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Health Sciences Group Inc · SB-2 · On 11/3/06

Filed On 11/3/06 5:26pm ET   ·   SEC File 333-138441   ·   Accession Number 1019687-6-2604

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  As Of               Filer                 Filing     As/For/On Docs:Pgs              Issuer               Agent

11/03/06  Health Sciences Group Inc         SB-2                   3:413                                    Publicease Inc/FA

Registration of Securities by a Small-Business Issuer   ·   Form SB-2
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: SB-2        Registration Statement                              HTML  1,726K 
 2: EX-23.2     Consent                                             HTML      5K 
 3: EX-23.3     Consent                                             HTML      5K 


SB-2   ·   Registration Statement
Document Table of Contents

Page (sequential) | (alphabetic) Top
 
11st Page
"Prospe C T U S S U Mmary
"Risk F A C T O Rs
"Capit A L I Zation
"Use of P R Oceeds
"Market F O R Co M Mon Stock and Related Shareholder Matters
"Divi D End Policy
"Selected Cons O Lidated Financial Data
"Manage M Ent S Discussion and Analysis of Financial Condition and Results of Operations
"Busi N E Ss
"Ma N A Gement
"Certa I N Transactions
"Descr I Pt I O N of Capital Stock
"Shares E L I G Ible for Future Sale
"The Sel L I N G Shareholders
"Plan O F Distribution
"Lega L M A Tters
"Ex P E R Ts
"Addi T Ional Information

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  REGISTRATION STATEMENT  
As Filed with the Securities and Exchange Commission on November 3, 2006
 Registration No. 333-______


SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________
FORM SB-2
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
____________________________
HEALTH SCIENCES GROUP, INC.
(Exact Name of Registrant as Specified in its Charter)
(State or other jurisdiction of
incorporation or organization)
(Primary Standard Industrial
Classification Code Number)
91-2079221
(I.R.S. Employer
Identification Number)
     

Howard Hughes Center
6080 Center Drive, 6th Floor
Los Angeles, California 90045
(310) 242-6700
(Address of Principal Executive Offices)

____________________________

Fred E. Tannous, Chief Financial Officer
Howard Hughes Center
6080 Center Drive, 6th Floor
Los Angeles, California 90045
(310) 242-6700
(Name, address, including zip code, and telephone number, including area code, of Agent for Service)

____________________________

Copies to
Leib Orlanski, Esq.
Kirkpatrick & Lockhart Nicholson Graham LLP
10100 Santa Monica Blvd., 7th Floor
Los Angeles, CA 90067
Telephone (310) 552-5000 Facsimile (310) 552-5001

____________________________

Approximate date of commencement of proposed sale to the public:
 
From time to time after the effective date of this Registration Statement
 
If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. x

 
 
 
 

 
 
 
If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
 
If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. o
 
If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement the same offering. o
 
If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. o
 
 CALCULATION OF REGISTRATION FEE

 
Title of each class of securities
to be registered
 
Amount to be
registered(8)
 
Proposed
Maximum
offering price
per share(7)
 
Proposed
Maximum
Aggregate
offering price
 
Amount of
registration fee
 
Common Stock, $.001 par value
   
1,655,764 (1
)
$
0.06
 
$
99,346
 
$
10.63
 
Common Stock, $.001 par value
   
1,000,000 (2
)
$
0.06
 
$
60,000
 
$
6.42
 
Common Stock, $.001 par value
   
812,269 (3
)
$
0.06
 
$
48,736
 
$
5.21
 
Common Stock, $.001 par value
   
300,000 (4
)
$
0.06
 
$
18,000
 
$
1.93
 
Common Stock, $.001 par value
   
236,764 (5
)
$
0.06
 
$
14,206
 
$
1.52
 
Common Stock, $.001 par value
   
71,426 (6
)
$
0.06
 
$
4,286
 
$
.46
 
TOTAL
   
4,076,223
       
$
244,574
 
$
26.17
 

(1)
 
Represents (i) 777,882 shares of common stock held by Vescap International, Ltd.; and (ii) 877,882 shares of common stock underlying warrants held by Vescap International, Ltd.
 
(2)
 
Represents (i) 500,000 shares of common stock underlying the convertible debenture held by Stranco Investments, Ltd.; and (ii) 500,000 shares of common stock underlying warrants issued in connection with the convertible debenture held by Stranco Investments, Ltd.
 
(3)
 
Represents (i) 518,151 shares of common stock held by Cedar Crescent Holdings, Ltd.; and (ii) 294,118 shares of common stock underlying warrants held by Cedar Crescent Holdings, Ltd.
 
(4)
 
Represents (i) 150,000 shares of common stock held by MarketByte, LLC; and (ii) 150,000 shares of common stock underlying warrants held by MarketByte, LLC.
 
(5)
 
Represents (i) 29,411 shares of common stock held by Vestcom, Ltd.; and (ii) 207,353 shares of common stock underlying warrants held by Vestcom, Ltd.
 
(6)
 
Represents 71,426 shares of common stock underlying warrants held by FCIM Corp.
 
(7)
 
Estimated pursuant to Rule 457(c) of the Securities Act of 1933, based on the average of the high and low prices of the common stock, as reported in the Over the Counter Bulletin Board as of October 26, 2006, solely for the purpose of computing the registration fee.
 
(8)
 
In accordance with Rule 416 of the Securities Act, the registration also covers such indeterminate amount of additional shares of common stock as may be issuable upon conversion of the convertible debentures to prevent dilution as a result of stock splits, stock dividends and the anti-dilution provisions applicable to convertible debentures.
 
_______________________________
 
The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall hereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Commission, acting pursuant to such Section 8(a), may determine.

 
 
 
 

 
 
PROSPECTUS
Subject to Completion, Dated November _____, 2006



4,076,223 Shares

HEALTH SCIENCES GROUP, INC.
COMMON STOCK

This prospectus covers up to 4,076,223 shares of common stock of Health Science Group, Inc. that may be sold from time to time by the selling shareholders named in this prospectus. The shares covered by this prospectus consist of (i) 777,882 shares of common stock and 877,882 shares of common stock underlying warrants held by Vescap International, Ltd., (ii) 500,000 shares of common stock underlying the convertible debenture and 500,000 shares of common stock underlying warrants issued in connection with the convertible debenture held by Stranco Investments, Ltd., (iii) 518,151 shares of common stock and 294,118 shares of common stock underlying warrants held by Cedar Crescent Holdings, Ltd., (iv) 29,411 shares of common stock and 207,353 shares of common stock underlying warrants held by Vestcom, Ltd., and (v) 150,000 shares of common stock and 150,000 shares of common stock underlying warrants held by Market Byte, LLC, and (vi) 71,426 shares of common stock underlying warrants held by FCIM Corp. We will not receive any proceeds from the sales of the common stock by the selling shareholders; however, we may receive up to $100,000 upon exercise of warrants.
____________________________
 
Our common stock is traded on the Over-The-Counter Bulletin Board maintained by the National Association of Securities Dealers, Inc. under the symbol “HESG.OB.”
 
____________________________
 
The securities offered by this prospectus involve a high degree of risk. See “Risk Factors” beginning on page 4.
 
____________________________
 
Neither the Securities and Exchange Commission (the “SEC”) nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.
 
____________________________
 
The date of this prospectus is ______________, 2006

[Printed on Left side panel] The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and we are not soliciting offers to buy these securities in any state where the offer or sale is not permitted.
 
 
 
 
 

 
 

INSIDE FRONT COVER
 

 
 
 
 

 
 

TABLE OF CONTENTS


 
Page
   
1
   
4
   
9
   
10
   
10
   
12
   
12
   
14
   
25
   
31
   
36
   
37
   
40
   
40
   
42
   
43
   
43
   
44
 
 
 
 
 

 
 

WHERE YOU CAN FIND MORE INFORMATION
 
We file annual and special reports and other information with the SEC. Certain of our SEC filings are available over the Internet at the SEC’s web site at http://www.sec.gov. You may also read and copy any document we file with the SEC at its public reference facilities:
 
Public Reference Room Office
450 Fifth Street, N.W.
Room 1024
Washington, D.C. 20549
 
You may also obtain copies of the documents at prescribed rates by writing to the Public Reference Section of the SEC at 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549. Callers in the United States can also call 1-800-732-0330 for further information on the operations of the public reference facilities.

 
 
 
 

 
 

 PROSPECTUS SUMMARY
 
You should read the following summary together with the more detailed information regarding our company and the common stock being sold in this offering, including “Risk Factors” and our consolidated financial statements and related notes, included elsewhere in, or incorporated by reference into, this prospectus.
 
Our Company
 
We are a provider of innovative products and services in the nutraceutical and wellness industries.  The term “nutraceutical” means nutritional food supplements. We offer value-added ingredients and proprietary technologies used in nutritional supplements, functional foods and beverages, and skin care products. “Nutritional supplements” means vitamins, minerals, herbs and chemical compounds designed to supplement nutrients derived from food for the purpose of maintaining the bodily requirements for proper health and nutrition. “Functional foods” means nutritional supplements which provide some of the same material elements as found in foods.
 
We develop and sell high-margin products based on proprietary technologies to customers who manufacture and distribute functional foods. We also developed a number of proprietary formulations which combine vitamins, herbs and other food supplements with traditional over-the-counter generic drugs.  
 
Our business strategy is to develop new customer relationships in our core business, expand our marketing program by increasing existing product lines, marketing through new outlets and securing new distribution relationships, and by so doing increase our revenues.  We had net losses attributed to common shareholders of $6,093,912, $10,959,108, and $8,447,276 for our fiscal years ended in December 31, 2005, 2004, and 2003.  Our cumulative losses for the last three years amount to $28,675,821.  Our losses are substantial and increasing.
 
We currently offer two products; Shugr | Zero-Calorie Sweetener, and Sequesterol | Advanced Cardio Formula. We also own the intellectual property rights for five patents which protect a proprietary formulation which combines pharmaceutical and nutraceutical products (“CoCare”). We are exploring opportunities to license these patents to strategic partners. To date, have not entered into any such alliances.
 

Summary of Risk Factors
 
The following summarizes the risk factors which are set forth below under heading, “RISK FACTORS”, as follows:
 
·   
 
Our independent registered public accounting firm has provided a “going concern” qualification to our consolidated financial statements.
 
·   
 
There is a risk that we will be unable to obtain additional funds as we need them.
 
·   
 
We face significant competition.
 
·   
 
  There is a risk that we may not be able to establish a marketing organization.
 
·   
 
  There may be insufficient consumer acceptance of integrative medicine products.
 
·   
 
  We may not be able to establish strategic alliances in order to market our products.
 
·   
 
  Government regulation could adversely affect the vitamin and supplement business.
 
·   
 
  We may be unable to retain or acquire additional skilled employees.
 
 
 
 
 
 
1

 
 

The Offering

Common stock offered by selling shareholders
4,076,223 shares
   
Common stock to be outstanding after the offering
46,736,694 shares
   
Use of proceeds
We will not receive any proceeds from
the sale of the common stock.
   
OTC Bulletin Board
HESG.OB

The above information is based on 44,135,915 shares of common stock outstanding as of September 30, 2006 which includes 1,475,444 shares being registered herein; assumes conversion into common stock of 500,000 shares of the convertible debenture; exercise of 500,000 warrants by convertible debenture holders; 877,882 warrants held by Vestcap International, Ltd.; 294,118 warrants held by Cedar Crescent Holdings, Ltd.; 207,353 warrants by Vestcom, Ltd.; 150,000 warrants held by MarketByte, LLC and exercise of 71,426 warrants held by the FCIM Corp. and excludes:
 
·
 
4,918,000 shares of common stock issuable upon exercise of outstanding vested stock options at exercise prices ranging from $0.25 to $1.37 per share;
 
·  
 
5,338,180 shares of common stock issuable upon exercise of outstanding warrants at exercise prices ranging from $0.25 to $1.25 per share;
 
·  
 
2,518,218 shares of common stock issuable upon exercise of warrants at $1.10 per share held by stockholders of a Series A Convertible Preferred Stock;
 
·  
 
305,312 shares of common stock issuable upon exercise of warrants at $1.10 per share and 470,588 shares of common stock issuable upon exercise of warrants at $0.85 per share held by the designees of Spencer Trask Ventures, Inc., a placement agent, issued in connection with a private placement of a Series A Convertible Preferred Stock;
 
·  
 
441,180 shares of common stock issuable upon exercise of warrants at $1.25 per share and 441,180 shares of common stock issuable upon exercise of warrants at $1.50 per share held by stockholders of a Series B Convertible Preferred Stock;
 
·  
 
44,118 shares of common stock issuable upon exercise of warrants at $1.25 per share and 44,118 shares of common stock issuable upon exercise of warrants at $1.50 per share held by the designees of First Montauk Securities, Inc., a placement agent, issued in connection with a private placement of a Series B Convertible Preferred Stock;
 
·  
 
1,439,091 shares of common stock issuable upon exercise of warrants at $1.60 per share held by stockholders of a Series C Convertible Preferred Stock;
 
·  
 
460,817 shares of common stock issuable upon exercise of warrants at $1.10 per share and 230,409 shares of common stock issuable upon exercise of warrants at $1.60 per share held by the designees of H.C. Wainwright & Co., Inc., a placement agent, issued in connection with a private placement of a Series C Convertible Preferred Stock;
 
·
 
1,397,224 shares of common stock issuable upon conversion of the Series A Convertible Preferred Stock at the conversion price of $0.85 per share;
 
·  
 
647,059 shares of common stock issuable upon conversion of 22 shares of Series B Preferred Stock at conversion price of $0.85 per share;
 
·  
 
2,878,188 shares of common stock issuable upon conversion of 3,166 shares of Series C Convertible preferred stock, at a conversion price of $1.10 per share.
 
·  
 
370,588 shares of common stock issuable upon conversion of $315,000 of the 12% Debentures;
 
Additional Information
 
Our executive offices are located at 6080 Center Drive, 6th Floor, Los Angeles, California 90045 and our telephone number is (310) 242-6700. We are a Delaware corporation.
 
In this prospectus, the terms “we,” “us,” and “our” refer to Health Sciences Group, Inc., a Delaware corporation and its consolidated subsidiaries, as appropriate in the context, and, unless the context otherwise requires, “common stock” refers to the common stock, par value $0.001 per share, of Health Sciences Group, Inc., to which we may also refer as “HESG”.
 
 
 
 
 
2

 
 

Summary Consolidated Financial Data

 
   
 
Six Months Ended June 30,
 
 
Six Months Ended June 30,
 
 
 
Year ended December 31,
 
     
2005
 
2005
 
2004**
 
Consolidated Statements of Operations Data:
                         
Net sales
 
$
27,979
 
$
4,369
 
$
60,142
 
$
67,204
 
Cost of sales
   
20,566
   
910
   
37,229
   
20,539
 
Operating expenses
   
3,524,287
   
3,577,506
   
7,942,872
   
5,588,114
 
Operating loss
   
(3,516,874
)
 
(3,574,047
)
 
(7,919,959
)
 
(5,541,449
)
Loss from discontinued operations     -     (161,045 )   (174,220 )   (5,008,183 )
Other income (expenses), net
   
683,478
   
23,445
   
2,343,820
   
97,916
 
Net loss
   
(2,833,396
)
 
(3,711,647
)
 
(5,750,359
)
 
(10,451,716
)
Preferred dividends
   
(182,925
)
 
(282,847
)
 
(343,553
)
 
(507,392
)
Net loss attributable to common shareholders
 
$
(3,016,321
)
$
(3,994,494
)
$
(6,093,912
)
$
(10,959,108
)
                           
Basic and diluted loss per common share
 
$
(0.10
)
$
(0.19
)
$
(0.25
)
$
(0.78
)
                           
Basic and diluted weighted average common shares outstanding
30,598,662
21,519,755
24,559,505
14,125,035


 
         
Balance Sheet Data:
             
Cash and cash equivalents
 
$
6,593
 
$
21,256
 
$
240,532
 
Working capital
 
$
(4,885,940
)
$
(4,897,615
)
$
(5,340,035
)
Total current assets
 
$
93,891
 
$
131,241
 
$
774,321
 
Total assets
 
$
3,787,776
 
$
4,155,552
 
$
4,401,174
 
Total current liabilities
 
$
4,979,831
 
$
5,028,856
 
$
6,114,356
 
Total liabilities
 
$
8,274,726
 
$
9,066,679
 
$
10,521,726
 
Total stockholders’ deficit
 
$
(4,486,950
)
$
(4,911,127
)
$
(6,120,552
)
 
** The table has been modified to reflect the discontinued operations of Quality Botanical Ingredients and XCEL Medical Pharmacy.

 
 
 
 
3

 
 

 RISK FACTORS
 
This offering and any investment in our common stock involve a high degree of risk. You should carefully consider the risks described below and all of the information contained in this prospectus before deciding whether to purchase our common stock. If any of the following risks actually occur, our business, financial condition and results of operations could be harmed. The trading price of our common stock could decline, and you may lose all or part of your investment in our common stock.
 
RISKS RELATED TO OUR COMPANY
 
The report of our Independent Registered Public Accounting Firm contains a statement that our accumulated deficit, working capital deficit and recurring operating losses raise substantial doubt about our ability to continue as a going concern.
 
Our independent registered public accounting firm has stated in their report in this prospectus that we have an accumulated deficit, working capital deficit and recurring operating losses that raise substantial doubt about our ability to continue as a going concern.  We had net losses attributable to common shareholders of $6,093,912, $10,959,108, and $8,447,276 for our fiscal years ended in December 31, 2005, 2004 and 2003.  Our cumulative losses through December 31, 2005 amount to $28,675,821.  We hope to continue to fund operations through additional debt and equity financing arrangements that we believe may be insufficient to fund our capital expenditures, working capital, and other cash requirements for the year ending December 31, 2006.  The successful outcome of future financing activities cannot be determined at this time and there are no assurances that if achieved, we will have sufficient funds to execute our intended business plan or generate positive operational results.

There is a risk that we will be unable to obtain additional funds to expand or grow our business.
 
We have limited cash liquidity and capital resources. If we engage in acquisitions or seek to expand operations or grow our business, we will need to raise funds in amounts necessary to finance any such acquisitions, expansion or growth. There can be no assurance that we will be able to raise any such additional funds. Moreover, if we obtain debt financing, there can be no assurance we will be able to service the debt.
 
We may be liable for the entire balance of the secured debt obligation of our discontinued wholly-owned subsidiary, Quality Botanical Ingredients, Inc.

We are a co-guarantor of the secured credit facility issued to QBI by La Salle Business Credit, LLC (“LaSalle”) pursuant to a Continuing Unconditional Corporate Guaranty dated as of February 21, 2003. In the first quarter of 2005, QBI’s assets were liquidated, netting approximately $308,000, with all proceeds applied to the balance due. It is expected that land owned by a separate co-guarantor will be sold with net proceeds also applied to the balance due. Proceeds from the land sale are expected to reduce the balance due, however we may be liable for the entire balance if the sale of such assets is unsuccessful.

 
The discontinuation of Quality Botanical Ingredients’ and XCEL HealthCare operations will decrease our consolidated revenues and may have a material adverse affect on our business.

In October 2004, we discontinued operations of our wholly-owned subsidiary, Quality Botanical Ingredients, Inc., and in May 2005, we discontinued operations of our wholly owned subsidiary, XCEL Medical Pharmacy, Inc. If we are unable to generate additional revenues through our other business operations, we will realize a significant decrease in annual revenues ranging from $1 million to $5 million per year which could have material adverse affect on our business.

We face significant competition.
 
The market for health-related retail goods and services is characterized by intense competition. Nearly all of our existing and potential competitors have longer operating histories, greater experience, greater name recognition, larger customer bases and significantly greater financial, technical and marketing resources than we do. Because of their greater resources, our competitors are able to undertake more extensive marketing campaigns for their brands and services, and make more attractive offers to potential employees, retail affiliates, and others. We cannot assure you that we will be able to compete successfully against our current or future competitors or that our business and financial results will not suffer from competition. Competition is based upon, price, timely delivery, product quality, safety, availability, product innovation, marketing assistance and customer service. We believe that we compare favorably in all of these categories, but do not contend that our products or services have characteristics which are different from those of our competitors. Our new products will face strong competition from pharmaceutical companies, healthcare companies, nutritional and alternative medicine companies.

 
 
 
 
4

 
 

Our Stockholders may be diluted as a result of future financings.
 
Any equity financings would result in dilution to our then-existing shareholders. Furthermore, the possible sale of restricted shares issued and outstanding may, in the future, dilute the percentage of free-trading shares held by a shareholder or subsequent purchaser of our securities in the market, and may have a depressive effect on the price of our securities. Further, such sales, if substantial, might also adversely affect our ability to raise additional equity capital in the future.
 
There is no assurance we will be able to establish a marketing organization.
 
Our long term business plan is to market the products which we develop, either through the utilization of contract sales representatives or through the establishment of our own sales force. If we do not establish a marketing organization, we may be hampered in the sale of our products. We have not yet begun to develop such marketing channels as to do so would require an investment of substantial amounts of capital, approximately $2,500,000, which we currently do not possess and which we may never be able to access. Accordingly, despite our plans, we may be unable to develop our own marketing channels and would therefore be relying on marketing partnerships with other companies with whom we have not yet established relationships or arrangements.
 
There is no assurance that we will be able to develop or to acquire complimentary products.
 
Although we are presently focusing on the in-house development of products, we may seek to acquire products, technologies or companies with products, manufacturing and distribution capabilities consistent with our commercial objectives. We have not yet, however, at this stage identified such other products, technologies or other companies and there can be no assurance that we will be able to acquire such products or companies. We presently do not have the capital to make acquisitions. Accordingly, in the near term, any such acquisitions would most likely require that we issue stock in our Company to effect acquisitions which would result in dilution to our shareholders. If we do not acquire or develop additional products, our growth will be constrained.
 
There may be insufficient consumer acceptance of integrative medicine products or our new products.
 
While we have developed a number of proprietary formulations that integrate traditional over-the-counter generic drugs with complimentary alternative medications such as vitamins, herbs and other nutraceutical supplements which we intend to market under the CoCare® brand name to address heart disease, cold and flu, arthritis, migraine, allergy and other conditions, there can be no assurance that the nascent field of integrative medicine will result in an established market for our products or that consumers will find our products, or our new products more beneficial than existing over-the-counter generic drugs or products offered by our competitors and already established in the marketplace.
 
There can be no assurance we will be able to successfully brand our CoCare® products, our Shugr™ product, or our Sequesterol™ product.
 
Creating a new nationally recognized brand normally requires a significant investment in advertising and promotion which would be beyond the current resources of our Company. Without such financial and other resources, it would be extremely difficult to establish CoCare®, Shugr™ or Sequesterol™ as nationally recognizable brands, or other branded products.
 
Our new Shugr™ product may be unable to compete against established sugar substitutes such as Nutrasweet™.
 
While we have recently begun to market our Shugr™ product in The Vitamin Shoppe and Meijer stores, a national and regional retail chain, respectively, we face formidable obstacles in consumer acceptance of this product in the face of established artificial sweeteners such as Nutrasweet™, Splenda™ and other such products. We believe that in the near term it will be difficult to convince food and beverage manufacturers to utilize our product as an ingredient as a sugar substitute due to the substantial marketing and branding and infrastructure investment that they have made in promoting and utilizing such products as Nutrasweet™, Splenda™ and other such sugar substitutes. We do expect that retail consumers may find our product available for sale in such retail chains as The Vitamin Shoppe and Meijer. Nevertheless, although we intend to establish promotional brochures and displays in such shops to create consumer awareness, we realize that, as a result of the enormous amounts of branding investments made by Nutrasweet™, Splenda™ and other such sugar substitutes, we may be unable to attract consumers to our product. We therefore may be unsuccessful in our marketing effort, in which case we may not realize significant revenues from the Shugr™ product line or other products.

 
 
 
 
5

 
 
 
We may not be able to establish strategic alliances in order to develop markets for our products.
 
Our business strategy for the exploitation of our CoCare® family of proprietary pharmaceutical and nutraceutical products require that we enter into strategic alliances and partnerships with pharmaceutical, nutraceutical and/or biotechnology companies in order to market and distribute such products. We have explored such potential relationships with several such companies but to date have not entered into any such alliances and there can be no assurance that we will be able to enter into such alliances or agreements. Failure to do so poses the risk that it may be difficult or impossible for us to realize our business plan objectives to develop or market our proprietary pharmaceutical and nutraceutical products.
 
Moreover, if we do enter into such agreements for alliances with pharmaceutical, nutraceutical and/or biotechnology companies, there can be no assurance that such agreements or alliances will be entered into upon terms which generate significant revenues or enable us to achieve profitability. Furthermore, our plan is to retain exclusive or co-marketing co-promotion rights in the United States to our products, while out-licensing rights for other uses to our strategic partners and alliances. There can be no assurance that we will be able to negotiate agreements which enable us to retain such rights.
 
We may be unable to protect our proprietary rights.
 
Although we have developed a number of proprietary formulations to integrate over-the-counter generic drugs with complimentary alternative medications for which we have patents, there can be no assurance that our formulations do not infringe on other parties patents or proprietary rights. Furthermore, there can be no assurance that we will be able to defend such patents against competitors with larger financial resources. We have to date not encountered any litigation or threats in regard to proprietary rights.
 
There is a risk that we will be unable to retain or acquire skilled employees to execute our growth plans.
 
Our potential for success depends significantly on our Chief Executive Officer, Stuart Avery Gold and our Chief Financial Officer, Fred E. Tannous. We do not carry key-man life insurance on either executive. Given the early stage of our development and our plans for rapid expansion, the loss of the services of any one of these executive or the services of any other key employees we may hire in the future would have a substantial, adverse effect on our business. We believe that our future success will depend in large part on our ability to attract and retain highly skilled technical, marketing and management personnel. If we are unable to hire the necessary personnel, the development of our business would likely be delayed or prevented. Competition for these highly-skilled employees is intense. As a result, we cannot assure you that we will be successful in retaining our key personnel or in attracting and retaining the personnel we require for expansion.
 
We have an employment agreement with Mr. Stuart Gold that commenced June 1, 2006 and ends May 31, 2009. The base salary under this employment contract is $200,000 per year, subject to annual increases of not less than 10% tied to the achievement of annual sales milestones. To date, Mr. Gold has agreed to defer and accrue his salary. This contract provides for a performance bonus calculated as the greater of (i) 10% of the earnings before interest, taxes, depreciation and amortization for said fiscal year or (ii) 50% of the salary, provided, however, that the Company has generated a minimum of $1 million EBITDA during the fiscal year and the annual bonus may not exceed 150% of the base salary at the time. Also, Mr. Gold received an option grant for the purchase of up to 6% of Company common stock, after the completion of the contemplated equity financing, exercisable at a price equal to the offering share price. The first 3% of the option shares shall vest equally on each anniversary date over the term of his agreement. The second 3% of the option shares shall vest as follows; one-third of the total option shares shall vest upon the achievement of the Company’s consolidated EBITDA for any fiscal year exceeding $1 million, another one-third of the total option shares shall vest upon the achievement of the Company’s consolidated EBITDA for any fiscal year exceeding $2 million; and the final one-third of the total option shares shall vest upon the achievement of the Company’s consolidated EBITDA for any fiscal year exceeding $3 million. If this employment contract is terminated by us without good cause, or if we are in breach of the agreement, or if we assign the executive without his consent to a lesser responsibility status than his current position, then we are required to pay Mr. Gold the lesser of (i) his salary for the remainder of the term of the agreement or (ii) one year’s salary and accrued benefits prorated through the date of termination.

 
 
 
 
6

 
 

We also have an employment agreement with Mr. Fred E. Tannous that commenced July 1, 2005 and ends June 30, 2008. The base salary under this employment contract is $250,000 per year. This contract provides for a performance bonus in an amount equal to of 5 % of the Adjusted EBITDA for each fiscal year and an option grant for the purchase of up to 500,000 shares of Company common stock exerciseable at a price equal to $0.65 per share. The option shall be exercisiable on a monthly pro rata basis over the term of the agreement. If the Company shall merge, sell a controlling interest, or sell a majority of its assets; or if there is a transaction (or series of transactions) in which the Company’s shareholders sell a majority of outstanding shares of Company capital stock, then we shall pay Mr. Tannous the greater of the remainder of his salary or two hundred fifty thousand dollars. Further, at the date of any such merger or sale is consummated, all unvested options shall be immediately accelerated and as to any unexercised options to purchases shares in the Company which are held by Mr. Tannous, the Company shall pay Mr. Tannous cash in the amount equal to the difference between the consideration paid to the Company on a per share basis less the exercise price of the option, the value of which is multiplied to the number of options which Mr. Tannous holds. If this employment contract is terminated by us without good cause, or if we are in breach of the agreement, or if we assign the executive without his consent to a lesser responsibility status than his current position, or require the executive to be based elsewhere other than our principal executive office, then we are required to Mr. Tannous the lesser of (i) his salary for the remainder of the term of the agreement or (ii) one year’s salary and accrued benefits prorated through the date of termination.

RISKS RELATED TO THE INDUSTRY
 
Government regulation could adversely affect viability of selling vitamins, supplements and minerals.
 
In the United States, extensive federal government regulations may restrict the way dietary supplement products are sold, resulting in restrictions on these products and content which may result in significant additional expenses to us. Also, numerous U.S. governmental agencies may regulate the manufacture, packaging, labeling, advertising, promotion, distribution and sale of dietary supplement products. The primary regulatory agency in the United States for these products is the Food and Drug Administration (FDA). The laws, regulations and enforcement policies governing dietary supplement products are relatively new and still evolving, and we cannot predict what enforcement positions the FDA or other governmental agencies may take with respect to our products. In general, the dietary supplement industry has adopted different interpretations of these laws than have the relevant regulatory agencies. We can not at this time determine the extent to which FDA regulation will impact our business.
 
Next, U.S. federal, state and local government regulations may restrict the products which we manufacture. The U.S. FDA regulates vitamin, supplements and other health care products under the Federal Food, Drug and Cosmetic Act and regulations promulgated thereunder. These products are also subject to regulation by, among other regulatory entities, the Consumer Product Safety Commission, the U.S. Department of Agriculture, and the Environmental Protection Agency. Additionally, the U.S. Federal Trade Commission regulates advertising and other forms of promotion and methods of marketing of these products under the Federal Trade Commission Act. Also, various state and local agencies may also regulate the manufacture, labeling and advertising of these products.
 
We cannot be certain that we comply with all laws and regulations in this area. Enforcement actions by any of these regulatory agencies can result in civil and criminal penalties, an injunction to stop or modify certain selling methods, seizure of products, adverse publicity or voluntary recalls and labeling changes. If any governmental agency were to undertake an enforcement action against us, this could cause an immediate decrease in our revenues, cause us to incur significant additional expenses and result in a decrease in our stock price.
 
There is a risk that the nutraceutical industry may become saturated.
 
We are part of the nutraceutical industry which has experienced the entry of new participants and suppliers on an ever increasing basis. If this trend continues, the industry may reach a saturation point at which none of the suppliers will be able to sell their products at a profit. Should that occur, our company would be adversely affected.
 
RISKS RELATED TO THE OFFERING
 
We are listed on the NASD OTC Electronic Bulletin Board, which can be a volatile market.
 
Our common stock is quoted on the OTC Electronic Bulletin Board (“OTCBB”). It is a more limited trading market than the NASDAQ SmallCap Market, and timely, accurate quotations of the price of our common stock may not always be available. You may expect trading volume to be low in such a market. Consequently, the activity of only a few shares may affect the market and may result in wide swings in price and in volume.

 
 
 
 
7

 
 
 
In 2001, our stock price ranged from a high of $4.90 to a low of $0.07; in 2002, our stock price ranged from a high of $4.20 to a low of $0.55; in 2003, our stock price ranged from a high of $1.80 to a low of $0.65; in 2004, our stock price ranged from a high of $1.50 to a low of $0.45; and from January 1, through December 31, 2005, our stock price ranged from a high of $1.54 to a low of $0.45. During the first six months of 2006, our stock price ranged from a high of $0.44 to a low of $0.03 per share.
 
The stock market has experienced significant price and volume fluctuations, and the market prices of nutraceutical companies, particularly small capitalization companies such as HESG, have been highly volatile. Investors may not be able to sell their shares at or above the then current, OTCBB price. Recent changes in the rules of the OTCBB may make it difficult for small companies such as ours to continue to be quoted on the OTCBB. In addition, our results of operations during future fiscal periods might fail to meet the expectations of stock market analysts and investors. This failure could lead the market price of our common stock to decline.
 
The market price of our common stock could also fluctuate substantially due to:
 
·  
 
quarterly fluctuations in operating results;
 
·  
 
announcements of new products or product enhancements by us or our competitors;
 
·  
 
technological innovations by us or our competitors;
 
·  
 
general market conditions or market conditions specific to our or our customers’ industries; or
 
·  
 
changes in earnings estimates or recommendations by analysts.
 
In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has at times been instituted against that company. If we become subject to securities litigation, we could incur substantial costs and experience a diversion of management’s attention and resources.
 
The market for our stock may be adversely affected by the penny stock rule.
 
Our common stock is subject to the requirements of Rule 15(g)9, promulgated under the Securities Exchange Act as long as the price of our common stock is below $5.00 per share. Under such rule, broker-dealers who recommend low-priced securities to persons other than established customers and accredited investors must satisfy special sales practice requirements, including a requirement that they make an individualized written suitability determination for the purchaser and receive the purchaser’s consent prior to the transaction. The Securities Enforcement Remedies and Penny Stock Reform Act of 1990 also requires additional disclosure in connection with any trades involving a stock defined as a penny stock. Generally, the Commission defines a penny stock as any equity security not traded on an exchange or quoted on NASDAQ that has a market price of less than $5.00 per share. The required penny stock disclosures include the delivery, prior to any transaction, of a disclosure schedule explaining the penny stock market and the risks associated with it. Such requirements could severely limit the market liquidity of the securities and the ability of purchasers to sell their securities in the secondary market.
 
Future issuances of our common stock could dilute current shareholders and adversely affect the market.
 
We have the authority to issue up to 80,000,000 shares of common stock and to issue options and warrants to purchase shares of our common stock and preferred stock without stockholder approval. These future issuances could be at values substantially below the price paid for our common stock by our current shareholders
 
Future sales of our common stock could adversely affect the market.
 
Future sales of our common stock into the market, including sales by our officers, directors and principal shareholders, may also depress the market price of our common stock. Sales of these shares of our common stock or the market’s perception that these sales could occur may cause the market price of our common stock to fall. These sales also might make it more difficult for us to sell equity or equity related securities in the future at a time and price that we deem appropriate or to use equity as consideration for future acquisitions. The conversion of the Series A Preferred Stock and exercise of outstanding option and warrants will dilute our common stockholders and may depress the price of our common stock.
 
 
 
 
 
8

 
 
 
Future sales of preferred stock could also adversely affect the rights of our common stock and have an anti-takeover effect.
 
We have the authority to issue up to 20,000,000 shares of preferred stock without shareholder approval. The issuance of preferred stock by our Board of Directors could adversely affect the rights of the holders of our common stock. An issuance of preferred stock could result in a class of outstanding securities that would have preferences with respect to voting rights and dividends and in liquidation over the common stock and could, upon conversion or otherwise, have all of the rights of our common stock. Our Board of Directors’ authority to issue preferred stock could discourage potential takeover attempts or could delay or prevent a change in control through merger, tender offer, proxy contest or otherwise by making these attempts more difficult or costly to achieve.

 
READ CAREFULLY
 
Please read this prospectus carefully. It describes our business, our financial condition and results of operations. We have prepared this prospectus so that you will have the information necessary to make an informed investment decision.
 
You should rely on the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. The selling shareholders are offering to sell shares of our common stock and seeking offers to buy shares of our common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of the prospectus, regardless of the time the prospectus is delivered or the common stock is sold.
 
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
In addition to historical information, this prospectus contains statements relating to our future business and/or results, including, without limitation, the statements under the captions “Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.” These statements include certain projections and business trends that are “forward-looking” within the meaning of the United States Private Securities Litigation Reform Act of 1995. You can identify these statements by the use of words like “may,” “could,” “should,” “project,” “believe,” “anticipate,” “expect,” “plan,” “estimate,” “forecast,” “potential,” “intend,” “continue” and variations of these words or comparable words. Forward-looking statements do not guarantee future performance and involve risks and uncertainties. Actual results will differ, and may differ materially, from projected results as a result of certain risks and uncertainties. These risks and uncertainties include, without limitation, those described under “Risk Factors” and those detailed from time to time in our filings with the SEC, and include, among others, the following:
 
·  
our limited operating history;
·  
continuing depletion of our assets as a result of having no income;
·  
our ability to obtain additional funds to maintain our operations; and
·  
other factors referenced or incorporated by reference in this prospectus and other filings with the Securities and Exchange Commission.
 
These risks are not exhaustive. See “Risk Factors” above. Moreover, new risk factors emerge from time to time and it is not possible for our management to predict all risk factors, nor can we assess the impact of all factors on our business or to the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results. These forward-looking statements are made only as of the date of this prospectus. Except for our ongoing obligation to disclose material information as required by federal securities laws, we do not intend to update you concerning any future revisions to any forward-looking statements to reflect events or circumstances occurring after the date of this prospectus.
 
 CAPITALIZATION
 
The following table presents the actual capitalization of our Company at June 30, 2006. You should read this table in conjunction with our financial statements and the related notes thereto, and the other financial information included elsewhere in this prospectus.

 
 
 
 
9

 
 
 
 
     
       
Warrant liability
 
$
208,796
 
Series A Preferred stock, par value $0.001 per share; $0.001 par value, 5,000,000 shares authorized, 1,350,169 shares issued and outstanding;
 
$
1,147,640
 
Series B Preferred stock, par value $0.001 per share, net of unamortized discount of $98,023; $0.001 par value, 130 shares authorized, 9 shares issued and outstanding, 264,708 shares, on an as if converted basis
 
$
126,978
 
Series C Preferred stock, par value $0.001 per share, net of unamortized discount of $1,354,519; $0.001 par value, 5,000 shares authorized, 3,166 shares issued and outstanding, 2,877,894 shares, on an as if converted basis
 
$
1,811,481
 
Long-term liability
 
$
3,294,895
 
Stockholders’ equity:
       
Common stock, par value $0.001 per share, 80,000,000 shares authorized, 36,813,747 shares issued and outstanding
 
$
36,818
 
Additional paid-in capital
 
$
26,985,449
 
         
Accumulated deficit
 
$
(31,509,217
)
Total stockholders’ deficit
 
$
(4,486,950
)
Total capitalization
 
$
(1,192,055
)
 
 
 
 
 
10

 
 

 USE OF PROCEEDS
 
We will not receive any proceeds from the sale of the shares of common stock by the selling shareholders.

 MARKET FOR COMMON STOCK AND RELATED SHAREHOLDER MATTERS
 
Our common stock began trading in the OTC Bulletin Board on August 3, 2001 and currently trades under the symbol “HESG.OB”. The following table sets forth the high and low bid price per share quotations as reported on the OTC Bulletin Board of the common stock for the periods indicated. These quotations reflect inter-dealer prices, without retail mark up, mark down or commission and may not necessarily represent actual transactions. Actual prices may vary.
 
 
   
High
 
Low
 
           
First Quarter Ended March 31, 2006
 
$
0.44
 
$
0.23
 
Second Quarter Ended June 30, 2006
 
$
0.28
 
$
0.03
 
               
Fiscal Year Ending December 31, 2005:
             
 
   
High
   
Low
 
First Quarter Ended March 31, 2005
 
$
1.54
 
$
0.65
 
Second Quarter Ended June 30, 2005
 
$
1.35
 
$
0.70
 
Third Quarter Ended September 30, 2005
 
$
1.20
 
$
0.69
 
Fourth Quarter Ended December 31, 2005
 
$
0.99
 
$
0.45
 
               
Fiscal Year Ending December 31, 2004:
             
 
   
High
   
Low
 
First Quarter Ended March 31, 2004       
 
$
1.50
 
$
1.13
 
Second Quarter Ended June 30, 2004                       
 
$
1.29
 
$
0.54
 
Third Quarter Ended September 30, 2004         
 
$
1.01
 
$
0.49
 
Fourth Quarter Ended December 31, 2004
 
$
0.99
 
$
0.45
 
               
Fiscal Year Ending December 31, 2003:
             
 
   
High
   
Low
 
First Quarter Ended March 31, 2003 
 
$
1.25
 
$
0.65
 
Second Quarter Ended June 30, 2003
 
$
1.29
 
$
0.71
 
Third Quarter Ended September 30, 2003
 
$
1.21
 
$
0.80
 
Fourth Quarter Ended December 31, 2003
 
$
1.80
 
$
0.90
 
               
Fiscal Year Ending December 31, 2002:
             
 
   
High
   
Low
 
First Quarter Ended March 31, 2002
 
$
4.20
 
$
2.70
 
Second Quarter Ended June 30, 2002
 
$
3.35
 
$
1.30
 
Third Quarter Ended September 30, 2002
 
$
2.00
 
$
0.80
 
Fourth Quarter Ended December 31, 2002
 
$
1.05
 
$
0.55
 

At September 30, 2006, we had 190 holders of record of our common stock; we estimate that the Company has approximately 4,900 additional beneficial holders of our common stock held in names of brokers and securities depositories, amounting to approximately 5,100 shareholders.

 
 
 
 
11

 
 
 
 DIVIDEND POLICY
 
We currently intend to retain future earnings, if any, to finance the expansion of our business, and we do not expect to pay any cash dividends in the foreseeable future. The decision whether to pay cash dividends on our common stock will be made by our board of directors, in their discretion, and will depend on our financial condition, operating results, capital requirements and other factors that the board of directors considers significant. We are required to pay a dividend of 8% per annum on our Series A Convertible Preferred Stock which we may pay in cash or in shares of common stock, which are registered. We are required to pay a dividend of 6% per annum on our Series B Convertible Preferred Stock, payable in cash or in shares of common stock. We are required to pay a dividend of 8% per annum on our Series C Convertible Preferred Stock, payable in cash or in shares of our common stock.
 
 SELECTED CONSOLIDATED FINANCIAL DATA
 
The following table presents summary historical consolidated financial information for the years ended December 31, 2005 and 2004, and for the six months ended June 30, 2006 and 2005. The information for the years ended December 31, 2005 and 2004 is derived from our audited consolidated financial statements included elsewhere in this prospectus. The summary historical consolidated financial information does not purport to indicate results of operations as of any future date or for any future period. In our opinion, all necessary adjustments, consisting only of normal recurring adjustments, have been included to present fairly the financial position and results of operations for the period presented in our unaudited consolidated financial information for the six months ended June 30, 2006. The summary historical consolidated financial information has been derived from and should be read in conjunction with “Management’s Discussion and Analysis of Results of Operations and Financial Condition,” of our consolidated financial statements and notes thereto, which are included elsewhere in this prospectus.
 
Effective October 2004 and May 2005, the Company discontinued operations of its wholly owned subsidiaries Quality Botanical Ingredients, Inc and XCEL Medical Pharmacy, Inc., respectively. Results described herein reflect the consolidated operations of the Company and its wholly-owned subsidiaries with continuing operations for the years ended December 31, 2005 and December 31, 2004, and for the six months ended June 30, 2006 and June 30, 2005.

Summary Consolidated Financial Data

 
   
Year Ended December 31,
 
 Six Months Ended June 30,
 
                   
     
2004
 
2006
 
2005
 
Net sales
 
$
60,142
 
$
67,204
 
$
27,979
 
$
4,369
 
Gross profit
 
$
22,913
 
$
46,665
 
$
7,413
 
$
3,459
 
                           
Selling, general and administrative expenses
 
$
(7,505,132
)
$
(4,593,856
)
$
(3,524,287
)
$
(1,917,259
)
Impairment of intangible assets
 
$
(437,740
)
$
(994,258
)
 
-
   
-
 
Other income (expense)
 
$
2,343,820
 
$
97,916
 
$
683,478
 
$
(2,246,102
)
Loss from discontinued operations
 
$
(174,220
)
$
(5,008,183
)
$
-
 
$
(78,949
)
Net income (loss)
 
$
(5,750,359
)
$
(10,451,716
)
$
(2,833,396
)
$
(4,238,851
)
                           
Net income (loss) attributable to common shareholders
 
$
(6,093,912
)
$
(10,959,108
)
$
(3,016,321
)
$
(4,294,616
)
                           
Net income (loss) per share available to common shareholders:
                         
Basic and Diluted
 
$
(0.25
)
$
(0.78
)
$
(0.10
)
$
(0.21
)
                           
Basic and diluted weighted average shares outstanding
   
24,559,505
   
14,125,035
   
30,598,662
   
20,040,199
 
 
 
 
 
 
12

 
 

Balance Sheet Data

 
         
               
Cash and cash equivalents
 
$
30,103
 
$
21,256
 
$
240,532
 
Working capital
 
$
(4,723,677
)
$
(4,897,615
)
$
(5,340,035
)
Total current assets
 
$
123,405
 
$
131,241
 
$
774,321
 
Total assets
 
$
4,082,098
 
$
4,155,552
 
$
4,401,174
 
Total current liabilities
 
$
4,847,082
 
$
5,028,856
 
$
6,114,356
 
Total liabilities
 
$
8,485,342
 
$
9,066,679
 
$
10,521,726
 
Total stockholders’ equity
 
$
(4,403,244
)
$
(4,911,127
)
$
(6,120,552
)
 
 
 
 
 
13

 
 

 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
 AND RESULTS OF OPERATIONS
 
This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Company's actual results could differ materially from those set forth as a result of general economic conditions and changes in the assumptions used in making such forward-looking statements. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the audited financial statements for the years ended December 31, 2005 and 2004 and the unaudited condensed consolidated financial statements for the three and six months ended June 30, 2006 and 2005 and accompanying notes therein.

Critical Accounting Policies

Our discussion and analysis of results of operations and financial condition are based upon our condensed consolidated financial statements, which have been prepared in accordance with Accounting Principles Generally Accepted in the United States of America (“GAAP”). The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an on-going basis, including those related to provisions for uncollectible accounts, inventories, goodwill, intangible assets, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Note 2 of the "Notes to Consolidated Financial Statements" includes a summary of the significant accounting policies and methods used in the preparation of our consolidated financial statements. The following is a brief description of the more significant accounting policies and methods we use.

Impairment of Long-lived Assets. Long-lived assets such as excess of fair value of net assets acquired, patents, license agreements and formulas could become impaired and require a write-down if circumstances warrant. Conditions that could cause an asset to become impaired include lower-than-forecasted revenues, changes in our business plans or a significant adverse change in the business climate. The amount of an impairment charge would be based on estimates of an asset’s fair value as compared with its book value. In accordance with Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standards (“SFAS”) Nos. 142 and 144, we perform a valuation, at least annually for goodwill and whenever other circumstances arise for other long-lived assets, of our intangible long-lived assets to determine if any impairment exists.

Issuance of Stock for Non-cash Consideration. All issuances of the Company's common stock for non-cash consideration have been assigned a dollar amount equaling either the market value of the shares issued or the value of consideration received whichever is more readily determinable. The majority of the non-cash consideration received pertains to services rendered by consultants and others and has been valued at the market value of the shares issued. In certain issuances, the Company may discount the value assigned to the stock issued for illiquidity and restrictions on resale.

Warrant Liability. In conjunction with raising capital through the sale of equity, the Company has issued various warrants that have registration rights for the underlying shares. As the contracts must be settled by the delivery of registered shares and the delivery of the registered shares is not controlled by the Company, pursuant to EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock”, the fair value of the warrants at the date of issuance is recorded as a warrant liability on the balance sheet and the change in fair value is included in other (expense) income.

Accounting for Stock-Based Incentive Programs. On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment," ("SFAS 123(R)") which requires the measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors based on estimated fair values. We adopted SFAS 123(R) using the modified prospective transaction method, which requires the application of the accounting standard as of January 1, 2006, the first day of our fiscal year 2006. Our financial statements as of and for the three and six months ended June 30, 2006 reflect the impact of SFAS 123(R). In accordance with the modified prospective transition method, our financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). The value of the portion of the award that is ultimately expected to vest is recognized as an expense over the requisite service periods in our statement of operations. Prior to the adoption of SFAS 123(R), we accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB 25 as allowed under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123). As stock-based compensation expense recognized in the statement of operations for the first quarter of fiscal 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimated. We estimated forfeitures to be 10%.

 
 
 
 
14

 
 
 
Stock-based compensation expense recognized as operating expense under SFAS 123(R) for the six months ended June 30, 2006 was approximately $567,000, determined by the Black-Scholes valuation model, and consisting of stock-based compensation expense related to employee stock options. See Note 2 - Summary of Significant Accounting Policies to the unaudited consolidated financial statements for additional information.
 
In accordance with SFAS 123R, in our first quarter of fiscal year 2006 we started to recognize compensation expense related to stock options and restricted stock purchase rights, which are equivalent to options granted to employees based on: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of December 31, 2005, based on the grant date fair value estimated in accordance with SFAS No 123, " Accounting for Stock-Based Compensation ," ("SFAS 123"), adjusted for an estimated future forfeiture rate, and (b) compensation cost for all share-based payments granted subsequent to December 31, 2005, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. 

Results of Operations for the Three Months Ended June 30, 2006 and 2005

Effective October 2004 and May 2005 the Company discontinued operations of its wholly owned subsidiaries Quality Botanical Ingredients, Inc and XCEL Medical Pharmacy, Inc., respectively. Results described herein reflect the consolidated operations of the Company and its two wholly-owned subsidiaries with continuing operations, Swiss Research, Inc. and BioSelect Innovations, Inc. for the three months ended June 30, 2006 as compared to the three months ended June 30, 2005.

Selected Statement of Operations Information

 
   
Three Months Ended June 30,
 
     
2005
 
Net sales
 
$
7,608
 
$
-
 
Gross profit
 
$
2,064
 
$
-
 
Net (loss) income
 
$
(1,167,951
)
$
527,204
 
               
Net (loss) income attributable to common shareholders
 
$
(1,257,347
)
$
244,357
 
               
Net loss per share available to common shareholders
 
$
(0.04
)
$
(0.01
)

Three months ended June 30, 2006 compared to the three months ended June 30, 2005

Net Sales. Our consolidated net sales for the three months ended June 30, 2006 and 2005 are as follows:

Our consolidated net sales from continuing operations for the three months ended June 30, 2006 and 2005 totaled approximately $8,000 and $0, respectively. The revenues for each period are generated from the sales of distinct product lines. Revenues in 2006 are from both Shugr and Sequesterol. In 2005, BioSelect completed its final transaction of offering topically applied base creams wholesale to distributors that sold the product to individual pharmacies. The Company discontinued base cream sales in January 2005.

Cost of Goods Sold Cost of goods sold for the three months ended June 30, 2006 and 2005 totaled approximately $6,000 and $0, or 73% and 0% of net sales, respectively. This resulted in gross profits totaling approximately $2,000 and $0, or 27% and 0% of net sales for the three months ended June 30, 2006 and 2005, respectively. The variance in year over year cost of goods sold is attributable to selling different products, base creams, Shugr and Sequesterol, each exclusively sold in only one period. 

 
 
 
 
15

 
 

Selling, General and Administrative. Total consolidated operating expenses from continuing operations for the three months ended June 30, 2006 and 2005 totaled approximately $1,504,000 or 19,768% of net sales, and approximately $1,660,000, respectively. Our operating expenses include the following amounts:

 
   
Three Months Ended June 30,
 
     
2005
         
Expense
 
$ Amount
 
% Sales
 
$ Amount
 
% Sales
 
Advertising and marketing
 
$
128,412
   
1,688
%
$
345,712
   
-
%
Salary expenses
 
$
(143,945
)
 
(1,892
)%
$
123,048
   
-
%
SFAS 123R expense
 
$
167,870
   
2,206
%
$
-
   
-
%
Professional, legal and accounting fees
 
$
923,420
   
12,137
%
$
659,305
   
-
%
Depreciation and amortization
 
$
166,216
   
2,185
%
$
180,135
   
-
%
Penalties
 
$
-
   
-
%
$
228,620
   
-
%
Other selling, general and administrative expenses
 
$
261,957
   
3,443
%
$
123,427
       
   
$
1,503,930
   
19,768
%
$
1,660,247
       

Advertising and marketing expenses in 2006 were attributable to expenditures promoting the Company’s new products Shugr and Sequesterol as well as the commencement of a national infomercial as compared to the expenses in 2005, sans Sequesterol promotion, that included expenditures for a non-recurring national corporate exposure campaign.

The Company’ s salary expense for the three month’s ended June 30, 2006 is entirely non-cash disbursements paid in shares of common stock, offset by the cancellation of shares previously issued to a former employee.

For the three months ended June 30, 2006, the Company recognized non-cash compensation cost of approximately $168,000 as a result of the adoption of SFAS 123(R). Under SFAS 123(R), the Company will continue to utilize the Black-Scholes model to estimate the fair value of options granted after January 1, 2006. The Company’s assessment of the estimated compensation charges is affected by its stock price as well as assumptions regarding a number of complex and subjective variables and the related tax impact. These variables include, but are not limited to, the Company’s stock price volatility and employee stock option exercise behaviors.

Professional, legal and accounting fees include cash and non-cash consideration paid to consultants for services including business development, financial communication programs, and fees paid for accounting and legal services. Approximately $892,000 and $512,000 or 97% and 78% of the professional, legal and accounting expense for the three months ended June 30, 2006 and 2005 respectively were non-cash expenses paid with the Company’s common stock or options and warrants to purchase shares of the Company’s common stock.

Penalties are due to the holders of the Company’s Convertible Preferred Stock for damages pursuant to the filing of registration statements for the shares underlying the offering. Approximately all of the total expense for the three months ended June 30, 2005 are non-cash expenses that will be paid with the Company’s common stock or options and warrants to purchase shares of the Company’s common stock. The requisite registration statement was declared effective in February of 2006, effectively limiting the Company’s future penalty expense.

Other selling, general and administrative expenses include such items as automobile expenses, delivery and freight costs, office supplies and services, rent, travel, and utilities. The period over period increase is attributable to approximately $138,000 of expense recognized for impairments to intangible assets.

Other expenses. Interest expense, net, totaled approximately $136,000 and $454,000 for the three months ended June 30, 2006 and 2005, respectively and includes interest paid on lines of credit, notes payable and amortization of discount on the sale of convertible debentures and the issuance of convertible preferred stock. Amortization of discounts on debentures and preferred stock represent the interest cost associated with issuing the convertible debentures and preferred stock with warrants totaled approximately $127,000 and $410,000 for the three months ended June 30, 2006 and 2005, respectively, and are non-cash expenditures. The period versus period decrease is attributable to the complete amortization of discounts related to the Company’s debentures and Series A preferred stock.

The change in fair value of warrant liability for the three months ended June 30, 2006 and 2005, respectively, totaled approximately $470,000 and $2,723,000, and represents the change in fair value of warrants issued with registration rights to various professionals and the purchasers of our common and preferred stock. The variance between periods is attributable to decreases in the Company’s closing stock price on June 30, 2006 versus June 30, 2005.

 
 
 
 
16

 
 

Net (Loss) Income. Net (loss) income for the three months ended June 30, 2006 and 2005 totaled approximately ($1,168,000) and approximately $527,000 of net sales, respectively. Net (loss) income per share of common stock was ($0.04) and $0.01 for the three months ended June 30, 2006 and 2005, respectively. Net loss from continuing operations for the three months ended June 30, 2006 and 2005 for the subsidiary company operations totaled approximately ($70,000) and ($38,000), respectively. Net loss from discontinued operations for the three months ended June 30, 2006 and 2005 for the subsidiary company operations totaled approximately $0 and ($82,000), respectively. There can be no assurance that we will ever achieve profitability or that a stream of revenue can be generated and sustained in the future. Income recognized during the three months ended June 30, 2005 was entirely attributable to reductions in the Company’s warrant liability that are recognized as other income.

Results of Operations for the Six Months Ended June 30, 2006 and 2005

 
   
Selected Statement of Operations Information
 
 
   
Six Months Ended June 30,
 
     
2005
 
Net sales
 
$
27,979
 
$
4,369
 
Gross profit
 
$
7,413
 
$
3,459
 
Net loss
 
$
(2,833,396
)
$
(3,711,647
)
               
Net loss attributable to common shareholders
 
$
(3,016,321
)
$
(3,994,494
)
               
Net loss per share available to common shareholders
 
$
(0.10
)
$
(0.19
)

Six months ended June 30, 2006 compared to six months ended June 30, 2005

Net Sales. Our consolidated net sales for the six months ended June 30, 2006 and 2005 are as follows:

The Company discontinued its sales of base creams attributable to 2005 revenues to focus on its core strategy of building the Swiss Research brands and product portfolio, including Shugr and Sequestrol. Our consolidated net sales from continuing operations for the six months ended June 30, 2006 and 2005 totaled approximately $28,000 and $4,000, respectively. The revenues for each period are generated from the sales of distinct product lines. Revenues in 2006 are from both Shugr and Sequesterol.

Cost of Goods Sold Cost of goods sold for the six months ended June 30, 2006 and 2005 totaled approximately $21,000 and $1,000, or 89% and 21% of net sales, respectively. This resulted in gross profits totaling approximately $7,000 and $3,000, or 26% and 79% of net sales for the six months ended June 30, 2006 and 2005, respectively. Cost of goods sold and gross profit were reduced to near zero for the six months ended June 30, 2005 due to the discontinued operations of XCEL Medical Pharmacy.

Selling, General and Administrative. Total consolidated operating expenses for the six months ended June 30, 2006 and 2005 totaled approximately $3,524,000 or 12,596% of net sales, and approximately $3,578,000, or 81,884% of net sales, respectively. Our operating expenses include the following amounts:

 
   
Six Months Ended June 30,
 
     
2005
         
Expense
 
$ Amount
 
% Sales
 
$ Amount
 
% Sales
 
Advertising and marketing
 
$
128,412
   
459
%
$
1,263,896
   
28,929
%
Salary expenses
 
$
97,861
   
350
%
$
236,990
   
5,424
%
SFAS 123R expense
 
$
567,432
   
2,028
%
$
-
   
-
%
Professional, legal and accounting fees
 
$
2,003,032
   
7,159
%
$
1,133,147
   
25,936
%
Depreciation and amortization
 
$
334,950
   
1,197
%
$
347,356
   
7,951
%
Penalties
 
$
40,000
   
143
%
$
369,920
   
8,467
%
Other selling, general and administrative expenses
 
$
352,600
   
1,245
%
$
226,197
   
5,177
%
   
$
3,524,287
   
12,581
%
$
3,577,506
   
81,884
%
 
Advertising and marketing expenses during the six months ended June 30, 2006 have decreased versus the six months ended June 30, 2005. During the six months ended June 30, 2005 the Company completed a national corporate awareness campaign. Current period expenditures are to promote the Company’s new products Shugr and Sequesterol.

 
 
 
 
17

 
 

The Company’ s salary expense for the six month’s ended June 30, 2006 is entirely non-cash disbursements paid in shares of common stock, offset by the cancellation of shares previously issued to a former employee.

For the six months ended June 30, 2006, the Company recognized non-cash compensation cost of approximately $567,000 as a result of the adoption of SFAS 123(R). Under SFAS 123(R), the Company will continue to utilize the Black-Scholes model to estimate the fair value of options granted after January 1, 2006. The Company’s assessment of the estimated compensation charges is affected by its stock price as well as assumptions regarding a number of complex and subjective variables and the related tax impact. These variables include, but are not limited to, the Company’s stock price volatility and employee stock option exercise behaviors.

Professional, legal and accounting include fees paid to consultants for services including business development, financial communication programs, and fees paid for accounting and legal services. Approximately $1,914,000 and $910,000 or 96% and 83% of the professional, legal and accounting fee expense for the quarters ended June 30, 2006 and 2005 respectively were non-cash expenses paid with the Company’s common stock or options and warrants to purchase shares of the Company’s common stock. The period over period increase is significantly attributable to an increase in legal expense paid in shares of the Company’s common stock.

Penalties are due to the holders of the Company’s Convertible Preferred Stock for damages pursuant to the filing of registration statements for the shares underlying the offering. The total expense for the six months ended June 30, 2006 and 2005 respectively is a non-cash expense that will be paid with the Company’s common stock or options and warrants to purchase shares of the Company’s common stock. In February 2006, the requisite registration statements were declared effective and the Company stopped incurring significant penalty charges.

Other selling, general and administrative expenses include such items as automobile expenses, delivery and freight costs, office supplies and services, rent, travel, and utilities.

Other expenses. Interest expense totaled approximately $319,000 and $623,000 for the six months ended June 30, 2006 and 2005, respectively and includes interest paid on lines of credit, notes payable and amortization of discount on the sale of convertible debentures and the issuance of convertible preferred stock. Amortization of discounts on debentures and preferred stock represent the interest cost associated with issuing the convertible debentures and preferred stock with warrants totaled approximately $319,000 and $623,000 for the six months ended June 30, 2006 and 2005, respectively, and are non-cash expenditures.

The change in fair value of warrant liability totaled approximately $1,002,000 and $646,000 and represents the change in fair value of warrants issued with registration rights to various professionals and the purchasers of our common and preferred stock for the six months ended June 30, 2006 and 2005, respectively. The variance between periods is attributable to decreases in the Company’s closing stock price on June 30, 2006 versus June 30, 2005.

Net Loss. Net loss for the six months ended June 30, 2006 and 2005 totaled approximately $2,833,000 or 10,127% of net sales, and approximately $3,712,000 or 84,954% of net sales, respectively. Net loss per share of common stock was $0.10 and $0.19 and for the six months ended June 30, 2006 and 2005, respectively. Net loss for the six months ended June 30, 2006 and 2005 for the subsidiary company operations totaled approximately $130,000 and $68,000 or 464% and 1,556% of net sales, respectively. There can be no assurance that we will ever achieve profitability or that a stream of revenue can be generated and sustained in the future.

Capital Resources and Liquidity

Assets. Our current assets totaled approximately $94,000 at June 30, 2006. Total assets were approximately $3,788,000 at June 30, 2006. At June 30, 2006, assets consisted primarily of inventory of $71,000, net intangibles totaling $3,694,000, net accounts receivable totaling $4,000, and cash on hand of $7,000, all approximate.

Liabilities and Working Capital. Our current liabilities totaled approximately $4,980,000 at June 30, 2006. This resulted in a working capital deficit totaling approximately $4,886,000 at June 30, 2006. Total liabilities were approximately $8,275,000 at June 30, 2006. At June 30, 2006 liabilities consisted primarily of accounts payable and accrued expenses totaling approximately $982,000. Loans payable to shareholders totaled approximately $50,000 at June 30, 2006. Warrant liability totaled approximately $315,000 at June 30, 2006. Liabilities of discontinued operations held for sale totaled approximately $3,328,000 at June 30, 2006.

 As reflected in the accompanying consolidated financial statements, the Company has realized financial losses, negative cash flows from operations and negative working capital. These matters raise substantial doubt about the Company’s ability to continue as a going concern.

 
 
 
 
18

 
 

In view of the matters described in the preceding paragraph, recoverability of a major portion of the recorded asset amounts shown in the accompanying consolidated balance sheet is dependent upon continued operations of the Company, which, in turn, is dependent upon the Company's ability to continue to raise capital and generate positive cash flows from operations. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classifications of liabilities that might be necessary should the Company be unable to continue its existence. 

Cash Requirements and Additional Funding

We generated financial growth primarily through cash flows provided by financing activities. Cash flows provided by financing activities totaled approximately $130,000 and $3,768,000 for the six months ended June 30, 2006 and 2005, respectively. Funds totaling approximately $100,000 were received during the six months ended June 30, 2006 and derived from the exercise of options. In 2005, funds totaling approximately $2,820,000 were received from the issuance of Series C Preferred Stock; funds totaling approximately $240,000 were received from the sale of common stock; funds totaling approximately $763,000 were received from the exercise of options and warrants. For the six months ended June 30, 2006, we used cash flows for operations totaling approximately $145,000 as compared to the six months ended June 30, 2005, we used cash flows for operations totaling approximately $2,862,000. Cash flows provided by investing activities were approximately $0 for the six months ended June 30, 2006 versus $200,000 for the six months ended June 30, 2005.

In August, 2006, the Company sold $15,000 of convertible debentures pursuant to a Securities Purchase Agreement to the Company’s Co-Chairman. Additionally, the Company issued 500,000 of common stock purchase warrants to the debenture holders. Each warrant entitles the holder to purchase one share of common stock at an exercise price of $0.05. The debentures accrue interest at 10% per annum. The warrants expire in August 2011. Additionally, the Company issued a convertible debenture in the amount of $30,000 outstanding liability to the Co-Chairman in a convertible debenture under the same terms.

In August, 2006, the Company sold $25,000 of convertible debentures pursuant to a Securities Purchase Agreement. Additionally, the Company issued 500,000 of common stock purchase warrants to the debenture holders. Each warrant entitles the holder to purchase one share of common stock at an exercise price of $0.05. The debentures accrue interest at 10% per annum. The warrants expire in August 2011.

In October, 2006, the Company received proceeds of $20,000 upon the sale of 400,000 shares of restricted common stock pursuant to a Securities Purchase Agreement. Additionally, the Company issued 400,000 of common stock purchase warrants to the debenture holders. Each warrant entitles the holder to purchase one share of common stock at an exercise price of $0.05. The warrants expire in October 2016.

We believe that cash on hand will be insufficient to meet our anticipated needs for working capital, capital expenditures and business development for the next twelve months. In order to expand our operations, we will need to raise additional financing. If we are unable to raise additional funds, we may be forced to curtail or cease operations.

Even if we are able to continue our operations, the failure to obtain debt or equity financing could have a substantial adverse effect on our business and financial results, and we may need to delay purchases of additional companies. Although we have historically relied upon financing provided by our officers and directors to supplement operations, they are not legally obligated to provide the Company with any additional funding in the future.

In the future, we may be required to seek additional capital by selling debt or equity securities, selling assets, or otherwise be required to bring cash flows in balance when it approaches a condition of cash insufficiency. The sale of additional equity securities, if accomplished, may result in dilution to our shareholders. We cannot assure shareholders, however, that financing will be available in amounts or on terms acceptable to us, or at all.

As of June 30, 2006, our principal commitments consisted of agreements with various consultants who will provide with business development, public and financial relations, and raising additional debt or equity financing in exchange for stock of the Company or a portion of proceeds from the sale of stock.
Subsequent Events

 Subsequent to the period ended June 30, 2006, Sid L. Anderson, a member of the Company’s board of directors, notified the Company that he was recently elected Chairman of the Board of Directors of another company. Due to the potential conflict of interest, he submitted his resignation from the board of Health Sciences Group, effective August 14, 2006.

 
 
 
 
19

 
 

Results of Operations for the year ended December 31, 2005 and 2004

Effective October 2004 and May 2005 the Company discontinued operations of its wholly owned subsidiaries Quality Botanical Ingredients, Inc and XCEL Medical Pharmacy, Inc., respectively. Results described herein reflect the consolidated operations of the Company and its two wholly-owned subsidiaries with continuing operations, Swiss Research, Inc. and BioSelect Innovations, Inc. for the year ended December 31, 2005 as compared to the year ended December 31, 2004. The data presented for the year ended December 31, 2004 has been adjusted from its original year-end presentation to reflect the subsequently discontinued operations of both Quality Botanical Ingredients and XCEL Medical Pharmacy.
 
 
   
Selected Statement of Operations Information
 
       
   
Year Ended December 31,
 
     
2004
 
Net sales
 
$
60,000
 
$
67,000
 
Gross profit
 
$
23,000
 
$
47,000
 
Selling, general and administrative expenses
 
$
7,505,000
 
$
4,594,000
 
Intangible asset impairment
 
$
437,740
 
$
994,258
 
Other (income) expense
 
$
(2,344,000
)
$
(98,000
)
Contingent loss of disc ops
 
$
-
 
$
2,077,000
 
Loss from disc. ops
 
$
174,000
 
$
2,931,000
 
Net loss
 
$
5,750,000
 
$
10,451,000
 
               
Net loss attributable to common shareholders
 
$
6,094,000
 
$
10,959,000
 
               
Net loss per share available to common shareholders
 
$
(0.25
)
$
(0.78
)

Year ended December 31, 2005 compared to year ended December 31, 2004

Net Sales. Our consolidated net sales from continuing operations for the years ended December 31, 2005 and 2004 totaled approximately $60,000 and $67,000, respectively. The revenues for each period are generated from the sales of two distinct product lines. In 2004, BioSelect sold base creams wholesale to distributors that sold the product to individual pharmacies. The Company discontinued base cream sales in January 2005. Significantly all revenues in 2005 are from Shugr, via the acquisition of Swiss Research, and are reported starting August 2005.

In 2005, the Company completed development of Shugr, the zero-calorie sweetener that tastes and bakes like cane sugar, and successfully placed the product in nearly 2,000 retail outlets. The Company expects to expand Shugr’s retail distribution in 2006.

Cost of Goods Sold. Cost of goods sold for the years ended December 31, 2005 and 2004 totaled $37,000 and $21,000, or 62% and 31% of net sales, respectively. This resulted in gross profits totaling $23,000 and $47,000, or 38% and 69% of net sales for the years ended December 31, 2005 and 2004, respectively. The variance in year over year cost of goods sold is attributable to selling two different products, base creams and Shugr, each exclusively sold in only one period.

Selling, General and Administrative. Total selling, general and administrative expenses for the years ended December 31, 2005 and 2004 totaled approximately $7,505,000 and $4,594,000, or 12,479% and 6,836% of net sales, respectively.
 
 
   
Years Ended December 31,
 
     
2004
         
   
Amount
 
% Sales
 
Amount
 
% Sales
 
Salary and payroll expense
 
$
685,000
   
1,141
%
$
627,000
   
933
%
Marketing and advertising
   
1,633,000
   
2,715
%
 
3,000
   
5
%
Professional fees
   
3,422,000
   
5,689
%
 
2,748,000
   
4,089
%
Depreciation and amortization
   
279,000
   
464
%
 
196,000
   
291
%
Penalties
   
789,000
   
1,311
%
 
611,000
   
910
%
                           
Other selling, general and administrative expenses
   
697,000
   
1,159
%
 
409,000
   
607
%
                           
Total selling, general and
                         
Administrative expenses
 
$
7,505,000
   
12,479
%
$
4,594,000
   
6,836
%

 
 
 
 
20

 
 

Salary and payroll expense includes salaries, taxes, vacation earnings and bonuses for the years ended December 31, 2005 and 2004. In 2005 and 2004, approximately $430,000 and $228,000, respectively, of total salary expense was paid by the issuance of our common stock and therefore did not affect cash flows.

Professional fees increased to 5,689% of net sales or $3,422,000 in 2005 and include fees paid to consultants for investor relations services including providing financial communication programs, increasing general market awareness, educating retail brokers and institutional networks, assisting management with the development of strategic approaches to accessing the equity and debt markets, and identifying and reviewing potential acquisition candidates and fees paid for legal services provided. Consulting expenses also include fees paid to consultants relating to the business development of Health Sciences Group and our subsidiary companies, Swiss Research and BioSelect. These services include developing corporate strategies, planning for our anticipated commercialization of new products, formulating and evaluating potential corporate options, and expanding subsidiary company operations through an integrated process of analysis. Approximately $2,795,000 and $1,932,000 were non-cash charges incurred for professional services through the issuance of common stock, common stock options and common stock warrants for the years ended December 31, 2005 and 2004, respectively. We expect to continue to increase market awareness, continue to develop our strategic approaches, perform due diligence on acquisition candidates and acquire them accordingly. However, we plan to reduce the related consulting expenses by using internal resources as much as possible.

In 2005, depreciation and amortization expense increased to 464% of net sales. This increase is attributable to the acquisition of licenses for Apple Peel, Polymann and Open Cell Biotech. With the successful approval of our patent applications, intellectual property amortization expense will account for the significant share of depreciation and amortization expense for the foreseeable future. Significantly all capitalized loan fees were fully amortization during 2004.

Penalties paid to preferred stock shareholders increased from $611,000 in 2004, to $789,000 in 2005. All penalties were paid with equity.

Other selling, general and administrative expenses include such items as automobile expenses, delivery and freight costs, office supplies and services, rent, travel, and utilities. Within other selling general and administrative expenses, insurance expense allocated to general and administrative expenses totaled approximately $149,000 for the year ended December 31, 2005 compared to $103,000 for the year ended December 31, 2004.

Impairment of intangible Assets. At December 31, 2005, the Company recognized approximately $438,000 as “Impairment of Intangible Assets” in the Company’s statement of operations resulting from a reduced valuation of the Company’s apple peel powder processing license. In addition, the Company abandoned certain patent applications, which had been previously capitalized in the purchase price allocation at the time BioSelect was acquired.

At December 31, 2004, impairments to goodwill and formulations at the Company’s discontinued XCEL subsidiary totaled approximately $351,000 and $540,000, respectively, and are included in Loss from Discontinued Operation of XCEL in the statement of operations. In 2004, impairments to patents held by BioSelect totaled approximately $994,000 and recognized as “Impairment of Intangible Assets” in the Company’s statement of operations.

Other expenses. Interest expense totaled approximately $1,072,000 and $691,000 for the years ended December 31, 2005 and 2004, respectively and includes interest paid on lines of credit, notes payable, capital leases and amortization of discount on convertible debentures and convertible preferred stock. Amortization of discounts on debentures and preferred stock are non-cash expenditures that represent the interest cost associated with issuing the convertible debentures and preferred stock with warrants and the intrinsic value of the beneficial conversion feature, which totaled approximately $1,013,000 and $558,000 for the years ended December 31, 2005 and 2004 respectively. Other non-cash expenditures included in interest expense total approximately $59,000 and $130,000 for the years ended December 31, 2005 and 2004, respectively and relate to discounts on notes payable and the value of the issuance of common stock due to a price adjustment provision.

The decrease in fair value of warrant liability totaled approximately $3,803,000 and $747,000 for the years ended December 31, 2005 and 2004 respectively, and represents the change in fair value of warrants issued with registration rights to various professionals and the purchasers of our preferred stock. The decrease in fair value is included as other income on our statement of operations.

 
 
 
 
21

 
 

Contingent Loss from Discontinued Operations. In 2004, upon the discontinuation of Quality Botanical Ingredients and per Statement of Financial Accounting Standards No. 5 “Accounting for Contingencies,” the Company recognized an expected loss of approximately $2,077,000 on both the disposal of assets held for sale and certain assets and capitalized costs whose future economic value has been determined to be unrealizable. This loss effectively reduces the carrying value of those assets identified with the discontinued operations to the realized fair market value established in January 2005 during the entity’s liquidation auction. The assets contributing to the loss include:

 
   
Amount
 
Accounts receivable, net
 
$
110,000
 
Inventory, net
   
1,235,000
 
Fixed assets, net
   
680,000
 
Capitalized loan fees, net
   
32,000
 
Security deposits
   
20,000
 
         
Total loss from discontinued operations
 
$
2,077,000
 

Loss from Discontinued Operations. Loss from discontinued operations, excluding contingent losses, for the years ended December 31, 2005 and 2004 totaled approximately ($174,000) or (290%) of net sales and approximately ($2,931,000) or (4,362%) of net sales, respectively. Net loss from discontinued operations, including contingent losses, per share of common stock was ($0.01) and ($0.36) for the years ended December 31, 2005 and 2004, respectively. The decrease in net loss is due to the discontinuance of QBI in October 2004 and XCEL Medical Pharmacy in May 2005.

Loss from Continuing Operations. Loss from continuing operations for the years ended December 31, 2005 and 2004 totaled approximately ($5,576,000) or (9,272%) of net sales and approximately ($5,445,000) or (8,100%) of net sales, respectively. Net loss from continuing operations per share of common stock was ($0.23) and ($0.42) for the years ended December 31, 2005 and 2004, respectively. Non-cash charges that contributed to the losses included asset impairments, services and financing costs associated with our debt and equity financing transactions and the issuance of registered shares without an effective registration statement as previously discussed. There can be no assurance that we will ever achieve profitability or that a stream of revenues can be generated and sustained in the future.

Capital Resources and Liquidity

Assets. At December 31, 2005, our assets from continuing operations consisted primarily of net patents, goodwill and licenses totaling approximately $4,024,000, and net accounts receivable totaling approximately $7,000, inventory totaling approximately $91,000 and cash on hand of approximately $21,000.

Liabilities and Working Capital. At December 31, 2005, our liabilities from continuing operations consisted primarily of accounts payable and accrued expenses totaling approximately $1,149,000, warrant liability of approximately $1,211,000, convertible preferred stock totaling $2,827,000, convertible debentures of $315,000, notes payable - including notes payable to shareholders - totaling $20,000, and dividends payable of approximately $215,000.

Decreases in current liabilities from continuing operations are significantly attributable to the payment of convertible debenture obligations, payroll tax obligations, and accrued expenses. Increases in long term liabilities from continuing operations were due to the sale of Series C Preferred Stock, which is to be settled in our registered common stock.

Liabilities held for sale from discontinued operations totaled approximately $3,329,000 at December 31, 2005, as follows:

 
   
Amount
 
       
Account payable and accrued expenses
 
$
1,175,000
 
Line of credit
   
1,789,000
 
Payroll taxes payable
   
97,000
 
Notes payable
   
201,000
 
Capital leases payable
   
67,000
 
         
Total liabilities held for sale
 
$
3,329,000
 

 
 
 
 
22

 
 

Cash Requirements and Additional Funding

We generated financial growth primarily through cash flows provided by financing activities. In 2005 and 2004, financing activities generated net cash of approximately $3,680,000 and $820,000, respectively. Proceeds totaling approximately $4,199,000 were received during the year ended December 31, 2005 and were derived from the sale of our equity securities (preferred and common), proceeds from the exercise of options and warrants, and loans from officers. Cash flows used by financing activities were primarily payments issued on notes payable ($55,000), expenses related to selling common and preferred stock, approximately ($356,000), and outflows from discontinued operations of approximately ($108,000). Proceeds totaling approximately $1,959,000 were received during the year ended December 31, 2004 from the sale of our equity securities (preferred and common) and proceeds from the exercise of options and warrants, and loans from officers. Cash flows used by financing activities were primarily payments issued on our notes payable ($224,000), cash flows used by discontinued operations, approximately ($758,000) and expenses related to selling common and preferred stock of approximately ($158,000). Cash and cash equivalents decreased by approximately $219,000 to approximately $21,000 at December 31, 2005.

The following table summarizes our contractual obligations from continuing operations at December 31, 2005:

 
   
Less Than
 
1 to 3
 
4 to 5
 
After
     
Contractual Obligation
 
Total
 
One Year
 
Years
 
Years
 
5 Years
 
Notes payable to shareholders
 
$
20,000
 
$
20,000
 
$
-
 
$
-
 
$
-
 
Operating leases
   
10,000
   
10,000
   
-
   
-
   
-
 
Convertible debentures
   
315,000
   
315,000
   
-
   
-
   
-
 
Employment contract - Tannous
   
750,000
   
250,000
   
500,000
   
-
   
-
 
                                 
Total contractual cash obligations
 
$
1,095,000
 
$
595,000
 
$
500,000
 
$
-
 
$
-
 

The operating lease for our offices and employment contracts are expected to be paid either with cash generated from operations or from financing activities. The repayment of principal on the shareholder loans will either be paid by cash generated from operations or from financing activities. The convertible debentures are expected to be converted into shares of our common stock pursuant to the agreements, resulting in additional issuances of our common stock. In 2005, cash used for operating activities totaled approximately ($4,099,000) while cash generated from financing activities totaled approximately $3,680,000. In 2004, cash used for operating activities totaled approximately ($1,054,000) while cash generated from financing activities totaled approximately $820,000.

Additionally, our other principal commitments consist of agreements with various consultants who will provide us with business development, public and financial relations, and raising additional debt or equity financing in exchange for stock of the Company or a portion of proceeds from the sale of stock. The amount due is based on the fair market price of our stock on the date the transaction is consummated and the value of the transaction.

We believe that cash on hand will be sufficient to meet our anticipated needs for working capital, capital expenditures and business development for the next twelve months. The failure to obtain future debt or equity financing could have a substantial adverse effect on our business and financial results, and we may need to delay the purchase of additional companies. Although we have historically relied upon financing provided by our officers and directors to supplement operations, they are not legally obligated to provide the Company with any additional funding in the future.

In the future, we may be required to seek additional capital by selling debt or equity securities, selling assets, or otherwise be required to bring cash flows in balance when it approaches a condition of cash insufficiency. The sale of additional equity securities, if accomplished, may result in dilution to our shareholders. We cannot assure shareholders, however, that financing will be available in amounts or on terms acceptable to us, or at all.

As reflected in the accompanying consolidated financial statements, the Company has realized financial losses, negative cash flows from operations and negative working capital. These matters raise substantial doubt about the Company’s ability to continue as a going concern.

In the first three months of 2006, management plans to take, or has taken, the following steps that it believes will be sufficient to provide the Company with the ability to continue in existence:

·
 
The Company has raised $100,000 from the exercise of options and warrants and management anticipates raising additional equity funds that will be used to fund any capital shortfalls.
 
·
 
The Company executed a distribution agreement with DNP International to sell Shugr; the Company’s zero-calorie, diabetic safe sweetener that tastes and bakes like cane sugar. Per the agreement, DNP is subject to a minimum sales requirement targeting $1.0 million in 2006, $4.0 million in 2007, and $5.5 million in 2008.
 

 
 
 
 
23

 
 

·
 
The Company will launch its new product, Sequesterol, in April of 2006 and commence an escalating marketing campaign thereafter.
 
·
 
Management is decreasing expenses by using internal resources to perform due diligence and other acquisition related duties on future acquisitions.
 
·
 
Management has streamlined its operations and is developing new products, which are anticipated to have increased gross profit margins.
 

Recently Issued Pronouncements

In December 2004, the FASB issued SFAS No.153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions.” The amendments made by Statement 153 are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. Previously, Opinion 29 required that the accounting for an exchange of a productive asset for a similar productive asset or an equivalent interest in the same or similar productive asset should be based on the recorded amount of the asset relinquished. Opinion 29 provided an exception to its basic measurement principle (fair value) for exchanges of similar productive assets. The Board believes that exception required that some nonmonetary exchanges, although commercially substantive, be recorded on a carryover basis. By focusing the exception on exchanges that lack commercial substance, the Board believes this Statement produces financial reporting that more faithfully represents the economics of the transactions. The Statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges occurring in fiscal periods beginning after the date of issuance. The provisions of this Statement was applied prospectively. The Company has evaluated the impact of the adoption of SFAS 153, and the impact was not significant to the Company's overall results of operations or financial position.

In December 2004, the FASB issued SFAS No.123 (revised 2004), “Share-Based Payment”. Statement 123(R) will provide investors and other users of financial statements with more complete and neutral financial information by requiring that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. Statement 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. Statement 123(R) replaces FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. Statement 123, as originally issued in 1995, established as preferable a fair-value-based method of accounting for share-based payment transactions with employees. However, that Statement permitted entities the option of continuing to apply the guidance in Opinion 25, as long as the footnotes to financial statements disclosed what net income would have been had the preferable fair-value-based method been used. The Company will be required to apply Statement 123(R) in 2006. The Company has evaluated the impact of the adoption of SFAS 123(R), and does not believe the impact will be significant to the Company's overall results of operations or financial position.

In May 2005, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 154, Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20 and FASB Statement No. 3. SFAS No. 154 requires retrospective application to prior periods' financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 also requires that retrospective application of a change in accounting principle be limited to the direct effects of the change. Indirect effects of a change in accounting principle, such as a change in nondiscretionary profit-sharing payments resulting from an accounting change, should be recognized in the period of the accounting change. SFAS No. 154 also requires that a change in depreciation, amortization or depletion method for long-lived, non-financial assets be accounted for as a change in accounting estimate effected by a change in accounting principle. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Early adoption is permitted for accounting changes and corrections of errors made in fiscal years beginning after the date this Statement is issued. Management does not expect the implementation of this new standard to have a material impact on their financial position, results of operations and cash flows. 

 
 
 
 
24

 
 

 BUSINESS
 
General
 
Health Sciences Group, Inc. (the “Company”), a Delaware corporation, is an integrated provider of innovative products proprietary technologies used in nutritional supplements and functional foods and beverages. Its subsidiaries include BioSelect Innovations, which holds the Company’s internally developed intellectual property, and Swiss Research, Inc., which markets and sells branded products addressing major wellness categories. We strive to differentiate ourselves through the use of:

·
Proprietary/patented technologies; and
·
Strategic marketing and distribution partnerships.

We identify, develop and commercialize products and functional food ingredients derived from natural sources to provide consumers and health professionals with preventive healthcare alternatives. We plan to leverage the exclusive and proprietary benefits of our internally developed and patented products and recently acquired licenses to increase sales through national and international channels as we endeavor to maximize our earnings potential. We envision building Health Sciences, Swiss DietTM and Swiss ResearchTM into leading brands while offering new and innovative products and functional ingredients that promote a positive health benefit for a wide variety of consumer needs.

Corporate Background

Health Sciences Group, Inc. was incorporated in the state of Colorado on June 13, 1996 as Centurion Properties Development Corporation. The Company remained dormant until October 16, 2000 when its name was changed to iGoHealthy.com, Inc. On September 10, 2001, the Company changed its name to Health Sciences Group, Inc. On June 20, 2005 the Company’s shareholders approved a resolution to reincorporate the Company in Delaware.

In December 2001, the Company acquired 100% of the outstanding stock of XCEL Medical Pharmacy, Inc., (“XCEL”) a California corporation and the outstanding shares of BioSelect Innovations, Inc., (“BioSelect”) a Nevada corporation for approximately $4.4 million. XCEL and BioSelect provide pharmaceutical and cosmeceutical products and services.

In February 2003, effective January 1, 2003, the Company completed its acquisition of Quality Botanical Ingredients, Inc. (“QBI”) pursuant to an Asset Purchase Agreement for approximately $1.5 million. Quality Botanical Ingredients is a manufacturer and contract processor of bulk botanical materials and nutritional ingredients supplied to buyers in various industries including pharmaceutical, nutraceutical and cosmetics.

In October 2004, the Company acquired Polymann Technologies, Inc. (“PTI”), a wholly-owned subsidiary of UTEK Corporation in a tax-free stock-for-stock exchange for approximately $810,000. PTI holds a license to a patented technology known as Low Molecular Weight Polymannuronate, a natural cholesterol reducing product.

In November 2004, the Company acquired Apple Peel Technologies, Inc. (“APTI”), a wholly-owned subsidiary of UTEK Corporation in a tax-free stock-for-stock exchange for approximately $830,000. APTI holds a license to a patented technology that has been shown to reduce cellular damage caused by free radicals.

In December 2004, the Company executed an asset purchase agreement to acquire Swiss Research, Inc. for approximately $360,000. This transaction was completed in August, 2005.

In February 2005, the Company acquired Open Cell Biotechnologies, Inc. (“OCBI”), a wholly-owned subsidiary of UTEK Corporation in a tax-free stock-for-stock exchange for approximately $955,000. OCBI holds a license to a patented edible open-cell hydrocolloid technology.

 
 
 
 
25

 
 

Discontinued Operations

In October 2004, the Board of Directors of the Company elected to discontinue operations of its wholly owned subsidiary, QBI. The Company is a co-guarantor of the obligations of QBI payable to La Salle Business Credit (“La Salle”) pursuant to a Continuing Unconditional Corporate Guaranty dated as of February 21, 2003. Since the decision to discontinue operations, and post asset liquidation, QBI has remained dormant. Management believes the Company’s continuing operations will not be adversely affected by this action.

In May 2005, management determined that its pharmaceutical business, XCEL Healthcare, Inc. was inconsistent with the Company’s revised strategic direction of identifying, developing and commercializing nutritional products and functional food ingredients and discontinued operations. Since the decision to discontinue XCEL has remained dormant.

BUSINESS STRATEGY

Our objective is to become a recognized leader in providing innovative and proprietary products and ingredients that promote a positive health benefit for a wide variety of consumer needs. To achieve our objective, we intend to:

Build Consumer Base and Brand Awareness through Advertising and Promotional Activities. We intend to achieve consumer awareness of and create a demand for our products through advertising and promotional activities in conjunction with the establishment of distribution channels. We believe that one of the most effective marketing tools is product sampling combined with the dissemination of educational information explaining the nutritional qualities of our products. Accordingly, we anticipate increasing our advertising and marketing budget as we increase emphasis on television advertising.

Promote the Proprietary, Science-based Qualities of our Products. The proprietary qualities of our products are important to significant consumer segments including the fitness, weight management and therapeutic markets. We intend to advertise in health and fitness magazines, in health-oriented publications and in various other magazines with wider circulation to promote consumer interest within these markets. We expect to distribute educational materials that promote interest in our brand and our products.

Introduce New Products and Product Line Extensions. Although we are initially focusing on a few products, we intend to introduce further extensions of our products.

Acquire Complementary Companies or Product Lines. To grow sales outside of existing product lines and related products, we will consider strategic acquisitions. We intend to focus on acquisitions of product lines or companies with product lines that are marketed to the nutraceutical and cosmeceutical markets. We may also consider possible acquisitions of or investments in manufacturers of foods and beverages.

Attract and Retain Quality Employees. We recognize the need to continue to attract and retain quality employees. We intend to target established leadership bases for growth in both existing and new markets, enhance our infrastructure to create an atmosphere of teamwork and cooperation, improve reward and recognition, and develop more interactive training programs.

Enter New Markets. We believe that, in addition to the North American market, significant growth opportunities continue to exist in international markets. New markets will be selected based on an assessment of several factors, including market size, anticipated demand for our products, receptivity to network marketing, and ease of entry, which includes consideration of possible regulatory restrictions on the products or network marketing system. We expect to register certain products with regulatory and government agencies in preparation for international expansion.

 
 
 
 
26

 
 

PRODUCT OVERVIEW

We focus on delivering a complete wellness program and way of life to health-conscious consumers. Our products are designed to appeal to the growing number of consumers who seek to live a long and healthy lifestyle. We are continuing to develop products in three categories which address (i) diet and weight management; (ii) cholesterol and heart health; and (iii) personal care and wellness.

Shugr™

Shugr™ is a zero-calorie sugar substitute, that tastes and bakes like cane sugar. It is made with high-quality ingredients and manufactured under strict Good Manufacturing Practices ("GMP") standards. Shugr is based on a proprietary blend of erythritol, tagatose, maltodextrin and a trace of sucralose. Erythritol occurs naturally in many fruits and vegetables, maltodextrin comes from corn starch, and tagatose provides added sweetness and prebiotic fiber which aids in digestion. Shugr's unique formulation results in a sweet taste that is remarkably like cane sugar without any aftertaste typically associated with zero-calorie sweeteners. Shugr tastes like sugar and cooks like sugar. Shugr™ has a patent pending. Shugr is made with high quality ingredients. and its ingredients have a GRAS (Generally Recognized as Safe) designation for food safety as determined by the U.S. Food & Drug Administration (FDA). Shugr™ is currently available through Vitamin Shoppe, Meijer, Drugstore.com, Amazon.com, and LavazzaStore.com.

Sequesterol Advance Cardio Formula

SequesterolTM Advance Cardio Formula is a proprietary blend of clinically studied ingredients selected by medical professionals for their unique ability to maintain cardiovascular health and a free-flowing circulatory system. SequesterolTM contains a proprietary blend of natural ingredients formulated to take a multi-faceted approach to maintain and support ones coronary vascular system. This combination includes: cassia nomame, a natural fat-blocking lipase inhibitor; octacosanol, a natural phytochemical and a major constituent of policosanol which has been found to maintain healthy cholesterol levels; and omega-3 (DHA) fatty acids, which have been found to be helpful in reducing the risk of coronary artery disease. SequesterolTM combines the benefits of these powerful nutrients with heart-healthy vitamins to provide cardio support! SequesterolTM is currently available for purchase at http://www.Sequesterol.com with plans to sell SequesterolTM directly to consumers via a direct to consumer television campaign.

Other unique and innovative products include Aplevia™ - an ultra-powerful antioxidant derived from apple peels and Edible SpongesTM, an open-cell hydrocolloid product.

PRODUCT MANUFACTURING

We use third-party vendors to produce our products. These third-party vendors and manufacturers produce and, in most cases, package these products according to formulations developed by or in conjunction with our in-house product development team.

We place a strong emphasis on quality control because we believe that quality standards play a critical factor in consumer purchasing decisions and in differentiating the Swiss Research brand. All of our products will be manufactured in accordance with current GMPs. Outsourcing key products is designed to allow us to enhance production flexibility and capacity while substantially reducing capital expenditures, avoiding the costs of managing a production work force, and to focus our energy and resources on marketing and sales.

The selected contract manufacturer will manufacture our products under formulations that we own. They will be prohibited from producing products for any other customers using our formulas. In addition, the selected contract manufacturer is contractually prohibited from producing products based on our organic functional nutrition concept for any other customer, with limited exceptions. Product will be shipped to locations throughout the nation from their centrally located warehouse facility.

We believe that the selected contract manufacturer will have the capacity to fulfill our planned production needs for at least the next twelve months. In addition, we believe that the manufacturer is willing to increase capacity to meet our additional production needs, if necessary. If our growth exceeds the production capacity of the selected contract manufacturer, or if they were unable or unwilling to continue production, we believe we could locate and qualify other contract manufacturers to meet our production needs.

 
 
 
 
27

 
 

Quality Assurance

We require all raw materials or finished products produced by third party vendors to be placed in quarantine upon receipt before release by our quality control laboratory. We conduct sample testing, weight testing, purity testing, dissolution testing and, where required, microbiological testing. When materials are released from quarantine, each lot is assigned a unique lot number which is tracked throughout the manufacturing process. Materials are blended, tested and then encapsulated or formed into pills which may or may not be coated. We routinely perform qualitative and quantitative quality control procedures on its finished products.

Our contract manufacturer is expected to produce and package our products in accordance with GMP standards. All raw materials are purchased from approved suppliers and inspected by the contract manufacturer as they are received into the production facilities. Raw materials are then labeled to indicate their source of supply, lot number, and date of receipt, and samples of the raw materials are kept for two years from the date received. The ingredients are mixed into batches under the supervision of two quality assurance contract manufacturer employees to verify adherence to our formulations and ensure taste consistency. The finished products are weighed, wrapped, and date coded. After each production run, samples are analyzed to test the product for micro-impurities and to ensure accurate labeling.

SALES & MARKETING

Nutritional products are distributed through six major sales channels. Each channel has changed in recent years, primarily due to advances in technology and communications that have resulted in improved product distribution and faster dissemination of information. We expect to distribute products through the following channels:

·
Mass market retailers - mass merchandisers, drug stores, supermarkets, and discount stores;
·
Direct response television;
·
Natural health food retailers;
·
Healthcare professionals and practitioners;
·
Mail order; and
·
The Internet.

We plan to build the Health Sciences, Swiss DietTM and Swiss ResearchTM brand name within multiple channels of distribution in order to develop increased brand awareness and strong brand recognition among consumers seeking products with a reputation for high quality and efficacious results. We plan to position our products within the specialty retail and direct-to-consumer distribution channel as high quality products using proprietary, pharmaceutical grade ingredients supported by clinical data which presents a positive health benefit. Our marketing strategy has the following components:

Product Branding and Wellness. Our underlying initiative is to build a reputation as a company that is focused on a complete wellness program and way of life. We believe we are ideally positioned to take advantage of current consumer trends indicating that individuals are turning more and more to nutritional supplements for weight loss, fitness and age-related health concerns. We plan to undertake an advertising, public relations and branding campaign. To further product awareness, we will concentrate our marketing efforts on those products that are proprietary and have scientific, clinical data that supports their efficacy.

Advertising. We intend to use advertising campaigns to create greater awareness of the convenience, taste, and nutritional attributes of our products. We plan to use a combination of print, Internet, radio, and television advertising, with primary emphasis on print and Internet advertising to reach our target audiences in a cost-effective manner. However, we expect to spend a significant portion of future our advertising budget on television advertising to reach a larger number of targeted consumers.

Promotions. We believe that one of our most effective marketing tools is product sampling combined with the on-site dissemination of information explaining the nutritional attributes of our products. We expect to participate in various trade shows targeted at buyers in the health and fitness, food, and sports markets, in addition to consumer health fairs.

Customer and Consumer Service. We are committed to providing superior service to our customers and consumers. Our sales and marketing team will continually gather information and feedback from consumers and retailers to enable us to better tailor our consumer support to meet changing consumer needs. We expect to provide access to nutritionists and consumer service representatives through a toll free number to answer questions and educate consumers on nutrition, new products and developments. In addition, we expect to maintain updated consumer information on our web site.

 
 
 
 
28

 
 

COMPETITION

The business of developing and distributing nutritional and personal care products, such as those we sell and distribute is highly competitive. Numerous manufacturers, distributors, and retailers compete for consumers and distributors. We expect to compete directly with other entities that develop, manufacture, market, and distribute products in each of our product lines. We compete with these entities by emphasizing the underlying science, value, and high quality of our products. However, many of our competitors are substantially larger and have greater financial resources and broader name recognition. Our markets are highly sensitive to the introduction of new products that may rapidly capture a significant share of those markets. The nutritional supplement market is characterized by:

·
Large selections of essentially similar products that are difficult to differentiate;
·
Retail consumer emphasis on value pricing;
·
Constantly changing formulations based on evolving scientific research;
·
Low entry barriers resulting from low brand loyalty, rapid change, widely available manufacturing, low regulatory requirements, and ready access to large distribution channels; and
·
A lack of uniform standards regarding product ingredient sources, potency, purity, absorption rate, and form.

Similar factors are also characteristic of products comprising our other product lines. There can be no assurance that we will be able to effectively compete in this intensely competitive environment. In addition, nutritional and personal care products can be purchased in a wide variety of channels of distribution, including retail stores. Our product offerings in each product category are relatively few compared to the wide variety of products offered by many of our competitors and are often premium priced. As a result, our ability to remain competitive depends in part upon the successful introduction of new products and enhancements of existing products.

GOVERNMENT REGULATION

The manufacturing, packaging, labeling, advertising, distribution, and sale of our products are subject to the regulation of various government agencies, principally the FDA. The FDA regulates our products pursuant to the Federal Food, Drug, and Cosmetic Act ("FDCA") and the Fair Packaging and Labeling Act ("FPLA") and regulations thereunder. The FDCA is intended, among other things, to assure consumers that foods are wholesome, safe to eat, and produced under sanitary conditions, and that food labeling is truthful and not deceptive. The FPLA provides requirements for the contents and placement of information required on consumer packages to ensure that labeling is useful and informative. Our products are generally classified and regulated as food under the FDCA, and are, therefore, not subject to pre-market approval by the FDA. However, our products are subject to the comprehensive labeling and safety regulations of the FDA, the violation of which could result in product seizure and condemnation, injunction of business activities, or criminal or civil penalties. Furthermore, if the FDA determines, on the basis of labeling, promotional claims, or marketing by the Company, that the intended use of any of our products is for the diagnosis, cure, mitigation, treatment, or prevention of disease, it could regulate those products as drugs and require, among other things, pre-market approval for safety and efficacy. We believe that we presently comply in all material respects with the foregoing laws and regulations. However, there can be no assurance that future compliance with such laws or regulations will not have a material adverse effect on our business, results of operations or financial condition.

Our advertising is subject to regulation by the FTC, pursuant to the Federal Trade Commission Act ("FTCA") which prohibits unfair or deceptive acts or practices including the dissemination of false or misleading advertising. Violations of the FTCA may result in a ‘cease and desist’ order, injunction, or civil or criminal penalties. The FTC monitors advertising and entertains inquiries and complaints from competing companies and consumers. It also reviews referrals from industry self-regulatory organizations, including the National Advertising Division (“NAD”). The NAD of the Council of Better Business Bureaus, Inc. administers a voluntary self-regulatory, alternative dispute resolution process that is supported by the advertising industry and serves the business community and the public by fostering truthful and accurate advertising.

Our activities are also regulated by various agencies of the states, localities, and foreign countries in which our products are sold. In addition, we may be required to re-formulate our products to comply with foreign regulatory standards. We believe that we presently comply in all material respects with the foregoing laws and regulations. There can be no assurance, however, that future compliance with such laws or regulations will not have a material adverse effect on our business, results of operations and financial condition.

 
 
 
 
29

 
 

We may be subject to additional laws or regulations administered by the FDA or other federal, state, or foreign regulatory authorities, the repeal of laws or regulations, or more stringent interpretations of current laws or regulations, from time to time in the future. We cannot predict the nature of such future laws, regulations, interpretations, or applications, nor can we predict what affect additional government regulations or administrative orders, when and if promulgated, would have on our business in the future. Such laws could, however, require the reformulation of products, the recall, withholding or discontinuance of products, the imposition of additional recordkeeping requirements, the revision of labeling, advertising, or other promotional materials, and changes in the level of scientific substantiation needed to support claims. Any or all such government actions could have a material adverse effect on our business, results of operation and financial condition.

Research and Development

Research and development efforts are generally devoted to four principal areas: (1) development of new technologies; (2) application of our existing technologies to new products; (3) improvement of existing processes; and (4) formulation of existing and new biologically active compounds.

As part of our focus on delivering a complete wellness program and way of life to our customers, we plan to explore and develop new products. New product ideas are derived from a number of sources, including trade publications, scientific and health journals, our executives, staff and consultants and outside parties. In general, we maintain a strategy of introducing our own proprietary formulations of products successfully offered by others in the market. Although our products use ingredients that we regard as safe when taken as suggested by us, we expect to conduct limited clinical studies of certain proprietary products. In advance of introducing products into our markets, local counsel and other representatives, retained by us, investigate product formulation matters as they relate to regulatory compliance and other issues. Our products are then reformulated to suit both the regulatory and marketing requirements of the particular market.

Patents and Trademarks

BioSelect has developed a number of proprietary and patented product formulations. These patents address the unique integration of selective traditional over-the-counter generic drugs with complementary alternative medications such as vitamins, herbs and other natural nutraceutical supplements. The product development effort focuses on developing proprietary formulations for existing products and on the creation of formulations for product line extensions. The preservation and improvement of the quality of BioSelect's products are also integral parts of its overall strategy. To date, BioSelect has been issued five patents.

We maintain and have applied for trademark and copyright protection in the United States relating to certain of our existing and proposed products and processes, including Swiss Research TM, Shugr TM, Sequesterol TM, Aplevia ™, Open Cell Biotechnology TM. There can be no assurance that we will be able to successfully protect our intellectual property.

BioSelect maintains and has applied for trademark and copyright protection in the United States relating to certain of its existing and proposed products and processes, including CoCareTM, ConaseTM, CoprofenTM, Epigest EessentialsTM, Femderm EssentialsTM, Femgest EssentialsTM, and TranslipobaseTM. There can be no assurance that BioSelect will be able to successfully protect its intellectual property.

Employees

At August 31, 2006, we employed two persons, both of which are full-time. The Company retains additional employees for accounting, administrative, sales and marketing duties on an as-needed basis. A standard package of employee benefits is provided to all full-time employees. The Company’s employees are not covered by a collective bargaining agreement nor are represented by labor unions. We do not have key man insurance on any employee.

At August 31, 2006, we had an employment agreement with the following personnel:
 
       
Expiration
 
Annual Base
Employee
 
Position
 
Date
 
Salary
Stuart Avery Gold
 
Chief Executive Officer1
 
June 2009
 
$200,000
Fred E. Tannous
 
CFO, Treasurer & Co-Chairman2
 
June 2008
 
$250,000

1 Mr. Gold commenced his employment effective as of June 1, 2006 and has agreed to defer and accrue cash compensation. Pursuant to his employment agreement dated June 28, 2006, Mr. Gold has received 300,000 shares of the Company’s common stock. 2 Since July 1, 2005 to date, Mr. Tannous received shares of the company’s common stock in lieu of cash for the payment of his salary.

 
 
 
 
30

 
 

Properties
 
Our executive office address is at Howard Hughes Center, 6080 Center Drive, 6th Floor, Los Angeles, California, 90045 and we also maintain an office located at 21515 Hawthorne Blvd., Suite 1070, Torrance, CA 90503. The annual lease payments for our office space totaled approximately $12,000. We are currently on a month-to-month basis at the Los Angeles address and have entered into a one-year lease at the Torrance location which expires on February 28, 2007. Management intends to seek alternative facilities upon expansion of its operations.
 
Legal Proceedings
 
Health Sciences Group vs. Miles

On February 10, 2006, the Company filed a Complaint in Los Angeles Superior Court against Loren Miles (“Miles”) alleging causes of action for: (1) breach of contract; (2) fraud; (3) intentional misrepresentation; (4) negligent misrepresentation; (5) conversion; (6) breach of fiduciary duty; and (7) constructive trust. The Complaint arises out of false and fraudulent representations made by Miles on or around December 2004 to the Company in connection with the Company’s purchase of the assets of Swiss Research, Inc., a California corporation (“SRI-CA”), of which Miles was the Chief Executive Officer and sole shareholder. Pursuant to the purchase, SRI-CA initially became a wholly owned subsidiary of Health Sciences and was thereafter to be liquidated. On March 2, 2006, Miles filed his answer to the Complaint.  Also, on March 2, 2006, Miles and SRI-CA filed a separate Complaint in Los Angeles Superior Court against the Company and Swiss Research, Inc., a Delaware corporation (“SRI-DE”), alleging causes of action for: (1) breach of contract (rescission); (2) declaratory relief and a temporary restraining order, preliminary and permanent injunction; (3) cancellation of instrument; (4) declaratory relief; (5) unpaid wages; and (6) breach of contract.  On April 7, 2006, the two cases were deemed related and the Company’s complaint was designated the lead case.  On April 14, 2006, the Company named SRI-CA as a defendant to the Complaint.  On April 19, 2006, the Company and SRI-DE filed their answer to the Complaint.  The Company and SRI-DE deny the claims and intend to vigorously defend against them.  On May 8, 2006, the Company filed a motion for leave to file a First Amended Complaint, adding SRI-DE as a plaintiff and a new cause of action for breach of contract (damages and specific performance), the hearing of which is set for June 12, 2006.  On April 27, 2006, the Court denied a motion for preliminary injunction filed by Miles and SRI-CA, finding that Miles and SRI-CA failed to establish that the asset purchase agreement had not closed and failed to establish any grounds for rescission of the asset purchase agreement.  Following the Court's denial of the preliminary injunction motion, Miles and SRI-CA filed a motion to disqualify the Company's counsel, which the Court denied on June 19, 2006.  On September 18, 2006, the Company and SRI-DE filed a Second Amended Complaint against Miles and SRI-CA, alleging causes of action for: (1) breach of contract; (2) fraud; (3) intentional misrepresentation; (4) negligent misrepresentation; and (5) breach of contract.  Miles and SRI-CA have filed a demurrer to the 2nd, 3rd, 4th and 5th causes of action of the Second Amended Complaint, which is set for hearing on November 22, 2006.  A trial date has yet to be set.

Fred Tannous, et al. vs.  Miles

On May 11, 2006, Fred Tannous, the chief financial officer and Co-Chairman of the Company, and Bill Glaser, Co-Chairman and former president of the Company, filed a Complaint in Los Angeles Superior Court against Loren Miles alleging a cause of action for defamation. The Complaint arises out of false and defamatory allegations made by Miles on or around May 2006.  On May 25, 2006, Tannous, Glaser and the Company filed a First Amended Complaint, alleging causes of action against Miles for: (1) defamation, (2) violation of right of privacy, (3) intentional interference with contract, (4) intentional interference with prospective economic advantage, and (5) negligent interference with prospective economic advantage.  On October 5, 2006, the Court granted Miles' Motion to Strike the Complaint.  However, the Court has not yet issued an Order specifying the basis for its ruling.  Tannous, Glaser and the Company intend on pursuing any available remedies in response to the Court's ruling.  The Court further continued the hearing on Miles' Motion for Attorneys' Fees and Sanctions to November 16, 2006.  On October 18, 2006, Miles filed a Motion for Appointment of a Receiver over the Company, set for hearing on November 16, 2006The Company intends to oppose Miles' motions vigorously.

Claim of Wrongful Termination

In November 2004, an attorney for Jacob Engel, wrote a letter to the Company alleging that Health Sciences Group, Inc. failed to pay Mr. Engel his salary since January 1, 2004 at the rate of $150,000 per annum and wrongfully terminated his participation in the Company’s health insurance coverage leaving him uninsured for three months during which he incurred medical expenses which would have been covered and compelling his acceptance, with a reservation of rights of COBRA coverage for which he has been obliged to pay premiums since September 2004. The letter stated that in the event cure is not fully effected by December 5, 2004, Mr. Engel will terminate his Employment Agreement for Good Reason pursuant to the Employment Agreement. The letter further stated that unless the defaults are fully cured prior to December 5, 2004, in addition to all unpaid base salary since January 1, 2004 through the date of termination and the reimbursement of COBRA payments made by Mr. Engel, the Company will be obligated to pay Mr. Engel one year of his base salary and all accrued vacation pay and to restore Mr. Engel to coverage under the health insurance plan. The letter further stated that in addition, Mr. Engel is entitled to have his rights in his stock options until December 5, 2005 and that Mr. Engel is owed $18,000 for legal expenses; has a claim for breach of the agreement between him and the Company by which he agreed to accept shares of the Company’s stock in lieu of $100,000 of his 2003 salary and has a claim for the automobile allowance of $350 per month which the Company agreed to provide him. There have been no further developments related to this matter through September 30, 2006. The Company does not agree with the allegations made and is prepared to vigorously assert its position.

 MANAGEMENT
 
The following table sets forth the name, age, position, and the start date of each director and executive officer of Health Sciences Group, Inc. and its subsidiaries at September 30, 2006. There are no other persons who can be classified as a promoter or controlling person of the Company.

               
 
Name
 
Age
 
Title
 
 HeldSince
               
 
Stuart Avery Gold
 
55
 
Chief Executive Officer
 
2006
               
 
Fred E. Tannous*
 
40
 
Chief Financial Officer, Treasurer, and Co-chairman of the Board
 
2000
               
 
Bill Glaser
 
40
 
Director, Co-chairman of the Board
 
2000
               
 
William T. Walker, Jr.
 
74
 
Director
 
2003
               
 
Merrill A. McPeak
 
70
 
Director
 
2005
 
 
 
 
 
31

 
 

Stuart Avery Gold joined Health Sciences Group, Inc. as the Chief Executive Officer in June 2006. Previously, Mr. Gold was Chief Operating Office of The Republic of Tea, Inc. where he is acknowledged as one of the innovative gurus behind the success of the Novato, California based company. Co-founded in 1992 by the creators of The Banana Republic, Stuart joined the fledgling company shortly thereafter to create a Tea Revolution in America. With Stuart as the lauded editorial voice for the company’s award winning mail-order catalogue, website and line of innovative products, The Republic of Tea soared to national prominence, spawned the entirely new category of specialty tea, and continues to thrive with enormous success as the industry leader. The Republic of Tea’s 200 varietals of premium teas, ready-to-drink bottled iced teas and its other signature offerings are available through specialty and natural food stores, select department stores, cafés and restaurants throughout North America. Stuart oversaw all aspects of the company’s business and was instrumental in the company’s brand building, marketing, and product development strategies that have made The Republic of Tea one of the most successful and fastest growing specialty brands in America today. The Republic of Tea has been featured in the New York Times, Business Week, The Wall Street Journal, USA Today, CNBC, The TODAY Show and other mainstream media. Stuart is often quoted in publications and books and is a sought-after facilitator and speaker having lectured at numerous schools including Wharton School of Business, New School University, Parson's School of Design and Fortune 500 companies such as American Express.

Fred E. Tannous is co-founder and co-Chairman of Health Sciences Group, Inc. and operated as Chief Executive Officer since founding the Company in 1996 through June 30, 2006. During his tenure, Mr. Tannous was involved in all aspects of the Company’s operations ranging from crafting and executing the Company’s overall growth strategy to structuring debt and equity financings and seeking and evaluating qualified acquisition candidates. Mr. Tannous maintains relationships with investment bankers, capital market participants, accountants, attorneys, and management consultants. Previously, Mr. Tannous was employed at DIRECTV, Inc. where he was involved in various capacities including valuing, structuring, and executing strategic investments. Prior to joining DIRECTV, a wholly owned subsidiary of Hughes Electronics Corporation, Mr. Tannous was with the corporate treasury organization of Hughes where he assisted in conducting valuations and effectuating financing transactions for the company’s satellite and network communication units. From February 1996 to May 1999, Mr. Tannous served as Treasurer and Chief Financial Officer of Colorado Casino Resorts, Inc., a gaming and lodging concern with operations in Colorado. In addition to overseeing the company’s finance and accounting operations, he was accountable for all corporate finance and treasury activities. Previously, as principal of his own consulting firm, Mr. Tannous consulted to several start-up ventures in various industries where he was instrumental in developing business plans, advising on business strategy and capital structure, and arranging venture financings. Mr. Tannous received an MBA in finance and accounting from the University of Chicago Graduate School of Business. He also holds a Masters and Bachelors degree in Electrical Engineering from the University of Southern California.

*On July 1, 2006, Mr. Tannous resigned as Chief Executive Officer and assumed the role of Chief Financial Officer.

Bill Glaser has been Co-chairman, President, and Secretary of Health Sciences Group since October 2000. Mr. Glaser was founder and Chief Executive Officer of Zenterprise, Inc., a comprehensive investment banking and corporate consulting firm which focused primarily on capital formation, M&A advisory, business strategy, marketing, and management consulting services for public and private companies. From September 1991 to July 1994, Mr. Glaser was a registered principal of a regional stock brokerage firm where he gained diverse experience in finance, management, marketing, sales, and public company relations. Previously, he was a registered representative at Drexel, Burnham, Lambert and Smith Barney. Mr. Glaser holds a Bachelors degree in finance and economics from the Ithaca College - School of Business.
 
William T. Walker, Jr. is a Director. Mr. Walker was appointed to the company’s Board of Directors in May, 2003, and is the founder of Walker Associates, a corporate finance consulting firm that acts as advisor to corporations and investment banks, and has served in that capacity since 1985. Prior to starting Walker Associates, he was Executive Vice President and Managing Director of Investment Banking for Bateman Eichler, Hill Richards, a regional West Coast NYSE investment banking firm, where he directed its merger into the Kemper Insurance Group. Mr. Walker currently chairs the board of SupraLife International and its subsidiaries, and serves as a director of King Thomason Group, Stone Mountain Financial Systems, Digid Technologies and Desert Health Products, Inc. He has served as a board member of the Securities Industry Association, a Governor of the Pacific Coast Stock Exchange, a member of the American Stock Exchange Advisory Committee, President of the Bond Club of Los Angeles, and Chairman of the California District Securities Industry Association. Mr. Walker graduated from Stanford University and served in the United States Air Force.

 
 
 
 
32

 
 

Merrill A. McPeak (General U.S. Air Force Ret.). In May 2005, Merrill A. McPeak was appointed to the Board of Directors. >From 1995 to the present, General McPeak has been the president of McPeak and Associates, a consulting firm. From October 1990 to October 1994, he was Chief of Staff of the U.S. Air Force. He is a director of TEKTRONIX (NYSE) - Chairman of the Audit Committee, organization and Compensation Committee; SPAN Communications (OTC) - Chairman of the Audit Committee, Chairman of the Board; Del Global Technologies (OTC) - Member of Compensation Committee; Gigabeam (OTC) - Member of Audit Committee. General McPeak is also a director of private companies and the author of numerous publications in scholarly journals and of several books. General McPeak has a B.A. in Economics from San Diego State University and an M.S. in International Relations from George Washington University and attended the Executive Development Program, University of Michigan Graduate School of Business.
 
Directors

Directors are elected annually and hold office until the annual meeting of the shareholders of Health Sciences and until the successors are elected and qualified. There are no family relationships among Health Sciences’ officers and directors. Non-management directors receive annual cash fees of $24,000 for attending board meetings and 50,000 options per year.

SUMMARY COMPENSATION TABLE      

 
         
 Annual Compensation 
   
 Awards 
 
                            Restricted       
Securities 
       
Name and                      Other Annual     
 Stock 
   
Underlying 
   
All Other 
 
Principal Position
 
Year 
    Salary($)      Bonus($)     
Compensation 
   
Awards($) 
    Options/SARs      Compensation   
Fred E. Tannous(1)
 
12/31/05
 
$
220,000
   
--
   
--
   
--
   
500,000
   
--
 
CFO, Treasurer
 
12/31/04
 
$
190,000
   
--
   
--
   
--
   
1,000,000
   
--
 
Co-Chairman
                                         
Health Sciences Group, Inc.
                                         
                                           
Bill Glaser(2)
 
12/31/05
 
$
110,833
   
--
   
--
   
--
   
500,000
   
--
 
President, Secretary
 
12/31/04
 
$
190,000
   
--
   
--
   
--
   
1,000,000
   
--
 
Co-Chairman
                                         
Health Sciences Group, Inc.
                                         
                                           
John Park(3)
 
12/31/05
 
$
31,806
   
--
   
--
   
--
   
--
   
--
 
President & CEO
 
12/31/04
 
$
125,000
   
--
   
--
   
--
   
100,000
   
--
 
XCEL Healthcare, Inc.
                                         


(1)
As of June 1, 2006, Mr. Tannous resigned from his position as Chief Executive Office and assumed the position of Chief Financial Officer and continues to serve as co-chairman of the Company’s Board of Directors.
(2)
As of August 1, 2005, Mr. Glaser resigned from his position as President and Secretary but has been retained as a consultant and continues to serve as co-chairman of the Company’s Board of Directors. In the table above, all options awarded Mr. Glaser in 2005, were granted post his resignation and pursuant to his consulting agreement.
(3)
As of March 18, 2005, Mr. Park was no longer employed with the Company.

In April 2005, the Company issued 120,000 and 110,000 shares to Messrs. Tannous and Glaser respectively for salary and vacation compensation accrued during 2004. The value of the shares totaled approximately $92,000 and $85,000, respectively, and was based on the fair value of the Company’s stock on the day the Board authorized the grant.

In August 2005, the Company issued 342,466 shares of its common stock to Messer Tannous for services to be provided over the next 11 months.  The value of the shares totaled approximately $257,000 on the date of issuance and was determined based on the fair value of the company’s common stock at the date of grant.

 
 
 
 
33

 
 
 
Option Grants

The following table provides information concerning grants of options to purchase the Company’s common stock that the Company made to each of the executive officers and significant employees named in the summary executive compensation table during the fiscal year ended December 31, 2005. We did not grant stock appreciation rights to these individuals during 2005.

     
Number of
 
Percentage of Total
 
Exercise
   
     
Securities Underlying
 
Options Granted to
 
Price Per
 
Expiration
 
Name
 
Options Granted
 
Employees in 2005
 
Share
 
Date
 
Fred E. Tannous
 
500,000
 
77%
 
$0.65
 

The table below sets forth information concerning the exercise of options during 2005 along with the aggregate 2005 year-end option holdings of the below named officers of the Company:
 
 
AGGREGATED OPTION EXERCISES IN 2005 AND YEAR END OPTION VALUES
COMMON STOCK
 
 
   
 
     
Number of securities
 
Value of unexercised
 
   
 
       underlying options at  
in-the-money
 
   
Shares Acquired
 
Value
   
options at
 
Name
 
on Exercise
 
Realized
 
Exercisable/Unexercisable
   
Fred E. Tannous
   
--
   
--
   
583,334/416,666
 
$
0
 
Bill Glaser(1)
   
--
   
--
   
708,330/291,670
 
$
0
 

(1)
As of August 1, 2005, Mr. Glaser resigned from his position as President and Secretary but has been retained as a consultant and continues to serve as co-chairman of the Company’s Board of Directors. Of the exercisable options noted above, 500,000 were granted pursuant to his consulting agreement of which 208,330 were vested as of December 31, 2005 and the remaining 291,670 were unvested.

Executive Compensation

The table above, for the fiscal years ended December 31, 2005 and 2004, sets forth the compensation paid or accrued by the Company to its named persons. The Company has employment agreements, nondisclosure/non-competition agreements and severance agreements with the following executive officers:

Stuart Avery Gold. We have an employment agreement with Mr. Stuart Gold that commenced June 1, 2006 and ends May 31, 2009. The base salary under this employment contract is $200,000 per year, subjected to annual increases of not less than 10% tied to the achievement of annual sales milestones. This contract provides for a performance bonus calculated as the greater of (i) 10% of the earnings before interest, taxes, depreciation and amortization for said fiscal year or (ii) 50% of the Salary, provided, however, that the Company has generated a minimum of $1 million EBITDA during the fiscal year and the annual bonus may not exceed 150% of the base salary at the time. Also, Gold received an option grant for the purchase of up to 6% of Company common stock, after the completion of the contemplated equity financing, exercisable at a price equal to the offering share price. The first 3% of the option shares shall vest equally on each anniversary date over the term of his agreement. The second 3% of the option shares shall vest as follows; one-third of the total option shares shall vest upon the achievement of the Company’s consolidated EBITDA for any fiscal year exceeding $1 million, another one-third of the total option shares shall vest upon the achievement of the Company’s consolidated EBITDA for any fiscal year exceeding $2 million; and the final one-third of the total option shares shall vest upon the achievement of the Company’s consolidated EBITDA for any fiscal year exceeding $3 million. If this employment contract is terminated by us without good cause, or if we are in breach of the agreement, or if we assign the executive without his consent to a lesser responsibility status than his current position, then we are required to pay Mr. Gold the lesser of (i) his salary for the remainder of the term of the agreement or (ii) one year’s salary and accrued benefits prorated through the date of termination.

 
 
 
 
34

 
 

Fred E. Tannous. We have an employment agreement with Mr. Fred E. Tannous that commenced July 1, 2005 and ends June 30, 2008. The base salary under this employment contract is $250,000 per year. This contract provides for a performance bonus in an amount equal to of 5% of the Adjusted EBITDA for each fiscal year and an option grant for the purchase of up to 500,000 shares of Company common stock exerciseable at a price equal to $0.65 per share. The option shall be exercisiable on a monthly pro rata basis over the term of the agreement. If the Company shall merge, sell a controlling interest, or sell a majority of its assets; or if there is a transaction (or series of transactions) in which the Company’s shareholders sell a majority of outstanding shares of Company capital stock, then we shall pay Mr. Tannous the greater of the remainder of his salary or two hundred fifty thousand dollars. Further, at the date of any such merger or sale is consummated, all unvested options shall be immediately accelerated and as to any unexercised options to purchases shares in the Company which are held by Mr. Tannous, the Company shall pay Mr. Tannous cash in the amount equal to the difference between the consideration paid to the Company on a per share basis less the exercise price of the option, the value of which is multiplied to the number of options which Mr. Tannous holds. If this employment contract is terminated by us without good cause, or if we are in breach of the agreement, or if we assign the executive without his consent to a lesser responsibility status than his current position, or require the executive to be based elsewhere other than our principal executive office, then we are required to Mr. Tannous the lesser of (i) his salary for the remainder of the term of the agreement or (ii) one year’s salary and accrued benefits prorated through the date of termination.

While we have not established an Audit Committee at the present time, the entire Board of Directors acts as the Audit Committee until such time that an Audit Committee is formed and financial expert is elected. The Board of Directors adopted a Code of Ethics on July 10, 2003

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth information concerning common stock ownership by beneficial owners as of September 30, 2006 of five percent or more of our common stock and each of our officers and directors and our officers and directors as a group:

   
Name and Address
 
Amount of
 
Percent of
Title of Class
 
of Beneficial Owner
 
Beneficial Ownership (1)
 
Class
Common
 
Bill Glaser
         
$0.001 par value
 
6080 Center Drive, 6th Floor
 
3,717,464
(2)
 
8.26%
             
Common
 
Fred E. Tannous
         
$0.001 par value
 
6080 Center Drive, 6th Floor
 
3,597,383
(2)
 
8.00%
             
Common
 
UTEK Corporation
         
$0.001 par value
 
202 South Wheeler Street
 
3,023,703
(3)
 
6.85%
             
Common
 
Stuart Avery Gold
         
$0.001 par value
 
6080 Center Drive, 6th Floor
 
300,000
(4)
 
0.68%
             
Common
 
William T. Walker, Jr.
         
$0.001 par value
 
6080 Center Drive, 6th Floor
 
300,000
(5)
 
0.68%
             
Common
 
Merrill A. McPeak
         
$0.001 par value
 
6080 Center Drive, 6th Floor
 
300,000
(6)
 
0.68%