Item 1. Business
Our Business
Total Nutraceutical Solutions, Inc. (TNS) is an emerging biotechnology company engaged in the discovery, formulation, and marketing of natural ingredients that can be used in organic nutraceutical and cosmetic products developed and sold by TNS and by third parties. Our current portfolio of ingredients includes ERGO D2, vitamin D, L-Ergothioneine, beta-glucans, polyphenols and curcumin. These highly potent antioxidants provide multiple health benefits for both humans and animals and address multi-billion dollar markets for inflammation control, immune system support, increased energy and stamina, reduced stress and anxiety, and hair and nail growth.
We utilize novel clinical models, biomarkers, and analytical tools to validate the nutritional and clinical efficacy of our ingredients and the products that incorporate them. Our scientific strategy and technology platform initially focused on the unique manufacturing and health benefits of specific bioactive nutrients found in certain whole natural mushrooms and their mycelial biomasses (mushroom powder and its active components). In early 2011, we expanded into curcumin extracted from tumeric (see description below).
TNS sells its ingredients directly to manufacturers of cosmetic and nutraceutical products and indirectly through its resellers. We also use our ingredients in nutraceutical products that we formulate and market to consumers. Our growing line of nutraceutical products are manufactured and distributed for us under contract with manufacturing, packaging, and fulfillment companies in the United States. We naturally enhance the vitamin D content of mushrooms supplied by domestic growers, utilizing TNS patent pending proprietary UV-light methodology at our Sherwood, Oregon facility. Research and development of new ingredients and nutraceutical products are also performed under contract with outside laboratories, such as the Department of Food Science, Pennsylvania State University.
TNS Ingredients
Our ingredients are sold in both concentrated and natural forms. All ingredients are produced utilizing nonchemical enhancement, extraction, and concentration methods.
Vitamin D2
Vitamin D is a fat-soluble vitamin that has many physiologic roles including maintaining blood levels of phosphorus and calcium, promotion of bone mineralization and calcium absorption, maintaining a healthy immune system, and regulating cell differentiation and growth. Recent studies have also shown a link between vitamin D deficiency and diseases such as cancer, chronic heart disease, inflammatory bowel disease and even mental illness.
Vitamin D is in an important food additive currently used in a variety of fortified food products including milk, margarine, cereal, orange juice, and vitamin supplements. Vitamin D is primarily available in two active forms, vitamin D2 (ergocalciferol) and vitamin D3 (cholecalciferol). Vitamin D3 (cholecalciferol) is chemically extracted from animal lanolin. Vitamin D2 is plant based and is produced naturally within mushrooms. TNS utilizes a proprietary natural UV enhancement process to naturally increase the vitamin D2 content in its ingredients by a factor of 1000.
L-Ergothioneine
L-Ergothioneine is a stable highly potent antioxidant. L-Ergothioneine has the ability to scavenge free radicals and protect cells from UV-induced damage with higher efficiency than antioxidants such as coenzyme Q10 or idebenone (a synthetic analog of coenzyme Q10), thus making it a more effective natural antioxidant. The compound has been shown to be a non-toxic antioxidant in vivo (in living specimens) serving as an electron donor helping to prevent cell death. L-Ergothioneine is currently being used in cosmetics (anti-aging products) and other applications promoting cell preservation and viability.
Ergo-D2
Ergo-D2 is an optimized blend of our L-Ergothioneine and vitamin D2 ingredients that is not available in a concentrated form. This ingredient is being marketed for use in dietary food supplements and organic food products, to naturally enhance product shelf life and aid in the suppression and or control of inflammation in various organ systems.
Curcumin
Curcumin, also known as diferuloylmethane, is a photochemical found in the spice turmeric. It is a powerful anti-inflammatory and antioxidant, and may help prevent the development of a variety of conditions related to oxidative and free-radical damage, including cataracts, heart disease, and cancer. A research study performed at Model Bio Systems and funded by TNS has verified many of the ingredient’s anti-inflammatory properties and its beneficial effect on Alzheimer’s disease. We have identified a proprietary source for a highly potent variety of curcumin, not currently available in the US market, that possesses many additional co-factors which enhance its effectiveness alone and in combination with other TNS ingredients.
Consumer Products
We have formulated several commercial products that showcase our proprietary ingredients and enhancement, extraction, and concentration technologies. As the market’s understanding and acceptance of these new products expand, we may sell or license them to third parties who will agree to purchase their ingredients from TNS exclusively. We currently market five dietary supplements that leverage our expertise of identifying unique combination of bionutrients and their associated health benefits. Four of these nutraceutical products are for human consumption and one is for the equine market.
ImmuSANOTM, nutritionally addresses the needs of the immune system by balancing cellular function and promoting a stronger immune system. This product is sold in capsule form.
GlucoSANOTM is designed to assist in maintaining more normal cellular metabolism and stabilizing blood sugar levels. This product is sold in capsule form.
EquiSANOTM, for consumption by horses, is composed of a proprietary blend of 5 types of certified organic medicinal mushrooms, each of which contains bioactive nutrients that assist the horse in balancing cellular function and promoting a stronger immune system which is associated with increased resistance to infections. This product is sold in powder form.
Groh, which nutritionally supports hair and nail growth. This product is sold in capsule form.
NuFlex - six nutraceutical products under the NuFlex trademark were marketed and sold through the Direct Marketing Affiliate Program or DMAP for joint support and joint pain. The six products are NuFlex LTR (Long Term Relief), NuFlex IR (Instant Relief, a topical spray for muscle aches and strains), NuFlex AF (Accelerator Formula, to boost the long term benefits of NuFlex long term relief formula), NuFlex Advanced Joint Repair, NuFlex Multi Joint Support and NuFex MSM. These products were sold under the DMAP which was terminated in February 2011. From September 2010 to the present the sale of these products were managed by TNS through direct marketing contract vendors. These products were produced by Pro-Tech Laboratories of Quitman, Texas and Columbia Nutritional Services of Vancouver, Washington.
We utilize several methods of product distribution including: independent retail outlets, direct mail, cyber-marketing, and a limited independent, commissioned sales force. Non-exclusive distribution agreements have been signed with Koch International (South Korea), Caribbean International Medical (Aruba, Curacao, Bonaire, Suriname and other Caribbean jurisdictions), and Intelligent Concepts Ltd. (United Kingdom and Western Europe). We maintain our inventory and ship the products from our offices in Stevenson, Washington, Sherwood, Oregon, and from a contracted facility in Quitman, Texas.
Third Party Products
In 2010, we began selling our ingredients to the DMAP for use in NuFlex, a collection of six nutraceutical products addressing the markets for joint support and joint pain and in 2011 to companies including NutriMedical (for use in their product Myco-D2, a private labeled vitamin D2 supplement), and Funguys LLC (for use in D for Dogs, a complete line of canine supplements),. During the first quarter of 2011, the DMAP agreement with American Charter Marketing was terminated and we are seeking a new licensee or purchaser interested in marketing the NuFlex product line.
Research Agreements and Sponsored Research on the Nutritional Value of Mushrooms
The dramatic growth in consumer demand for organic nutritional and nutriceutical products over the past decade has created an opportunity for companies to offer new and upgraded products to address this demand. Our scientific strategy is to support our efforts by applying modern scientific and medical technology to understand and promote the medicinal and other benefits found in natural whole foods. We contract with leading food technologists at major scientific universities to identify and quantify the key bionutrients and antioxidant components of specific foods. Once the components have been identified we design and implement outsourced studies that validate the health benefit of our natural ingredients and the products that contain them. TNS additionally invests in research and development of proprietary extraction, concentration, and delivery technologies for use with its ingredients.
Marvin S. Hausman, M.D., our CEO and Chairman of the Board, beginning in 2006, developed certain intellectual property pursuant to research agreements with Pennsylvania State University (PSU) dated May 1, 2006 and May 20, 2006. These research endeavors resulted in the filing of two patent applications. Exclusive Option Agreements related to these research developments and patent applications were also negotiated and signed with PSU.
We funded research in 2008 and 2009 in the Department of Food Science, PSU, studying the effect of pulsed UV light treatment on increasing vitamin D2 levels in four commonly consumed U.S. mushroom varieties. Pulsed UV light is a technology that delivers energy from a specific spectrum of UV light at a high peak power in a short amount of time. This study demonstrated that after a very short exposure time of about one second (the system generated three pulses per second) the vitamin D2 content of these mushroom varieties increased from very little to upwards of 800% of the daily recommended value per serving. Previous studies using continuous UV light have indicated that it takes several minutes of exposure to obtain similar values.
The vitamin D2 research resulted in the filing of a patent application entitled “Methods of Use and Rapid Generation of Vitamin D2 from Mushrooms and Fungi Using Pulsed UV-light.” In November 2008, we acquired an exclusive option to license the vitamin D2 patent from The Penn State Research Foundation (PSRF). On June 9, 2010 TNS exercised the option and licensed the vitamin D2 patent from PSRF.
During 2009 and 2010 TNS funded studies performed under contract with Model BioSystems, Inc. of San Clemente, California and Bangalore, India to evaluate the antioxidant and bionutrient properties of common and specialty mushrooms including a proprietary grown mushroom, Agaricus blazei Murill (AbM) by Sylvan Bio, Inc. and Creekside Mushrooms, Ltd. A fruit fly model (Drosophila melanogaster) was used to study biologic survival, suppression of oxidative/inflammatory stress, and suppression of Alzheimer’s disease. In the study, unenriched and vitamin D2 enriched mushroom dried powders were evaluated, as well as the efficacy of pure Vitamin D2 and vitamin D3. Positive clinical findings resulted in the filing of three provisional patents. Marvin S. Hausman MD, our Chief Executive Officer, who assisted in design of the clinical studies, wrote and filed the provisional patents and subsequently assigned the provisional patents to TNS. Positive additional clinical data plus consolidation of the three provisional patents allowed the filing of a new patent on September 21, 2010 entitled “Vitamin D2 Enriched Mushrooms and Fungi For Treatment of Oxidative Stress, Alzheimer’s Disease and Associated Disease States”.
On November 10, 2009 TNS acquired rights to a patent entitled “Use of Ergothioneine as a Preservative in Foods and Beverages.” The transfer of the patent to TNS was subject to an “Assignment and Assumption” between Dr. Philip Sobol, Dr. Robert Beelman, and Dr. Marvin Hausman. Under that agreement TNS agreed to issue a maximum of 1,500,000 shares of common stock to the assignors upon the first to occur of the following events up to 1,500,000 shares: upon issuance of the patent in the U.S. (1 million shares), upon issuance of the patent in the first European Union jurisdiction (500,000 shares), if TNS enters into a license agreement for the patent with any third party
(1,500,000 shares), or upon the successful commercialization of any product or technology covered by the patent (500,000 shares). Upon the successful commercialization of any product or technology covered by the patent, TNS will grant to assignors a royalty equal to 3% of net sales of any such product or technology and/or 20% of any sublicensing payments if the patent is sublicensed.
On March 9, 2010 TNS acquired from the University of Cologne, Cologne, Germany, an exclusive license agreement on the invention entitled “Ergothioneine Transporter.” The license comprises the patent application entitled; “Identification of Ergothioneine Transporter and Therapeutic Uses Thereof.” This transporter is present in human cells, especially red and white blood cells, and can efficiently move the antioxidant L-Ergothioneine (ERGO) across cell membranes.
Intellectual Property
We are substantially dependent on our ability to obtain and maintain patents and other proprietary rights and know-how which serve as the basis for our intellectual property portfolio.
Patent Applications
US patent application No. 12/887,276, PCT US10/49684 filed on September 21, 2010 entitled: “Vitamin D2 Enriched Mushrooms and Fungi For Treatment of Oxidative Stress, Alzheimer’s Disease and Associated Disease States.” Assigned to TNS by Marvin S. Hausman, M.D. on September 21, 2010.
US patent application No. 61/438,483 (related to application No. 12/887,276) filed on February 1, 2011 entitled “Anti-Inflammatory Approach to Prevention and Suppression of Post-Traumatic Stress Disorder, Traumatic Brain Injury, Depression and Associated Disease States.”
The following patent applications were assigned to TNS by our President and Chief Executive Officer, Marvin S. Hausman, M.D. in November 2009.
US patent application No. 61/277,150 filed September 21, 2009 entitled “Vitamin Fortified Mushrooms and Fungi for Increasing Survivability and Longevity”.
US patent application Serial number 61/280,578 filed November 5, 2009 entitled “Vitamin Fortified Mushrooms and Fungi for Increasing Resistance to Oxidative Stress”.
PCT/US 2008/056234 Serial number 12/529,859 entitled “Use of Ergothioneine as a Preservative in Foods and Beverages” inventors Beelman, R.B. and M. Hausman, PCT filed on March 7, 2008. Assigned to TNS on November 10, 2009 by Hausman, Beelman, and Sobol.
Patent Applications Subject to License Agreements
US patent application No. 12/386,810 entitled “Methods of Use and Rapid Generation of Vitamin D2 from Mushrooms and Fungi Using Pulsed UV-light.” filed on April 23, 2009. On June 9, 2010, TNS acquired an exclusive license from The Penn State Research Foundation (PSRF) on this patent application. This patent application was derived from U.S. Provisional Patent Application No. 61/047,268 entitled “Methods and Compositions for Improving the Nutritional Content of Mushrooms and Fungi” filed April 23, 2008.
Patent application No. PCT/EP 2005/005613 entitled; “Identification of Ergothioneine Transporter and Therapeutic Uses Thereof.” Filed on May 24, 2005, US Patent ApplicationNo. 11/569,451 filed on June 25, 2007. On March 9, 2010 TNS acquired from the University of Cologne, Cologne, Germany, an exclusive license agreement to this patent application.
Production, Distribution and Marketing
Since July 2009 we have been utilizing Columbia Nutritional Services, Inc. of Vancouver, Washington to manufacture, per our specifications, our four nutraceutical mushroom supplement products, ImmuSANO, GlucoSANO, EquiSANO and Groh.
We currently market our products directly to the consumer utilizing direct mail order, reseller distribution programs, internet marketing, and commission sales people. Fulfillment and distribution is performed at facilities in Stevenson, WA, Sherwood, OR and Quitman, TX.
In March 2010 we entered into a Profit Sharing Agreement with American Charter and Marketing LLC and Delta Group Investments Limited under which we agreed to form an association referred to as the Direct Marketing Affiliates Project (“DMAP”). Pursuant to the agreement the parties agreed to work together to undertake a direct mail campaign designed to sell TNS nutraceutical products for a period of three years, with the day to day management and control of business operations of the association being vested in TNS as the managing affiliate. Between March 2010 and February 2011, six nutraceutical products under the NuFlex trademark were marketed and sold through the DMAP for joint support and joint pain. The six products were NuFlex LTR (Long Term Relief), NuFlex IR (Instant Relief, a topical spray for muscle aches and strains), NuFlex AF (Accelerator Formula, to boost the long term benefits of NuFlex long term relief formula), NuFlex Advanced Joint Repair NuFlex Multi Joint Support and NuFex MSM. These products were produced by Pro-Tech Laboratories of Quitman, Texas and Columbia Nutritional Services of Vancouver, Washington and were sold through direct marketing contract vendors. In February 2011 the parties to the Profit Sharing Agreement agreed to terminate the DMAP leaving TNS in possession of the property and assets of the DMAP.
In February 2009 we signed an Agreement for Removal of Mushroom Substrate Waste with Hokto Kinoko Co. to acquire mushroom spent substrate from the Hokto Kinoko 250,000 square foot mushroom growing facility in San Marcos, California. The facility, which is designed to produce fresh specialty mushrooms, has the potential at full capacity to produce 20-25 tons of spent substrate per day. Mushroom substrate waste is defined as the spent substrate (growing media) and all mushroom residuals resulting from cleaning the growing bottles after the harvest of mushroom fruit bodies at the growing facility. The Hokto state-of-the-art facility, the largest of its kind in the United States, produces the following mushrooms: Brown Beech (Buna Shimeji), White Beech (Bunapi), King Trumpet (Pleurotus eryngii), and Maitake.
Under the agreement we purchased an auger and other related equipment to facilitate collection and removal of the mushroom substrate and we are leasing that equipment to Hokto Kinoko on a monthly basis at $944 per month. Golden Gourmet Mushrooms personnel used the facilities on the Hokto Kinoko premises to grow mushrooms and also supervised the use of the auger for collection and removal of the mushroom substrate. The mushroom substrate waste is sold by TNS to Evergreen Nurseries, San Diego, California. Golden Gourmet Mushrooms has changed its name to M2i. Under the terms of an amendment to the Agreement Removal of Mushroom Substrate Waste with Hokto Kinoko signed in March 2011 TNS shares the gross proceeds of its sales of mushroom substrate to Evergreen Nurseries with Hokto Kinoko and M2i on an equal basis.
Competitive Environment
The ingredients market is highly competitive, with many well-known and established suppliers. The biotechnology industry is subject to rapid change. New products are constantly introduced to the market. Our ability to remain competitive depends on our ability to develop and manufacture new products in a timely and cost effective manner, to accurately predict market transitions, and to effectively market our products. Our future financial results will depend to a great extent on the successful introduction of several new products. We cannot be certain that we will be successful in selecting, developing, contract manufacturing and marketing new products.
The success of new product introductions depends on various factors, including, but not limited to the following:
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proper new product selection;
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availability of raw materials;
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pricing of raw materials;
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timely delivery of new products;
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regulatory allowance of the products;
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customer acceptance of new products.
We face challenges in developing new products, primarily with funding development costs and diversion of management time. On a regular basis, we will evaluate opportunities to develop new products through product line extensions and product modifications. There is no assurance that we will successfully develop product line extensions or integrate newly developed products into our business. In addition, there are no assurances that newly developed products will contribute favorably to our operations and financial condition. Our failure to develop and introduce new products on a timely basis could adversely affect our future operating results.
Industry
The nutritional supplements industry is intensely competitive. It includes companies that manufacture and distribute products which are generally intended to enhance the body's performance as well as to enhance well being. Nutritional supplements include vitamins, minerals, dietary supplements, herbs, botanicals and compounds derived therefrom. Opportunities in the nutritional supplements industry were enhanced by the enactment of the Dietary Supplement Health and Education Act of 1994 ("DSHEA"). Under DSHEA, vendors of dietary supplements are now able to educate consumers regarding the effects of certain component ingredients. However, they are subject to many regulations regarding labeling and advertising of such products. See “Government Regulation” below.
Competition
The market for nutraceuticals is highly competitive. This market includes manufacturers, distributors, and physicians. Numerous manufacturers and distributors will compete with us for customers throughout the United States, Canada, and internationally in the packaged nutritional supplement industry selling products to retailers such as mass merchandisers, drug store chains, independent pharmacies, and health food stores. Most all of our competitors are substantially larger and more experienced than us and have longer operating histories, and they also have materially greater financial and other resources than us. We may not be able to successfully compete with them in the marketplace.
The principal competition in the health food store distribution channel that we will face comes from a limited number of large nationally known manufacturers and many smaller manufacturers of dietary supplements. Some of the main competitors include, but are not limited to, Beyond a Century, Dr. Whittaker, Unigen Pharma, Dr’s Best, Metagenics, Twin Labs, Herbalife, Nutrilite, and Isagenix. We also face competition in the health food store distribution channels from private label dietary supplements offered by health and natural food store chains. In addition, we anticipate that there will be competition from sellers that utilize internet commerce.
The market is highly sensitive to the introduction of new products. As a result, in order to be competitive, we will need to successfully introduce new products that are accepted by our future customers. Management has positioned TNS as an emerging biotech company with collaborative research projects at major universities, including but not limited to Pennsylvania State University, State College, Pennsylvania and University of Cologne, Cologne, Germany.
We also face competition from many large drug companies. Many of these drug companies are substantially larger and more experienced than us, have longer operating histories, and have materially greater financial and other resources than us. These drug companies also have substantially greater political influence and regulatory support for the use of their products.
Government Regulation
In both the United States and foreign jurisdictions, we will be subject to compliance with laws, governmental regulations, administrative determinations, court decisions and similar constraints. Although the products we plan to produce and distribute are not deemed to be drugs, they are considered to be dietary supplements and therefore are subject to all regulations regarding products ingested by consumers. Such laws, regulations and other constraints exist
at the federal, state and local levels in the United States and at all levels of government in foreign jurisdictions. These regulations include constraints pertaining to (i) the manufacturing, processing, formulating, packaging, labeling, distributing and selling (ii) advertising of products and product claims (iii) transfer pricing, and (iv) method of use.
In the United States, the formulation, manufacturing, packaging, storing, labeling, advertising, distribution and sale of products are subject to regulation by various governmental agencies, which include, among others (i) the Food and Drug Administration (“FDA”), (ii) the Federal Trade Commission (“FTC”), and (iii) the Consumer Product Safety Commission. The most active regulation has been administered by the Food and Drug Administration, which regulates the formulation, manufacture and labeling of products pursuant to the Federal Food, Drug and Cosmetic Act (“FDCA”) and regulations promulgated thereunder. Most importantly, the FDA has guidelines under the Dietary Supplement Health and Education Act (DSHEA) to enable the manufacturing, advertising, marketing, and sale of dietary supplements. In addition, the FTC has overlapping jurisdiction with the FDA to regulate the interstate labeling, promotion, advertising and sale of dietary supplements, over the counter drugs, and foods.
Compliance with applicable FDA and any state or local statutes is crucial. Although we believe that we will be in compliance with applicable statutes, should the FDA amend its guidelines or impose more stringent interpretations of current laws or regulations, we may not be able to comply with these new guidelines. As a marketer of products that are ingested by consumers, we are always subject to the risk that one or more of our products that currently are not subject to regulatory action may become subject to regulatory action. Such regulations could require the reformulation of certain products to meet new standards, market withdrawal or discontinuation of certain products not able to be reformulated, imposition of additional record keeping requirements, expanded documentation regarding the properties of certain products, expanded or different labeling and/or additional scientific substantiation. Failure to comply with applicable requirements could result in sanctions being imposed on us, or the contract manufacturers of any of our products, including but not limited to fines, injunctions, product recalls, seizures and criminal prosecution.
The FDCA generally regulates ingredients added to foods and requires that such ingredients making up a food product are themselves safe for their intended uses. In this regard, generally when a company adds an ingredient to a food, the FDCA requires that the ingredient either be determined by the Company to be generally regarded as safe (“GRAS”) by qualified experts or go through FDA’s review and approval process as a food additive.
The FDCA has been amended with respect to dietary supplements by the Dietary Supplement Health and Education Act of 1994 (“DSHEA”). The DSHEA provides a statutory framework governing the safety, composition and labeling of dietary supplements. It regulates the types of statements that can be made concerning the effect of a dietary supplement. The DSHEA generally defines the term “dietary supplement” to include products that contain a “dietary ingredient” which may include vitamins, minerals, herbs or other botanicals, amino acids, and metabolites. Under the DSHEA, a dietary supplement manufacturer is responsible for ensuring that a dietary supplement is safe before it is marketed. Under DSHEA, dietary ingredients that were on the market before October 15, 1994 may be sold without FDA pre-approval and without notifying the FDA. On the other hand, a new dietary ingredient (one not lawfully on the market before October 15, 1994), requires proof that it has been present in the food supply as an article used for food without being chemically altered, or evidence of a history of use or other evidence of safety establishing that it is reasonably expected to be safe. With respect to products or supplements that are manufactured and distributed on our behalf, we intend to comply with and will endeavor to bring our operations into compliance with regulatory requirements relating to such products or supplements. However, the FDA may not accept the evidence of safety for any new dietary ingredients that we may decide to use, and the FDA’s refusal to accept such evidence could result in regulation of such dietary ingredients as adulterated, until such time as reasonable expectation of safety for the ingredient can be established to the satisfaction of the FDA.
With respect to labeling, DSHEA permits “statements of nutritional support” for dietary supplements without FDA pre-approval. Such statements may describe how particular dietary ingredients affect the structure, function or general well being of the body, or the mechanism of action by which a dietary ingredient may affect body structure, function or well being (but may not state that a dietary supplement will diagnose, mitigate, treat, cure or prevent a disease). A company making a statement of nutritional support must possess substantiating evidence for the statement, and disclose on the label that the FDA has not reviewed that statement and that the product is not intended to diagnose, treat, cure or prevent a disease.
The DSHEA allows the dissemination of “third party literature”, publications such as reprints of scientific articles linking particular dietary ingredients with health benefits. Third party literature may be used in connection with the sale of dietary supplements to consumers. Such a publication may be so used if, among other things, it is not false or misleading, no particular brand of dietary supplement is promoted and a balanced view of available scientific information on the subject matter is presented. There can be no assurance, however, that all pieces of third party literature that may be disseminated in connection with our products will be determined by the FDA to satisfy each of these requirements, and any such failure could subject the product involved to regulation as a new drug or as a “misbranded” product, causing us to incur substantial fines and penalties.
The products covered by the Patent and product related activities may also be subject to regulation by other regulatory agencies, including but not limited to the Federal Trade Commission (“FTC”), the Consumer Products Safety Commission, the United States Department of Agriculture, the United States Postal Service, the United States Environmental Protection Agency and the Occupational Safety and Health Administration. Advertising of dietary supplement products is subject to regulation by the FTC under the Federal Trade Commission Act (“FTCA”). The FTCA prohibits unfair methods of competition and unfair or deceptive trade acts or practices in or affecting commerce. Furthermore, the FTCA provides that the dissemination or the causing to be disseminated of any false advertising pertaining to drugs or foods, which would include dietary supplements, is an unfair or deceptive act or practice. Under the FTC’s Substantiation Doctrine, an advertiser is required to have a “reasonable basis” for all objective product claims before the claims are made. Pursuant to this FTC requirement, we are required to have adequate substantiation of all material advertising claims made for products covered by the Patent. Failure to adequately substantiate claims may be considered either deceptive or unfair practices.
The FTC has recently issued a guidance document to assist supplement marketers of dietary supplement products in understanding and complying with the substantiation requirement.
The FTC is authorized to use a variety of processes and remedies for enforcement, both administratively and judicially including compulsory process, cease and desist orders, and injunctions. FTC enforcement can result in orders requiring, among other things, limits on advertising, corrective advertising, consumer redress, divestiture of assets, rescission of contracts and such other relief as may be deemed necessary. State and local authorities can also regulate advertising and labeling for dietary supplements and conventional foods.
Our activities are also regulated by various agencies of the states and localities in which products are sold. The products and product-related activities may also be regulated by the applicable regulatory agencies in other countries in which the products are sold. In foreign markets, prior to commencement of operations and prior to making sales, we may be required to obtain approval, license or certification from the country’s agency governing health. The approval process can be lengthy and costly and may require reformulation of products or labeling. Our failure to comply with foreign regulations could result in products being rejected for sale in such country.
We believe that current and reasonably foreseeable governmental regulation will have minimal impact on our business.
Compliance with Environmental Laws
We are not aware of any environmental laws that have been enacted, nor are we aware of any such laws being contemplated for the future, that impact issues specific to our business. In our industry, environmental laws are anticipated to apply directly to the owners and operators of companies. They do not apply to companies or individuals providing consulting services, unless they have been engaged to consult on environmental matters. We are not planning to provide environmental consulting services.
Employees
We have no full-time employees at the present time. We utilize contractors to market our products. Our Chief Executive Officer, Marvin S. Hausman, M.D. provides employee like services pursuant to a consulting arrangement which began in November 2008. In addition, our Vice President for Sales and Marketing, Devin Andres provides employee like services pursuant to a consulting agreement dated March 1, 2010.
Our President, Chief Executive Officer and Chairman, Marvin S. Hausman, M.D. became the Chief Science Officer of Genesis Biopharma, Inc. pursuant to an Employment Agreement dated March 1, 2011 which has an initial two year term. Under the Employment Agreement Dr. Hausman will perform the duties of a Chief Science Officer in charge of formulating the biotechnology strategy of Genesis Biopharma and other tasks and duties as assigned by the Chief Executive Officer of Genesis Biopharma. Genesis Biopharma states in the agreement that it understands and approves of the fact that Dr. Hausman is engaged in other business activities and will continue to do so during the term of the Employment Agreement. Dr. Hausman estimates that he will work less than seven hours per week for Genesis Biopharma. Under the agreement Dr. Hausman shall receive an annual salary of $78,000 and will have access to medical insurance coverage, will be paid $1,000 per month for office expenses and will be reimbursed for all reasonable and necessary expenses incurred in connection with the performance of his duties. He was also granted two three year stock options, one to purchase 500,000 shares at $1.25 which vests immediately, and another to purchase 2,000,000 shares of common stock for $1.25, which vests in monthly installments. Genesis Biopharma is a biopharmaceutical company engaged in the development and commercialization of drugs and other clinical solutions for metastatic cancers and lethal infectious diseases.
The board of directors of TNS other than Dr. Hausman, have considered the terms of Dr. Hausman’s Employment Agreement with Genesis Biopharma and have determined that while Dr. Hausman’s performance of his duties as Chief Science Officer could impact the amount of time that Dr. Hausman will have available for performing his duties as President, Chief Executive Officer and Chairman of TNS, such impact appears unlikely to materially impair Dr. Hausman’s performance at TNS. However, the disinterested members of the board of directors will periodically assess the situation to ensure that Dr. Hausman’s performance at TNS is not impaired and that his compensation and reimbursement for expenses is reasonable and not duplicative.
Item 1A.
Item 1A. Risk Factors.
RISK FACTORS RELATING TO OUR COMPANY
WE HAVE SIGNIFICANT OUTSTANDING DEBT WHICH WE MUST REPAY WITH INTEREST AND LIMITED REVENUES FROM WHICH TO REPAY SUCH DEBT
We currently have aggregate debt in the principal amount of $612,500 with $300,000 of debt at 6% per annum interest and the other $312,500 of debt at 5% per annum interest. Of this aggregate amount, $100,000 plus $6,000 in interest matured on December 31, 2010 and the repayment of this debt is under negotiation, $200,000 plus $12,000 in interest is due December 31, 2011 and $312,500 plus interest of approximately $22,000 is due June 30, 2012. All of the debt is convertible into shares of our company at the option of the relevant payee. Given that our revenues have not been sufficient to allow for repayment of this debt, we will likely have to undertake private placements of new debt or equity securities to repay these obligations.
WE DID NOT PAY A PROMISSORY NOTE AT THE MATURITY DATE AND IF NEGOTIATIONS CONCERNING THE RESCHEDULING OR REPAYMENT OF THAT DEBT ARE UNSUCCESSFUL THE HOLDER OF THE NOTE COULD DECLARE US IN DEFAULT AND PROCEED AGAINST US.
A promissory note with Larry Johnson in the principal amount of $100,000 with accrued interest of approximately $6,000 matured and was payable in full on December 31, 2010. The note remains unpaid of the date of this report. We have been in negotiations with Mr. Johnson concerning replacement of the previous note with a new note with a later maturity date and the issuance of warrants, however such negotiations have not been finalized and other solutions are being pursued including the assumption of the note by a third party. At Mr. Johnson’s option under the terms of the promissory note, he may proceed against us for costs and expenses of collection, including attorney’s fees, repayment of the principal and accrued interest at maturity, as well as interest from the maturity date at the maximum rate permissible by law. With cash on hand as of December 31, 2010 of $65,061 repayment of this debt would likely involve taking on additional debt or selling our shares in a private placement on terms that could be unfavorable to our financial position and involve significant dilution to our shareholders.
OUR PRESIDENT, CHIEF EXECUTIVE OFFICER, INTERIM CHIEF FINANCIAL OFFICER AND CHAIRMAN COULD DEVOTE LESS TIME TO OUR BUSINESS BECAUSE OF HIS POSITION AS AN EMPLOYEE AND CHIEF SCIENCE OFFICER OF ANOTHER COMPANY.
Our President, Chief Executive Officer and Chairman, Marvin S. Hausman, M.D. became the part time Chief Science Officer of Genesis Biopharma, Inc. pursuant to an Employment Agreement dated March 1, 2011 which has an initial two year term but which may be terminated by either party with thirty (30) days notice. Dr. Hausman will perform the duties of a Chief Science Officer in charge of formulating the biotechnology strategy of Genesis Biopharma and other tasks and duties as assigned by the Chief Executive Officer of Genesis Biopharma. Dr. Hausman estimates that the time required to perform these duties will not exceed seven (7) hours per week and Genesis Biopharma states in the agreement that it understands and approves of the fact that Dr. Hausman is engaged in other business activities and will continue to do so during the term of the Employment Agreement. Under the agreement Dr. Hausman shall receive an annual salary of $78,000 and may have medical insurance coverage, will be paid $1,000 per month for office expenses and will be reimbursed for all reasonable and necessary expenses incurred in connection with the performance of his duties. Performance of his duties as Chief Science Officer could impact the amount of time that Dr. Hausman will have available for performing his duties as President, Chief Executive Officer and Chairman of TNS. The disinterested members of the board of directors will periodically assess the situation to ensure that Dr. Hausman’s performance at TNS is not impaired and that his compensation and reimbursement for expenses is reasonable and not duplicative. Our board of directors will have to be vigilant to ensure that there are no conflicts of interest on the part of Dr. Hausman concerning his duties at TNS and at Genesis Biopharma.
WE EXPECT LOSSES IN THE FUTURE BECAUSE WE HAVE GENERATED LIMITED REVENUE.
We have generated limited revenues and we expect losses over the next year since we have modest revenues to offset the expenses associated in executing our business plan. We cannot guarantee that we will ever be successful in generating substantial revenues in the future or becoming profitable. We recognize that if we are unable to generate substantial revenues, we will not be able to earn profits or continue operations as a going concern. There is no history upon which to base any assumption as to the likelihood that we will prove successful, and we can provide investors with no assurance that we will generate any operating revenues or ever achieve profitable operations.
IF OUR BUSINESS PLAN IS NOT SUCCESSFUL, WE MAY NOT BE ABLE TO CONTINUE OPERATIONS AS A GOING CONCERN AND OUR STOCKHOLDERS MAY LOSE THEIR ENTIRE INVESTMENT IN TNS.
As discussed in the Notes to Financial Statements included in this annual report, at December 31, 2010 we had a working capital deficit of $(233,492). We had a net loss of $(1,266,315) for the year ending December 31, 2010 and an accumulated deficit of $2,313,274 from inception (July 19, 2007) through December 31, 2010.
These factors raise substantial doubt that we will be able to continue operations as a going concern, and our independent auditors included an explanatory paragraph regarding this uncertainty in their audit report. Our ability to continue as a going concern is dependent upon our generating cash flow sufficient to fund operations and reducing operating expenses. Our business plans may not be successful in addressing these issues. If we cannot continue as a going concern, our stockholders may lose their entire investment in us.
OUR INCOME MAY SUFFER IF WE RECEIVE RELATIVELY LARGE ORDERS WITH SHORT LEAD TIMES, OR OUR MANUFACTURING CAPACITY DOES NOT OTHERWISE MATCH OUR DEMAND.
Because we cannot immediately adapt our production capacity and related cost structures to rapidly changing market conditions, when demand does not meet our expectations, our manufacturing capacity will likely exceed our production requirements. Fixed costs associated with excess manufacturing capacity could adversely affect our income. Similarly, if we receive relatively large orders with short lead times, we may not be able to increase our manufacturing capacity to meet product demand, and, accordingly, we will not be able to fulfill orders in a timely manner. During a market upturn, we may not be able to purchase sufficient supplies to meet increasing product demand. In addition, suppliers may extend lead times, limit supplies or increase prices due to capacity constraints or other factors. These factors could materially and adversely affect our results.
OUR FUTURE PROFITABILITY IS UNCERTAIN.
We cannot predict our ability to reduce our costs or achieve profitability. Our research and development expenses are expected to increase as we attempt to develop potential products. As evidenced by the substantial net
losses during 2009 and 2010, losses and expenses may increase and fluctuate from quarter to quarter. There can be no assurance that we will ever achieve profitable operations.
WE HAVE A LIMITED OPERATING HISTORY AS AN INDEPENDENT PUBLIC COMPANY AND WE MAY BE UNABLE TO OPERATE PROFITABLY AS A STAND-ALONE COMPANY.
In order to establish our business, we will need to rely on the sales of our products and we incur expenses for advertising, information systems, rent and additional personnel to support these activities in addition to the salary expenses already mentioned. We therefore expect to incur substantial operating losses for the foreseeable future. Our ability to become profitable depends on our ability to have successful operations and to generate and sustain sales, while maintaining reasonable expense levels, all of which are uncertain in light of our absence of any prior operating history.
We may not be able to successfully put in place the financial, administrative, and managerial structure necessary to operate as fully reporting independent public company, and the development of such structure will require a significant amount of management's time and other resources.
OUR BUSINESS IS SENSITIVE TO PUBLIC PERCEPTION. IF ANY PRODUCT WE DEVELOP PROVES TO BE HARMFUL TO CONSUMERS OR IF SCIENTIFIC STUDIES PROVIDE UNFAVORABLE FINDINGS REGARDING THEIR SAFETY OR EFFECTIVENESS, THEN OUR IMAGE IN THE MARKETPLACE WOULD BE NEGATIVELY IMPACTED.
Our results of operations may be significantly affected by the public’s perception of our company and similar companies. In addition, our business could be adversely affected if any of our future products prove to be harmful to consumers or if scientific studies provide unfavorable findings regarding the safety or effectiveness of our products or any similar products. Moreover, the U.S. FDA could potentially regulate our industry in the future and adversely affect our marketing ability and success. While quality control testing is conducted on the ingredients in such products, we are highly dependent upon consumers' perception of the overall integrity of the dietary supplements business. The safety and quality of products made by competitors in our industry may not adhere to the same quality standards that ours do, and may result in a negative consumer perception of the entire industry. If our products suffer from negative consumer perception, it is likely our sales will slow and we will have difficultly generating revenues.
IF OUR PRODUCTS DO NOT HAVE THE HEALTHFUL EFFECTS INTENDED, OUR BUSINESS MAY SUFFER.
In general, our products consist of food, nutritional supplements which are classified in the United States as “dietary supplements” which we believe do not require approval from the FDA or other regulatory agencies prior to sale. Although many of the ingredients in such products are vitamins, minerals, herbs and other substances for which there is a long history of human consumption, they contain innovative ingredients or combinations of ingredients. Although we believe all of such products and the combinations of ingredients in them are safe when taken as directed, there is little long-term experience with human or other animal consumption of certain of these innovative product ingredients or combinations thereof in concentrated form. The products could have certain side effects if not taken as directed or if taken by a consumer that has certain medical conditions. In addition, such products have been proven to be more effective when taken in accordance with certain instructions which include certain dietary restrictions. Therefore, such products may not be effective if such instructions are not followed. Furthermore, there can be no assurance that any of the products, even when used as directed, will have the effects intended or will not have harmful side effects. If any of such products were shown to be harmful or negative publicity resulted from an individual who was allegedly harmed by one product, it could hurt our business, profitability and growth prospects.
WE MAY NOT BE ABLE TO RAISE SUFFICIENT CAPITAL OR GENERATE ADEQUATE REVENUE TO MEET OUR OBLIGATIONS AND FUND OUR OPERATING EXPENSES.
Failure to raise adequate capital and generate adequate sales revenues to meet our obligations and develop and sustain our operations could result in reducing or ceasing our operations. Additionally, even if we do raise sufficient capital and generate revenues to support our operating expenses, there can be no assurances that the revenue will be sufficient to enable us to develop business to a level where it will generate profits and cash flows from operations.
These matters raise substantial doubt about our ability to continue as a going concern. Our independent auditors currently included an explanatory paragraph in their report on our financial statements regarding concerns about our ability to continue as a going concern.
WE MAY NOT BE ABLE TO COMPETE WITH LARGER SALES CONTRACT COMPANIES, THE MAJORITY OF WHOM HAVE GREATER RESOURCES AND EXPERIENCE THAN WE DO.
The market for nutraceuticals is highly competitive. Numerous manufacturers and distributors compete with us for customers throughout the United States, Canada and internationally in the packaged nutritional supplement industry selling products to retailers such as mass merchandisers, drug store chains, independent pharmacies, and health food stores. Many of our competitors are substantially larger and more experienced than we are. In addition, they have longer operating histories and have materially greater financial and other resources than we do. They therefore have the advantage of having established reputations, brand names, track records, back office and managerial support systems and other advantages that we will be unable to duplicate in the near future. Many of these competitors are private companies, and therefore, we cannot compare our revenues with respect to the sales volume of each competitor. If we cannot compete in the marketplace, we may have difficulty selling our products and generating revenues. Additionally, competition may drive down the prices of our products, which could adversely affect our cost of goods sold and our profitability, if any.
We are also subject to competition from many drug companies due to the fact that our product has what we believe to be health benefits that certain drugs are created to produce.
We are also subject to competition in the attraction and retention of employees. Many of our competitors have greater financial resources and can offer employees compensation packages that are difficult for us to compete with.
WE DEPEND UPON OUR EXECUTIVE OFFICERS AND KEY PERSONNEL.
Our performance depends substantially on the performance of our executive officers. Our chief executive officer is the inventor of the process and formulas used to contract manufacture the future products to be sold by us. We anticipate that he will be the developer of any additional products that we plan to add to our product line. The loss of services of our chief executive officer could have a material adverse effect on our business, revenues, and results of operations or financial condition. We do not maintain key person life insurance on the lives of our officers or key employees.
The success of our business in the future will depend on our ability to attract, train, retain and motivate high quality personnel. Competition for talented personnel is intense, and we may not be able to continue to attract, train, retain or motivate other highly qualified technical and managerial personnel in the future. In addition, market conditions may require us to pay higher compensation to qualified management and technical personnel than we currently anticipate. Any inability to attract and retain qualified management and technical personnel in the future could have a material adverse effect on our business, prospects, financial condition, and/or results of operations.
OUR SUCCESS IS DEPENDENT UPON OUR ABILITY TO PROTECT AND PROMOTE OUR PROPRIETARY RIGHTS.
Our success will depend in large part on our ability to protect and promote our proprietary rights to our formulas and proprietary processes and ingredients.
Our ability to compete effectively depends, to a significant extent, on our ability to maintain the proprietary nature of our intellectual property. There can be no assurance that the scope of the steps we take to protect all of our interests cant be circumvented, or that it will not violate the proprietary rights of others, or that we will not be prevented from using our product if challenged. In fact, even if broad enough, others may still infringe upon our rights, which will be costly to protect. Furthermore, the laws of other countries may less effectively protect our proprietary rights than U.S. laws. Infringement of our rights by a third party could result in uncompensated lost market and revenue opportunities.
WE ARE AT RISK FOR PRODUCT LIABILITY CLAIMS AND REQUIRE ADEQUATE INSURANCE TO PROTECT US AGAINST SUCH CLAIMS. IF WE ARE UNABLE TO SECURE THE NECESSARY INSURANCE COVERAGE AT AFFORDABLE COST TO PROTECT OUR BUSINESS AGAINST ANY CLAIMS, THEN OUR EXPOSURE TO LIABILITY WILL GREATLY INCREASE AND OUR ABILITY TO MARKET AND SELL OUR PRODUCTS WILL BE MORE DIFFICULT SINCE CERTAIN CUSTOMERS RELY ON THIS INSURANCE IN ORDER TO DISTRIBUTE OUR PRODUCTS.
We are constantly at risk that consumers and users of our products will bring lawsuits alleging product liability. Even though we do not manufacture products, a consumer could bring a lawsuit against us alleging product liability due to our ownership of the product(s). We are not aware of any claims pending against us that would adversely affect our business. While we will continue to attempt to take what we consider to be appropriate precautions, these precautions may not protect us from significant product liability exposure in the future. We currently do not have any product liability insurance and there can be no assurance that even if we were to attempt to obtain such insurance that we will be able to obtain, retain coverage or that this coverage will be cost-justified or sufficient to satisfy any future claims. If we are sued, we may not have sufficient resources to defend against the suit or to pay damages. A material lawsuit could negatively impact our business.
OUR OFFICERS/DIRECTORS OWN A CONTROLLING INTEREST IN OUR VOTING STOCK AND INVESTORS WILL NOT HAVE ANY VOICE IN OUR MANAGEMENT, WHICH COULD RESULT IN DECISIONS ADVERSE TO THE INTERESTS OF OUR GENERAL SHAREHOLDERS.
Our officers/directors, in the aggregate, beneficially own approximately or have the right to vote approximately 30% of our outstanding common stock. As a result, these stockholders, acting together, will have the ability to control matters submitted to our stockholders for approval including:
a) election of our board of directors;
b) removal of any of our directors;
c) amendment of our Articles of Incorporation or bylaws; and
d) adoption of measures that could delay or prevent a change in control or impede a merger, takeover or other business combination involving us.
As a result of their ownership and positions, these individuals have the ability to influence all matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions. In addition, the future prospect of sales of significant amounts of shares held by our director and executive officer could affect the market price of our common stock if the marketplace does not orderly adjust to the increase in shares in the market and the value of your investment in the company may decrease. Management's stock ownership may discourage a potential acquirer from making a tender offer or otherwise attempting to obtain control of us, which in turn could reduce our stock price or prevent our stockholders from realizing a premium over our stock price.
RISKS RELATING TO OUR COMMON SHARES
WE MAY, IN THE FUTURE, ISSUE ADDITIONAL COMMON SHARES, WHICH WOULD REDUCE
INVESTORS' PERCENT OF OWNERSHIP AND MAY DILUTE OUR SHARE VALUE.
Our Articles of Incorporation authorize the issuance of 150,000,000 shares of common stock and 5,000,000 preferred shares. The future issuance of common stock may result in substantial dilution in the percentage of our common stock held by our then existing shareholders. We may value any common stock issued in the future on an arbitrary basis. The issuance of common stock for future services or acquisitions or other corporate actions may have the effect of diluting the value of the shares held by our investors, and might have an adverse effect on any trading market for our common stock.
OUR COMMON SHARES ARE SUBJECT TO THE "PENNY STOCK" RULES OF THE SEC AND THE TRADING MARKET IN OUR SECURITIES IS LIMITED, WHICH MAKES TRANSACTIONS IN OUR STOCK CUMBERSOME AND MAY REDUCE THE VALUE OF AN INVESTMENT IN OUR STOCK.
The Securities and Exchange Commission has adopted Rule 15g-9 which establishes the definition of a "penny stock," for the purposes relevant to us, as any equity security that has a market price of less than $5.00 per share or with an exercise price of less than $5.00 per share, subject to certain exceptions.
For any transaction involving a penny stock, unless exempt, the rules require: (a) that a broker or dealer approve a person's account for transactions in penny stocks; and (b) the broker or dealer receive from the investor a written agreement to the transaction, setting forth the identity and quantity of the penny stock to be purchased.
In order to approve a person's account for transactions in penny stocks, the broker or dealer must: (a) obtain financial information and investment experience objectives of the person; and (b) make a reasonable determination that the transactions in penny stocks are suitable for that person and the person has sufficient knowledge and experience in financial matters to be capable of evaluating the risks of transactions in penny stocks.
The broker or dealer must also deliver, prior to any transaction in a penny stock, a disclosure schedule prescribed by the Commission relating to the penny stock market, which, in highlight form: (a) sets forth the basis on which the broker or dealer made the suitability determination; and (b) that the broker or dealer received a signed, written agreement from the investor prior to the transaction. Generally, brokers may be less willing to execute transactions in securities subject to the "penny stock" rules. This may make it more difficult for investors to dispose of our Common shares and cause a decline in the market value of our stock.
Disclosure also has to be made about the risks of investing in penny stocks in both public offerings and in secondary trading and about the commissions payable to both the broker-dealer and the registered representative, current quotations for the securities and the rights and remedies available to an investor in cases of fraud in penny stock transactions. Finally, monthly statements have to be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks.
BECAUSE WE DO NOT INTEND TO PAY ANY CASH DIVIDENDS ON OUR COMMON STOCK, OUR STOCKHOLDERS WILL NOT BE ABLE TO RECEIVE A RETURN ON THEIR SHARES UNLESS THEY SELL THEM.
We intend to retain any future earnings to finance the development and expansion of our business. We do not anticipate paying any cash dividends on our common stock in the foreseeable future. Unless we pay dividends, our stockholders will not be able to receive a return on their shares unless they sell them. There is no assurance that stockholders will be able to sell shares when desired.
WE MAY ISSUE SHARES OF PREFERRED STOCK IN THE FUTURE THAT MAY ADVERSELY IMPACT YOUR RIGHTS AS HOLDERS OF OUR COMMON STOCK.
Our articles of incorporation authorize us to issue up to 5,000,000 shares of preferred stock. Accordingly, our board of directors will have the authority to fix and determine the relative rights and preferences of preferred shares, as well as the authority to issue such shares, without further stockholder approval. As a result, our board of directors could authorize the issuance of a series of preferred stock that would grant to holders preferred rights to our assets upon liquidation, the right to receive dividends before dividends are declared to holders of our common stock, and the right to the redemption of such preferred shares, together with a premium, prior to the redemption of the common stock. To the extent that we do issue such additional shares of preferred stock, your rights as holders of common stock could be impaired thereby, including, without limitation, dilution of your ownership interests in us. In addition, shares of preferred stock could be issued with terms calculated to delay or prevent a change in control or make removal of management more difficult, which may not be in your interest as holders of common stock.
WE HAVE INCURRED INCREASED COSTS AS A RESULT OF BEING A PUBLIC COMPANY.
As a public company, we have incurred significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act of 2002, as well as related rules adopted by the Securities and Exchange Commission, has imposed substantial requirements on public companies, including certain corporate governance practices and requirements relating to internal control over financial reporting. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly. In addition, in the future we will be required to document, evaluate, and test our internal control procedures under Section 404 of the Sarbanes-Oxley Act and the related rules of the Securities and Exchange Commission which will be costly and time consuming. Effective internal controls are necessary for us to produce reliable financial reports and are important in helping prevent financial fraud. If we are unable to achieve and maintain adequate internal controls, our business and operating results could be harmed.
Item 1B.
Item 1B. Unresolved Staff Comments.
Not applicable.
Item 2.
Item 2. Properties.
Our corporate headquarters are located at 80 Columbia Street Stevenson, Washington 98648. We believe our current office space is adequate for our immediate needs; however, as our operations expand, we may need to relocate and secure additional office space.
Item 3.
Item 3. Legal Proceedings.
From time to time, we may become involved in various lawsuits and legal proceedings, which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business.
We are not presently a party to any material litigation, nor to the knowledge of management is any litigation threatened against us, which may materially affect us.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
(a) Market Information
Total Nutraceutical Solutions common stock, $0.001 par value, has been quoted on the OTC-Bulletin Board under the symbol: TNUS.OB. As of the date of this Report, the TNS common stock is quoted on the OTC Bulletin Board under the symbol TNUSE.OB on a temporary basis pending the filing of this Annual Report on Form 10-K. If this Annual Report is filed on or prior to May 18, 2011, and if TNS files its required periodic reports on a timely basis, the stock symbol will revert to TNUS.OB. The stock was initially cleared for trading on the OTC-Bulletin Board on November 1, 2007.
The table below sets forth the high and low bid prices of our common stock for each quarter shown, Quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.
(b) Holders of Common Stock
As of May 12, 2011, there were approximately 128 shareholders of record of our common stock with 61,362,470 total shares outstanding.
(c) Dividends
In the future we intend to follow a policy of retaining earnings, if any, to finance the growth of the business and do not anticipate paying any cash dividends in the foreseeable future. The declaration and payment of future dividends on the Common Stock will be the sole discretion of board of directors and will depend on our profitability and financial condition, capital requirements, statutory and contractual restrictions, future prospects and other factors deemed relevant.
(d) Securities Authorized for Issuance under Equity Compensation Plans
The following table sets forth information about the common stock available for issuance under compensatory plans and arrangements as of December 31, 2010.
(a)
(b)
(c)
Plan Category
Number of securities to be issued upon exercise of outstanding options, warrants, and rights.
Weighted-average exercise price of outstanding options, warrants, and rights
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
Equity compensation plan
approved by security holders
$0
15,000,000
Total
15,000,000
The Total Nutraceutical Solutions, Inc. 2010 Stock Incentive Plan was adopted by the board of directors on September 17, 2010 and approved by the stockholders on October 21, 2010. No grants under the 2010 Stock Incentive Plan were made during the fiscal year ended December 31, 2010.
Recent Sales of Unregistered Securities
There were no sales of unregistered securities that have not previously been disclosed in our periodic reports.
Issuer Purchases of Equity Securities
We did not repurchase any of our equity securities during the years ended December 31, 2010 or 2009.
Item 6.
Item 6. Selected Financial Data.
Not applicable.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Overview of Current Operations
Total Nutraceutical Solutions, Inc. is an emerging nutraceutical company with a focus on discovering, formulating and marketing products composed primarily of organic natural mushrooms that contain bioactive nutrients for potential health benefits. We develop production and analytic technologies for food and nutritional supplements composed primarily of mushrooms. In addition to preventative healthcare formulations and nutritional approaches to a wide variety of human conditions and illnesses, we also develop and acquire nutritional tools and products in the fields of animal husbandry and livestock feeds.
We have developed mushroom based nutraceutical dietary supplement products that are made entirely of naturally occurring dietary substances which are manufactured under contract by third parties, Columbia Nutritional Services, Inc. of Vancouver, Washington and Pro-Tech Laboratories of Quitman, Texas. These naturally occurring dietary substances have not been chemically altered, and we believe these products have both health benefits and mass appeal to people wanting natural and non-toxic nutritional-based healthcare. We sell directly to consumers our own proprietary formulations of over the counter mushroom based nutraceutical products or through our Direct Marketing Affiliates Program (DMAP).
Results of Operations for the year ended December 31, 2010
Revenues and Cost of Goods Sold (in thousands, except percentages):
Revenues. Revenues are generated primarily from the sale of our mushroom based nutraceutical dietary supplement products. Revenues increased in 2010 compared to 2009 primarily because in 2010 we sold our mushroom supplement products for the entire year, whereas in 2009, we did not begin to sell our products until the third quarter. In addition we released a new product, Groh, in the second quarter of fiscal 2010 which increased revenues by approximately $20,000. We also began selling the NuFlex product line through the DMAP in the second quarter of fiscal 2010, which increased revenues by approximately $120,000.
Cost of Goods Sold. Cost of goods sold includes raw materials such as nutraceutical mushrooms, as well as production costs for manufacturing our supplement products. Cost of goods sold as a percentage of revenue decreased from 334% in fiscal year 2009 to 41% in fiscal year 2010. Our cost of goods for fiscal year 2009 increased due to the addition to our inventory reserve in our restatement of the 2009 financial statements and our cost of goods for fiscal year 2010 decreased as our production processes have become more efficient in our second year of production.
The following is a summary of certain consolidated statement of operations data for the periods:
Operating Expenses (in thousands, except percentages):
Advertising and promotional expenses. These costs include costs for promotional products, production fees for marketing materials, costs associated with fulfillment, fees for advertising programs such as ad placement fees, and postage fees for mailing marketing materials. The increase from 2009 is primarily due to advertising costs related to the launch of the NuFlex product line by the Direct Marketing Affiliate Program.
Professional fees. These expenses primarily include the legal, accounting and auditing fees associated with establishing and maintaining the infrastructure of a public company. The decrease from 2009 is primarily due to lower legal fees.
Sales Commissions/Consulting fees. These expenses are comprised of fees incurred by third-party consultants for the provision of administrative, information technology and marketing management services. The increase from 2009 is primarily due to expenses related to a consulting arrangement whereby we issued shares of our common stock in exchange for certain marketing services.
General and administrative expenses. These expenses primarily include costs related to travel, rent and utilities, insurance, depreciation, product development and bad debt. The increase from 2009 is partially attributable to bad debt expense from a related party in the DMAP and the reserve for an uncollectible note receivable from a related party. In addition, product development expenses increased due to a one year research project with a university. There were also increases in travel, insurance and depreciation expense attributable to the growth in our business.
Other income and expense: Other income and expense consists of interest income, interest expense, and gains or losses related to foreign currency transactions. The increase from fiscal 2009 is due to the amortization of discounts from warrants and the beneficial conversion feature on convertible notes payable entered into during fiscal 2010.
Inflation
Inflation has not had a significant impact in the current or prior periods.
Significant changes in the number of employees
As of December 31, 2010, we did not have any employees. We are dependent upon Marvin S. Hausman, M.D., our Chief Executive Officer and Devin Andres our Vice President of Sales and Marketing, each of whom provides employee like services under consulting arrangements for our future business development. As our operations expand we anticipate the need to hire employees, and contract with additional consultants; however, the exact number is not quantifiable at this time.
Liquidity and Capital Resources
At December 31, 2010, cash totaled $65,061, compared to $48,141 at December 31, 2009. The primary reasons for the net increase in 2010 are described below. Cash is held primarily in general checking accounts. Working capital was $(233,492) at December 31, 2010, compared to $66,117 at December 31, 2009. The change in working capital was due primarily to financing activities as discussed below. The net change in cash and cash equivalents for the periods presented was comprised of the following (in thousands):
Operating Activities. The overall net decrease in cash used by operating activities was due primarily to our net loss, offset by an increase in accrued compensation - officer as payments for consulting services, and out of pocket travel expenses as well as office expenses to our Chief Executive Officer Marvin Hausman have been deferred since June 2010, as well as an increase in non-cash activities due to the amortization of the discounts on convertible notes payable entered into in fiscal 2010 and stock based-compensation primarily due to a consulting arrangement whereby we issued shares of our common stock in exchange for certain marketing services.
Investing Activities. The decrease in net cash flows from investing activities was due primarily to a loan made to a related party in fiscal 2010, partially offset by collections of a lease receivable.
Financing Activities. The increase in net cash flows from financing activities was due primarily to convertible notes payable entered into during fiscal 2010. We had borrowings of approximately $550,000 in fiscal 2010 with terms of one to three years.
Future Liquidity. We have a history of incurring net losses and negative operating cash flows. We are also deploying new technologies and continue to develop commercial products and services. Based on our cash on hand, income from operations and the degree to which our burn rate can be reduced while continuing operations, management believes it has sufficient funds to remain operational through June 2011.
We expect our revenues to increase slightly in 2011. With approximately $177,000 in inventory as of December 31, 2010, increased revenues could help our liquidity position in 2011. Notwithstanding, we anticipate generating losses in 2011 and therefore we may be unable to continue operations in the future. In order for us to continue as a going concern and ultimately to achieve profitability, we may be required to obtain capital from external sources, increase revenues and reduce operating costs. We will require additional capital of at least $300,000 to repay debt during our fiscal year ending December 31, 2011 and we intend to raise the monies by undertaking one or more equity private placements. We may also pursue re-negotiation and re-structuring of the debt. However, there can be no assurances that our operations will become profitable or that external sources of financing, including the issuance of debt and/or equity securities, will be available at times and at terms acceptable to us, or at all. The issuance of additional equity or convertible debt securities will also cause dilution to our shareholders. If external financing sources are not available or are inadequate to fund our operations, we will be required to reduce operating costs, which could jeopardize our future strategic initiatives and business plans. For example, reduction in operating costs could jeopardize our ability to launch, market and sell new nutraceutical supplement products necessary to grow and sustain our operations.
Subsequent Events
In January 2011, we issued 2,000,000 shares of common stock to Keith Manfred under a Consulting Agreement dated August 26, 2010 pursuant to which Mr. Manfred has performed various marketing services to TNS. These shares were registered under a registration statement on Form S-8.
On January 26, 2011, we entered into a convertible note payable with Delta Group Investments Limited (DGI) which replaces the convertible note payable with DGI dated March 26, 2010. This convertible note payable is in the amount of $312,500 and bears interest at 5% per year and expires on June 30, 2012. DGI has the option to convert the outstanding note into TNS restricted common shares at $0.06 per share at any time prior to payment in full of the principal balance of the convertible note payable. In connection with the issuance of the convertible note payable, we granted DGI a warrant to purchase 600,000 common shares exercisable at $0.12 per share expiring 3 years from the date of issuance.
Effective February 17, 2011, we entered into a Termination of Profit Sharing Agreement, whereby the DMAP was terminated. Per this termination agreement, all assets and property of the DMAP will be transferred to TNS. As managing affiliate of the DMAP, TNS is responsible for the wind up the activities of the DMAP.
On March 15, 2011 we entered into a non-cancelable lease for office and warehouse space. This lease replaces the existing lease for these premises and expires May 31, 2012.
In April 2011 we issued 1,000,000 shares to MSH Ventures pursuant to an Assignment and Assumption Agreement between TNS and MSH Ventures dated October 26, 2009 under which MSH Ventures assigned all of its rights to an Exclusive License Agreement with the University of Cologne in Germany pertaining to a patent application entitled “Identification of Ergothioneine Transporter and Therapeutic Uses Thereof.” Our President and Chief Executive Officer, Marvin S. Hausman, M.D. owns a 66% equity interest in MSH Ventures.
Going Concern
Our independent auditors included an explanatory paragraph in their report on the accompanying financial statements regarding concerns about our ability to continue as a going concern. Our financial statements contain additional note disclosures describing the circumstances that lead to this disclosure by our independent auditors.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results or operations, liquidity, capital expenditures or capital resources that is material to investors.
Critical Accounting Policies and Estimates
Revenue Recognition: We recognize revenue from product sales once all of the following criteria for revenue recognition have been met: pervasive evidence that an agreement exists; the services have been rendered; the fee is fixed and determinable and not subject to refund or adjustment; and collection of the amount due is reasonable assured.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
Not applicable.
Item 8.
Item 8. Financial Statements and Supplementary Data
Total Nutraceutical Solutions, Inc.
December 31, 2010 and 2009
Index to Consolidated Financial Statements
Contents Page(s)
Reports of Independent Registered Public Accounting Firms
27-28
Consolidated Balance Sheets at December 31, 2010 and 2009
Consolidated Statements of Operations for the Years Ended December 31, 2010 and 2009
Consolidated Statements of Stockholders’ Deficit for the Years Ended December 31, 2010 and 2009
Consolidated Statements of Cash Flows for the Years Ended December 31, 2010 and 2009
Notes to the Consolidated Financial Statements
33-50
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
Total Nutraceutical Solutions, Inc.
Stevenson, Washington
We have audited the accompanying consolidated balance sheet of Total Nutraceutical Solutions, Inc. and subsidiary ("the Company") as of December 31, 2010, and the related consolidated statements of operations, stockholders' equity (deficit), and cash flows for the year then ended. 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 audit.
We conducted our audit 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. The Company has determined that it is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. 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 audit provides 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 Total Nutraceutical Solutions, Inc. and subsidiary as of December 31, 2010, and the results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States.
The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has a history of incurring net losses and net operating cash flow deficits. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans regarding these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ PETERSON SULLIVAN LLP
Seattle, Washington
May 18, 2011
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Total Nutraceutical Solutions, Inc.
Stevenson, Washington
We have audited the accompanying balance sheets of Total Nutraceutical Solutions, Inc. (the “Company”) as of December 31, 2009 and the related statements of operations, stockholders’ equity and cash flows for the year then . 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 audit.
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. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. 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 audit provides a reasonable basis for our opinion.
The Company’s balance sheet at December 31, 2009, the related statement of operations, statements of stockholders’ equity and cash flows for the year then ended have been restated. The restatements of the financial statements are described in Note 3.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2009 and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company had an accumulated deficit at December 31, 2009 and had a net loss and cash used in operations for the year then ended. These factors raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regards to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/Li & Company, PC
Li & Company, PC
Skillman, New Jersey
May 18, 2011
Total Nutraceutical Solutions, Inc.
December 31, 2010 and 2009
Notes to the Consolidated Financial Statements
NOTE 1 - ORGANIZATION AND OPERATIONS
Generic Marketing Services, Inc. was incorporated on July 19, 2007 under the laws of the State of Nevada as a subsidiary of Basic Services, Inc., also a Nevada corporation. On December 31, 2007, Basic Services spun off Generic Marketing Services. On October 8, 2008, Generic Marketing Services changed its name to Total Nutraceutical Solutions, Inc. (TNS, the Company, us, we, or our). We engage in the distribution of organic dietary supplement nutraceutical products in the United States of America.
On March 26, 2010 we entered into a Profit Sharing Agreement or Direct Marketing Affiliates Project (DMAP) with American Charter & Marketing LLC (ACM) and Delta Group Investments Limited (DGI), with the primary focus of undertaking a direct mail marketing campaign designed to sell nutraceutical products developed and manufactured by TNS. The Company acted as Managing Affiliate. DGI provided $300,000 in the form of a loan, as starting capital for the project. The net profits of the DMAP project were to be shared with 25% going to the Company, 25% to DGI, 25% to ACM and 25% as a return on the initial loan. This agreement was terminated subsequent to December 31, 2010, effective February 17, 2011.
We have a history of incurring net losses and net operating cash flow deficits. We are also developing new technologies related to our organic nutraceutical products. At December 31, 2010, we had cash and cash equivalents of $65,061. As a result, we anticipate that our cash and cash equivalent balances, anticipated cash flows from operations and anticipated operating cash flows will be sufficient to meet our cash requirements through June 2011. In order for us to continue as a going concern beyond this point and ultimately to achieve profitability, we may be required to obtain capital from external sources, increase revenues and reduce operating costs. The issuance of equity securities will also cause dilution to our shareholders. If external financing sources of financing are not available or are inadequate to fund our operations, we will be required to reduce operating costs including personnel costs, which could jeopardize our future strategic initiatives and business plans. The accompanying consolidated financial statements have been prepared assuming that the company continues as a going concern. The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the matters discussed herein.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
References to Authoritative Accounting Literature
In June 2009, the Financial Accounting Standards Board (FASB) issued the Accounting Standards Codification (ASC) as the single source of authoritative U.S. generally accepted accounting principles (U.S. GAAP) recognized by the FASB to be applied by non-governmental entities in preparation of financial statements in conformity with U.S. GAAP, except for additional authoritative rules and interpretative releases issued by the SEC. While the adoption of the ASC changes how we reference accounting standards, the adoption did not have an impact on our consolidated financial statements.
Basis of presentation and principles of consolidation
The accompanying consolidated financial statements and related notes have been prepared in accordance with U.S. GAAP. Investments for which we possess the power to direct or cause the direction of the management and policies, either through majority ownership or other means, are accounted for under the consolidation method. Material intercompany transactions and balances have been eliminated in consolidation.
The consolidated financial statements include the accounts of TNS as of December 31, 2010 and 2009 and the accounts of DMAP as of December 31, 2010 and for the period from March 26, 2010 (inception) through December 31, 2010. All inter-company balances and transactions have been eliminated.
Use of estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash
We consider all highly liquid, short-term investments with original maturities of three months or less when purchased to be cash equivalents.
Accounts receivable
Accounts receivable are recorded at the invoiced amount, net of allowance for doubtful accounts. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses based on specific identification of accounts in our existing accounts receivable. Outstanding account balances are reviewed individually for collectibility. We determine the allowance based on historical write-off experience, customer specific facts and economic conditions. Bad debt expense is included in general and administrative expenses, if any. We consider all accounts greater than 30 days old to be past due. Account balances are charged off against allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The allowance for doubtful accounts was $54,582 and zero at December 31, 2010 and 2009, respectively.
Inventory
Inventory, which consists primarily of raw materials to be used in the production of our dietary supplement products, is stated at the lower of cost or market using the first-in, first-out method. We regularly review our inventory on hand and, when necessary, record a provision for excess or obsolete inventory. The inventory reserve was $149,602 and $164,987 at December 31, 2010 and 2009, respectively.
Property and equipment
Property and equipment are recorded at cost. Additions and improvements that increase the value or extend the life of an asset are capitalized. Maintenance and repairs are expensed as incurred. Upon sale or retirement of property and equipment, the related cost and accumulated depreciation are removed from the accounts and any gain or loss is reflected in the consolidated statement of operations. Depreciation is computed on a straight-line basis over the following estimated useful lives of the assets:
Office equipment
3 years
Production equipment
5 to 7 years
Leasehold improvements
Lesser of lease term or useful life of improvement
Patents
Patents, once issued or purchased, are amortized using the straight-line method over their economic remaining useful lives. All internally developed process costs incurred to the point when a patent application is to be filed are expensed as incurred and classified as research and development costs. Patent application costs, generally legal costs, are capitalized pending disposition of the individual patent application, and are subsequently either amortized based on the initial patent life granted, generally 15 to 20 years for domestic patents and 5 to 20 years for foreign patents, or expensed if the patent application is rejected. The costs of defending and maintaining patents are expensed as incurred. Upon becoming fully amortized, the related cost and accumulated amortization are removed from the accounts.
Impairment of long-lived assets
Our long-lived assets, which include property and equipment, patents and licenses of patents are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
We assess the recoverability of our long-lived assets by comparing the projected undiscounted net cash flows associated with the related long-lived asset or group of long-lived assets over their remaining estimated useful lives against their respective carrying amounts. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets. Fair value is generally determined using the asset’s expected future discounted cash flows or market value, if readily determinable. If long-lived assets are determined to be recoverable, but the newly determined remaining estimated useful lives are shorter than originally estimated, the net book values of the long-lived assets are depreciated over the newly determined remaining estimated useful lives. We determined that there was no impairment of long-lived assets as of December 31, 2010 or 2009.
Lease receivable
We amortize the unearned income and initial direct costs on a direct financing lease to income over the term of the lease to produce a constant periodic rate of return on the net investment in the lease.
Discount on convertible notes payable
We allocate the proceeds received from convertible notes between convertible notes payable and warrants, if applicable. The resulting discount for warrants is amortized using the effective interest method over the life of the debt instrument. After allocating a portion of the proceeds to the warrants, the effective conversion price of the convertible note payable can be determined. If the effective conversion price is lower than the market price at the date of issuance, a beneficial conversion feature is recorded as an additional discount to the convertible note payable. The beneficial conversion feature discount is amortized using the effective interest method over the life of the debt instrument. The amortization is recorded as interest expense on the consolidated statement of operations.
Derivatives embedded in certain debt securities
We evaluate financial instruments for freestanding or embedded derivatives. Derivative instruments that have been separated from the host contract and do not qualify for hedge accounting are recorded at fair value with changes in value recognized as other income (expense) in the consolidated statements of operations.
Fair value of financial instruments
The carrying amounts of our financial assets and liabilities, such as cash, accounts receivable, prepaid expenses, accounts payable and accrued officer’s compensation, approximate their fair values because of the short maturity of these instruments. Our lease receivable, notes payable and convertible notes payable approximate the fair value of such instruments based upon management’s best estimate of interest rates that would be available to TNS for similar financial arrangements at December 31, 2010 and 2009.
Fair value measurements
We measure fair value as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that is determined based on assumptions that market participants would use in pricing an asset or liability. We utilize a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:
We do not have any assets or liabilities measured at fair value on a recurring or a non-recurring basis. Consequently, we did not have any fair value adjustments for assets and liabilities measured at fair value at December 31, 2010 or 2009, nor any gains or losses reported in the consolidated statement of operations that are attributable to the change in unrealized gains or losses relating to those assets and liabilities still held at the reporting date for the periods ended December 31, 2010 and 2009.
Revenue recognition
We recognize revenue when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been performed, (iii) amounts are fixed or determinable and (iv) collectibility of amounts is reasonably assured.
Revenues from the sale of products, including shipping and handling fees but excluding statutory taxes collected from customers, as applicable, are recognized when shipment has occurred. We sell our products directly to customers. Persuasive evidence of an arrangement is demonstrated via order and invoice, product delivery is evidenced by a bill of lading from the third party carrier and title transfers upon shipment, the sales price to the customer is fixed upon acceptance of the order and there is no separate sales rebate, discount, or volume incentive.
Shipping and handling costs
Amounts charged to customers for shipping products are included in revenues and the related costs are classified in cost of goods sold as incurred.
Advertising costs
Costs associated with the advertising of our products are expensed as incurred.
Research and development
Research and development costs are charged to expense as incurred. Research and development costs consist primarily of material and testing costs for research and development as well as research and development arrangements with unrelated third party research and development institutions. These research and development arrangements usually involve one specific research and development project. We may make non-refundable advances upon signing of these arrangements. Non-refundable advance payments for goods or services that will be used or rendered for future research and development activities are deferred and capitalized. Such amounts are recognized as an expense as the related goods are delivered or as the related services are performed. Management periodically evaluates whether the goods will be delivered or services will be rendered. If management does not expect the goods to be delivered or services to be rendered, the capitalized advance payment is charged to expense. Research and development expense was $81,804 and $55,437 in 2010 and 2009, respectively.
Foreign currency transactions
Foreign currency transactions are transactions denominated in currencies other than U.S. Dollar, our functional and reporting currency. Foreign currency transactions may produce receivables or payables that are fixed in terms of the amount of foreign currency that will be received or paid. A change in exchange rates between the functional currency and the currency in which a transaction is denominated increases or decreases the expected amount of functional currency cash flows upon settlement of the transaction. That increase or decrease in expected functional currency cash flows is a foreign currency transaction gain or loss that we include in determining net income for the period in which the exchange rate changes. Likewise, a transaction gain or loss (measured from the transaction date or the most recent intervening balance sheet date, whichever is later) realized upon settlement of a foreign currency transaction is reported in net income for the period in which the transaction is settled.
Equity instruments issued to parties other than employees for acquiring goods or services
We account for all transactions in which goods or services are the consideration received for the issuance of equity instruments based on the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more reliably measurable. The measurement date used to determine the fair value of the equity instrument issued is the earlier of the date on which the performance is complete or the date on which it is probable that performance will occur. Currently such transactions are primarily awards of warrants to purchase common stock.
The fair value of each warrant award is estimated on the date of grant using a Black-Scholes option-pricing valuation model. The assumptions used to determine the fair value of our warrants are as follows:
Income taxes
We recognize deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance to the extent management concludes it is more likely than not that the assets will not be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in our consolidated statements of income in the period that includes the enactment date.
We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in our consolidated financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Should they occur, our policy is to classify interest and penalties related to tax positions as income tax expense.
Net loss per common share
Basic and diluted net loss per share has been computed by dividing our net loss by the weighted average number of common shares issued and outstanding. Options and warrants to purchase our common stock as well as debt which is convertible into common stock are anti-dilutive and therefore are not included in the determination of the diluted net loss per share for 2010 and 2009. The following table presents a reconciliation of basic and diluted loss per share:
Reclassifications
Certain reclassifications have been made to prior period financial statements and footnotes in order to conform to the current period's presentation.
Segments
We have determined that we operate in one segment for financial reporting purposes.
Recently issued accounting pronouncements
In March 2010, the FASB issued new authoritative guidance regarding revenue recognition to define a milestone and clarify that the milestone method of revenue recognition is a valid application of the proportional performance model when applied to research or development arrangements. Accordingly, a company can make an accounting policy election to recognize a payment that is contingent upon the achievement of a substantive milestone in its entirety in the period in which the milestone is achieved. This guidance began phasing in during the third quarter of 2010. The implementation of this guidance did not have a material impact on our consolidated financial position, results of operations or cash flows.
In January 2010, the FASB issued new authoritative guidance regarding the disclosure of fair value measurements, which clarifies certain existing disclosure requirements as well as requiring new disclosures related to significant transfers between each fair value level as well as requiring additional information about Level 3 activity. This guidance began phasing in during the first fiscal period after December 15, 2009. The implementation of this guidance did not have a material impact on our consolidated financial position, results of operations or cash flows.
In October 2009, the FASB issued new authoritative guidance to require companies to allocate revenue in multiple-element arrangements based on an element's estimated selling price if vendor-specific or other third-party evidence of value is not available. The new guidance is effective for revenue transactions entered into during fiscal years beginning on or after June 15, 2010, with earlier application permitted. The early adoption of this guidance did not have a material impact on our consolidated financial position, results of operations or cash flows.
Management does not believe that any other recently issued, but not yet effective accounting pronouncements, if adopted, would have a material effect on the accompanying financial statements.
NOTE 3 - RESTATEMENT OF FINANCIAL STATEMENTS
Subsequent to the issuance of our consolidated balance sheet, consolidated statement of operations, consolidated statement of stockholders’ equity (deficit) and consolidated statement of cash flows as of and for the year ended December 31, 2009, our management identified certain accounting misstatements. Accordingly, we have restated those previously issued financial statements. Details of the restatements are set out below:
(i)
To establish a reserve for excess and obsolete inventory in the amount of $164,987 as of December 31, 2009.
(ii)
To accrue legal fees for services rendered in 2009 in the amount of $67,348 as of December 31, 2009 received by the Company on November 2, 2010.
The restatements resulted in an increase to the 2009 net loss and accumulated deficit at January 1, 2010 of $232,335. The net cash used in operating activities for 2009 was not changed.
The following table summarizes the impact of the above mentioned adjustments to the financial statement information.
NOTE 4 - INVENTORY
Inventory at consisted of the following at:
NOTE 5 - PROPERTY AND EQUIPMENT
Property and equipment, stated at cost, less accumulated depreciation at consisted of the following at:
Depreciation expense was $7,012 and $2,290 for the years ended December 31, 2010 and 2009, respectively.
NOTE 6 - PATENTS AND LICENSES, NET
Our identifiable long-lived intangible assets are patents and prepaid licenses. As of December 31, 2010, none of our patents have been completed and are not being amortized. The licenses are being amortized over an economic useful life of 17 years. The gross carrying amounts and accumulated amortization related to these intangible assets consist of the following at:
License amortization expense was $544 and zero for the years ended December 31, 2010 and 2009. Annual aggregate amortization expense for each of the next five years through December 31, 2013 is estimated to be $1,000 per year.
NOTE 7 - LEASE RECEIVABLE
We have entered into an agreement which expires in January 2012, to lease certain production equipment.
The components of the lease receivable for the years ending December 31:
NOTE 8 - NOTES PAYABLE
Notes payable consisted of the following at:
NOTE 9 - CONVERTIBLE NOTES PAYABLE - RELATED PARTIES
Proceeds from the issuance of a $50,000 convertible promissory note and warrants from related parties was allocated between the notes and warrants on a relative fair value basis. This note bears interest at 6% per annum and matures on December 31, 2011. The related party note holders are (i) Marvin Hausman, M.D., Chief Executive Officer, Director and Stockholder of TNS and (ii) Philip Sobol, a Director of the TNS. The total value allocated to the warrants was approximately $22,200. The fair value of the warrants was determined using the Black-Scholes option pricing model based on the following assumptions: expected dividend yield of 0%, risk-free interest rate of 2.69%,volatility of 80.52% and a contractual life of 5 years. The value of the warrants was recorded as a debt discount against the proceeds of the note. In addition, the beneficial conversion feature related to the note was determined to be approximately $27,800. As a result, the total discount on the note totaled $50,000, and is being amortized over term of the note. Amortization of debt discount of approximately $25,000 and zero was recorded for 2010 and 2009, respectively.
NOTE 10 - SHORT-TERM CONVERTIBLE NOTES PAYABLE
Proceeds from the issuance of $250,000 from short-term convertible promissory notes and warrants were allocated between the notes and warrants on a relative fair value basis. The issuance of $250,000 includes one $100,000 promissory note that bears interest at 6% per annum and matures on December 31, 2010. We are currently negotiating an extension to this note. In addition, two promissory notes were issued with principal of $100,000 and $50,000 which bear interest at 6% per annum and mature on December 31, 2011. The total value allocated to the warrants was approximately $123,750. The fair value of the warrants was determined using the Black-Scholes option pricing model based on the following assumptions: expected dividend yield of 0%, risk-free interest rate of 2.46 - 2.49%, volatility of 72.67 - 78.08% and a contractual life of 5 years. The value of the warrants was recorded as a debt discount against the proceeds of the notes. In addition, the
beneficial conversion features related to the notes were determined to be approximately $126,250. As a result, the total discount on the notes totaled $250,000, and is being amortized over term of the notes. Amortization of debt discount of approximately $170,000 and zero was recorded for 2010 and 2009, respectively.
NOTE 11 - CONVERTIBLE NOTES PAYABLE
Proceeds from the issuance of a $300,000 convertible promissory note and warrants were allocated between the notes and warrants on a relative fair value basis. This note bears interest at 5% per annum and matures on March 26, 2013. The total value allocated to the warrants was approximately $68,700. The fair value of the warrants was determined using the Black-Scholes option pricing model based on the following assumptions: expected dividend yield of 0%, risk-free interest rate of 1.64%, volatility of 67.63% and a contractual life of 3 years. The value of the warrants was recorded as a debt discount against the proceeds of the note. In addition, beneficial conversion feature related to the note were determined to be approximately $68,700. As a result, the total discount on the notes totaled $137,400, and is being amortized over term of the note. Amortization of debt discount of approximately $34,350 and zero was recorded for 2010 and 2009, respectively.
NOTE 12 - RELATED PARTY TRANSACTIONS
Consulting services from Chairman and CEO
Expense for consulting services provided by the Chairman and CEO were $120,000 for both of the years ended December 31, 2010 and 2009.
Receivables from and payables to Related Parties
During 2010 we loaned $62,500 to one of the principals of ACM, Gary Ballen. ACM is one of the affiliates of the DMAP. The funds were transferred from the DMAP. In the quarter ended December 31, 2010 we determined that this loan was uncollectible and established a reserve for the entire amount of the loan.
As of December 31, 2010, $54,582 of accounts receivable was due from ACM, one of the affiliates of the DMAP. In the quarter ended December 31, 2010 we determined that these receivables were uncollectible and established a reserve for the entire $54,582.
NOTE 13 - STOCKHOLDERS’ EQUITY (DEFICIT)
Common stock
In 2009, we opened a private placement offering to sell a minimum of 1,200,000 units and a maximum of 3,000,000 units, at an offering price of $0.50 per unit. Each unit is comprised of two shares of common stock, $0.001 par value, and two, three year callable warrants - an "A" warrant to purchase one share of common stock exercisable at $0.75 per share and a "B" warrant to purchase one share of common stock exercisable at $1.00 per share. This private placement offering closed on June 9, 2009. On February 5, 2009, 300,000 units or 600,000 shares of common stock were issued to an individual for $150,000. On June 9, 2009, 819,000 units or 1,638,000 shares of common stock were issued to individuals in exchange for $409,500. The aggregate amount raised under this offering was $559,500.
On March 31, 2009, 720 shares of common stock were issued as a consulting fee and valued at $180 based on the terms of the consulting agreement.
On September 22, 2009, 100,000 shares of common stock were issued for $25,000 cash to one investor for $0.25 a share.
On January 29, 2010 a Certificate of Amendment to Articles of Incorporation of TNS was filed with the Secretary of State of Nevada. On January 4, 2010, a majority of the stockholders of TNS, holding 54% of the outstanding shares of TNS, pursuant to a written consent in lieu of a special meeting, adopted amendments to the Articles of Incorporation of the corporation. The amendments involved the change of the name of the corporation from Total Nutraceutical Solutions to
Total Nutraceutical Solutions, Inc. and an increase in the number of shares of common stock authorized to be issued from 70 million shares to 150 million shares.
On August 26, 2010, we entered into a consulting agreement for marketing services. Under this agreement the consultant will provide certain marketing services in exchange for 4,000,000 shares of our common stock valued at $420,000 at the date of grant, the fair value of service to be rendered which is more reliably measurable. 2,000,000 shares were issued at signing and the remaining shares to be issued on a quarterly basis over the second year of the agreement.
On October 22, 2010, we issued 1,300,000 shares of common stock to a law firm to settle accounts payable of $67,348.
In 2010, we opened a private placement offering to sell up to 6,000,000 units, at an offering price of $0.04 per unit. Each unit is comprised of one share of common stock, $0.001 par value, and two, three year callable warrants - an "A" warrant to purchase one share of common stock exercisable at $0.15 per share and a "B" warrant to purchase one share of common stock exercisable at $0.30 per share. This private placement offering closed on December 14, 2010 and 3,050,000 shares of common stock were issued for an aggregate amount of funding of $122,000.
Stock incentive plan
On September 17, 2010, our Board of Directors adopted the Total Nutraceutical Solutions, Inc. 2010 Stock Incentive Plan (the Plan) effective October 21, 2010 upon approval by the stockholders The Plan provides for awards in the form of restricted shares or options (which may constitute incentive stock options or nonstatutory stock options). The Plan shall be administered by the Board of Directors or a committee of the Board of Directors consisting of two or more directors.
Common shares issuable pursuant to the Plan may be authorized but unissued shares or treasury shares. The aggregate number of options and restricted shares awarded under the Plan shall not exceed (a) 15 million common shares plus (b) the annual increase in shares of 500,000 as of January 1 of each year, commencing with the year 2012. If options are forfeited or terminate for any other reason before being exercised, then the corresponding common shares shall again become available for the grant of options or restricted shares under the Plan. If restricted shares or common shares issued upon the exercise of options are forfeited, then such common shares shall again become available for the grant of nonstatutory stock options (NSOs) and restricted shares under the Plan. The aggregate number of common shares that may be issued under the Plan upon the exercise of incentive stock options (ISOs) shall not be increased when restricted shares or other common shares are forfeited.
Each grant of an option under the Plan shall be evidenced by a stock option agreement between the optionee and TNS. Such option shall be subject to all applicable terms of the Plan and may be subject to any other terms that are not inconsistent with the Plan. Options granted to any optionee in a single fiscal year of the company shall not cover more than 500,000 common shares or $100,000 of aggregate fair market value of ISOs exercisable for the first time by an optionee during any calendar year. The exercise price under an ISO shall in no event be less than 100% of the fair market value of a common share on the date of grant and the exercise price under an NSO shall in no event be less than 85% of the fair market value of a common share on the date of grant. In the case of an NSO, a stock option agreement may specify an exercise price that varies in accordance with a predetermined formula while the NSO is outstanding.
There were no options or restricted shares issued under the Plan in 2010.
Warrants
Outstanding warrants to purchase TNS stock are as follows:
There were no warrants exercised in 2010 or 2009.
Warrants - Consulting Agreements
In 2010, we issued warrants to purchase 407,000 shares of common stock under agreements for consulting services. These warrants have exercise prices ranging from $0.15 to $0.25 per share and have terms from three to five years. In 2009, we issued warrants to purchase 319,000 shares of common stock under agreements for consulting services. These warrants have exercise prices of $0.25 per share and have terms from three to five years.
Our consulting agreements typically have additional warrant issuances in the second and third years of service, if the agreement is considered to be in good standing at the time of issuance. Unissued warrants to purchase shares of our common stock under consulting agreements were 389,000 and 156,000 at December 31, 2010 and 2009, respectively.
The fair value of the warrants issued under consulting agreements is recorded as deferred compensation. The amortization of deferred compensation is recorded as consulting expense and was $42,495 and $30,797 for 2010 and 2009, respectively.
Warrants - Private Offerings
In connection with the private placement of common stock on December 14, 2010, we issued warrants to purchase common stock to the investors, and to the placement consultants as a fee. The fair value of these warrants granted, estimated on the date of grant, has been recorded as additional paid-in capital. The placement fee was recorded as consulting expense. There were a total of 3,060,000 warrants to purchase shares of common stock exercisable at $0.15 per share and 3,055,000 warrants to purchase shares common stock exercisable at $0.30 per share. These warrants have a term of three years.
In connection with the private placement of common stock during 2009, we issued warrants to purchase common stock to the investors, and to the placement consultants as a fee. The fair value of these warrants granted, estimated on the dates of grant, has been recorded as additional paid-in capital. The placement fee was recorded as consulting expense. There were a total of 1,230,900 warrants to purchase shares of common stock exercisable at $0.75 per share and 1,230,900 warrants to purchase shares common stock exercisable at $1.00 per share. These warrants have a term of three years.
Warrants - Debt Agreements
During the first quarter of fiscal 2010, we issued warrants to purchase 1,250,000 shares of common stock at $0.10 per share in conjunction with the issuance of convertible promissory notes. The warrants have as term of five years. The
fair value of these warrants was recorded as debt discount. The amortization related to these warrants is recorded as interest expense and was $83,990 for 2010.
During the first quarter of fiscal 2010, we issued warrants to purchase 600,000 shares of common stock at $0.15 per share in conjunction with the issuance of convertible promissory notes. The warrants have as term of three years. The fair value of these warrants was recorded as debt discount. The amortization related to these warrants is recorded as interest expense and was $17,150 for 2010.
On December 31, 2009 we issued a warrant to purchase 250,000 shares of common stock at $0.10 per share to a related party in conjunction with the issuance of convertible promissory notes. The warrant has as term of five years. The fair value of these warrants was recorded as debt discount. The amortization related to these warrants is recorded as interest expense and was $11,100 and zero for 2010 and 2009, respectively.
We use the Black-Scholes option-pricing model to determine the fair value of warrants on the date of grant. In the fourth quarter of fiscal 2010, we changed the methodology for determining certain inputs to the Black-Scholes model. The methodology for determining the stock price input was changed from using an historical price to using the stock price on the date of issuance. The methodology for determining the volatility input was changed from using the average volatility over the service period to using the average volatility over the warrant term. There were no changes to the methodology for determining the remaining Black-Scholes inputs.
In determining the fair value of warrants, we employed the following key assumptions:
NOTE 14 - INCOME TAXES
For the years ended December 31, 2010, and 2009, we incurred net operating losses and, accordingly, no provision for income taxes has been recorded. In addition, no benefit for income taxes has been recorded due to the uncertainty of the realization of any tax assets. At December 31, 2010, we had approximately $1,508,000 of net operating losses. The net operating loss carryforwards, if not utilized, will begin to expire in 2026.
The components of our deferred tax assets/liabilities as of December 31, are as follows:
For financial reporting purposes, we have incurred a loss in each period since inception. Based on the available objective evidence, including our history of losses, management believes it is more likely than not that the net deferred tax assets will not be fully realizable. Accordingly, we provided for a full valuation allowance against our net deferred tax assets at December 31, 2010, and 2009. A reconciliation between the amount of income tax benefit determined by applying the applicable U.S. statutory income tax rate to pre-tax loss for the years ended December 31, is as follows:
NOTE 15 - COMMITMENTS AND CONTINGENCIES
Leases
We have entered into a non-cancelable operating lease for approximately 3,136 square feet of office and warehouse facilities in Sherwood, Oregon, which expires in May 2012. The lease includes a security deposit of one month’s rent.
Future minimum lease payments for all of our facilities are as follows:
Rent expense for the years ended December 31, 2010 and 2009 was $25,142 and $9,440, respectively.
NOTE 16 - CONCENTRATIONS AND CREDIT RISK
Customers and Credit Concentrations
During 2009, approximately 31% of our net sales were made to one customer. There were no significant customer concentrations during 2010.
Vendor Concentrations
During 2009, approximately 38% of our purchases were made from one vendor. There were no significant vendor concentrations during 2010.
NOTE 17 - SUBSEQUENT EVENTS
In January 2011, we issued 2,000,000 shares of common stock to Keith Manfred under a Consulting Agreement dated August 26, 2010 pursuant to which Mr. Manfred has performed various marketing services to TNS.
On January 26, 2011, we entered into a convertible note payable with DGI which replaces the convertible note payable with DGI dated March 26, 2010. This convertible note payable is in the amount of $312,500 and bears interest at 5% per year and expires on June 30, 2012. DGI has the option to convert the outstanding note into TNS restricted common shares at $0.06 per share at any time prior to payment in full of the principal balance of the convertible note payable. In connection with the issuance of the convertible note payable, we granted DGI a warrant to purchase 600,000 common shares exercisable at $0.12 per share expiring 3 years from the date of issuance.
Effective February 17, 2011, we entered into a Termination of Profit Sharing Agreement, whereby the DMAP was terminated. Per this termination agreement, all assets and property of the DMAP will be transferred to TNS. As managing affiliate of the DMAP, TNS is responsible for the wind up the activities of the DMAP.
On March 15, 2011 we entered into a non-cancelable lease for office and warehouse space. This lease replaces the existing lease for these premises and expires May 31, 2012.
In April 2011 we issued 1,000,000 shares to MSH Ventures pursuant to an Assignment and Assumption Agreement between TNS and MSH Ventures dated October 26, 2009 under which MSH Ventures assigned all of its rights to an Exclusive License Agreement with the University of Cologne in Germany pertaining to a patent application entitled “Identification of Ergothioneine Transporter and Therapeutic Uses Thereof.” Our President and Chief Executive Officer, Marvin S. Hausman, M.D. owns a 66% equity interest in MSH Ventures.
Item 9.
Item 9. Changes in and Disagreements With Accountants On Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
Evaluation of disclosure controls and procedures
Management is responsible for establishing and maintaining adequate internal control over financial reporting and for the assessment of the effectiveness of those internal controls. As defined by the SEC, internal control over financial reporting is a process designed by our principal executive officer/principal financial officer, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the financial statements in accordance with U. S. generally accepted accounting principles.
As of the end of the period covered by this report, we initially carried out an evaluation, under the supervision and with the participation of our President (who is also our principal financial and accounting officer), of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our President and chief financial officer initially concluded that our disclosure controls and procedures were not effective.
Management's 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 Rule 13a-15(f) or 15d-15(f) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, our principal executive and principal financial officers and effected by our 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 accounting principles generally accepted in the United States of America and 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 the assets of the company;
·
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and
·
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. 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. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Because of the inherent limitations of internal control, 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.
As of December 31, 2010 our Chief Executive Officer and Principal Accounting and Financial Officer, Marvin S. Hausman, M.D., assessed the effectiveness of our internal control over financial reporting based on the criteria for effective internal control over financial reporting established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") and SEC guidance on conducting such assessments. Based on that evaluation, our management concluded that, during the period covered by this report, such internal controls and procedures were not effective to detect the inappropriate application of US GAAP rules as more fully described below.
This was due to deficiencies that existed in the design or operation of our internal controls over financial reporting that adversely affected our internal controls and that may be considered to be material weaknesses.
The matters involving internal controls and procedures that our management considered to be material weaknesses under the standards of the Public Company Accounting Oversight Board were: (1) lack of a functioning audit committee resulting in ineffective oversight in the establishment and monitoring of required internal controls and procedures; (2) inadequate segregation of duties consistent with control objectives; and (3) ineffective controls over period end financial disclosure and reporting processes. The aforementioned material weaknesses were identified by our Chief Executive Officer and Principal Accounting and Financial Officer, Marvin S. Hausman, M.D., in connection with the review of our financial statements as of December 31, 2010. These material weaknesses were also identified in our annual evaluation as of December 31, 2009.
This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by our registered public accounting firm pursuant to SEC rules that permit smaller reporting issuers like us to provide only the management's report in this annual report.
Management's Remediation Initiatives
In an effort to remediate the identified material weaknesses and other deficiencies and enhance our internal controls, we have initiated, or plan to initiate, the following series of measures:
When we have sufficient capital resources we will hire new executive officers, including a Chief Accounting and Financial Officer, to segregate duties consistent with control objectives and will increase our personnel resources and technical accounting expertise within the accounting function. We also intend to appoint additional outside directors to our board of directors after which our board of directors will appoint an audit committee when sufficient funds are available to us.
We anticipate that these initiatives will be at least partially, if not fully, implemented by December 31, 2011.
Changes in internal controls over financial reporting
There was no change in our internal controls over financial reporting that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
Item 9B.
Item 9B. Other Information.
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
The following table sets forth certain information regarding our current directors and executive officers. Our executive officers serve one-year terms.
Biography of Marvin S. Hausman M.D., Chairman and CEO
Dr. Hausman received his M.D. degree from New York University School of Medicine in 1967 and is a Board Certified Urological Surgeon. He has 30 years of drug development and clinical care experience at various pharmaceutical companies, including working in conjunction with Bristol-Myers International, Mead-Johnson Pharmaceutical Co., and E.R. Squibb.
Dr. Hausman served on the board of directors of OXIS International, Inc. from March 2002 to November 2003. Subsequently, Dr. Hausman was re-appointed to the board of directors of OXIS in August 2004. On December 10, 2004, the board of directors appointed Marvin S. Hausman, M.D. to serve as Chairman of the Board, Acting Chief Executive Officer and Acting Chief Financial Officer of OXIS. In February 2005, Dr. Hausman ceased to be the Chief Executive Officer of OXIS. In September 2006, Dr. Hausman was again appointed to serve as President and Chief Executive Officer by the board of directors of OXIS. In June 2008 Dr. Hausman resigned as President, Chief Executive Officer, Acting Principal Accounting and Financial Officer and Chairman of the Board of OXIS International, Inc. and as a director. Dr. Hausman served as a director and as Chairman of the Board of Axonyx Inc., a biotechnology company developing drugs for Alzheimer’s disease, from 1997 until the merger of Axonyx into Torrey Pines Therapeutics in October 2006, and had served as President and Chief Executive Officer of Axonyx from 1997 until September 2003 and March 2005, respectively. Dr. Hausman was a co-founder of Medco Research Inc., a pharmaceutical biotechnology company specializing in adenosine products which was subsequently acquired by King Pharmaceuticals. He has also served as a director of Arbios Technologies, Los Angeles, CA from 2003-2005 and of Regent Assisted Living, Inc., Portland, OR, from 1996-2001.
Dr. Hausman has done residencies in General Surgery at Mt. Sinai Hospital in New York, and in Urological Surgery at U.C.L.A. Medical Center in Los Angeles. He also worked as a Research Associate at the National Institutes of Health, Bethesda, Maryland. He has been a Lecturer, Clinical Instructor and Attending Surgeon at the U.C.L.A. Medical Center Division of Urology and Cedars-Sinai Medical Center, Los Angeles. He has been a Consultant on Clinical/ Pharmaceutical Research to various pharmaceutical companies, including Bristol-Meyers International, Mead-Johnson Pharmaceutical Company, Medco Research, Inc., and E.R. Squibb.
Dr. Hausman is President of Northwest Medical Research Partners, Inc. a firm specializing in the identification and acquisition of breakthrough pharmaceutical and nutraceutical products and which has assigned certain intellectual property to the Company in consideration for 3,500,000 shares of the Company’s common stock. He is also a scientific consultant to Golden Gourmet Mushrooms of San Marcos, CA, and has developed a novel product called Mushroom Matrix, a potent natural organic antioxidant mushroom complex for use in humans and animals.
Dr. Hausman’s experience as a medical doctor who also has extensive experience with pharmaceutical and biotechnology companies, both as an executive and as a director, served as a basis for his qualification to be a member of our board of directors.
Biography of Philip A. Sobol, M.D., Director
Dr. Sobol has served on our board of directors since August 2008. Dr. Sobol is a practicing Orthopedic Surgeon who is the managing director of Sobol Orthopedic Medical Group, Inc., of Southern California. Dr. Sobol is certified by the American Board of Orthopedic Surgery and a Fellow of the American Academy of Orthopedic Surgery. From June 2007 to April 2010 Dr. Sobol served as a director of Cordex Pharma, Inc., formerly named Duska Therapeutics, Inc. Since 2004 he has been a member of S&B Surgery Center Board of Directors, and from 1984 until 1993 he was an Assistant Clinical Professor at the University of Southern California. Dr. Sobol received his BA degree from the University of Rochester, Rochester, New York and a Medical Doctorate degree from the University of Southern California, Los Angeles, California. Dr. Sobol’s experience as a medical doctor who also has experience with early stage companies and drug development was the basis for his appointment as a director of our company.
Dr. Sobol’s experience as a medical doctor who also has experience with early stage companies and drug development was the basis for his appointment as a director of our company.
Biography of Devin Andres, Vice President for Marketing and Sales
Devin Andres was appointed as Vice President for Marketing and Sales on October 22, 2010. Devin Andres has been compensated as a consultant to TNS from January 1, 2010 to the present, related to developing and integrating of a successful social media strategy for marketing, building the market position of TNS by locating, developing, and defining strategic business positions and maximizing opportunities for TNS and TNS products. Mr. Andres was the Information Technology and Marketing Director at Willamette Autogroup Pontiac Buick GMC in Salem Oregon from September 2003 to March 2009. Mr. Andres has also been a consultant to Barrier Pest Control of Sherwood Oregon from 2002 to the present, serving as a technical and business marketing advisor to Barrier’s president to supplement existing marketing campaigns with affordable online marketing solutions and deployed and implemented domain infrastructure to secure and maintain data for over 5,000 customers. Mr. Andres received a Master of Business Administration from Capella University, Minneapolis, Minnesota in August 2009 and a Bachelor of Science, Information Technologies - Network Communications from Capella University in March 2008. Mr. Andres’ experience with information technology and marketing was the basis for his appointment as a director.
Biography of Elliot L. Shelton, Director
Mr. Shelton has served on our board of directors since August 2008. Mr. Shelton received his law degree from Pepperdine University in 1975 and from 1975 until the present has practiced law in the State of California. He has been Of Counsel, from September 1998 to date, to Fenigstein and Kaufman, a Professional Corporation, and the President of Elliot L. Shelton, a Professional Corporation. From 1999 to the present, he has been President and Director of the Assisted Living foundation of America, a non-profit corporation. Mr. Shelton has worked as a partner in several law firms, including Mitchell, Silberberg & Knupp, Shea & Gould and, Gold, Marks, Ring & Pepper. Mr. Shelton’s experience as an attorney with a corporate related practice served as the basis for his appointment as a director of our company.
Our directors, executive officers and control persons have not been involved in any of the following events during the past ten years:
1.
any bankruptcy petition filed by or against any business of which such person was a general partner or executive officer either at the time of the bankruptcy or within two years prior to that time;
2.
any conviction in a criminal proceeding or being subject to a pending criminal proceeding (excluding traffic violations and other minor offenses);
3.
being subject to any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction, permanently or temporarily enjoining, barring, suspending or otherwise limiting his involvement in any type of business, securities or banking activities; or
4.
being found by a court of competent jurisdiction (in a civil action), the Securities and Exchange Commission or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended, or vacated.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), requires our executive officers and directors, and persons who beneficially own more than ten percent of our common stock, to file initial reports of ownership and reports of changes in ownership with the SEC. Executive officers, directors and greater than ten percent beneficial owners are required by SEC regulations to furnish us with copies of all Section 16(a) forms they file. Based upon a review of the copies of such forms furnished to us and written representations from our executive officers and directors concerning the fiscal year ended December 31, 2010, we believe that as of the date of this report one executive officer and one director were not current in their 16(a) reports. Devin Andres, our Vice President for Sales and Marketing, failed to file a Form 3 timely. Philip Sobol, a member of our board of directors, failed to timely report the transfer of 450,000 shares which occurred on November 29, 2010.
Code of Ethics
We have not adopted a Code of Ethics for the Board and any salaried employees.
Audit Committee and Financial Expert
We do not have an Audit Committee; our directors perform some of the same functions of an Audit Committee, such as: recommending a firm of independent certified public accountants to audit the annual financial statements; reviewing the independent auditors independence, the financial statements and their audit report; and reviewing management’s administration of the system of internal accounting controls. We do not currently have a written audit committee charter.
We have no financial expert. We believe the cost related to retaining a financial expert at this time is prohibitive. Further, because of our start-up operations and financial experience of our officers, we believe the services of a financial expert are not warranted.
Item 11.
Item 11. Executive Compensation.
The following table sets forth summary compensation information for the fiscal year ended December 31, 2010 for our Chief Executive Officer, (our “Named Executive Officer”) who was appointed on August 14, 2008. We did not have any other executive officers during the fiscal years ended December 31, 2010 and 2009 who received compensation in excess of $100,000.
Summary Compensation Table
(1) All other compensation for 2010 includes payment of $13,816 in reimbursement for travel expenses, $18,000 in reimbursement for office expenses and $40,000 for consulting services pursuant to a consulting arrangement under which Dr. Hausman is being paid $10,000 per month plus $3,000 for office expenses and reimbursement for reasonable travel expenses.
(2) All other compensation for 2009 includes: payment to Marvin Hausman, M.D., of $46,118 in reimbursement for travel expenses, $33,000 to cover office expenses and $120,000 for consulting services pursuant to a consulting arrangement under which Dr. Hausman is being paid $10,000 per month plus reimbursement for reasonable travel expenses.
We do not have an employment agreement with Marvin S. Hausman, M.D., our Named Executive Officer, however we do have a consulting arrangement beginning November 2008 with Dr. Hausman under which he is paid $10,000 per month for his services, $3,000 per month for office expenses and is reimbursed for reasonable travel expenses. In 2010 Dr. Hausman was paid through May 2010, thereafter, due to a lack of sufficient capital resources, his compensation was
accrued, in the amount of $80,000 for this monthly consulting services, $18,000 for office expenses and $49,028 for travel reimbursement. We do not maintain key-man life insurance for any our executive officers/directors. We do not have any long-term compensation plans.
Stock Option Grants
We made no grants of stock options or stock appreciation rights to Dr. Hausman during the period from our inception on July 19, 2007 through the fiscal year ending December 31, 2010.
Outstanding Equity Awards at Fiscal Year-Ending December 31, 2010
We did not have any outstanding equity awards as of December 31, 2010 to our Dr. Hausman, our Named Executive Officer.
Option Exercises for Fiscal Year-Ending December 31, 2010
There were no options exercised by our Named Executive Officer in fiscal year ending December 31, 2010.
Potential Payments Upon Termination or Change in Control
We have not entered into any compensatory plans or arrangements with respect to our named executive officer, which would in any way result in payments to such officer because of his resignation, retirement, or other termination of employment with us or our subsidiaries, or any change in control of, or a change in his responsibilities following a change in control.
Director Compensation
We did not pay our directors any compensation during fiscal years ending December 31, 2010. On January 24, 2011 we granted options to Philip Sobol, M.D. and Elliot Shelton, Esq., a portion of which was in compensation for board services rendered in 2009 and 2010. Dr. Sobol and Mr. Shelton were each granted stock options to purchase 1 million shares of common stock at $0.085 per share with 500,000 options vesting immediately for past service, 250,000 vesting on January 24, 2012 and 250,000 options vesting on January 24, 2013.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The following table presents information, to the best of our knowledge, about the ownership of our common stock on May 12, 2011 relating to those persons known to beneficially own more than 5% of our capital stock and by our named executive officers and directors. The percentage of beneficial ownership for the following table is based on 61,362,470 shares of common stock outstanding.
Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and does not necessarily indicate beneficial ownership for any other purpose. Under these rules, beneficial ownership includes those shares of common stock over which the stockholder has sole or shared voting or investment power. It also includes shares of common stock that the stockholder has a right to acquire within 60 days after May 12, 2011 pursuant to options, warrants, conversion privileges or other right. The percentage ownership of the outstanding common stock, however, is based on the assumption, expressly required by the rules of the Securities and Exchange Commission, that only the person or entity whose ownership is being reported has converted options or warrants into shares of Total Nutraceutical Solutions’ common stock.
* Less than 1%
1.
Such figures are based upon 61,362,470 shares of our common stock outstanding as of May 12, 2011. Except as otherwise noted in these footnotes, the nature of beneficial ownership for shares reported in this table is sole voting and investment power.
2.
Marvin Hausman’s holdings include 10,000,000 shares of common stock and a five year warrant to purchase 125,000 shares at $0.10 per share. Dr. Hausman’s holdings of 14,291,666 shares also include 3,500,000 common shares owned by Northwest Medical Research Partners Inc., which is controlled by Marvin S. Hausman, M.D. and 666,666 our of 1,000,000 shares owned by MSH Ventures, Inc., in which Dr. Hausman has an equity interest of 66.66%. This number does not include 2,825,760 shares of common stock owned by the adult children of Marvin S. Hausman, M.D.
3.
Devin Andres’ holdings include 37,500 shares issuable upon exercise of a common stock purchase warrant exercisable at $0.25 per share
4.
Phil Sobol’s holdings include 150,000 shares of common stock, 500,000 shares of common stock issuable upon exercise of vested non-statutory stock options exercisable at $0.085 per share granted on January 24, 2011, and a five year warrant to purchase 125,000 shares at $0.10 per share. Dr. Sobol’s holdings of 1,525,000 shares also include 500,000 shares of common stock and a five year warrant to purchase 250,000 shares at $0.25 per share owned by the Philip and Debra Sobol Trust.
5.
Elliot Shelton’s holdings include 2,500,000 shares of common stock, 500,000 shares of common stock issuable upon exercise of vested non-statutory stock options exercisable at $0.085 per share granted on January 24, 2011, and a five year warrant to purchase 250,000 shares at $0.25 per share.
6.
Northwest Medical Research Partners, Inc., #90 NW Second Street, Stevenson Washington 98648. The holdings of this company are beneficially owned by Marvin S. Hausman, as described in (2) above
7.
The holdings of the executive officers and directors as a group include an aggregate of 17,316,666 shares of common stock, and 1,787,500 convertible securities exercisable currently or within 60 days of May 12, 2011
Unless indicated otherwise, the address of each person or entity listed above is 80 Columbia Street, Stevenson, Washington 98648.
We are not aware of any arrangements that may result in "changes in control" as that term is defined by the provisions of Item 403(c) of Regulation S-B.
We believe that all persons named have full voting and investment power with respect to the shares indicated, unless otherwise noted in the table. Under the rules of the Securities and Exchange Commission, a person (or group of persons) is deemed to be a "beneficial owner" of a security if he or she, directly or indirectly, has or shares the power to vote or to direct the voting of such security, or the power to dispose of or to direct the disposition of such security. Accordingly, more than one person may be deemed to be a beneficial owner of the same security. A person is also deemed to be a beneficial owner of any security, which that person has the right to acquire within 60 days, such as options or warrants to purchase our common stock.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
On December 30, 2009, we entered into a Promissory Note with Marvin Hausman, our Chief Executive Officer, and Philip Sobol., a director, whereby Dr. Hausman and Dr. Sobol made a loan in the amount of $50,000 ($25,000 each) to our company for a period of two (2) years. The promissory note bears interest at 6% per annum. This note, at the sole discretion of Drs. Hausman and Sobol, the payees, is due and payable in the event we complete a capital fund raising of any
amount greater than $250,000. Upon completion of this fundraising, the payees shall have 30 days from the close of the fundraising to exercise their right to convert their debt to equity in the form of restricted common stock at $0.20 per share. The payees may also convert at any time prior to December 31, 2011, if the fundraising has not been completed. We also granted the payees 250,000 (125,000 warrants for each payee) five (5) year stock purchase warrants with an exercise price of $0.10 per share.
Director Independence
Our Board of Directors has determined that one of our three directors are currently “independent directors” as that term is defined in Rule 4200(a)(15 ) of the Marketplace Rules of the National Association of Securities Dealers. We are not presently required to have a majority of independent directors. If we ever become a listed issuer whose securities are listed on a national securities exchange or on an automated inter-dealer quotation system of a national securities association, which has independent director requirements, we intend to comply with all applicable requirements relating to director independence.
Item 14.
Item 14. Principal Accountant Fees and Services.
Li & Company, PC, served as our principal independent public accountants for the fiscal year ending December 31, 2009. Our current auditors, Peterson Sullivan LLP, were appointed in March 2011 audited our financial statements for the fiscal year ended December 31, 2010. Aggregate fees billed to us for the years ended December 31, 2010 and 2009 by Li & Company for review of quarterly reports for those two years and for the 2009 audit were as follows:
(1)
“Audit fees” consists of the aggregate fees billed for each of the last two fiscal years for professional services rendered by the principal accountant for the audit of the registrant’s annual financial statements and review of interim financial statements included in our quarterly reports on Form 10-Q, or services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements for those fiscal years.
(2)
“Audit-related fees” consists of fees billed for assurance and related services by the principal accountant that are reasonably related to the performance of the audit or review of our financial statements, but are not reported under “Audit fees.”
(3)
“Tax fees” consists of the aggregate fees billed in each of the last two fiscal years for professional services rendered by the principal accountant for tax compliance, tax advice and tax planning.
(4)
“All other fees” consists of the aggregate fees billed in each of the last two fiscal years for products and services provided by the principal accountant other than the services reported in the other sections.
Audit Committee Policies and Procedures
We do not have an audit committee; therefore our board of directors pre-approves all services to be provided to us by our independent auditor. This process involves obtaining (i) a written description of the proposed services, (ii) the confirmation of our Principal Accounting Officer that the services are compatible with maintaining specific principles relating to independence, and (iii) confirmation from our securities counsel that the services are not among those that our independent auditors have been prohibited from performing under SEC rules. Our directors then make a determination to approve or disapprove the engagement of Peterson Sullivan LLP, for the proposed services.
Less than 50 percent of hours expended on the principal accountant's engagement to audit the registrant's financial statements for the most recent fiscal year were attributed to work performed by persons other than the principal accountant's full-time, permanent employees.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules.
The following information required under this item is filed as part of this report:
(a)
1. Financial Statements
The financial statements listed below are filed in Item 8 of Part II of this Form 10-K above:
2. Financial Statement Schedules
Not Applicable
3. Exhibits specified by Item 601 of Regulation S-K.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act of 1934, as amended, the registrant caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, in Portland, Oregon on this 18th day of May, 2011.
TOTAL NUTRACEUTICAL SOLUTIONS, INC.
By:
/s/ Marvin S. Hausman, M.D.
Marvin S. Hausman, M.D.
Chief Executive Officer, Chairman of the Board
(Principal Executive Officer)
(Principal Financial and Accounting Officer)
In accordance with Section 13 or 15(d) of the Exchange Act of 1934, as amended, this Annual Report on Form 10-K has been signed below by the following persons on behalf of the registrant in the capacities indicated below on this 18th day of May, 2011.
Signature
Title
/s/ Marvin S. Hausman, M.D.
Chief Executive Officer, Chairman of the Board, Director
Marvin Hausman, M.D.
(Principal Executive Officer)
(Principal Financial and Accounting Officer)
/s/ Philip A. Sobol, M.D.
Director
Philip A. Sobol, M.D.
/s/ Elliot L. Shelton, Esq.
Director
Elliot A. Shelton, Esq.