, 2003.
10.6 6% Convertible Debenture entered into by the registrant and various holders
on August 22, 2003, incorporated by reference to our Annual Report on Form
10-KSB (File No. 000-25022) dated as of September 19, 2003.
31.1 Certification Pursuant to Rule 13a-14(a) and 15d-14(a), filed herewith.
31.2 Certification Pursuant to Rule 13a-14(a) and 15d-14(a), filed herewith.
31.3 Certification Pursuant to Rule 13a-14(a) and 15d-14(a), filed herewith.
32. Certification Pursuant to Section 1350 of Title 18 of the United States
Code, filed herewith.
(b) Reports on Form 8-K
On August 4, 2003 the Company filed a Current Report indicating that it intended
to file a restraining order against Platinum Products LLC and to enforce its
exclusive license agreement with Marshall Anlauf Thompson, the holder of the
patent for NICOWater.
On August 27, 2003 the Company filed a Current Report disclosing the receipt of
$1,000,000 in proceeds from the sale of its 6% Convertible Debentures.
21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
QT 5, INC.
By:/s/ Steven Reder
-----------------------------------------
Date: November 12, 2003 Steven Reder, President
By:/s/ Norman A. Kunin
-----------------------------------------
Date: November 12, 2003 Norman A. Kunin, Chief Financial Officer
22