ITEM 1. DESCRIPTION OF BUSINESS.
Overview
We were organized as a Nevada corporation in March 1988. Our principal executive offices are located at 10845 Rancho Bernardo Road, Suite 105, San Diego, California 92127, and our telephone number is (858) 674-8455. Our home page can be located on the World Wide Web at http://www.imagenetix.net.
We develop, formulate and market over-the-counter, natural-based nutritional supplements and skin care products. Our products are proprietary, often supported by scientific studies which we request and are offered through multiple channels of distribution, including direct marketing companies, also known as network marketing or multi-level marketing companies, and chain store retailers. Our primary product is Celadrin® a product formulation which we sell to the mass market through retailers and on a private label basis to wholesale customers.
A key part of our marketing strategy is to provide to our wholesale customers a "turnkey" approach to the marketing and distribution of our products. This turnkey approach provides these customers with all the services necessary to market our products, including developing specific product formulations, providing supporting scientific studies regarding the effectiveness of the product and arranging for the manufacture and marketing of the product.
We sell Celadrin,® our own branded product, directly to the mass markets through retail sellers. We also develop and sell products and formulations to businesses and organizations that market these products through multiple channels of distribution, including direct marketing companies, mass marketing companies, medical, health and nutritional professionals, medical newsletters and direct response radio and television. We also offer Celadrin® products through wholesale customers that in turn offer their products containing Celadrin® to mass market retailers.
Our Business
We develop, formulate and market over-the-counter, natural-based nutritional supplements and skin care products. Our products are proprietary, often supported by scientific studies which we request and are offered through multiple channels of distribution including direct sales to the mass market through retailers, direct marketing companies, medical, health and nutritional professionals, medical newsletters and direct response radio and television.
A key part of our marketing strategy is to provide a "turnkey" approach to the marketing and distribution of our products. Our "turnkey" approach provides:
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Specific product formulations requested by our customers;
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Scientific studies to support claims made for our products;
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Assistance in complying with U.S. laws and regulations;
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Assistance in obtaining foreign country regulatory approval for sale of our products;
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Marketing materials and marketing assistance to support product sales; and
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Manufacture of products with delivery directly to the customer.
Following development of a new product, and on behalf of our customers, we:
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Conduct and complete any scientific studies necessary for regulatory compliance;
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Arrange for the manufacture of finished products to our specifications; and
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Develop marketing tools and plans to promote product sales, including labels and graphic designs, promotional brochures and providing speakers to promote the products.
Our management and key personnel have many years experience in developing and selling nutritional products to domestic and international marketers, including direct marketers, health food stores and mass market merchandisers.
Our largest customers accounted for 42% and 15% of our net sales for the year ended March 31, 2010 and 23%, 19% and 17% for the year ended March 31, 2009.
Our Strategy
We are a developer, formulator and supplier of natural-based products, designed to enhance human and animal health. We develop, formulate over-the-counter topical creams, nutritional and skin care products marketed globally through multiple channels of distribution. Our strategy involves:
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Continuing to develop innovative and proprietary nutritional and skin care products;
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Continuing to offer "turnkey" services, including product development, regulatory compliance, manufacturing and marketing services, to assist our customers in quickly bringing new products to market;
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Marketing our products internationally by assisting our customers in registering their products for sale in foreign countries.
To date, we have completed the registration of over 25 products in foreign countries, including Japan, Australia, Norway, Venezuela, Germany, India and Canada. Most of the products registered contain our proprietary Celadrin® compound.
Industry Overview
The dietary supplement industry is highly diversified and intensely competitive. It includes companies that manufacture, distribute and sell products that are generally intended to supplement our daily diets with nutrients that may enhance the body's performance and well-being. Dietary supplements include vitamins, minerals, herbs, botanicals, amino acids and compounds. Specific statutory provisions governing the dietary supplement industry were codified in the Dietary Supplement Health and Education Act. This act provides statutory protections for dietary supplements and allows for statements that inform consumers of the effect dietary supplements have upon the structure or functions of the body.
We expect that the following factors will contribute to the ongoing growth of the domestic nutritional supplement industry:
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The aging of the American population, which is likely to cause increased consumption of nutritional supplements;
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New product introductions in response to new research supporting the positive health effects of certain nutrients;
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The nationwide trend toward preventative medicine resulting from rising health care costs;
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Increased consumer interest in alternative health products such as herb-based nutritional supplements;
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A heightened awareness of the connection between diet and health.
Nutritional supplements are sold primarily through:
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Mass market retailers, including mass merchandisers, drug stores, supermarkets and discount stores;
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Health food stores;
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Mail order companies; and
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Direct sales organizations, including network marketing companies.
Products
We offer a variety of specialized proprietary nutritional formulations, over-the-counter topical creams, and skin care products. Since beginning operations in February 1999, we have developed and sold over 90 products and formulations to businesses and organizations that market these products through multiple channels of distribution, including direct selling, sales to mass market retailers, direct response radio, nutritional newsletters and medical care professionals. Our product formulations may be developed by our customers, co-developed by us and our customers or developed exclusively by us for the customer.
Our leading product is Celadrin®, a nutritional supplement compound comprised of a complex of fatty acid esters which plays a role in human and animal joint health and scientifically supported by our clinical studies. For the year ended March 31, 2010, approximately 72% of our revenue was generated from the sale of various formulations containing Celadrin®. We offer Celadrin® as part of a formulated branded or private label product and also as a branded ingredient to be used by our wholesale customers in their own product formulations.
A number of safety and efficacy studies have been conducted on Celadrin's® principal composition, cetylated fatty acids. Studies have been presented at international scientific conferences, with two studies having been published in the Journal of Rheumatology and one study published in the Journal of Strength and Conditioning Research. We are continuing research to determine Celadrin®'s effects on the body, including any role it may play in providing support for the normal functioning of muscles and joints. We produce a wide range of formulas using the Celadrin® compounds and market these formulations through multiple distribution channels. Our wholesale customers resell Celadrin® and other formulated products under their own labels and trade names. We do not own or have any ownership interest in the labels or trade names under which these products are sold. Using multiple manufacturing processes to produce Celadrin®, we offer the product to our customers in soft gel capsule, tablet, two-piece capsules and topical cream forms.
We use paid consultants who are medical doctors, scientific research consultants, independent scientific researchers and laboratories and universities to assist us in the development and testing of our products. We believe Celadrin® will continue to be our principal compound. We intend to expand the number of customers who use this compound in formulas and to develop other formulas for new customers.
In addition to Celadrin®, which we sell in many formulations including an oral product, a cream, and a pet product, we have also developed other natural based products designed to address specific health issues, including compounds and formulations involving a proprietary blend of fruit and vegetable extracts which represented approximately 10% of our sales, a weight loss product which represented approximately 13% of our sales, and a probiotic, BioGuard®, for ear, nose and throat protection which represented approximately 5% of our sales for the year ended March 31, 2010.
We also are at the early stage of developing therapies for the treatment of inflammatory conditions, such as periodontal disease. We have conducted in-vivo and in-vitro efficacy and safety studies on our drug compound for the treatment of gum disease including periodontitis.
Raw Materials and Manufacturing
We develop and formulate proprietary, natural based, nutritional supplements, over-the-counter topical creams and skin care products but do not manufacture any of these products. We currently purchase ingredients from suppliers for delivery to manufacturers chosen by us. We have had in the past agreements with our sole supplier of Celadrin® to purchase sufficient quantities of the compound to meet our anticipated needs. We believe our relationship with this supplier will continue although we can give no such assurance. All other ingredients can be obtained from a number of suppliers, although the loss of any supplier could adversely affect our business.
We use a number of manufacturers to combine ingredients furnished by our suppliers into our nutritional and skin care products. By outsourcing product manufacture, we eliminate the capital required to manufacture our own products and increase the flexibility of our manufacturing resources. We have written confidentiality and exclusivity agreements with key manufacturers and believe suitable replacement manufacturers are available. However, the loss of a manufacturer could adversely affect our business.
Marketing and Distribution.
We market our products to customers in multiple channels of distribution. Our marketing strategy consists of:
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Continuing to offer our proprietary products to existing customers while seeking new customers, emphasizing those engaged in the mass marketing of nutraceutical supplements and other nutraceutical products;
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Continuing to assist our customers in designing new nutritional, topical, and skin care products using our formulations;
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Continuing to design marketing materials, provide marketing spokespersons and offering other value added services to assist customers in expanding their sales of our product;
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Developing and offering new products to direct marketing and mass marketing companies;
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Offering products for distribution through medical and nutritional oriented professionals;
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Offering products for distribution through direct response radio and television.
We will continue to offer our customers a turn key approach to their product needs. This approach emphasizes providing the customer with the support necessary to allow them to sell our products, including providing the scientific studies required by U.S. and foreign regulators, tailoring our product formulations specifically for each customer, obtaining approvals in foreign countries for our customers to market there, providing full marketing support for the products, including product information, product descriptions and speakers to discuss products at customer conventions and seminars and arranging for manufacture and shipment of the products according to customer instructions.
Approximate sales by principal geographic area (as a percentage of sales) for fiscal years ended March 31, 2010 and 2009 were as follows:
All of our operating assets are located within the United States. While sales to certain geographic areas generally vary from year to year, we do not expect that changes in the geographic composition of sales will have a material adverse effect on operations.
Competition
The nutritional supplement and skin care industries are large and intensely competitive. We compete generally with companies that manufacture and market competitive nutritional products in each of our product lines, including companies such as Twin Labs, Weider Nutrition, IVC Industries and Perrigo. We also compete with companies that supply nutritional products to direct distribution companies, such as Leiner Health, Natural Alternatives and Vitatech. We also compete with companies that develop and sell skin care products, such as West Coast Cosmetics, CA Botana and Cosmetic Products International.
Competitive factors in the nutritional supplement and skin care markets include product effectiveness, scientific validation, proprietary formulations, price, quality of products, reliability of product delivery and marketing services offered to customers. We believe we compete favorably with respect to each of these factors. Nevertheless, most of our competitors have longer operating histories, wider product offerings, greater name recognition and financial resources than do we. However, we believe our turnkey approach of offering our customers significant regulatory and marketing support, as well as unique, scientifically validated products, improves our competitive position.
Government Regulation
In both the United States and foreign markets, we are subject to extensive laws and governmental regulations at the federal, state and local levels. For example, we are subject, directly or indirectly, to regulations pertaining to:
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Dietary ingredients;
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The manufacturing, packaging, labeling, promotion, distribution, importation, sale and storage of our products;
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Product claims, labeling and advertising (including direct claims and advertising by us as well as claims in labeling and advertising by others, for which we may be held responsible);
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Transfer pricing and similar regulations that affect the level of foreign taxable income and customs duties; and
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Taxation, which in some instances may impose an obligation on us to collect taxes and maintain appropriate records.
The dietary ingredients, manufacturing, packaging, storing, labeling, advertising, promotion, distribution and sale of our products are subject to regulation by one or more governmental agencies, including the Food and Drug Administration, the Federal Trade Commission, the Consumer Product Safety Commission, the Department of Agriculture, the Department of Customs, the Patent and Trademark Office, and the Environmental Protection Agency. Our activities are, or may be, regulated by various agencies of the states, localities and foreign countries in which our products are manufactured, distributed and/or sold. The FDA, in particular, regulates the ingredients, manufacture, packaging, storage, labeling, promotion, distribution and sale of foods, dietary supplements and over-the-counter drugs, such as those we distribute. We and our suppliers are required by FDA regulations to meet relevant current good manufacturing practice guidelines for the preparation, packing and storage of foods and drugs. The FDA has also published proposed rules for the establishment of good manufacturing practices for dietary supplements, but it has not yet issued a proposal rule. The FDA conducts unannounced inspections of companies that manufacture, distribute and sell dietary supplements, issues warning letters for rule violations found during these inspections and refers matters to the U.S. Attorney and Justice Department for prosecution under the Federal Food, Drug and Cosmetic Act. There can be no assurance that the FDA will not question our labeling or other operations in the future.
The Dietary Supplement Health and Education Act revised the provisions governing dietary ingredients and labeling of dietary supplements. The legislation created a new statutory class of "dietary supplements." This new class includes vitamins, minerals, herbs, botanicals, other dietary substances to supplement the daily diet, and concentrates, metabolites, constituents, extracts and combinations thereof. The legislation requires no federal pre-market approval for the sale of dietary ingredients that were on the market before October 15, 1994. Since cetylated fatty acids, the primary ingredient in Celadrin®, were on the market prior to October 15, 1994, we have not been required to provide the FDA with any proof as to safety or efficacy of Celadrin®. Dietary ingredients first marketed after October 15, 1994 may not be distributed or marketed in interstate commerce unless:
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The manufacturer has proof that the dietary ingredient has been present in the food supply as an article used for food and in a form in which the food has not been chemically altered, or
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The manufacturer supplies the FDA with proof to the FDA's satisfaction of the dietary ingredient's safety.
Manufacturers and distributors of dietary supplements may include statements of nutritional support, including structure and function claims, on labels and in advertising if:
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The claims are corroborated by "competent and reliable scientific evidence" consistent with FTC standards for advertising review;
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The claims for labels and labeling are filed in a certified notice with the FDA no later than 30 days after first market use of the claims;
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The manufacturer retains substantiation that the claims are truthful and non-misleading;
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Each claim on labels and in labeling is cross-referenced by an asterisk to a mandatory FDA disclaimer.
The majority of the products marketed, or proposed to be marketed, by us are classified as dietary supplements. In September 1997, the FDA issued regulations governing the labeling and marketing of dietary supplement products. The regulations cover:
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The identification of dietary supplements and their nutrition and ingredient labeling;
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The terminology to be used for nutrient content claims, health claims and statements of nutritional support, including structure and function claims;
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Labeling requirements for dietary supplements for which "high potency" and "antioxidant" claims are made;
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Notification procedures for statements of nutritional support, including structure and function claims, on dietary supplement labels and in their labeling;
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Pre-market notification procedures for new dietary ingredients in dietary supplements.
Dietary supplements are subject to federal laws dealing with drugs and regulations imposed by the FDA. Those laws regulate, among other things, health claims, ingredient labeling and nutrition content claims characterizing the level of nutrient in the product. They also prohibit the use of any health claim for dietary supplements, unless the health claim is supported by significant scientific agreement and is pre-approved by the FDA. A federal court has ruled that the FDA must authorize health claims presented to the agency in health claims petitions unless they are inherently misleading and must rely on disclaimers to eliminate any potentially misleading connotation conveyed by a claim. The court also held that even claims not supported by significant scientific agreement must be allowed if disclaimers can correct misleading connotations.
Prior to permitting sales of our products in foreign markets, we may be required to obtain an approval, license or certification from the country's ministry of health or comparable agency. The approval process generally would require us to present each product and product ingredient to appropriate regulators and, in some instances, arrange for testing of products by local technicians for ingredient analysis. These approvals may be conditioned on reformulation of our products or may be unavailable with respect to certain products or certain ingredients. We must also comply with product labeling and packaging regulations that vary from country to country.
The Federal Trade Commission, which exercises jurisdiction over the marketing practices and advertising of products similar to those we offer, has in the past several years instituted enforcement actions against several dietary supplement companies for deceptive marketing and advertising practices. These enforcement actions have frequently resulted in consent orders and agreements. In certain instances, these actions have resulted in the imposition of monetary redress requirements. Importantly, the commission requires that "competent and reliable scientific evidence" corroborate each claim of health benefit made in advertising before the advertising is first made. A failure to have that evidence on hand at the time an advertisement is first made violates federal law. While we have not been the subject to enforcement action for the advertising of our products, there can be no assurance that this agency will not question our advertising or other operations in the future.
We believe we are in compliance with all material government regulations which apply to our products. However, we are unable to predict the nature of any future laws, regulations, interpretations or applications, nor can we predict what effect additional governmental regulations or administrative orders, when and if promulgated, would have on our business in the future. These future changes could, however, require the reformulation or elimination of certain products; imposition of additional record keeping and documentation requirements; imposition of new federal reporting and application requirements; modified methods of importing, manufacturing, storing or distributing certain products; and expanded or different labeling and substantiation requirements for certain products and ingredients. Any or all of these requirements could harm our business.
Trademarks and Patents
We received a trademark for "Celadrin" in February 2002.
In April 2009, we were conveyed ownership of U.S. Patent 5,569,676. This patent is a method for alleviating the symptoms of non-rheumatoid arthritis by administering to the afflicted subject a therapeutically effective amount of cetyl myristoleate either orally, topically, or parenterally.
In November 2009 we were issued U.S. Patent 7,612,111. This patent is directed to compositions comprising lecithin, olive oil, esterified fatty acids and mixed tocophenols for use in the treatment and prevention of various types of arthritis and other inflammatory joint conditions, periodontal diseases and psoriasis, which avoid many of the side effects associated with known treatments. The compositions have the advantage of increased stability, a reduction of arachidonic acid in cells, a reduction in eicosanoid production and enhanced cell regulation and communication. The invention also discloses methods for using the compositions for treatment and prevention. There can be no assurance that others may not develop compounds superior to those covered by this patent.
Employees
At March 31, 2010, we had 9 full-time employees and 7 part-time consultants, including our executive officers.
ITEM 1A.
ITEM 1A. RISK FACTORS.
You should consider the following discussion of risks as well as other information regarding our common stock. The risks and uncertainties described below are not the only ones. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risks actually occur, our business could be harmed.
There Is Only One Supplier for Celadrin®. If We Are Unable to Purchase Celadrin® from This Supplier, Our Business Would Be Harmed.
There is only one supplier for Celadrin®, which we use in approximately 61% of our products and which represented approximately 72% of our sales for the year ended March 31, 2010. We will rely upon Celadrin® to expand our product lines and revenue in the future. If our Celadrin® supplier goes out of business or elects for any reason not to supply us with Celadrin®, we would have to find another Celadrin® supplier or suffer a significant reduction in our revenue.
We Rely upon a Limited Number of Customers the Loss of Which Would Reduce Our Revenue and Any Earnings.
Our largest customers accounted for 42% and 15% of our net sales for the year ended March 31, 2010 and 23%, 19% and 17% for the year ended March 31, 2009. The loss of any of these customers could significantly reduce our revenue and adversely affect our cash flow and earnings, if any.
We Rely upon Other Outside Suppliers to Produce Our Products Which Could Delay Our Product Deliveries.
All of our products are produced by outside manufacturers who process ingredients provided to them by our suppliers and with whom we have contracts. Our profit margins and our ability to deliver products on a timely basis are dependent upon these manufacturers and suppliers. Should any of these manufacturers or suppliers fail to provide us with product, we would be required to obtain new manufacturers and suppliers, which would be costly and time consuming and could delay our product deliveries.
Product Liability Claims Against Us Could Be Costly.
Some of our nutritional supplements contain newly-introduced ingredients or combinations of ingredients, and we have little long-term health information about individuals consuming those ingredients. If any of these products were thought or proved to be harmful, we could be subject to litigation. Although we carry product liability insurance in the face amount of $1,000,000 per occurrence and $2,000,000 in the aggregate and require our suppliers and manufacturers to include us as insured parties on their product liability insurance policies, our coverage may not be adequate to protect us from potential product liability claims and costs of defense.
We Are Subject to Intense Competition from Other Nutritional Supplement Marketers Which Could Reduce Our Revenue and Profit Margins.
Competition in the nutritional supplement market is intense. We compete with numerous companies that have longer operating histories, more products and greater name recognition and financial resources than we do. In order to compete, we could be forced to lower our product prices, which would reduce our revenue and profit margins.
We Are Highly Regulated, Which Increases Our Costs of Doing Business.
We are subject to laws and regulations which cover:
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the formulation, manufacturing, packaging, labeling, distribution, importation, sale and storage of our products;
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the health and safety of food and drugs;
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trade practice and direct selling laws; and
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product claims and advertising by us; or for which we may be held responsible.
Compliance with these laws and regulations is time consuming and expensive. Moreover, new regulations could be adopted that would severely restrict the products we sell or our ability to continue our business. We are unable to predict the nature of any future laws, regulations, interpretations or applications, nor can we predict what effect additional governmental regulations or administrative orders, when and if promulgated, would have on our business in the future. These future changes could, however, require the reformulation or elimination of certain products; imposition of additional record keeping and documentation requirements; imposition of new federal reporting and application requirements; modified methods of importing, manufacturing, storing or distributing certain products; and expanded or different labeling and substantiation requirements for certain products and ingredients. Any or all of these requirements could harm our business.
There Are Limitations on the Liability of Our Officers and Directors Which May Restrict Our Stockholders from Bringing Claims.
Our Bylaws substantially limit the liability of our officers and directors to us and our stockholders for negligence and breach of fiduciary or other duties to us. This limitation may prevent stockholders from bringing claims against our officers and directors in the future.
Shares of Our Common Stock Which Are Eligible for Sale by Our Stockholders May Decrease the Price of Our Common Stock.
As of March 31, 2010, we have 11,010,788 common shares outstanding which are freely tradeable or saleable under Rule 144. We also have outstanding common stock warrants and stock options exercisable into up to 5,549,707 shares of common stock which could become free trading if exercised. If our stockholders sell substantial amounts of our common stock, the market price of our common stock could decrease.
There is a Limited but Potentially Volatile Trading Market in Our Common Stock, Which May Adversely Affect Our Stock Price.
Our common stock trades on the Electronic Bulletin Board. The Bulletin Board tends to be highly illiquid, in part because there is no national quotation system by which potential investors can track the market price of shares except through information received or generated by a limited number of broker-dealers that make a market in particular stocks. There is a greater chance of market volatility for securities that trade on the Bulletin Board as opposed to a national exchange or quotation system. This volatility may be caused by a variety of factors, including:
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The lack of readily available price quotations;
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The absence of consistent administrative supervision of "bid" and "ask" quotations;
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Lower trading volume; and
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Market conditions.
There could be wide fluctuations in the market price of our common stock. These fluctuations may have an extremely negative effect on the market price of our securities and may prevent an investor from obtaining a market price equal to his purchase price when he attempts to sell our securities in the open market. In these situations, the investor may be required to either sell our securities at a market price which is lower than his purchase price, or to hold our securities for a longer period of time than he planned.
Because Our Common Stock May Be Classified as "Penny Stock," Trading in it Could Be Limited, and Our Stock Price Could Decline.
In the future, our common stock may fall under the definition of "penny stock" if our net tangible assets decline below $2,500,000. In such event, trading in our common stock would be limited because broker-dealers will be required to provide their customers with disclosure documents prior to allowing them to participate in transactions involving our common stock. These disclosure requirements are burdensome to broker-dealers and may discourage them from allowing their customers to participate in transactions involving our common stock.
"Penny stocks" are equity securities with a market price below $5.00 per share, other than a security that is registered on a national exchange or included for quotation on the Nasdaq system, unless, as in our case, the issuer has net tangible assets of more than $2,000,000 and has been in continuous operation for greater than three years. Issuers who have been in operation for less than three years must have net tangible assets of at least $5,000,000.
Rules promulgated by the Securities and Exchange Commission under Section 15(g) of the Exchange Act require broker-dealers engaging in transactions in penny stocks, to first provide to their customers a series of disclosures and documents, including:
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A standardized risk disclosure document identifying the risks inherent in investment in penny stocks;
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All compensation received by the broker-dealer in connection with the transaction;
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Current quotation prices and other relevant market data; and
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Monthly account statements reflecting the fair market value of the securities. In addition, these rules require that a broker-dealer obtain financial and other information from a customer, determine that transactions in penny stocks are suitable for such customer and deliver a written statement to such customer setting forth the basis for this determination.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None
ITEM 2.
ITEM 2. PROPERTIES.
We conduct our corporate functions and manufacturing, product development, sales and marketing activities in San Diego, California. We rent 5,426 square feet of office space at 10845 Rancho Bernardo Road, Suite 105, San Diego, California 92127 under a seven-year lease ending December 2012 for a monthly rent ranging from a current level of $11,830 increasing annually to $12,673 for the seventh year. The average monthly rent for the seven-year period is $11,212. In addition we rent 4,575 square feet of distribution and storage space at 1420 Decision Street, Suite B, Vista, California 92083 under a month to month lease at a monthly rent of $3,889. This space is intended to meet our needs for the foreseeable future.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
Sun Research Arbitration
On November 23, 2009, Sun Research, Inc., a sales distributor for Imagenetix, submitted a demand for arbitration with the American Arbitration Association related to a Regional Distributor Agreement entered into on March 31, 2008. Sun Research asserted that under the terms of the Agreement, it was entitled to compensation from an acceleration agreement Imagenetix entered into with a customer. Sun Research has demanded damages of approximately $265,625 (excluding claims for costs, interests and attorneys fees). The Company denied the allegations and believed the claims to be frivolous and totally devoid of merit. In April 2010, the Company and Sun Research agreed to settle the dispute by the Company paying $82,000 to Sun Research over a six month period. The $82,000 was recorded as a charge against settlement income during the fiscal year ended March 31, 2010.
TriPharma Suit
On April 30, 2010, TriPharma, Inc., a customer of Imagenetix, filed a legal action in the United States Southern District Court of California, case number 10CV0933IEG, related to an Exclusive Marketing and Supply Agreement, as amended on June 19, 2008. TriPharma asserts that Imagenetix breached the terms of the Agreement and seeks injunctive relief and unspecified damages. The Company denies the allegations and believes the claims to be frivolous and totally devoid of merit. The Company has retained litigation counsel and intends to vigorously defend the claims. The amount, if any, of ultimate liability with respect to the foregoing cannot be determined. Despite the inherent uncertainties of litigation, the Company at this time does not believe that TriPharma's claim will have a material adverse impact on its financial condition, results of operations, or cash flows.
ITEM 4.
ITEM 4. RESERVED.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Our Common Stock is traded in the over-the-counter market and is quoted on the NASD OTC Bulletin Board system maintained by the National Association of Securities Dealers, Inc. Prices reported represent prices between dealers, do not include markups, markdowns or commissions and do not necessarily represent actual transactions. The market for our shares has been sporadic and at times very limited.
The following table sets forth the high and low closing price for the Common Stock for the fiscal years ended March 31, 2010 and 2009:
We had approximately 300 shareholders of record as of June 18, 2010. Because most of our common stock is held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of beneficial owners represented by these record holders. We have never paid a cash dividend on our common stock and do not expect to pay one in the foreseeable future.
Recent Sale of Unregistered Securities
In May 2010 we issued common stock and common stock purchase warrants as follows:
Common Stock
Common Stock Purchase Warrants
With respect to the above securities issuances, the Registrant relied on exemptions provided by Section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”) and Rule 506 under the Securities Act. No advertising or general solicitation was employed in offering the securities. The securities were issued to a limited number of persons all of whom were accredited investors as that term is defined in Rule 501 of Regulation D under the Securities Act. All were capable of analyzing the merits and risks of their investment, acknowledged in writing that they were acquiring the securities for investment and not with a view toward distribution or resale, and understood the speculative nature of their investment. All securities issued contained a restrictive legend prohibiting transfer of the shares except in accordance with federal securities laws.
The proceeds received from the issuance of the above securities will be used for working capital purposes.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
Not Applicable
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.
Overview
We develop, formulate and market over-the-counter, natural-based nutritional supplements and skin care products. Our products are proprietary, often supported by scientific studies which we request and are offered through multiple channels of distribution, including direct marketing companies, also known as network marketing or multi-level marketing companies, and chain store retailers. Our primary product is Celadrin® a product formulation which we sell to the mass market through retailers and on a private label basis to wholesale customers.
A key part of our marketing strategy is to provide to our wholesale customers a "turnkey" approach to the marketing and distribution of our products. This turnkey approach provides these customers with all the services necessary to market our products, including developing specific product formulations, providing supporting scientific studies regarding the effectiveness of the product and arranging for the manufacture and marketing of the product.
We sell our own branded product, Celadrin®, directly to the mass markets through retail sellers. We also develop and sell products and formulations to businesses and organizations that market these products through multiple channels of distribution, including direct marketing companies, mass marketing companies, medical, health and nutritional professionals, medical newsletters and direct response radio and television. We also offer Celadrin® products through wholesale customers that in turn offer their products containing Celadrin® to mass market retailers.
Management's discussion and analysis of results of operations and financial condition are based upon the Company's financial statements. These statements have been prepared in accordance with accounting principles generally accepted in the United States of America. These principles require management to make certain estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates based on historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Critical Accounting Policies and Estimates
We have identified nine accounting principles that we believe are key to an understanding of our financial statements. These important accounting policies require management's most difficult, subjective judgments.
1. Cash and Cash Equivalents.
For purposes of the financial statements, we consider all highly liquid debt investments purchased with a maturity of three months or less to be cash equivalents.
2. Accounts receivable.
Accounts receivable are carried at the expected net realizable value. The allowance for doubtful accounts is based on management’s assessment of the collectibility of specific customer accounts and the aging of the accounts receivable. If there were a deterioration of a major customer’s creditworthiness, or actual defaults were higher than historical experience, our estimates of the recoverability of amounts due to us could be overstated, which could have a negative impact on operations.
3. Inventory
Inventory is carried at the lower of cost or market. Cost is determined by the first-in first-out method. Indirect overhead costs are allocated to inventory.
4. Property and Equipment
Property and equipment are stated at cost. Expenditures for major renewals and betterments that extend the useful lives of property and equipment are capitalized, upon being placed in service. Expenditures for maintenance and repairs are charged to expense as incurred. Depreciation is computed over the estimated useful life of three to seven years, except leasehold improvements which are depreciated over the lesser of the remaining lease life or the life of the asset, using the straight-line method. We follow the provisions of the Financial Accounting Standards Board Accounting Standards Codification ("ASC") No. 360. Under ASC No. 360, long-lived assets and certain identifiable intangibles to be held and used by us are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We continuously evaluate the recoverability of our long-lived assets based on estimated future cash flows and the estimated fair value of such long-lived assets, and provide for impairment if such undiscounted cash flows are insufficient to recover the carrying amount of the long-lived asset.
5. Trademarks and Patents
Patents and trademarks are carried at cost less accumulated amortization and are amortized over their estimated useful lives of from 8 to 17 years for patents and 17 years for trademarks. The carrying value of patents and trademarks is periodically reviewed and impairments, if any, are recognized when the expected future benefit to be derived from individual intangible assets is less than its carrying value determined based on the provisions of ASC No. 360 as discussed above.
6. Stock Based Compensation
We adopted ASC Nos.718 and 505, which require that share-based payments be reflected as an expense based upon the grant-date fair value of those awards. The expense is recognized over the remaining vesting periods of the awards. The Company estimates the fair value of these awards, including stock options and warrants, using the Black-Scholes model. This model requires management to make certain estimates in the assumptions used in this model, including the expected term the award will be held, volatility of the underlying common stock, discount rate and forfeiture rate. We develop our assumptions based on our past historical trends as well as consider changes for future expectations.
7. Revenue Recognition
We recognize revenue in accordance with the SEC’s Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial Statements” (SAB104) and ASC No. 605. SAB 104 requires that four basic criteria be met before revenue can be recognized: 1) there is evidence that an arrangement exists; 2) delivery has occurred; 3) the fee is fixed or determinable; and 4) collectibility is reasonably assured. ASC No. 605 states that revenue from sales transactions where the buyer has the right to return the product shall be recognized at the time of sale only if (1) the seller’s price to the buyer is substantially fixed or determinable at the date of sale; (2) the buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product; (3) the buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product; (4) the buyer acquiring the product for resale has economic substance apart from that provided by the seller; (5) the seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer; and (6) the amount of future returns can be reasonably estimated. We recognize revenue upon determination that all criteria for revenue recognition have been met. The criteria are usually met at the time title passes to the customer, which usually occurs upon shipment. Revenue from shipments where title passes upon delivery is deferred until the shipment has been delivered.
We account for payments made to customers in accordance with ASC No. 605, which states that cash consideration (including a sales incentive) given by a vendor to a customer is presumed to be a reduction of the selling prices of the vendor’s products or services and, therefore, should be characterized as a reduction of revenue when recognized in the vendor’s income statement, rather than a sales and marketing expense. We have various agreements with customers that provide for discounts and rebates. These agreements are classified as a reduction of revenue. Certain other costs associated with customers that meet the requirements of ASC No. 605 are recorded as sales and marketing expense. Vendor considerations recorded as a reduction of sales were $1,185,000 and $261,000 for the years ended March 31, 2010 and 2009.
We guarantee customer satisfaction. Our policy requires the customer to return the unused product to the retailer from whom they originally purchased it. We pay the retailer for the returned product plus a handling cost. We review gross revenue for estimated returns of private label contract manufacturing products and direct-to-consumer products. The estimated returns are based upon the trailing six months of private label contract manufacturing gross sales and our historical experience for both private label contract manufacturing and direct-to-consumer product returns. However, the estimate for product returns does not reflect the impact of a large product recall resulting from product nonconformance or other factors as such events are not predictable nor is the related economic impact estimable. We periodically assess the adequacy of this policy and record a liability as necessary. For the year ended March 31, 2010, we recorded a reserve of $86,000 for potential returns, allowances and product buy backs.
As part of the services we provide to our private label contract manufacturing customers, we may perform, but are not required to perform, certain research and development activities related to the development or improvement of their products. While our customers typically do not pay directly for this service, the cost of this service is included as a component of the price we charge to manufacture and deliver their products.
8. Income Taxes
We account for income taxes in accordance with ASC No. 740. This statement requires an asset and liability approach for accounting for income taxes and prescribes a comprehensive model of how a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. ASC No. 740 states that a tax benefit from an uncertain position may be recognized if it is "more likely than not" that the position is sustainable, based upon its technical merits. The tax benefit of a qualifying position is the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority having full knowledge of all relevant information.
9. Research and Development
We incur expenses to further develop our products and formulas, commission entities to perform clinical trials and evaluate potential products to expand our portfolio. In addition, we recently received a new patent for a drug candidate which, if successful, will address periodontal diseases. We have started the initial new drug process and have completed several animal studies. During the years ended March 31, 2010 and 2009 we incurred research and development expenses of $127,540 and $69,667, respectively.
Selected Financial Information
Results of Operations
Year Ended March 31, 2010 Compared to Year Ended March 31, 2009
Net Sales
Net sales for the year ended March 31, 2010 decreased $864,801, 11.6%, to $6,596,071 compared to $7,460,872 for the year ended March 31, 2009. Net sales to distributors and wholesalers decreased by approximately $2,040,000 and to our weight loss customers by approximately $530,000. These decreases were partially offset by a $1,840,000 increase in net sales to the mass market. We anticipate the sales increases to the mass market to continue during our next fiscal year as a result of an expanding customer base and our continuing marketing and advertising campaigns.
Cost of Goods Sold
Cost of goods sold as a percentage of net sales increased from 54% for the year ended March 31, 2009 to 57% for the year ended March 31, 2010. This increase was primarily due to an increase in mass market customer allowances and promotions which are reduced from revenue and negatively impact cost of goods sold as a percentage of net sales.
General and Administrative
General and administrative expenses increased by $330,092, a 14.7% increase, to $2,571,080 for the year ended March 31, 2010 from $2,240,988 for the year ended March 31, 2009. The primary reasons for the increase were an approximate increase of $158,000 of marketing costs related to introducing Celadrin® into the mass market, $63,000 increase in research and development expenses related to clinical studies and advancement of the periodontal drug candidate, and a $112,000 increase in facility, insurance and travel expenses.
Payroll Expense
Payroll expense increased to $1,089,597 for the year ended March 31, 2010, an increase of 1.2% or $13,124, compared to $1,076,473 for the year ended March 31, 2009. This increase was a result of normal salary and bonus increases during the current fiscal year.
Consulting Expenses
Consulting expenses increased to $1,481,331 for the year ended March 31, 2010, an increase of 39.8% or $422,022, compared to $1,059,309 for the year ended March 31, 2009. This increase was a result of an increase of $390,000 for product demonstrations at mass market stores, an increase of $63,000 for investor relations activities, partially offset by a decrease in legal expenses of $43,000.
Other Income
During the year ended March 31, 2009, we received $2,100,000 ($1,785,000 after costs) as a result of entering into a settlement agreement with a company we alleged was infringing on the Celadrin® trademark. In addition, we entered into a supply agreement with the same company whereby we provided Celadrin® for use in their products. During the year ended March 31, 2010, we received an additional $1,250,000 from this customer as a result of accelerating and terminating the supply agreement which was partially offset by an $82,000 settlement with a sales distributor involved in this transaction.
Provision for Income Taxes
As a result of income during the year ended March 31, 2009, we reflected an income tax provision of $459,114 compared to income tax benefit of $407,700 for the year ended March 31, 2010 when we incurred a taxable loss.
Capital Resources
Liquidity
We have historically financed our operations internally and through debt and equity financings. At March 31, 2010, we had cash holdings of $981,510, a decrease of $244,213 compared to March 31, 2009. Our net working capital position at March 31, 2010, was $3,273,523 compared to $3,772,853 as of March 31, 2009. This decrease was primarily the result of operating losses incurred during the year. In May 2010, we issued common stock to two institutional investors for $400,000 and issued bridge debentures to a group of six individuals for $410,000. The proceeds from these debt and equity financings will be used to meet working capital needs particularly an increase in inventories, accounts receivable and advertising with respect to an increased level of sales activity to our mass market customers. We believe that our cash position is sufficient to fund our operating activities for at least the next 12 months.
New Accounting Pronouncements
In June 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification No. 105, FASB Accounting Standards and the Hierarchy of Generally Accepted Accounting Principles (“ASC 105”). ASC 105 replaces SFAS 162 and establishes the FASB Accounting Standards Codification (“Codification”) as the single source of authoritative U.S. generally accepted accounting principles (“GAAP”) recognized by the FASB to be applied by nongovernmental entities, except for rules and interpretive releases by the Securities and Exchange Commission (“SEC”) which are sources of authoritative GAAP for SEC registrants. ASC 105 and the Codification was effective for interim and annual periods ending after September 15, 2009. We adopted ASC 105 on July 1, 2009, and all references made to GAAP within our consolidated financial statements now use the new Codification numbering system. The Codification does not change or alter existing GAAP and, therefore, the adoption of ASC 105 did not have an impact on our financial position, results of operations or cash flows.
A variety of proposed or otherwise potential accounting standards are currently under study by standard-setting organizations and various regulatory agencies. Because of the tentative and preliminary nature of these proposed standards, management has not determined whether implementation of such proposed standards would be material to the Company’s consolidated financials statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements required by this item begin on page with the index to consolidated financial statements.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None
ITEM 9A(T).
ITEM 9A(T). CONTROLS AND PROCEDURES
(a)
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act, as amended, as a process designed by, or under the supervision of, a company’s principal executive and principal financial officers and effected by a company’s board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that:
*
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;
*
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors;
*
and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.
Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate. In order to evaluate the effectiveness of our internal control over financial reporting as of March 31, 2010, as required by Sections 404 of the Sarbanes-Oxley Act of 2002, our management commenced an assessment, based on the criteria set forth in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “ COSO Framework “). A material weakness is a control deficiency, or a combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. In assessing the effectiveness of our internal control over financial reporting, our management, including the chief executive officer and chief financial officer, identified the following deficiencies:
(1)
Deficiencies in Segregation of Duties. The Chief Executive Officer and the Chief Financial Officer are actively involved in the preparation of the financial statements, and therefore cannot provide an independent review and quality assurance function within the accounting and financial reporting group. The limited number of qualified accounting personnel discussed above results in an inability to have independent review and approval of financial accounting entries. Furthermore, management and financial accounting personnel have wide-spread access to create and post entries in the Company’s financial accounting system. There is a risk that a material misstatement of the financial statements could be caused, or at least not be detected in a timely manner, due to insufficient segregation of duties.
Management believes that the financial statements included in this report fairly present in all material respects our financial condition, results of operations and cash flows for the periods presented.
This annual report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Our internal controls were not subject to attestation by our independent registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only managements report in this annual report.
(b) Changes in Internal Control Over Financial Reporting. 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 the evaluation above.
ITEM 9B.
ITEM 9B. OTHER INFORMATION.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
The following table and biographical summaries set forth information, including principal occupations and business experience, about our directors and the executive officer at March 31, 2010:
Name
Age
Position
William P. Spencer
Chief Executive Officer, President and Director
Debra L. Spencer
Secretary, Treasurer and Director
Lowell W. Giffhorn
Chief Financial Officer
Derek C. Boosey
Vice President-International
Jeffrey G. McGonegal
Director
Robert Burg
Director
Barry S. King
Director
Biographical Information
William P. Spencer has served as a director and has been our president since January 1999. From January 1986 to December 1996 he served as chief operating officer, chief financial officer and executive vice-president of Natural Alternatives International, Inc., a company engaged in the formulation and production of encapsulated vitamins and nutrients. He was president of NAI from December 1996 to October 1998 and was a director from January 1986 to October 1998. From 1976 to 1988 he was a regional vice president for San Diego Trust and Savings Bank. Mr. Spencer earned a B.S. degree in finance and an MBA degree from San Diego State University.
Debra L. Spencer has served as a director and has been our secretary since March 1999 and served as our treasurer from March 1999 to July 2005. Her responsibilities also include product label copy and graphic design in compliance with FDA regulations as well as developing marketing materials for our private label products. From 1970 to 1981 she was an Executive Assistant to the Vice President of a local San Diego bank. She was a homemaker from 1981 to 1987. From 1987 to 1993 she served as vice president, secretary and treasurer for Vitamin Direct, Inc., a consumer mail order vitamin company.
Derek C. Boosey has served as our vice-president-international since September 1999. From 1994 to September 1999, he was new business manager for Natural Alternatives International, Inc., and from 1990 to 1994 was director of marketing for Athletics Canada. From 1984 to 1990, Mr. Boosey was a technical advisor to the Korean Ministry of Sports and a sports and marketing consultant for MKC International. He earned degrees in physical education from Keele University (England) and Opu University (England) and is the Senior Olympics world record holder in the triple jump in the age 55 to 60 class.
Barry S. King joined our Board in 2003. He was the Director of Marketing for the United States Olympic Committee from 1987 to 2002. Since 2002, Mr. King has been the Vice President and General Manager of Triactive America. Mr. King graduated with a B.A. degree from the University of Colorado in 1969.
Lowell W. Giffhorn has served as our Chief Financial Officer since July 2005. Since October 2005, Mr. Giffhorn also has served as the Chief Financial Officer and, since December 2005, has served on the board of directors of Brendan Technologies, Inc., a publicly held company that provides computer software to the pharmaceutical and life science industries. From November 1996 to June 2005, Mr. Giffhorn was the Chief Financial Officer of Patriot Scientific Corp., a publicly held semiconductor and intellectual property company. From June 1992 to August 1996 and from September 1987 to June 1990 he was the CFO of Sym-Tek Systems, Inc. and Vice President of Finance for its successor, Sym-Tek Inc., a supplier of capital equipment to the semiconductor industry. Mr. Giffhorn obtained a M.B.A. degree from National University in 1976 and he obtained a B.S. in Accountancy from the University of Illinois in 1969. Mr. Giffhorn devotes approximately 50% of his time to our affairs.
Jeffrey G. McGonegal joined our board in 2005. He also serves as the chief financial officer of AspenBio Pharma, Inc., a publicly-held biomedical company, and of PepperBall Technologies, Inc., a publicly held security products and services company, and as senior vice president - finance of Cambridge Holdings, a publicly-held real estate and business development firm with limited activities, and since 1997, Mr. McGonegal has served as managing director of McGonegal and Co., a company engaged in providing accounting and business consulting services. From 1974 to 1997, he was an accountant with BDO Seidman LLP. While at BDO Seidman, Mr. McGonegal served as managing partner of the Denver, Colorado office. Until its sale in April 2007, he was also a member of the board of directors of Applied Medical Devices, Inc., a publicly-held shell company. Mr. McGonegal received a B.A. degree in accounting from Florida State University and he is a certified public accountant licensed in Colorado.
Robert Burg joined our board in 2005. Since 2009, Mr. Burg is the president of CMC Golf, a worldwide leader, manufacturer, and distributor of fine golf accessories. Since 1998, Mr. Burg has been the owner of The Burg Group, a national sales and marketing agency specializing in the golf industry. From 1992 to 1998, Mr. Burg held several executive level positions, including President from 1995 to 1998, with Royal Grip, Inc., a publicly traded company that designed and distributed golf club grips and athletic headware. He received a B.A. degree in Business from Great Western University in 1977.
William P. Spencer and Debra L. Spencer are married to each other.
Committees of the Board of Directors
Compensation Committee. Our Compensation Committee is currently comprised of the following, each of whom is independent as defined under applicable NASDAQ and SEC rules: Jeffrey G. McGonegal (Committee Chair), Robert Burg, and Barry King. The Compensation Committee was formed in November 2010 and has not did hold any formal meetings during the current fiscal year.
The Compensation Committee was formed to review and recommend to the Board the salaries, bonuses and perquisites of our executive officers. The Compensation Committee also will review and recommend to the Board any new compensation or retirement plans and will administer our 2000 Stock Option Plan. The Compensation Committee will also review and approve corporate goals and objectives relevant to the compensation of our executive officers and evaluate their performance in light of these goals and objectives. The Compensation Committee will present a charter at its first formal meeting. The initial charter and any changes to the charter will be recommended by the Compensation Committee and must be approved by the Board.
Audit Committee. The Audit Committee is responsible for: (1) selection and oversight of our independent accountant; (2) establishing procedures for the receipt, retention and treatment of complaints regarding accounting, internal controls and auditing matters; (3) establishing procedures for the confidential, anonymous submission of concerns regarding accounting and auditing matters; (4) engaging outside advisors; and, (5) funding for the outside auditors and any outside advisors engagement by the audit committee. The Audit Committee, which met four times during fiscal year 2010, is composed of one employee director and one other director, who was determined by the Board to be an independent director. During fiscal year 2010, the Audit Committee consisted of Mr. McGonegal (Chairman) and Mr. Spencer.
The Board of Directors has determined that Mr. McGonegal is an audit committee financial expert as defined in Item 401 of Regulation S-B promulgated by the Securities and Exchange Commission. The Board's conclusions regarding the qualifications of Mr. McGonegal as an audit committee financial expert were based on his service as a chief financial officer of a public company, his prior practice as an audit partner for a national certified public accounting firm and his degrees in accounting and business administration.
Code of Ethics
Imagenetix has set forth its policy on ethical behavior in a document called "Code of Business Conduct and Ethics." This policy applies to the members of our Board of Directors and all employees, including (but not limited to) our principal executive officer, principal financial officer, principal accounting officer or controller and persons performing similar functions. This policy comprises written standards that are reasonably designed to deter wrongdoing and to promote the behavior described in Item 406 of Regulation S-B promulgated by the Securities and Exchange Commission. No waivers of the Code were granted in 2010.
Compliance with Section 16(a) of the Securities Exchange Act
Due to our status as a Section 15(d) reporting company, our executive officers, directors, and persons who beneficially own more than 10% of a registered class of our equity securities are not required to file with the SEC reports of ownership and changes in ownership of Imagenetix's equity securities pursuant to Section 16(a) of the Securities Exchange Act of 1934.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
There is shown below information concerning the compensation of our principal executive officer and the most highly compensated executive officers whose total compensation exceeded $100,000 (each a “Named Officer”) for the fiscal years ended March 31, 2010 and 2009.
SUMMARY COMPENSATION TABLE
The amounts included in other compensation are car allowances paid to Mr. and Mrs. Spencer and Mr. Boosey.
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END
Employment Contracts
Effective as of August 7, 2009, we entered into employment agreements with Mr. and Mrs. Spencer and Mr. Giffhorn to serve as our President and Chief Executive Officer, Secretary, and Chief Financial Officer, respectively (the Employees). These employment agreements have 24 month terms with automatic 24 month renewals. The employment agreements provide that the Employees may voluntarily terminate their employment with a thirty day written notice to us. The employment agreements also provide that if the Employees are involuntarily terminated (excluding for cause), we will pay the Employees twenty-four months’ salary as severance pay.
The employment agreements contain change of control provisions that provide severance pay and other benefits in the event of a change of control. The Agreements provide for severance payments of three times the executive’s annual base salary in the event the executive’s employment is terminated, either voluntarily with “good reason” or involuntarily, during the one-year period following a change in control. Severance payments to the Employees under the change of control provisions would be in lieu of any severance otherwise due them under their employment agreements discussed above.
DIRECTOR COMPENSATION
We estimate the fair value of the options issued to our officers and directors at the issuance date by using the Black-Scholes option-pricing model with the following weighted-average assumptions used for those options issued during the year ended March 31, 2010: dividend yield of zero percent; expected volatility of 73% to 78%, risk-free interest rates of 2.19% to 2.95%; and expected life of 5 years.
Liability and Indemnification of Officers and Directors
Our Articles of Incorporation provides that our directors will not be liable for monetary damages for breach of their fiduciary duty as directors, other than the liability of a director for:
•
A breach of the director’s duty of loyalty to our company or our stockholders;
•
Acts or omissions by the director not in good faith or which involve intentional misconduct or a knowing violation of law;
•
Willful or negligent declaration of an unlawful dividend, stock purchase or redemption; or
•
Transactions from which the director derived an improper personal benefit.
Our Articles of Incorporation require us to indemnify all persons whom we may indemnify pursuant to Nevada law to the full extent permitted by Nevada law.
Our bylaws require us to indemnify our officers and directors and other persons against expenses, judgments, fines and amounts incurred or paid in settlement in connection with civil or criminal claims, actions, suits or proceedings against such persons by reason of serving or having served as officers, directors, or in other capacities, if such person acted in good faith and in a manner such person reasonably believed to be in or not opposed to our best interests and, in a criminal action or proceeding, if he had no reasonable cause to believe that his/her conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction or upon a plea of no contest or its equivalent shall not, of itself, create a presumption that the person did not act in good faith and in a manner which he or she reasonably believed to be in or not opposed to our best interests or that he or she had reasonable cause to believe his or her conduct was unlawful. Indemnification as provided in our bylaws shall be made only as authorized in a specific case and upon a determination that the person met the applicable standards of conduct. Insofar as the limitation of, or indemnification for, liabilities arising under the Securities Act of 1933 may be permitted to directors, officers, or persons controlling us pursuant to the foregoing, or otherwise, we have been advised that, in the opinion of the Securities and Exchange Commission, such limitation or indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
The following table sets forth certain information concerning our common stock ownership as of June 18, 2010, by (1) each person who is known by us to be the beneficial owner of more than five percent of our common stock; (2) each of our executive officers and directors; and (3) all of our directors and executive officers as a group. The address of each such stockholder is in care of us at 10845 Rancho Bernardo Road, Suite 105, San Diego, California 92127.
*
Represents less than 1%
(1)
Reflects amounts as to which the beneficial owner has sole voting power and sole investment power.
(2)
Includes stock options and common stock purchase warrants exercisable within 60 days from the date hereof.
(3)
Comprised of 2,705,000 shares and 378,000 stock options. William P. and Debra Spencer are husband and wife and are deemed to share beneficial ownership of these shares and options.
(4)
Comprised of 1,435,557 shares and 1,468,926 common stock purchase warrants, all of which are owned by entities controlled by Mr. McAdam.
(5)
Includes 370,000 shares and 448,000 common stock purchase warrants, all of which are owned by entities controlled by the estate of Mr. Scibelli.
(6)
Comprised of 39,000 stock options.
(7)
Comprised of 85,000 stock options.
(8)
Comprised of 10,000 shares and 120,000 stock options.
(9)
Comprised of 50,000 shares and 235,000 stock options.
(10)
Comprised of 2,765,000 shares and 932,000 stock options.
Equity Compensation Plan Information
Common shares issuable on the exercise of common stock warrants have not been approved by the security holders and, accordingly, have been segregated in the above table.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
In January 2005 we entered into a consulting agreement with Business Partners Operations, LLC., a company in which Mr. McAdam is an officer and principal stockholder. Under the agreement, Mr. McAdam provides us with business consulting in the areas of finance and marketing strategies. The agreement, which was verbally amended in January 2009, calls for us to pay a fee of $6,500 per month and can be terminated by either party with a 30 day notice.
We believe that the above transactions were fair, reasonable and upon terms at least as favorable to us as those we might have obtained from unaffiliated third parties.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following is a summary of the fees billed to Imagenetix by its principal accountants for the fiscal years ended March 31, 2010 and 2009:
Audit fees. Consists of fees for professional services rendered by our principal accountants for the audit of our annual financial statements and the review of financial statements included in our Forms 10-Q or services that are normally provided by our principal accountants in connection with statutory and regulatory filings or engagements.
Audit-related fees. Consists of fees for assurance and related services by our principal accountants that are reasonably related to the performance of the audit or review of our financial statements and are not reported under "Audit fees."
Tax fees. Consists of fees for professional services rendered by our principal accountants for tax compliance, tax advice and tax planning.
All other fees. Consists of fees for products and services provided by our principal accountants, other than the services reported under "Audit fees," "Audit-related fees" and "Tax fees" above. The fees disclosed in this category include due diligence, preparation of pro forma financial statements as a discussion piece for a Board member, and preparation of letters in connection with the filing of Current Reports on Form 8-K.
Pre-Approval Policies and Procedures
All services provided by our independent registered public accounting firm, HJ Associates & Consultants LLP (“HJ”), are subject to pre-approval by our Audit Committee. The Audit Committee has authorized each of its members to approve services by HJ in the event there is a need for such approval prior to the next full Audit Committee meeting. The Audit Committee has also adopted policies and procedures that are detailed as to the particular service and that do not include delegation of the Audit Committee’s responsibilities to management under which management may engage HJ to render audit or non-audit services. Any interim approval given by an Audit Committee member and any such engagement by management must be reported to the Audit Committee no later than its next scheduled meeting. Before granting any approval, the Audit Committee (or a committee member if applicable) gives due consideration to whether approval of the proposed service will have a detrimental impact on HJ’s independence. The full Audit Committee pre-approved all services provided by HJ in fiscal 2010.
Based upon the Audit Committee's discussion with management and the independent auditors and the Audit Committee review of the representations of management and the report of the independent accountants to the Audit Committee, the Audit Committee recommended that the Board of Directors include our audited financial statements in our Annual Report on Form 10-K for the year ended March 31, 2010 filed with the Securities and Exchange Commission.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a)
The following documents are filed as a part of this Report:
1.
Financial Statements. The following consolidated financial statements and Report of Independent Registered Certified Public Accounting Firm are included in Part II of this Report:
Report of HJ Associates & Consultants LLP, Independent Registered Public Accounting Firm
Consolidated Balance Sheets- As of March 31, 2010 and 2009
Consolidated Statements of Operation- Years Ended March 31, 2010 and 2009
Consolidated Statement of Stockholders' Equity- Years Ended March 31, 2010 and
Consolidated Statements of Cash Flows- Years Ended March 31, 2010 and 2009
Notes to Consolidated Financial Statements
2.
Exhibits. The following Exhibits are filed as part of, or incorporated by reference into, this Report:
Exhibit No.
Title
3.01
Articles of Incorporation of the Registrant (1)
3.02
Bylaws of the Registrant (1)
3.03
Amendment to Articles of Incorporation (Name change) (2)
3.04
By laws, as amended (7)
4.01
Stock Option Plan (6)
10.01
Celadrin® Supply Agreement with Organic Technologies (2)
10.19
Business Partners Operations Agreement (4)
10.20
Office Lease Agreement with Bernardo Gateway Partners (5)
10.21
Patent License with University of Minnesota (5)
10.22
Patent License with EHP Products, Inc. (5)
10.23
Employment Agreement with William P. Spencer dated August 7, 2009 (7)
10.24
Employment Agreement with Debra L. Spencer dated August 7, 2009 (7)
10.25
Engagement Agreement with Lowell W. Giffhorn dated August 7, 2009 (7)
Code of Ethics (3)
31.1
Certification of William P. Spencer
31.2
Certification of Lowell W. Giffhorn
32.1
Certification of William P. Spencer
32.2
Certification of Lowell W. Giffhorn
(1)
Incorporated by reference to our Registration Statement on Form SB-1, file number 333-87535, filed on September 22, 1999.
(2)
Incorporated by reference to our Registration Statement on Form SB-2, File Number 333-71756, declared effective on July 26, 2002 and post-effective amendment No. 1 thereto declared effective on August 25, 2003.
(3)
Incorporated by reference to our Annual Report on Form 10-K for the year ended March 31, 2005.
(4)
Incorporated by reference to our Registration Statement on Form SB-2, File Number 333-123159, declared effective on March 18, 2005.
(5)
Incorporated by reference to our Annual Report on Form 10-K for the year ended March 31, 2006.
(6)
Incorporated by reference to our Registration Statement on Form S-8, File Number 333-146318, filed on September 26, 2007.
(7)
Incorporated by reference to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2009.
Index to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
To the Board of Directors
Imagenetix, Inc.
San Diego, California
We have audited the accompanying consolidated balance sheets of Imagenetix, Inc. and subsidiary as of March 31, 2010 and 2009, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the two years in the period ended March 31, 2010. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Imagenetix, Inc. and subsidiary as of March 31, 2010 and 2009, and the results of their operations and their cash flows for each of the two years in the period ended March 31, 2010, in conformity with U.S. generally accepted accounting principles.
We were not engaged to examine management's assessment of the effectiveness of Imagenetix, Inc.'s internal control over financial reporting as of March 31, 2010, included in the accompanying Form 10-K and, accordingly, we do not express an opinion thereon.
HJ Associates & Consultants, LLP
Salt Lake City, Utah
June 18,
Imagenetix, Inc.
Consolidated Balance Sheets
See accompanying report of independent registered public accounting firm, summary of accounting policies and notes to consolidated financial statements.
Imagenetix, Inc.
Consolidated Statements of Operations
See accompanying report of independent registered public accounting firm, summary of accounting polices and notes to consolidated financial statements.
Imagenetix, Inc.
Consolidated Statements of Stockholders' Equity
See accompanying report of independent registered public accounting firm, summary of accounting policies and notes to consolidated finacial statements.
Imagenetix, Inc.
Consolidated Statements of Cash Flows
See accompanying report of independent registered public accounting firm, summary of accounting policies and notes to consolidated financial statements.
IMAGENETIX, INC.
Notes to the Consolidated Financial Statements
March 31, 2010 and 2009
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
The accompanying consolidated financial statements represent the accounts of Imagenetix, Inc. [“Parent”] organized under the laws of the State of Nevada on March 28, 1988; and its subsidiary Imagenetix, Inc [“Subsidiary”] organized under the laws of the state of Colorado on July 26, 1996 and its subsidiary Imagenetix [“Imagenetix CA”] organized under the laws of the State of California on January 7, 1999. We are engaged in the business of developing and marketing nutritional supplements and skin care products primarily in domestic markets.
On March 23, 1999, Subsidiary completed an exchange agreement with Imagenetix CA wherein Subsidiary issued its common stock in exchange for all of the outstanding common stock of Imagenetix CA. The Acquisition was accounted for as a recapitalization of Imagenetix CA as the shareholders of the Imagenetix CA controlled the combined entity after the acquisition. There was no adjustment to the carrying values of the assets or liabilities of the Subsidiary or Imagenetix CA as a result of the recapitalization.
During October 2000, the Subsidiary entered into a definitive merger agreement and plan of reorganization with Parent. The transaction was accounted for as a recapitalization of the Subsidiary, wherein the Subsidiary became a wholly owned subsidiary of the Parent. In connection with the reverse acquisition, the Parent changed its name to Imagenetix, Inc.
We have, at the present time, not paid any dividends, and any dividends that may be paid in the future will depend upon our financial requirements and other relevant factors.
Consolidation
All significant intercompany transactions between the Parent, Subsidiary, and Imagenetix CA have been eliminated in consolidation.
Accounting Estimates
The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that effect the reported amounts of assets and liabilities, the disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from those estimated by management.
Cash and Cash Equivalents
For purposes of the financial statements, we consider all highly liquid debt investments purchased with a maturity of three months or less to be cash equivalents. At various times throughout the year, we have exceeded federally insured limits.
IMAGENETIX, INC.
Notes to the Consolidated Financial Statements (Continued)
March 31, 2010 and 2009
Accounts receivable
Accounts receivable are carried at the expected net realizable value. The allowance for doubtful accounts is based on management’s assessment of the collectibility of specific customer accounts and the aging of the accounts receivable. If there were a deterioration of a major customer’s creditworthiness, or actual defaults were higher than historical experience, our estimates of the recoverability of amounts due to us could be overstated, which could have a negative impact on operations.
Inventories
Inventories are carried at the lower of cost or market. Cost is determined by the first-in first-out method. Indirect overhead costs are allocated to inventory.
Property and Equipment
Property and equipment are stated at cost. Expenditures for major renewals and betterments that extend the useful lives of property and equipment are capitalized, upon being placed in service. Expenditures for maintenance and repairs are charged to expense as incurred. Depreciation is computed over the estimated useful life of three to seven years, except leasehold improvements which are depreciated over the lesser of the remaining lease life or the life of the asset, using the straight-line method. We follow the provisions of the Financial Accounting Standards Board Accounting Standards Codification ("ASC") No. 360. Under ASC No. 360, long-lived assets and certain identifiable intangibles to be held and used by us are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We continuously evaluate the recoverability of our long-lived assets based on estimated future cash flows and the estimated fair value of such long-lived assets, and provide for impairment if such undiscounted cash flows are insufficient to recover the carrying amount of the long-lived asset.
Trademarks and Patents
Patents and trademarks are carried at cost less accumulated amortization and are amortized over their estimated useful lives of from 8 to 17 years for patents and 17 years for trademarks. The carrying value of patents and trademarks is periodically reviewed and impairments, if any, are recognized when the expected future benefit to be derived from individual intangible assets is less than its carrying value determined based on the provisions of ASC No. 360 as discussed above.
Stock Based Compensation
We adopted ASC Nos.718 and 505, which require that share-based payments be reflected as an expense based upon the grant-date fair value of those awards. The expense is recognized over the remaining vesting periods of the awards. The Company estimates the fair value of these awards, including stock options and warrants, using the Black-Scholes model. This model requires management to make certain estimates in the assumptions used in this model, including the expected term the award will be held, volatility of the underlying common stock, discount rate and forfeiture rate. We develop our assumptions based on our past historical trends as well as consider changes for future expectations.
IMAGENETIX, INC.
Notes to the Consolidated Financial Statements (Continued)
March 31, 2010 and 2009
Revenue Recognition
We recognize revenue in accordance with the SEC’s Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial Statements” (SAB104) and ASC No. 605. SAB 104 requires that four basic criteria be met before revenue can be recognized: 1) there is evidence that an arrangement exists; 2) delivery has occurred; 3) the fee is fixed or determinable; and 4) collectibility is reasonably assured. ASC No. 605 states that revenue from sales transactions where the buyer has the right to return the product shall be recognized at the time of sale only if (1) the seller’s price to the buyer is substantially fixed or determinable at the date of sale; (2) the buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product; (3) the buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product; (4) the buyer acquiring the product for resale has economic substance apart from that provided by the seller; (5) the seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer; and (6) the amount of future returns can be reasonably estimated. We recognize revenue upon determination that all criteria for revenue recognition have been met. The criteria are usually met at the time title passes to the customer, which usually occurs upon shipment. Revenue from shipments where title passes upon delivery is deferred until the shipment has been delivered.
We account for payments made to customers in accordance with ASC No. 605, which states that cash consideration (including a sales incentive) given by a vendor to a customer is presumed to be a reduction of the selling prices of the vendor’s products or services and, therefore, should be characterized as a reduction of revenue when recognized in the vendor’s income statement, rather than a sales and marketing expense. We have various agreements with customers that provide for discounts and rebates. These agreements are classified as a reduction of revenue. Certain other costs associated with customers that meet the requirements of ASC No. 605 are recorded as sales and marketing expense. Vendor considerations recorded as a reduction of sales were $1,185,000 and $261,000 for the years ended March 31, 2010 and 2009.
We guarantee customer satisfaction. Our policy requires the customer to return the unused product to the retailer from whom they originally purchased it. We pay the retailer for the returned product plus a handling cost. We review gross revenue for estimated returns of private label contract manufacturing products and direct-to-consumer products. The estimated returns are based upon the trailing six months of private label contract manufacturing gross sales and our historical experience for both private label contract manufacturing and direct-to-consumer product returns. However, the estimate for product returns does not reflect the impact of a large product recall resulting from product nonconformance or other factors as such events are not predictable nor is the related economic impact estimable. We periodically assess the adequacy of this policy and record a liability as necessary. For the year ended March 31, 2010, we recorded a reserve of $86,000 for potential returns, allowances and product buy backs.
IMAGENETIX, INC.
Notes to the Consolidated Financial Statements (Continued)
March 31, 2010 and 2009
As part of the services we provide to our private label contract manufacturing customers, we may perform, but are not required to perform, certain research and development activities related to the development or improvement of their products. While our customers typically do not pay directly for this service, the cost of this service is included as a component of the price we charge to manufacture and deliver their products.
Income Taxes
We account for income taxes in accordance with ASC No. 740. This statement requires an asset and liability approach for accounting for income taxes and prescribes a comprehensive model of how a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. ASC No. 740 states that a tax benefit from an uncertain position may be recognized if it is "more likely than not" that the position is sustainable, based upon its technical merits. The tax benefit of a qualifying position is the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority having full knowledge of all relevant information.
Research and Development
We incur expenses to further develop our products and formulas, commission entities to perform clinical trials and evaluate potential products to expand our portfolio. In addition, we recently received a new patent for a drug candidate which, if successful, will address periodontal diseases. We have started the initial new drug process and have completed several animal studies. During the years ended March 31, 2010 and 2009 we incurred research and development expenses of $127,540 and $69,667, respectively.
Earnings Per Share
The computation of earnings per share is based on the weighted average number of shares outstanding during the period presented in accordance with ASC No. 260 (See Note 11).
New Accounting Pronouncements
In June 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification No. 105, FASB Accounting Standards and the Hierarchy of Generally Accepted Accounting Principles (“ASC 105”). ASC 105 replaces SFAS 162 and establishes the FASB Accounting Standards Codification (“Codification”) as the single source of authoritative U.S. generally accepted accounting principles (“GAAP”) recognized by the FASB to be applied by nongovernmental entities, except for rules and interpretive releases by the Securities and Exchange Commission (“SEC”) which are sources of authoritative GAAP for SEC registrants. ASC 105 and the Codification was effective for interim and annual periods ending after September 15, 2009. We adopted ASC 105 on July 1, 2009, and all references made to GAAP within our consolidated financial statements now use the new Codification numbering system. The Codification does not change or alter existing GAAP and, therefore, the adoption of ASC 105 did not have an impact on our financial position, results of operations or cash flows.
A variety of proposed or otherwise potential accounting standards are currently under study by standard-setting organizations and various regulatory agencies. Because of the tentative and preliminary nature of these proposed standards, management has not determined whether implementation of such proposed standards would be material to the Company’s consolidated financials statements.
NOTE 2 - ACCOUNTS RECEIVABLE
Accounts receivable are carried at the expected realizable value. Accounts receivable consisted of the following:
NOTE 3 - INVENTORY
Inventory consisted of the following:
NOTE 4 - PROPERTY AND EQUIPMENT
The following is a summary of equipment, at cost, less accumulated depreciation:
IMAGENETIX, INC.
Notes to the Consolidated Financial Statements (Continued)
March 31, 2010 and 2009
Depreciation expense for the year ended March 31, 2010 and 2009 was $33,281 and $34,468, respectively.
NOTE 5 - OTHER ASSETS
The following is a summary of other assets included on the face of the balance sheet:
For the year ended March 31, 2010 and 2009 amortization expense was $19,858 and $10,599, respectively. The estimated future amortization expense related to intangible assets as of March 31, 2010 is as follows:
NOTE 6 - LICENSE AND ROYALTY PAYABLE
In May, 2005, we entered into an agreement with EHP Products, Inc. acquiring a non-exclusive world-wide license to make, use and sell products relating to Cetyl Myristoleate covered under U.S. Patent No. 5,569,676. The agreement provided for payments of $3,000 per month from May, 2005 through April, 2009, at which time EHP Products, Inc. conveyed ownership in the product to us.
As of March 31, 2010 and 2009, the following obligation was outstanding related to this license:
IMAGENETIX, INC.
Notes to the Consolidated Financial Statements (Continued)
March 31, 2010 and 2009
NOTE 7 - LEASES OBLIGATIONS
Operating Leases
We entered into a seven-year building lease for our office commencing in January 2006 and expiring in December 2012. In addition we entered into a three-year lease for warehouse space commencing in September 2006 and expiring in August 2010. Lease expense for the years ended March 31, 2010 and 2009 amounted to $161,592 and $165,782, respectively. The following is a schedule of minimum annual rental payments for the next five years.
NOTE 8 - COMMITMENTS AND CONTINGINCIES
Sun Research Arbitration
On November 23, 2009, Sun Research, Inc., a sales distributor for Imagenetix, submitted a demand for arbitration with the American Arbitration Association related to a Regional Distributor Agreement entered into on March 31, 2008. Sun Research asserted that under the terms of the Agreement, it was entitled to compensation from an acceleration agreement Imagenetix entered into with a customer. Sun Research has demanded damages of approximately $265,625 (excluding claims for costs, interests and attorneys fees). The Company denied the allegations and believed the claims to be frivolous and totally devoid of merit. In April 2010, the Company and Sun Research agreed to settle the dispute by the Company paying $82,000 to Sun Research over a six month period. The $82,000 was recorded as a charge against settlement income during the fiscal year ended March 31, 2010.
IMAGENETIX, INC.
Notes to the Consolidated Financial Statements (Continued)
March 31, 2010 and 2009
TriPharma Suit
On April 30, 2010, TriPharma, Inc., a customer of Imagenetix, filed a legal action in the United States Southern District Court of California, case number 10CV0933IEG, related to an Exclusive Marketing and Supply Agreement, as amended on June 19, 2008. TriPharma asserts that Imagenetix breached the terms of the Agreement and seeks injunctive relief and unspecified damages. The Company denies the allegations and believes the claims to be frivolous and totally devoid of merit. The Company has retained litigation counsel and intends to vigorously defend the claims. The amount, if any, of ultimate liability with respect to the foregoing cannot be determined. Despite the inherent uncertainties of litigation, the Company at this time does not believe that TriPharma's claim will have a material adverse impact on its financial condition, results of operations, or cash flows.
Contingencies
We are involved in litigation from time to time in the normal course of business.
Management believes there are no such claims, which would have a material effect on our financial position.
Other agreements
We routinely enter into contracts and agreements with suppliers, manufacturers, consultants, product marketing, and sales representatives in the normal course of doing business. These agreements can be either short or long term and are normally limited to specific products and
marketing opportunities.
NOTE 9 - CAPITAL STOCK
Preferred Stock
We have authorized 5,000,000 shares of preferred stock, $.001 par value, with such rights, preferences and designations and to be issued in such series as determined by the Board of Directors. No shares are issued and outstanding at March 31, 2010 and 2009.
Common Stock
The Company has authorized 50,000,000 shares of common stock at $.001 par value. At March 31, 2010 and 2009, the Company had 11,010,788 shares of common stock issued and outstanding.
During the year ended March 31, 2009, we recorded $25,000 as non-cash general and administrative expenses as a result of issuing 50,000 restricted shares of common stock to an individual who had met certain sales levels under a marketing and sales agreement.
IMAGENETIX, INC.
Notes to the Consolidated Financial Statements (Continued)
March 31, 2010 and 2009
Warrants
A summary of the status of the warrants granted under various agreements at March 31, 2010 and 2009, and changes during the years then ended is presented below:
During the year ended March 31, 2010, we issued warrants to three individuals for services valued at $117,947 of which we expensed $63,033 to general and administrative expenses during the current fiscal year and we will amortize the balance over the remaining term of the service contracts. We estimated the fair value of each warrant at the issuance date by using the Black-Scholes option-pricing model with the following weighted-average assumptions used for the year ended March 31, 2010: dividend yield of zero percent; expected volatility of 78%, risk-free interest rates ranging from 2.16% to 2.20%; and expected lives of 5 years.
During the year ended March 31, 2009, we issued warrants to four individuals for services valued at $38,378 which we expensed to general and administrative expenses during the fiscal year ended March 31, 2009. We estimated the fair value of each warrant at the issuance date by using the Black-Scholes option-pricing model with the following weighted-average assumptions used for the year ended March 31, 2009: dividend yield of zero percent; expected volatility of 56% to 61%, risk-free interest rates ranging from 3.12% to 3.36%; and expected lives of 5 years.
A summary of the status of the warrants granted under the various agreements at March 31, 2010, are presented in the table below:
IMAGENETIX, INC.
Notes to the Consolidated Financial Statements (Continued)
March 31, 2010 and 2009
Stock Option Plan
In August 2000 we adopted a Stock Option Plan, which we refer to as the "Plan," which provides for the grant of stock options intended to qualify as "incentive stock options" and "nonqualified stock options" (collectively "stock options") within the meaning of Section 422 of the United States Internal Revenue Code of 1986 (the "Code"). Stock options may be issued to any of our officers, directors, key employees or consultants.
Under the Plan, we have reserved 2.0 million shares underlying stock options for issuance, of which 1,599,000 options have been granted to executive officers, employees and consultants at prices ranging from $0.31 to $2.35 per share. The Plan is administered by the Compensation Committee, who determines which individuals shall receive stock options, the time period during which the stock options may be exercised, the number of shares of common stock that may be purchased under each stock option and the stock option price.
The per share exercise price of incentive stock options may not be less than the fair market value of the common stock on the date the option is granted. The aggregate fair market value (determined as of the date the stock option is granted) of the common stock that any person may purchase under an incentive stock option in any calendar year pursuant to the exercise of incentive stock options will not exceed $100,000. No person who owns, directly or indirectly, at the time of the granting of an incentive stock option, more than 10% of the total combined voting power of all classes of our stock is eligible to receive incentive stock options under the Plan unless the stock option price is at least 110% of the fair market value of the common stock subject to the stock option on the date of grant.
IMAGENETIX, INC.
Notes to the Consolidated Financial Statements (Continued)
March 31, 2010 and 2009
No incentive stock options may be transferred by an optionee other than by will or the laws of descent and distribution, and, during the lifetime of an optionee, the stock option may only be exercisable by the optionee. Except as otherwise determined by the Board of Directors, stock options may be exercised only if the stock option holder remains continuously associated with us from the date of grant to the date of exercise. The exercise date of a stock option granted under the Plan may not be later than ten years from the date of grant. Any stock options that expire unexercised or that terminate upon an optionee's ceasing to be employed by us will become available once again for issuance. Shares issued upon exercise of a stock option will rank equally with other shares then outstanding. No stock options will be granted by us at an exercise price less than 85% of the fair market value of the stock underlying the option on the date the option is granted. During the years ended March 31, 2010 and 2009 there were options granted to purchase up to 340,000 and 305,000, respectively, shares of common stock and there were no options exercised.
A summary of the status of the options granted under the Company’s 2000 stock option plan at March 31, 2010 and 2009, and changes during the years then ended is presented below:
A summary of the status of the options granted under the stock option plan at March 31, 2010, are presented in the table below:
IMAGENETIX, INC.
Notes to the Consolidated Financial Statements (Continued)
March 31, 2010 and 2009
NOTE 10 - INCOME TAXES
At March 31, 2010 and 2009, the total of all deferred tax assets was approximately $957,400 and $549,700, respectively. There are no deferred tax liabilities for either year.
The temporary differences gave rise to the following deferred tax asset:
The reconciliation of income tax from continuing operations computed at the U.S. federal statutory tax rate to our effective rate is as follows for the year ended:
IMAGENETIX, INC.
Notes to the Consolidated Financial Statements (Continued)
March 31, 2010 and 2009
The components of federal income tax (benefit) expense from continuing operations consisted of the following for the year ended:
Deferred income tax expense (benefit) results primarily from the reversal of temporary timing differences between tax and financial statement income.
At March 31, 2010, the Company has net operating loss carry forwards for income tax reporting purposes of approximately $1,280,000 and $3,231,782 available to offset future federal and California taxable income, respectively. Based on current tax law, the Company’s federal net operating loss carry forward will begin to expire in the year ending March 31, 2028 and the state net operating loss carry forward will begin to expire in the year ending March 31, 2017. During the fiscal years ending March 31, 2008 and 2009, California suspended the use of the state net operating loss carry forwards. Accordingly, based on taxable income for the year ended March 31, 2009, we paid $69,803 of state income tax expense.
IMAGENETIX, INC.
Notes to the Consolidated Financial Statements (Continued)
March 31, 2010 and 2009
We periodically evaluate the likelihood of the realization of deferred tax assets, and adjust the carrying amount of the deferred tax assets by the valuation allowance to the extent the future realization of the deferred tax assets is not judged to be more likely than not. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent cumulative earnings experience by taxing jurisdiction, expectations of future taxable income or loss, the carry forward periods available to us for tax reporting purposes, and other relevant factors.
At March 31, 2010, based on the weight of available evidence, including current year taxable income and expectations of future taxable income, the Company determined that it was more likely that its deferred tax assets would be realized and has not recorded a valuation allowance associated with its deferred tax assets.
The Company has adopted ASC No. 740. This statement requires an asset and liability approach for accounting for income taxes and prescribes a comprehensive model of how a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. ASC No. 740 states that a tax benefit from an uncertain position may be recognized if it is "more likely than not" that the position is sustainable, based upon its technical merits. The tax benefit of a qualifying position is the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority having full knowledge of all relevant information.
Upon adoption of ASC No. 740, there was no impact to the Company's consolidated financial statements. The Company estimates that the unrecognized tax benefit will not change significantly within the next twelve months. The Company will continue to classify income tax penalties and interest as part of general and administrative expense in its statements of operations. Accrued interest on uncertain tax positions is not significant. There are no penalties accrued as of March 31, 2010. The following table summarizes the open tax years for each major jurisdiction:
As the Company has significant net operating loss carry forwards, even if certain of the Company’s tax positions were disallowed, it is not foreseen that the Company would have to pay any taxes in the near future. Consequently, the Company does not calculate the impact of interest or penalties on amounts that might be disallowed.
IMAGENETIX, INC.
Notes to the Consolidated Financial Statements (Continued)
March 31, 2010 and 2009
NOTE 11 - EARNINGS PER SHARE
The following data show the amounts used in computing earnings per share of common stock for the period presented:
Basic income (loss) per common share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding during each period. Diluted income per share is computed by dividing net income by the weighted-average number of common shares and common equivalent shares outstanding during each period. Common equivalent shares include stock options and warrants using the treasury stock method. For periods which include a loss, the computation of diluted income (loss) per share excludes the impact of stock options and warrants because they would be antidilutive and diluted income (loss) per share is therefore the same as basic loss per share.
NOTE 12 - CONCENTRATIONS
Sales
During the year ended March 31, 2010, we had two significant customers which accounted for 42% and 15% of sales.
During the year ended March 31, 2009, we had three significant customers which accounted for 23%, 19% and 17% of sales.
Supplier
We also have a single source and exclusive supplier arrangement with the supplier of a specific raw material, which is used as part of products which account for approximately 72% of our sales. The interruption of raw materials provided by this supplier or the loss of a significant customer would adversely affect our business and financial condition.
IMAGENETIX, INC.
Notes to the Consolidated Financial Statements (Continued)
March 31, 2010 and 2009
During the year ended March 31, 2010, we had three significant vendors who accounted for 13%, 12% and 10% of cost of sales.
During the year ended March 31, 2009, we had two significant vendors who accounted for 39% and 23% of cost of sales.
Accounts Receivable
At March 31, 2010, we had three customers which accounted for 48%, 21%, and 10% of our accounts receivable balances.
At March 31, 2009, we had four customers which accounted for 29%, 26%, 17% and 15% of our accounts receivable balances.
NOTE 13 - LITIGATION SETTLEMENT
In May 2008, we received $2,100,000 ($1,785,000 after costs) as a result of entering into a settlement agreement with a company we alleged was infringing on the Celadrin trademark. In addition, we entered into a supply agreement with the same company whereby we provide Celadrin for use in their products.
In September 2009, we entered into an agreement with the company whereby they bought out the remaining order commitments under the supply agreement. As part of the buyout agreement, we agreed to a one time payment of $1,250,000 to satisfy their purchase commitments which were scheduled to continue through May 2013. Also, as part of the agreement, we were not required to ship any product. The negotiated amount was reflected as other income during the year ended March 31, 2010. In April 2010, the Company settled a dispute with a sales distributor involved in this transaction by agreeing to pay $82,000 to the distributor over a six month period. The $82,000 was recorded as a charge against settlement income during the fiscal year ended March 31, 2010.
NOTE 14 - SUBSEQUENT EVENTS AND FINANCIAL STATEMENT DISCLOSURES
In May 2010, we entered into convertible bridge debentures with attached warrants with a group of six individuals for an aggregated amount of $410,000. Under the terms of the debentures, the debenture holders will receive 7% interest payable in cash quarterly, we have the right to call the notes through November 25, 2010 conditioned on us paying a premium of 7% cash. The debenture holders have the right to convert the notes into common stock at a conversion price of $.050 per share if the notes are not called previous to November 25, 2010. The debenture holders received initial five year warrants equal to one-half warrant for each dollar invested and, if the debentures are not called previous to November 25, 2010, will receive an additional like number of warrant shares each with an exercise price of $0.50 per warrant share.
In May 2010, we issued 800,000 shares of restricted common stock to two institutional investors for an aggregated amount of $400,000, or $0.50 per share.
IMAGENETIX, INC.
Notes to the Consolidated Financial Statements (Continued)
March 31, 2010 and 2009
We have evaluated subsequent events under the provisions of ASC 855. Based upon this evaluation, we have determined that no material subsequent events occurred that require recognition or disclosure in the financial statements other than those already disclosed above or in note 8 to our consolidated financial statements titled, “Commitments and Contingencies.”
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
Signature
Title
Date
/s/ WILLIAM P. SPENCER
Chief Executive Officer,
June 18, 2010
William P. Spencer
President and Director
/s/ DEBRA L. SPENCER
Secretary, Treasurer, and Director
June 18, 2010
Debra L. Spencer
/s/ BARRY S. KING
Director
June 18, 2010
Barry S. King
/s/ JEFFREY G. MC GONEGAL
Director
June 18, 2010
Jeffrey McGonegal
/s/ ROBERT BURG
Director
June 18, 2010
Robert Burg
/s/ LOWELL W. GIFFHORN
Chief Financial Officer (Principal
June 18, 2010
Lowell W. Giffhorn
Accounting Officer)