U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
MARK ONE
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended December 31, 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 $.001 per
share, outstanding on February 12, 2004 was 105,235,640.
QT 5, INC.
INDEX TO FORM 10-QSB
Page
Part I-- FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheet at December 31, 2003 (Unaudited) 2
Consolidated Statements of Operations for the Three and Six Months
Ended December 31, 2003 and 2002 (Unaudited) 3
Consolidated Statements of Cash Flows for the Six Months Ended
December 31, 2003 and 2002 (Unaudited) 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
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
QT 5, Inc.
Consolidated Balance Sheet
December 31, 2003
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 58,478
Accounts receivable, net of allowance for doubtful
accounts of $9,415 10,842
Notes receivable, net of allowance of $69,750 69,750
Other prepaid expenses 31,043
------------
Total current assets 170,113
------------
Property and equipment, net of accumulated depreciation
of $7,485 27,893
Deferred financing cost, net of accumulated amortization
of $67,184 462,435
License 358,684
Other assets 15,537
------------
Total assets $ 1,034,662
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 745,780
Accrued salaries 584,755
Lease liability 156,400
Accrued legal fees 150,000
Deferred rent expense 7,422
------------
Total current liabilities 1,644,357
Convertible debentures payable, net of unamortized
debt discount of $237,432 462,568
------------
Total liabilities 2,106,925
------------
Commitments and contingencies
Stockholders' equity (deficit):
Common stock; $0.001 par value; 300,000,000 shares
authorized; 76,533,436 shares issued and
outstanding 76,553
Additional paid-in capital 14,466,445
Prepaid consulting expense (38,194)
Accumulated deficit (15,577,067)
------------
Total stockholders' equity (deficit) (1,072,263)
------------
$ 1,034,662
============
See accompanying notes to unaudited consolidated financial statements.
QT 5, Inc.
Consolidated Statements of Operations
(Unaudited)
Three Months Ended Six Months Ended
December 31, December 31,
------------------------------ ------------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Revenue $ 44,937 $ -- $ 190,404 $ --
Costs and expenses:
Cost of sales 27,841 -- 108,362 --
General and administrative 1,674,050 384,546 3,416,060 703,083
Impairment loss 687,648 -- 687,648 --
------------ ------------ ------------ ------------
Loss from operations (2,344,602) (384,546) (4,021,666) (703,083)
Other expense:
Interest expense (1,044,666) -- (1,341,706) --
Other (7,420) -- (27,919) --
------------ ------------ ------------ ------------
Net loss $ (3,396,688) $ (384,546) $ (5,391,291) $ (703,083)
============ ============ ============ ============
Basic and diluted net loss per common share $ (0.06) $ (0.02) $ (0.11) $ (0.04)
============ ============ ============ ============
Basic and diluted weighted average shares
outstanding 56,346,891 18,455,745 49,601,771 18,405,597
============ ============ ============ ============
See accompanying notes to unaudited consolidated financial statements.
QT 5, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
For the Six Months
Ended December 31,
----------------------------
2003 2002
----------- -----------
(Unaudited) (Unaudited)
Cash flows from operating activities
Net loss $(5,391,291) $ (703,083)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 3,448 3,548
Amortization of debt discount and deferred
financing cost 1,104,419 --
Amortization of prepaid compensation 42,932 --
Loss on issuance of shares for settlement
of accounts payable 27,919 --
Interest expense on issuance of shares for
settlement of note payable to a related party 202,500 --
Stocks and options issued for services 873,668 --
Write-off of note receivable - related party 69,750 --
Write-off of inventory and intellectual property
and accrued legal fees 488,893 --
Changes in operating assets and liabilities:
Accounts receivable 84,384 --
Inventories (205,476) --
Deferred costs 21,551 --
Prepaid expenses and other assets 175,879 --
Accounts payable and accrued expenses 474,923 39,480
Accrued salaries 331,255 --
Deferred revenue (86,184) --
Deferred rent expense (3,478) (301)
----------- -----------
Net cash used in operating activities (1,784,908) (660,356)
----------- -----------
Cash flows used in investing activities
Purchase of property and equipment -- (8,451)
----------- -----------
Cash flows from financing activities
Proceeds from sale of stock 150,000 --
Proceeds from exercise of warrants 80,000 --
Payments on notes payable to related parties (67,500) --
Payments on notes payable (215,000) --
Payments on installment financing (46,930) --
Proceeds from notes payable -- 300,000
Proceeds from convertible debentures, net of
cash costs of $237,000 1,763,000 --
Proceeds from notes payable to related
parties 112,500 50,000
Capital contribution -- 300,000
----------- -----------
Net cash provided by financing
activities 1,776,070 650,000
----------- -----------
Net decrease in cash (8,838) (18,807)
Cash, beginning of period 67,316 62,391
----------- -----------
Cash, end of period $ 58,478 $ 43,584
=========== ===========
See accompanying notes to unaudited consolidated financial statements.
QT 5, Inc.
Consolidated Statements of Cash Flows (continued)
For the Six Months
Ended December 31,
---------------------------------
2003 2002
-------------- --------------
(Unaudited) (Unaudited)
Supplemental disclosure of cash flow information:
Installment financing payable and prepaid
insurance recorded for insurance premium
financed $ 431,908 $ --
============== ==============
Common stock issued as prepaid consulting
services $ 9,240 $ --
============== ==============
Cancellation of financed insurance $ 375,444 $ --
============== ==============
Amortization of prepaid consulting expense $ 400,003 $ --
============== ==============
Debt discount recognized related to
convertible debentures $ 1,274,667 $ --
============== ==============
Common stock issued for settlement of
accounts payable $ 255,510 $ --
============== ==============
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 $ --
============== ==============
Warrant issued in connection with deferred
financing cost $ 276,619 $ --
============== ==============
Common stock issued in connection with license
agreement $ 358,684 $ --
============== ==============
Furniture purchased under a note payable
to related party $ -- $ 17,500
============== ==============
See accompanying notes to unaudited consolidated financial statements.
QT 5, Inc.
Notes to Unaudited Consolidated Financial Statements December 31, 2003
NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BACKGROUND AND ORGANIZATION
The Company is currently the licensee of various quick test devices and
quantitative testing analyzers which it is preparing to bring to market. In
October 2003, the Company entered into a License Agreement of Intellectual
Property with VMM, LLC. Under this agreement, the Company licensed the exclusive
right, worldwide, to sell and distribute, under its brand name, all of the
licensor's products including, but not limited to, specific point of care
quick-test devices and quantitative testing analyzers to the retail,
professional and governmental healthcare markets. These include an FDA cleared
urine specimen drug screening test and a disease testing target system platform
to identify Rubella, Herpes, Roravirus, Strep Group A, Infectious Mononucleosis,
Myoglobin, CK-MB, Cardiac Troponin and Pregnancy. In addition, an HIV 1&2 test
is pending phase 3 clearance by the FDA. During the next 12 months, the Company
expects to submit tests for Hepatitis, Prostate PSA count, West Nile Virus and
SARS to the FDA for clearance. 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 (see Note 5).
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 water-based products. This patent is referred to as the
"NICO Patent." The agreement was effective 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 water-based homeopathic nicotinum (nicotine)
product was NICOWater(TM), an odorless and tasteless water-based product that is
designed to relieve the self-diagnosed symptoms of tobacco cravings. In May 2003
the Company began shipping NICOWater(TM).
In May 2003, Mr. Marshall Anluaf Thompson, owner of the NICO Patent, alleged
that he was entitled to terminate the assignment of the NICO Patent based upon
the Company's failure to meet certain conditions required by the assignment
agreement, including performance conditions. The dispute was heard by a panel of
arbitrators who, on January 8, 2004, concluded that Mr. Thompson was entitled to
terminate the assignment agreement. Immediately following the decision, the
Company stopped marketing NICOWater(TM). Although the Company has acquired other
products, NICOWater(TM) was the only product sold.
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 and six months ended December 31,
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 $3,396,688 and $5,391,291
during the three and six months ended December 31, 2003, respectively, only had
$44,937 and $190,404 of revenue during the three months and six months ended
December 31, 2003 respectively, and had a cash balance of $58,478 at December
31, 2003. In addition, the Company had an accumulated deficit of $15,577,067 and
negative working capital of $1,474,244 and on January 8, 2004 has lost its NICO
patent rights for its only revenue-generating product (see Note 5) at December
31, 2003. The Company is now commencing the marketing and sales of its new
disease and drug quick-test products and management recognizes that the Company
must generate additional resources to fund overhead and for the eventual
achievement of revenue and 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 for its
new products. The Company anticipates that certain of its new product line may
enter the market in second calendar quarter of 2004 and management believes that
revenues generated by this product could lead to future profitability. Also, in
November 2003, the Company completed an accounts receivable financing facility
with AeroFund Financial which enables it to finance approved customer invoices
to a maximum of $1,500,000 at any given time. Although the Company is currently
in default of this financing agreement, caused by the loss of its NICO patent
and non-payment by certain customers, the Company intends to cure the default
and anticipates utilizing this financing, when and if required, in connection
with future sales of new product. Also, in February 2004 management successfully
obtained additional capital through a $1 million sale and issuance of 6%
convertible debentures with an original issuance discount of 25%, from which the
Company received initial gross proceeds of $350,000 on February 12 , 2004 with
an additional $150,000 anticipated on or about February 20, 2004 and the
$250,000 balance of which is scheduled to be paid following the effective date
of a registration statement (which the Company anticipates filing with the
Securities and Exchange Commission in February 2004) covering the common stock
underlying the debentures and related warrants. However, no assurance can be
given that the accounts receivable financing facility will remain available 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, license agreement, 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 December
31, 2003, there was no uninsured cash balance.
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 December 31, 2003, management of the Company has
written off the unamortized value of Intellectual Property Rights totaling
$44,854 (see Note 6) related to the NICO Patent which was lost on January 8,
2004.
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 these changes have been reflected in the
accompanying December 31, 2003 consolidated financial statements.
REVENUE RECOGNITION
The Company recognizes revenue at the time of shipment of its products to
customers. The Company was still in its initial stages of selling the new
product line to customers or distributors as of December 31, 2003. Pursuant to
Staff Accounting Bulletin No. 101, the Company was deferring its sales and
corresponding cost of sales to certain distributors as the payment terms were
contingent upon customer sell-through of product and therefore collectibility of
these receivables was not reasonably assured. As all sales activity was
terminated due to the loss of the Company's NICO Patent on January 8, 2004, the
Company reversed all deferred sales of $269,100 against accounts receivable and
the corresponding cost of sales of $80,109 against inventory during the three
months ended December 31, 2003. The Company also wrote off sales and cost of
sales of $58,459 and $31,802, respectively, to impairment loss in the
accompanying consolidated statements of operations for the three months ended
December 31, 2003.
ADVERTISING
The Company expenses the cost of advertising when incurred as general and
administrative expense. Advertising expense was approximately $237,000 and
$31,000 for the three months ended December 31, 2003 and 2002, respectively, and
$376,000 and $72,000 for the six months ended December 31, 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 December 31, 2003, the Company has two stock-based employee
compensation plans, which are described more fully in Note 9. During the three
and six months ended December 31, 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 Six Months Ended
December 31, December 31,
---------------------------- ----------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net loss as reported $(3,396,688) $ (384,546) $(5,391,291) $ (703,083)
Deduct:
Total stock-based employee
compensation expense under
APB 25 -- -- -- --
Add:
Total stock-based employee
compensation under fair value
based method for all awards, net
of related tax effects (111,185) -- (111,185) --
----------- ----------- ----------- -----------
Pro forma net loss $(3,507,873) $ (384,546) $(5,502,476) $ (703,083)
=========== =========== =========== ===========
Basic and diluted loss per share,
as reported $ (0.06) $ (0.02) $ (0.11) $ (0.04)
=========== =========== =========== ===========
Basic and diluted loss per share,
pro forma $ (0.06) $ (0.02) $ (0.11) $ (0.04)
=========== =========== =========== ===========
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, 16,035,613 and 0 as of December 31, 2003 and 2002, respectively, have
been excluded from dilutive loss per share, as their effect would be
anti-dilutive for the periods ended December 31, 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.
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 adoption of SFAS No. 150 did not have a material impact on the
Company's financial position, cash flows or results of operations.
NOTE 2 - ACCOUNTS RECEIVABLE AND INVENTORIES
Due to the Company's loss of the NICO Patent and the Company's subsequent
decision to stop marketing NICOWater(TM) (see Note 1), the Company's product
NICOWater(TM) could no longer be sold and the Company wrote off accounts
receivable from certain customers and its inventories of raw materials and
finished goods in the aggregate amount of $37,075 and $294,039, respectively, to
impairment loss which is reflected in the accompanying condensed statements of
operations for the three months ended December 31, 2003.
NOTE 3 - DUE FROM INSURANCE COMPANIES
The Company financed its product liability insurance premiums totaling $431,908
in August 2003. The principal amounts had interest at 7.85% per annum and were
payable in equal monthly installments totaling $46,930 through May 1, 2004. The
related product liability policies were cancelled effective October 31, 2003, in
favor of one replacement policy at a substantially reduced annual premium,
resulting in recording a receivable balance from the insurance companies of
$30,000 in other prepaid expenses in the accompanying balance sheet as of
December 31, 2003. The cancellation resulted in an elimination of the financing
payable and related prepaid expense of $375,444. The replacement policy premium
was collaterized by a letter of credit, which required the Company to maintain a
restricted cash balance of $25,000, which is reflected in cash and cash
equivalents in the accompanying balance sheet as of December 31, 2003. This
policy was also cancelled in January 2004 as a result of the Company's loss of
the NICO Patent and the inability to sell NICOWater(TM). The Company anticipates
obtaining new product liability insurance covering the sale of its new products
when they are brought to market.
NOTE 4 - 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 were 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 10) 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. As the
collection of the notes is not reasonably assured, the Company reserved $69,750
of the notes receivable balance during the three months ended December 31, 2003.
Thus, the remaining balance of notes receivable as of December 31, 2003 is
$69,750.
NOTE 5 - LICENSE
In October 2003, the Company entered into a License Agreement of Intellectual
Property (the "License") with VMM, LLC (see Note 1). In consideration for the
License, the Company released 3,260,760 previously issued shares of its common
stock from escrow valued at $358,684 (or $0.11 per share, which was the fair
market value of the stock on the date of the License Agreement). The term of the
License Agreement is one year, although so long as the Company meets certain
proposed sales projections, the License 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. The Company will
begin the amortization of the License at the time the required regulatory
clearances will be obtained and the License Agreement becomes effective. The
Company anticipates to amortize the License over the estimated useful life of
five years using a straight-line method.
NOTE 6 - PATENT AND ROYALTY FEE
On April 7, 2002, the Company entered into an Agreement relating to the
formulation of nicotine water-based products (see Note 1). The Agreement was
effective 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 had been 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. In June 2002, the Company prepaid royalties
through the issuance of 399,000 shares of its common 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. The Company's first
water-based homeopathic nicotinum (nicotine) product was NICOWater(TM), an
odorless and tasteless water-based product that is designed to relieve the
self-diagnosed symptoms of tobacco cravings, which the Company began shipping in
May 2003.
During the three and six months ended December 31, 2003, the Company recorded
$(3,431) and $9,534 respectively, of royalty expense in the accompanying
condensed consolidated statements of operations. Due to the Company's loss of
the NICO Patent (see Note 1), the Company wrote off the unamortized portion of
the Intellectual Property Rights related to the NICO Patent of $44,854 and the
balance of prepaid royalties of $135,023 to impairment loss in the accompanying
condensed statements of operations for the three months ended December 31, 2003.
NOTE 7 - 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 8 - 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. On
October 15, 2003, the holders advanced $200,000 of the remaining $1,000,000 in
gross proceeds prior to the date they were required to do so. In November 2003,
the Company received the remaining $800,000 in gross proceeds due at the second
closing. 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. The debentures also
require that, in the event that the Company loses its patent relating to
NICOWater(TM), the conversion price shall thereafter equal the lesser of (A) the
Set Price and (B) 60% of the average of the 5 closing prices for the 5 trading
days immediately prior to the applicable conversion date. The holders have
agreed that such price will be fixed at $0.01 per share. The Company intends to
register additional shares of common stock to cover such additional conversion
shares. As of December 31, 2003, a total of $1,300,000 of the convertible
debentures was converted into 17,333,332 shares of the Company's common stock.
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 9). On October 15, 2003, as a
consideration to receiving an early advance of $200,000, the Company reduced the
exercise price of the warrants to purchase 13,333,333 shares of the Company's
common stock 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 below) 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 the Company
is in compliance with their obligations under the debentures, the convertible
debenture purchasers agreed to subordinate their security interests to a factor
lien as was required for the Company to factor its accounts receivable.
In connection with the issuance of detachable warrants and the beneficial
conversion feature of the debentures, the Company has recorded a debt discount
of $1,274,667. The Company is amortizing the discount using the effective
interest method through August 2006 and immediately recording the corresponding
unamortized debt discount as interest expense when the related debenture is
converted into the Company's common stock. During the three and six months ended
December 31, 2003, the Company recorded interest expense related to the
amortization of the debt discount and conversion of debentures totaling
$67,184 and $1,037,235, respectively.
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 had an exercise price of $0.075
per share and expire in five years. The Company recorded the value of the
warrant of $596,938 (under the Black-Scholes pricing model) as an issuance cost,
which was included in the deferred financing cost in the accompanying condensed
consolidated balance sheet. On October 15, 2003 as a consideration to receiving
an early advance of $200,000, the Company reduced the exercise price from $0.075
to $0.01. As a result, the Company recorded a decrease in issuance cost of
$320,319 (under the Black-Scholes pricing model) from the original value of the
warrant of $596,938 during the quarter ended December 31, 2003. During the six
months ended December 31, 2003, the Company incurred other issuance costs
totaling $237,000 and an additional $16,000 related to the issuance of the
Company's common stock for finders fees (see Note 9), 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
straight-line method, adjusted prospectively for the reduction in the warrant
value as discussed above, through August 2006 and recorded interest expense
related to the amortization of the deferred financing cost of $40,118 and
$67,184 during the three and six months ended December 31, 2003, respectively.
NOTE 9 - 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.
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.
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 other expense in the accompanying condensed consolidated statements of
operations for the six months ended December 31, 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 11). 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 six months ended December 31, 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 670,773 shares of the Company's common
stock under the 2003 Plan, valued at $113,333 (or $0.17 per share, which is the
fair market value of the stock on the dates of issuance) for consulting services
rendered.
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 six months ended December 31, 2003.
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 8). The Company issued the shares in
November 2003.
In November 2003, the Company issued 381,829 shares of the Company's common
stock under the 2003 Plan, valued at $32,948 (or $0.09 per share, which is the
fair market value of the stock on the date of issuance), for settlement of
accrued legal fees. The Company recorded a loss on settlement of accounts
payable of $6,761 in other expense in the consolidated statement of operations
in the three months ended December 31, 2003.
Certain common stock purchase agreements with certain investors included 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
December 31, 2003, the aggregate purchase price paid by these investors totaled
$310,000. For the five consecutive trading days ended October 3, 2003, the
Company's common stock closing price fell below $0.15 per share, requiring the
Company to issue the 1,033,334 shares of common stock to those investors, which
were issued in November 2003. 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 1,945,476 shares of the Company's common
stock under the 2003 Plan and 93,750 shares of the Company's restricted common
stock, valued at a total of $183,138 (or $0.09 per share, which is the fair
market value of the stock on the dates of issuance), to consultants for services
performed.
In November 2003, the Company issued 83,136 shares of the Company's restricted
common stock , valued at $6,651 ( or $0.08 per share, which is the fair market
value of the stock on the date of issuance), in satisfaction of an accounts
payable in the amount of $20,656. The Company recorded a gain on settlement of
accounts payable of $14,005 in other expense in its accompanying condensed
statement of operations.
In November 2003, the Company issued 9,883,333 shares of the Company's
previously registered common stock, valued at $741,250 (or $0.075 per share,
which is the conversion rate pursuant to the terms of the 6% convertible
debentures), to holders of the Company's 6% convertible debentures (see Note 8).
In November 2003, the Company issued 666,667 shares of the Company's previously
registered common stock for $6,667 in cash in connection with the exercise of
warrants which were issued in connection with the Securities Purchase Agreement
(see Note 8).
In December 2003, the Company issued 7,449,999 shares of the Company's
previously registered common stock, valued at $558,750 (or $0.075 per share
which is the conversion rate pursuant to the terms of the 6% convertible
debentures), to holders of the Company's 6% convertible debentures (see Note 8).
In December 2003, the Company issued 7,333,334 shares of the Company's
previously registered common stock for $73,333 in cash in connection with the
exercise of warrants which were issued in connection with the Securities
Purchase Agreement (see Note 8).
In December 2003, the Company issued 663,408 shares of the Company's common
stock under the 2003 Plan and 760,322 shares of the Company's restricted common
stock, valued at a total of $113,898 (or $0.08 per share, which is the fair
market value of the stock on the date of issuance), for legal retainer and
settlement of accrued legal fees. The Company recorded a loss on settlement of
accounts payable of $14,664 in other expense in the consolidated statement of
operations in the three months ended December 31, 2003.
In December 2003, the Company issued 596,818 shares of the Company's common
stock under the 2003 Plan and 100,000 shares of the Company's restricted common
stock, valued at a total of $51,609 (or $0.07 per share, which is the fair
market value of the stock on the dates of issuance), to consultants for services
performed.
In December 2003, the Company issued 20,000 shares of the Company's common stock
under the 2003 Plan, valued at $1,600 (or $0.08 per share, which is the fair
market value of the stock on the date of issuance), to an employee as additional
compensation.
During the three and six months ended December 31, 2003, the Company amortized
$105,224 and $462,295, respectively, of prepaid consulting expense which is
being amortized over the respective service periods.
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 December 31, 2003 was 2,055,830.
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 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 December 31, 2003 was
271,330.
No options were issued or outstanding during the six months ended December 31,
2003.
WARRANTS
From time to time, the Company issues warrants pursuant to various employment,
consulting and third party agreements.
During the six months ended December 31, 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 8), 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
December 31, 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 8). On October 15, 2003, as a
consideration to receiving an early advance of $200,000, the Company reduced the
exercise price of these warrants from $0.075 to $0.01 (see Note 8).
(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 8). The warrant had 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. On October
15, 2003 as a consideration to receiving an early advance of $200,000, the
Company reduced the exercise price of this warrant from $0.075 to $0.01. As a
result, the Company recorded a decrease in issuance cost of $320,319 from the
original value of the warrant of $596,938 during the quarter ended December 31,
2003 (see Note 8).
Certain common stock purchase warrant agreements issued prior to the six months
ended December 31, 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 10 - 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 of defending this litigation and has
recorded a liability of $156,400 in the accompanying consolidated balance sheet.
On April 7, 2002 the Company entered into an Agreement for the Assignment of
Patent Rights to U.S. Patent No. 6,268,386 relating to the formulation of
nicotine water-based products. This patent is referred to as the "NICO Patent."
The agreement was effective 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 water-based homeopathic nicotinum (nicotine) product was
NICOWater(TM), an odorless and tasteless water-based product that is designed to
relieve the self-diagnosed symptoms of tobacco cravings. In May 2003 the Company
began shipping NICOWater(TM).
In May 2003 Mr. Marshall Anluaf Thompson, owner of the NICO Patent, alleged that
he was entitled to terminate the assignment of the NICO Patent based upon the
Company's failure to meet certain conditions required by the assignment
agreement, including performance conditions. The dispute was heard by a panel of
arbitrators who, on January 8, 2004, concluded that Mr. Thompson was entitled to
terminate the assignment agreement. Immediately following the decision the
Company stopped marketing NICOWater(TM). Although the Company has acquired other
products, NICOWater(TM) was the only product sold. The Company is in the process
of negotiating the settlement as a result of the arbitration and is liable for
reimbursement of the opposing party's attorneys fees, an amount which has not
yet been determined. The Company accrued legal fees of $150,000 which is an
estimate of fees related to the arbitration and is reflected in impairment loss
in the accompanying consolidated statement of operations for the three months
ended December 31, 2003.
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. The Company indemnifies its directors, officers employees
and agents to the maximum extent permitted under the laws of the State of
Delaware. In connection with a certain facility lease, the Company has
indemnified its lessor for certain claims arising from the use of the
facilities. 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 11 - RELATED PARTY TRANSACTIONS
During the six months ended December 31, 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 six months
ended December 31, 2003, mainly because these related parties became employees
of the Company under employment agreements.
Also, during the six months ended December 31, 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 six months ended December 31, 2003 in the accompanying
condensed consolidated statement 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.
NOTE 12 - 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 and six
months ended December 31, 2003 and 2002:
Three Months Ended Six Months Ended
December 31, December 31,
------------------------------ ------------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Numerator for basic and diluted loss
per common share - net loss $ (3,396,688) $ (384,546) $ (5,391,291) $ (703,083)
============ ============ ============ ============
Denominator for basic and diluted loss
per common share - weighted
average shares 56,346,891 18,455,745 49,601,771 18,405,597
============ ============ ============ ============
Basic and diluted loss per common
share $ (0.06) $ (0.02) $ (0.11) $ (0.04)
============ ============ ============ ============
NOTE 13 - SUBSEQUENT EVENTS
On February 12, 2004, the Company entered into a financing with several
investors for the issuance of up to $1,000,000 in 6% Convertible Debentures with
an original issuance discount of 25%. The funds will be received and the
debentures will be issued in two closings. The first closing, pursuant to which
the Company received gross proceeds of $350,000 in financing, took place on
February 12, 2004 with $150,000 anticipated by February 20, 2004. The second
closing, pursuant to which the Company will receive an additional $250,000 in
gross proceeds, will take place immediately after a registration statement
registering the shares in connection with the financing is declared effective.
The debentures have a term of two years. Interest is payable quarterly. The
Company may choose to pay the interest with shares of its common stock, so long
as there is an effective registration statement covering the sale of the common
stock issued for the interest payment, the Company's common stock is listed on a
Principal Market, as defined in the debenture, and has enough authorized but
unissued shares of common stock available to issue all the shares that could be
issued in conjunction with the placement of the debentures. At any time after
the original issue date, the debenture may be convertible into shares of the
Company's common stock at the option of the holder. The number of shares of
common stock issuable upon a conversion is determined by the quotient obtained
by dividing the outstanding principal amount of the debenture to be converted by
the Set Price. The Set Price is defined as $0.01. The Company has reserved
100,000,000 shares of its common stock to cover the conversion of the
debentures.
In conjunction with the 6% Convertible Debentures that were offered in the
private offering dated February 12, 2004 we also issued warrants (the "Debenture
Warrants"). The Debenture Warrants were issued at the first closing and were
immediately exercisable following the first closing at a price of $0.01 per
share. The Debenture Warrants expire five years from the date of issuance. By
exercising the Debenture Warrants, each holder of the 6% Convertible Debentures
is entitled to purchase a number of shares of common stock equal to one-half of
the number of shares of common stock into which the shareholder may convert the
debenture. The Company has reserved 50,000,000 shares of our common stock, the
number of shares that may be purchased through the exercise of the Debenture
Warrants. In connection with the issuance of detachable warrants and the
beneficial conversion feature of the debentures, the Company anticipates to
record a debt discount up to the amount of proceeds received.
On February 3, 2004, the Company received a letter of default and demand for
reimbursement in the sum of $26,870 from AeroFund Financial, with whom the
Company has an accounts receivable financing agreement. The default was caused
by non-payment of invoices to certain customers against which AeroFund had
advanced funds to the Company. The non-payment, in turn, was caused by the
Company's loss of the NICO Patent and the inability of that product to be sold.
The Company intends to cure the default by reimbursing AeroFund for their
advances including related fees. The Company recorded an accrued liability of
$21,496 as of December 31, 2003 in the accounts payable and accrued liabilities
in the accompanying balance sheet related to the reimbursement.
On January 20, 2004, the Company registered an additional 10,000,000 shares
under the 2003 Plan.
In January 2004, the Company issued 4,596,558 shares of the Company's previously
registered common stock, valued at $150,000 (or $0.033 per share, which is the
conversion rate pursuant to the terms of the 6% convertible debentures), to
holders of the Company's 6% convertible debentures pursuant to Notices of
Conversion of Convertible Debenture debt to the Company's common stock.
In January 2004, the Company issued 3,333,333 shares of the Company's previously
registered common stock, valued at $33,333 (or $0.01 per share, which is the
exercise price of warrants issued related to the 6% Convertible Debentures), to
holders of the Company's 6% convertible debentures and related warrants pursuant
to Notices to Exercise such warrants. The Company received $33,333, the exercise
price for the warrants.
In January 2004, the Company issued 1,000,000 shares of the Company's common
stock under the 2003 Plan, valued at $20,000 (or $0.02 per share, which is the
fair market value of the stock on the date of issuance), to a consultant for
services performed.
In February 2004, the Company issued 8,772,282 and 9,000,000 shares of the
Company's previously registered and restricted common stock, respectively,
valued at $215,667 (or $0.012 per share, which is the conversion rate pursuant
to the verbal mutual understanding of the terms of the 6% Convertible
Debentures), to holders of the Company's 6% convertible debentures pursuant to
Notices of Conversion of Convertible Debenture debt to the Company's common
stock.
In February 2004, the Company issued 2,000,000 shares of the Company's
previously registered common stock, valued at $20,000 (or $0.01 per share, which
is the exercise price of warrants issued related to the 6% Convertible
Debentures), to holders of the Company's 6% convertible debentures and related
warrants pursuant to Notices to Exercise such warrants. The Company received
$20,000, the exercise price for the warrants.
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 December 31, 2003, the unaudited consolidated statements of
operations for the three and six-months ended December 31, 2003, and the
unaudited consolidated statements of cash flows for the six-months ended
December 31, 2002 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
As a result of an arbitration decision concerning our right to retain patent
rights, on January 8, 2004 we lost the patent rights for our only
revenue-generating product (see Note 1 to Financial Statements). Although we are
now commencing the marketing and sales of our new specific point of care
quick-test products, management recognizes that the we must generate additional
resources to fund overhead and for the eventual achievement of revenue and
sustained profitable operations. Our success is dependent upon numerous items,
including the successful development of effective marketing strategies to
customers in a competitive market for new products. We anticipate that certain
products in our new product line may enter the market in the second calender
quarter of 2004 and management believes that revenues generated by these
products will lead to future profitability. Although we completed an accounts
receivable financing facility in November 2003 with AeroFund Financial which
enables us to finance approved customer invoices to a maximum of $1,500,000 at
any given time, we are currently in default of this financing agreement caused
by the loss of the NICOWater patent and non-payment by certain Nico customers.
We intend to cure the default and anticipate utilizing this financing, when and
if required, in connection with future sales of new products. Also, in February
2004 management successfully obtained additional capital through a $1 million
sale and issuance of 6% convertible debentures,with an original issuance
discount of 25% from which the Company received initial gross proceeds of
$350,000 on February 12, 2004 with $150,000 anticipated by February 20, 2004 and
the $250,000 balance of which is scheduled to be paid following the effective
date of a registration statement (which we anticipate filing with the Securities
and Exchange Commission in February 2004) covering the common stock underlying
the debentures and related warrants. However, no assurance can be given that the
accounts receivable financing facility will remain available and the balance of
the convertible debenture funding will be consummated as contemplated or will
generate sufficient cash to satisfy our need for additional capital or that
other debt or equity financing will be available to us on satisfactory terms.
These factors, among others, raise substantial doubt about our ability to
continue as a going concern. The accompanying condensed consolidated financial
statements do not include any adjustments relatin 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.
During the six-month period ended December 31, 2003 we were still in our initial
stages of selling NICOWater(TM), our only product to customers or distributors.
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
We are currently the licensee of various specific point of care quick test
devices and quantitative testing analyzers which we are preparing to bring to
market. In October 2003, we entered into a License Agreement of Intellectual
Property with VMM, LLC. Under this agreement we licensed the exclusive right,
worldwide, to sell and distribute, under its brand name, all of the licensor's
products including, but not limited to, specific point of care quick-test
devices and quantitative testing analyzers to the retail, professional and
governmental healthcare markets. These include an FDA cleared urine specimen
drug screening test and a disease testing target system platform to identify
Rubella, Herpes, Roravirus, Strep Group A, Infectious Mononucleosis, Myoglobin,
CK-MB, Cardiac Troponin and Pregnancy. In addition, an HIV 1&2 test is pending
phase 3 clearance by the FDA. During the next 12 months, we expect to submit
tests for Hepatitis, Prostate PSA count, West Nile Virus and SARS to the FDA for
clearance. The term of the License Agreement is one year, although so long as we
meet 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.
On April 7, 2002, we entered into an Agreement for the Assignment of Patent
Rights to U.S. Patent No. 6,268,386 relating to the formulation of nicotine
water-based products. This patent is referred to as the "NICO Patent." The
agreement was effective 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 water-based homeopathic nicotinum (nicotine) product was
NICOWater(TM), an odorless and tasteless water-based product that is designed to
relieve the self-diagnosed symptoms of tobacco cravings. In May 2003 we began
shipping NICOWater(TM). In May 2003 Mr. Marshall Anluaf Thompson, owner of the
NICO Patent, alleged that he was entitled to terminate the assignment of the
NICO Patent based upon our failure to meet certain conditions required by the
assignment agreement, including performance conditions. The dispute was heard by
a panel of arbitrators who, on January 8, 2004, concluded that Mr. Thompson was
entitled to terminate the assignment agreement. Immediately following the
decision we stopped marketing NICOWater(TM). Although we have acquired other
products, NICOWater(TM) was the only product sold. We previously reported that
our revenues reflected a slower than anticipated entrance and expansion into the
marketplace with our initial product. During the current quarter, due to the
indecision of the outcome of the arbitration proceeding, sales were at a
minimum. Based upon the arbitration result and the cessation of NICOWater(TM)
sales on January 9, 2004, as of December 31, 2003 we credited customers for
unsalable merchandise and wrote off certain accounts receivable, all of the
NICOWater (TM) inventory, unamortized patent rights and prepaid patent
royalties, all of which have been reflected in impairment loss in the
accompanying condensed consolidated statement of operations.
Although we believe in the marketability of our new 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 December 31, 2003, we had revenues of $44,937 and
incurred a net loss of $3,396,688 compared to $0 revenue and a net loss of
$384,546 during the three-months ended December 31, 2002. Cost of sales for the
three-month period ended December 31, 2003 was $27,841 compared to $0 during the
development stage three-month period ended December 31, 2002. General and
administrative expenses for the three-months ended December 31, 2003 were
$1,674,050 compared to $384,546 for the three-months ended December 31, 2002.
The increase in expenses of $1,289,504 for the current three-month period were
due substantially to non-cash medical, marketing and other advisory consulting
fees of $219,443, legal and accounting fees of $95,444, salaries and commissions
of $376,174, insurance of $73,017, advertising and marketing of $287,904 and
other operating expenses of approximately $237,522. During the three-month
period ended December 31, 2003, we issued 4,409,774 shares of common stock for
legal, medical, marketing and other advisory consulting services pursuant to
consulting agreements and 20,000 shares of common stock to employees as
additional compensation. On the date of issuance the fair market value of the
common stock was $388,645 and $1,600, respectively. Also during the three-month
period ended December 31, 2003, we issued 17,333,332 shares of common stock to
holders of our 6% convertible debentures for conversions of principal debt in
the amounts of $1,300,000 and exercises of 8,000,001 warrants. During the
three-months ended December 31, 2003 and 2002, we recorded interest expense of
$1,044,666 and $0, respectively, representing accrued interest and amortization
of a discount on convertible debentures. Also, on December 31, 2003 we wrote-off
$37,075 of accounts receivable from certain customers, $294,039 of inventory,
$44,854 of unamortized intellectual property, $135,023 of prepaid royalties,
$58,459 in sales and $31,802 in cost of sales, and $150,000 of accrued legal
fees all in connection with the loss of our NICOWater(TM) patent which occurred
as a result of a binding arbitration decision rendered January 8, 2004.
During the six-months ended December 31, 2003, we had revenues of $190,404 and
incurred a net loss of $5,391,291 compared to $0 revenue and a net loss of
$703,083 during the six-months ended December 31, 2002. Additional shipments to
certain pharmacies in the amount of $269,100 during the current six-month
period, not included as revenue and reflected as deferred revenue, have been
reversed against accounts receivable in our December 31, 2003 balance sheet. The
six-month period ended December 31, 2002 was part of our development stage
activities.
Cost of sales for the six-month period ended December 31, 2003 was $108,362
compared to $0 during the development stage six-month period ended December 31,
2002. General and administrative expenses for the six-months ended December 31,
2003 were $3,416,060 compared to $703,083 for the six-months ended December 31,
2002. The increase in expenses of $2,712,977 for the current six-month period
were due substantially to non-cash medical, marketing and other advisory
consulting fees of $755,530, legal and accounting fees of $259,579, salaries and
commissions of $723,481, insurance of $222,902, advertising and marketing of
$364,727 and other operating expenses of approximately $386,758. During the
six-month period ended December 31, 2003, we issued 5,434,148 shares of common
stock for medical, marketing and other advisory consulting services pursuant to
consulting agreements and 20,000 shares of common stock to employees as
additional compensation. On the date of issuance the fair market value of the
common stock was $618,134. Also during the six-month period ended December 31,
2003, we issued 17,333,332 shares of common stock to holders of our 6%
convertible debentures for conversions of principal debt in the amounts of
$1,300,000 and exercises of 8,000,001 warrants. During the six-months ended
December 31, 2003 and 2002, we recorded interest expense of $1,139,206 and $0,
respectively, representing accrued interest and amortization of a discount on
convertible debentures. Also, on December 31, 2003 we wrote wrote-off $37,075 of
accounts receivable from certain customers, $294,039 of inventory, $44,854 of
unamortized intellectual property, $135,023 of prepaid royalties, $58,459 in
sales and $31,802 in cost of sales, and $150,000 of accrued legal fees all in
connection with the loss of our NICOWater(TM) patent which occurred as a result
of a binding arbitration decision rendered January 8, 2004.
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 products we may acquire,
whether or not a market develops for any product we acquire and, if a market
develops, the pace at which it develops.
While we had begun to earn revenues from the sale of NICOWater(TM), the revenues
we had generated to date were not sufficient to fund our operations and will
cease entirely in the future due to the loss of the Nico Patent. We must,
therefore, rely upon bringing to market and selling our point of care quick test
devices and quantitative testing products. In February 2004, we obtained
additional capital to roll-out our new products by entering into a financing for
the issuance of $1 million of 6% convertible debentures with an original
issuance discount of 25%. We received gross proceeds of $350,000 from this
financing on February 12, 2004. We anticipate receiving $150,000 by February 20,
2004 and the remaining $250,000in gross proceeds following the effective date of
a registration statement to be 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. Even
if 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 $58,478 in cash, of which $25,025 collateralizes a letter of credit
issued in favor of an insurance company, $10,842 in accounts receivable, $30,000
receivable from an insurance company in connection with our cancellation of
product liability insurance and $1,043 in prepaid expenses at December 31, 2003.
We have written off $131,592 of prepaid royalties pertaining to NICOWater (TM)
sales and expensed the $100,000 previously recorded prepayment for the
production of in store display racks for NICOWater (TM). An additional $38,194
of prepaid expense, representing consulting services to be rendered in
subsequent periods pursuant to consulting agreements for which we 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 $69,750
representing consideration for the assumption of a lease liability. We have
written off deferred costs in the amount of $78,628 which represented the cost
of sales attributable to the $264,165 of product shipments that were reflected
as deferred revenue. Also, in connection with our 6% convertible debentures, we
have deferred financing costs of $462,435 net of accumulated amortization of
$67,184.
Current liabilities in the amount of $1,644,357 include accounts payable and
accrued expenses of $745,780,accrued salaries of $584,755, a lease liability of
$156,400 related to assumed pre-merger Moneyzone liabilities, deferred rent of
$7,422 and $150,000 of accrued legal fees in connection with the Nico Patent
arbitration. Convertible debentures payable in the amount of $462,568 represent
the gross $700,000 outstanding principal balance, net of unamortized debt
discount of $237,432,related to our placement of convertible debentures. We have
written off deferred revenue in the amount of $264,165 which represented
shipments to certain pharmacies during the current six-month period designated
as consigned sales and not included as revenue. We had negative working capital
in the amount of $1,474,244 at December 31, 2003.
During the six-months ended December 31, 2003, our net cash position decreased
by $8,838 from a beginning balance of $67,316 as of June 30, 2003. As of
December 31, 2002, we had cash of $58,478. During the six and three-months ended
December 31, 2003, we had a loss from operations of $5,391,291 and $701,153,
respectively. Also, during the six-months ended December 31, 2003 we had no cash
flows from investing activities and net cash flows provided by financing
activities were $1,776,070. During this period, our operating activities
utilized net cash of $1,784,908.
Also during the six-months ended December 31, 2003, our trade accounts payable
and accrued expenses increased by $474,923, 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 an increase of $39,480 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
NEW LICENSE AGREEMENT AND LOSS OF NICO PATENT
The Company is currently the licensee of various point of care quick test
devices and quantitative testing analyzers which it is preparing to bring to
market. In October 2003 we entered into a License Agreement of Intellectual
Property with VMM, LLC. Under this agreement the we licensed the exclusive
right, worldwide, to sell and distribute, under its brand name, all of the
licensor's products including, but not limited to, specific point of care
quick-test devices and quantitative testing analyzers to the retail,
professional and governmental healthcare markets. These include an FDA cleared
urine specimen drug screening test and a disease testing target system platform
to identify Rubella, Herpes, Roravirus, Strep Group A, Infectious Mononucleosis,
Myoglobin, CK-MB, Cardiac Troponin and Pregnancy. In addition, an HIV 1&2 test
is pending phase 3 clearance by the FDA. During the next 12 months, the Company
expects to submit tests for Hepatitis, Prostate PSA count, West Nile Virus and
SARS to the FDA for clearance. 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.
On April 7, 2002 we entered into an Agreement for the Assignment of Patent
Rights to U.S. Patent No. 6,268,386 relating to the formulation of nicotine
water-based products. This patent is referred to as the "NICO Patent." The
agreement was effective 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 water-based homeopathic nicotinum (nicotine) product was
NICOWater(TM), an odorless and tasteless water-based product that is designed to
relieve the self-diagnosed symptoms of tobacco cravings. In May 2003 the Company
began shipping NICOWater(TM). In May 2003 Mr. Marshall Anluaf Thompson, owner of
the NICO Patent, alleged that he was entitled to terminate the assignment of the
NICO Patent based upon the Company's failure to meet certain conditions required
by the assignment agreement, including performance conditions. The dispute was
heard by a panel of arbitrators who, on January 8, 2004, concluded that Mr.
Thompson was entitled to terminate the assignment agreement. Immediately
following the decision the Company stopped marketing NICOWater(TM). Although the
Company has acquired other products, NICOWater(TM) was the only product sold.
We have transitioned from a development stage enterprise to an operating company
and have, at the beginning of our current fiscal year, begun to generate
revenues from sales of our initial product NICOWater(TM), notwithstanding the
fact that in January 2004 we lost the Nico Patent and all rights to sell that
product. 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 from the sale of new
products, 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.
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.
On November 15, 2002, Fidelity Mortgage, Inc. filed a lawsuit against us in the
Supreme Court of the State of New York alleging that we breached a sublease.
Fidelity is seeking $156,400 in damages plus interest, costs and attorneys'
fees. We are defending this litigation.
On April 7, 2002 the Company entered into an Agreement for the Assignment of
Patent Rights to U.S. Patent No. 6,268,386 relating to the formulation of
nicotine water-based products. This patent is referred to as the "NICO Patent."
The agreement was effective 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 water-based homeopathic nicotinum (nicotine) product was
NICOWater(TM), an odorless and tasteless water-based product that is designed to
relieve the self-diagnosed symptoms of tobacco cravings. In May 2003 the Company
began shipping NICOWater(TM). In May 2003 Mr. Marshall Anluaf Thompson, owner of
the NICO Patent, alleged that he was entitled to terminate the assignment of the
NICO Patent based upon the Company's failure to meet certain conditions required
by the assignment agreement, including performance conditions. The dispute was
heard by a panel of arbitrators who, on January 8, 2004, concluded that Mr.
Thompson was entitled to terminate the assignment agreement. Immediately
following the decision the Company stopped marketing NICOWater(TM). Although the
Company has acquired other products, NICOWater(TM) was the only product sold.
The Company is in the process of negotiating the settlement as a result of the
arbitration and is liable for reimbursement of the opposing party's attorneys
fees, an amount which has not yet been determined.
In October 2003 Thomas A. Slamecka and Michael T. Pieniazek filed a lawsuit
against us for specific performance in the Circuit Court of Cook County,
Illinois. The plaintiffs allege that we asked them to provide management
consulting and advisory services to us in exchange for warrants to purchase
2,000,000 shares of our common stock. The plaintiffs allege that the services
were provided, and have asked the Court to order us to issue the common stock.
Other than attorneys fees and costs, the plaintiffs have not asked for monetary
damages. We are defending this action.
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.
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
our common stock closing price for 5 consecutive trading days falls below $0.15
per share, we 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 December 31, 2003, the
aggregate purchase price paid by these investors totaled $310,000. Our common
stock closing price fell below $0.15 per share for the 5 consecutive trading
days ended October 3, 2003, requiring the us to issue an additional 1,033,334
shares of common stock to those certain investors. Such shares were issued in
November 2003 and are exempt from registration pursuant to Section 4 (2) of the
Securities Act of 1933.
In November 2003, the Company issued 83,136 shares of the Company's restricted
common stock , valued at $6,651 ( or $0.08 per share, which is the fair market
value of the stock on the date of issuance), in satisfaction of an account
payable in the amount of $20,656. The Company recorded a gain on settlement of
accounts payable of $14,005 in general and administrative expense in its
accompanying condensed statement of operations. These securities were issued
pursuant to an exemption from registration provided by Section 4 (2) of the
Securities Act of 1933.
In November 2003, the Company issued 93,750 shares of the Company's restricted
common stock , valued at $7,500 ( or $0.08 per share, which is the fair market
value of the stock on the date of issuance), to a consultant for services
performed. These securities were issued pursuant to an exemption from
registration provided by Section 4 (2) of the Securities Act of 1933.
In December 2003, the Company issued 760,322 shares of the Company's restricted
common stock, valued at $60,826 ( or $0.08 per share, which is the fair market
value of the stock on the date of issuance), for legal services performed. These
securities were issued pursuant to an exemption from registration provided by
Section 4 (2) of the Securities Act of 1933.
In December 2003, the Company issued 100,000 shares of the Company's restricted
common stock, valued at $9,000 ( or $0.09 per share, which is the fair market
value of the stock on the date of issuance), to a consultant for services
performed. 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 September 26, 2003, a majority of our shareholders took action by written
consent and approved an increase in our authorized common stock from 100,000,000
to 300,000,000. 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.
In February 2004, we entered into a Securities Purchase Agreement with several
accredited institutional investors for the issuance of an aggregate of
$1,000,000 principal amount 6% convertible debentures with an original issue
discount of 25%. As of February 12, 2003, we closed on an aggregate principal
amount of $437,500 of convertible debentures and received gross proceeds of
$350,000. We anticipate closing on an additional $187,500 by the end of
February. The last tranche of $500,000 in principal amount of convertible
debentures will be issued within 5 days of effectiveness of the registration
statement underlying these securities. The debentures are due two years from the
date of issuance. The debentures are convertible at the option of the holders
into our shares of common stock at a fixed conversion price of $0.01 per share.
In connection with the Securities Purchase Agreement, we also issued warrants to
purchase 50,000,000 shares of our common stock at an exercise price of $0.01 per
share to these investors. The term of the warrants is five years. Furthermore we
entered into a Registration Rights Agreement in order to register the
above-referenced securities. We paid a finders fee of 9% and issued 100,000
warrants to such finder. These securities were issued pursuant to an exemption
from registration pursuant to Section 4 (2) of the Securities Act of 1933.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
3.11 Certificate of Amendment to Certificate of Incorporation, dated as of
November 3, 2003
4.1 Securities Purchase Agreement dated February 12, 2004
4.2 Registration Rights Agreement dated February 12, 2004
4.3 Form of 6% Convertible Debenture dated February 12, 2004
4.4 Form of Warrant dated February 12, 2004
31.1 Certification Pursuant to Rule 13a-14(a) and 15d-14(a)
31.2 Certification Pursuant to Rule 13a-14(a) and 15d-14(a)
31.3 Certification Pursuant to Rule 13a-14(a) and 15d-14(a)
32. Certification Pursuant to Section 1350 of Title 18 of the United States
Code
(b) Reports on Form 8-K
On October 31, 2003, we filed a Form 8-K describing a $2 million financing
transaction.
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
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Date: February 17, 2004 Steven Reder, President
By: /s/ Norman A. Kunin
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Date: February 17, 2004 Norman A. Kunin, Chief Financial Officer