Annual Report — Small Business — Form 10-KSB Filing Table of Contents
Document/ExhibitDescriptionPagesSize 1: 10KSB Form 10-Ksb for September 30, 2007 HTML 632K
4: EX-3.1 Certificate of Amendment HTML 9K
2: EX-21.1 Subsidiaries of Registrant HTML 7K
3: EX-23.1 Consent of Bdoseidman, LLP HTML 10K
7: EX-31.1 Certification per Sarbanes-Oxley Act (Section 302) HTML 12K
8: EX-31.2 Certification per Sarbanes-Oxley Act (Section 302) HTML 12K
5: EX-32.1 Certification per Sarbanes-Oxley Act (Section 906) HTML 8K
6: EX-32.2 Certification per Sarbanes-Oxley Act (Section 906) HTML 8K
(State
or
other jurisdiction of
incorporation (I.R.S.
Employer Identification No.)
or
organization)
65
Dan
Road, Canton,
MA 02021
(Address
of principal executive
offices) (Zip
code)
Issuer's
telephone
number: (781)
821-2440
Securities
registered under Section 12(b) of the Exchange Act: None
Securities
registered under Section 12(g) of the Exchange Act:
Title
of Class
Common
Stock
Check
whether the issuer (1) filed all reports required to be filed by Section 13
or
15(d) of the Exchange Act during the past 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days.
Yes X No
Check
if
disclosure of delinquent filers pursuant to Item 405 of Regulation S-B is not
contained in this form, and no disclosure will be contained, to the best of
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment
to
this Form 10-KSB. [X]
Issuer's
revenues for its most recent fiscal year: $3,106,232
Page
1
of pages.
Exhibit
Index is on page hereof.
The
aggregate market value of the common equity held by non-affiliates of the
Registrant (assuming solely for purposes hereof that all directors and officers
of the Registrant are "affiliates") as of December 12,2007: $494,498
The
approximate number of shares of Common Stock outstanding (including shares
held
by affiliates of the Registrant) as of December 12,2007: 98,988,868
Documents
incorporated by
reference: NONE
Transitional
Small Business Disclosure Format (check
one): Yes ; No X
Part
I
Item
1. Description of Business
Introduction
Avitar,
Inc. (the “Company” or “Avitar”) through its wholly-owned subsidiary Avitar
Technologies, Inc. (“ATI”) develops, manufactures, markets and sells diagnostic
test products and proprietary hydrophilic polyurethane foam disposables
fabricated for medical, diagnostics, dental and consumer use. During
Fiscal 2007, the Company continued the development and marketing of innovative
point of care oral fluid drugs of abuse tests, which use the Company’s foam as
the means for collecting the oral fluid sample. Avitar sells its
products and services to employers, diagnostic test distributors, large medical
supply companies, governmental agencies, and corporations. Through
its wholly owned subsidiary, BJR Security, Inc. (‘BJR”), the Company provided,
until April 30, 2007, specialized contraband detection and education services.
The Company operates in one reportable segment.
The
Company’s one for fifty (1 for 50)
reverse split of its common stock that was authorized by the Company’s
shareholders at their annual meeting held on January 18, 2006 became effective
on February 17, 2006. Accordingly, the numbers of common stock shares
and related data presented herein reflect the results of the reverse split
for
current and prior reporting periods.
In
December 2003, Avitar consummated
the sale of the business and net assets, excluding cash, of its wholly-owned
subsidiary, United States Drug Testing Laboratories, Inc.
(“USDTL”). The Company received $500,000 in cash upon the closing of
the sale and was entitled to receive an additional $500,000 if the buyer of
USDTL achieved certain revenue targets. In November 2005, the Company
negotiated an agreement with the new owners of USDTL to settle all outstanding
matters related to the sale of USDTL (see Note 3 to the accompanying
consolidated financial statements).
Due
to the current
financial condition at Avitar, the Company had been considering selling assets
and/or operations. On May 1, 2007, Avitar consummated a sale of the
business of its BJR subsidiary for $40,000, payable no later than April 30,2012. Due to the length of the payment period, payments will be
recorded as income when they are received (see Note 3 to the accompanying
consolidated financial statements). The USDTL and BJR businesses have
been treated as discontinued operations.
Products
Currently,
the Company offers the following products, which utilize its proprietary medical
polyurethane foam technology:
Diagnostic
Test
Products and Drug Detection Services
The
Company makes products and offers
services for the diagnostic test applications described below. These
products accounted for approximately 60% of the Company’s revenue in Fiscal 2007
and approximately 42% of the Company’s revenue in Fiscal 2006.
Drugs
of Abuse Point of
Collection Tests. The Company’s ORALscreen ® 4 and
ORALscreen ® DRUGOMETER are oral fluid-based, rapid on-site assay systems for
detecting drugs of abuse such as opiates (including heroin, morphine, codeine
and synthetic opiates like Oxycocone-Oxycontin®, Percoset®, Hydrocodone-Vicodin®
and others), cocaine (including crack), marijuana and methamphetamines
(including Meth, Ecstasy and others). These tests are performed
on-site and yield accurate results in a 5-15 minute period of
time. In addition, Avitar offers ORALconfirm™, an oral fluid
laboratory test to confirm the results of ORALscreen tests, ORALscreenLab™, a
comprehensive array of laboratory-based oral fluid drug screening products,
and
various other services to enable an employer to manage and control its drug
testing program. The National Institute of Drug Abuse has reported
that 10% of workers in the United States abuse drugs, resulting in an annual
cost in excess of $140 billion to employers. Currently, approximately $1.5
billion annually is spent in the United States for drugs of abuse tests, the
majority of which are for pre-employment testing using traditional
laboratory-based urinalysis services. Drug abusers can defeat pre-employment
urine testing by substituting or adulterating the urine
sample. Significant advantages exist for saliva to replace urine in
many of the drug tests and at the same time, to expand the market where current
infrastructure cost limitations prohibit the use of these much needed drug
tests. Use of the ORALscreen products will provide employers with the
ability to implement a random testing program that has been proven to be a
more
effective tool for deterring the use of drugs by employees in the
workplace. The primary customers for these products are employers,
schools, and military services.
Foam
Disposable
Products
The
Company produces medical-grade
hydrophilic polyurethane foam disposables fabricated for the applications
described below. These products accounted for approximately 40% of
the Company’s revenue in Fiscal 2007 and approximately 58% of the Company’s
revenue in Fiscal 2006.
Wound
Dressings. Avitar’s Hydrasorb®
(“Hydrasorb”)
wound
dressing product is a highly absorbent topical dressing for moderate to heavy
exudating wounds. These dressings have a unique construction that
provides a moist wound healing environment which promotes skin growth and
closure. The Hydrasorb product is marketed by the Dukal Corp., Abbott
Laboratories, Ltd. and other specialty distributors worldwide. In
addition to the Hydrasorb line, the Company has custom developed specialty
wound
dressings for the cardiac catheter lab market as well as the Illizarov Dressing
used for dressing external bone fixators in orthopedic procedures. Customers
for
these products include Smith and Nephew and Cardinal Health.
Custom
Foam
Products.The Company continues to have
applications for its proprietary technologies in a variety of other
medical/consumer markets. They include a sinus dressing and a device
used by astronauts for relieving ear pressure while in a pressurized space
suit. Customers for these products include ArthroCare and
NASA.
Development
The
Company employs a product strategy that is based on its expertise in research
and development with oral fluid diagnostics, and when appropriate, forming
partnerships with market leading companies and recognized persons or entities
in
diagnostic testing and foam products application areas. With this
approach, proprietary products are either developed with internal sources or
co-developed through the generation and development of product ideas either
internally or through these strategic partnerships. To any such
partnership, Avitar contributes the proprietary foam technology, the oral fluid
processing expertise, the product design, development and prototyping, and
the
start-up and commercial-scale manufacturing. The ability of the
Company to keep current on technology and purchase new equipment in connection
with development of new, improved products will be affected by its existing
and
future need for, and the availability of, financing.
Products
go through several stages of
development. After each stage, the Company will conduct studies to
determine the effectiveness of each product. Once a product is
developed and the Company determines it may be commercially viable, Avitar
will
obtain governmental approvals, if necessary, prior to marketing the
product. See “Government Regulation.” There can be no
assurance, however, that such approvals will actually be
obtained. The Company intends to conduct marketing trials with any
new product to determine the effectiveness of the product. If such
marketing trials prove to be successful and after the product is ready for
marketing, Avitar will begin selling the product. See “Sales and Marketing”
below.
Sales
and Marketing
To
sell
its ORALscreen products, the Company relies on its direct sales force, its
strategic partners and a network of distributors that currently sell to the
drugs of abuse testing market. When sufficient additional capital is
raised, the Company intends to expand its sales and marketing staff from its
current level of 6 full-time employees to at least 14 full-time employees and
to
continue to explore strategic partnering arrangements with companies that have
established distribution channels such as significant diagnostic test and health
care product companies and employee related service
organizations. Avitar anticipates that such arrangements may involve
the grant by Avitar of the exclusive or semi-exclusive rights to sell specific
products to specified market segments and/or in particular geographic
territories in exchange for a royalty, joint venture or other financial
interest. The Company generally has sold, and intends to continue to
sell, its wound dressing and custom foam products through large, recognized
distributors of medical products and does not anticipate that a large direct
sales force will be required for these products. If the Company
is unable to establish satisfactory product distribution arrangements in the
manner described above, it will be required to devote substantial resources
to
the expansion of its direct sales force. There can be no assurance
that Avitar would have the resources required for such an endeavor.
To
introduce its products to direct
customers and targeted distributors, the Company participates in trade shows
and
conducts webinars and e-briefings. Avitar also conducts user trials
to support the marketing efforts of its distribution partners. The
Company believes that these arrangements will be more effective in promoting
and
distributing its products in view of Avitar’s limited resources and the
extensive marketing networks of such distributors.
The
Company’s most significant distribution arrangements are summarized as
follows:
Drugs
of
AbuseTest. In October 2001, the Company entered
into an agreement with Quest Diagnostics, Inc. (“Quest”). Under this
agreement, Avitar granted Quest the right to distribute the Company’s ORALscreen
product line.
Hydrasorb
Wound Dressings. From January 1, 2000 through December 31,2006, the Company had a Supply Agreement with the Kendall Company (“Kendall”), a
subsidiary of Tyco Healthcare, for the distribution of its Hydrasorb products
in
the United States. In August 2000, the Company amended this Supply
Agreement to permit Kendall to distribute the Hydrasorb products
internationally.
In
September 2006, the Company entered
into a Supply Agreement with the Dukal Corporation (“Dukal”) for the
distribution of its Hydrasorb products in the United States beginning January1,2007. In the event that Dukal purchases less that $500,000 during the
first year of this Supply Agreement, the Company has the right to convert the
Dukal’s distribution rights to a non-exclusive basis.
Since
November 1993, the Company has
maintained a distribution agreement with Knoll Pharma (the “Knoll Agreement”)
pursuant to which Knoll, now owned by Abbott Laboratories, Ltd., was granted
the
right to distribute Hydrasorb products throughout Canada. The Knoll
Agreement provides that Hydrasorb products are to be sold at agreed upon prices
(subject to annual inflation adjustments) and that certain minimum quantities
are maintained.
Other
Wound Care
Products. Custom medical foam products (including the
Illizarov dressing and certain nasal and sinus products) are marketed and
distributed (in the United States and abroad) primarily by Smith & Nephew on
a non-exclusive basis pursuant to an oral agreement.
Manufacturing
and Supply
The
Company’s only manufacturing facility is located in Canton, Massachusetts and as
of September 30, 2007, comprises approximately 37,000 square feet, of which
10,000 square feet are currently being used for administrative and office space
and 27,000 square feet are being used for product manufacturing and
warehousing.
Given
the use of certain products in
the diagnostic tests, medical and dental markets, the Company is required to
conform to the Food and Drug Administration (“FDA”) Good Manufacturing Practice
regulations, International Standard Organization (“ISO”) rules and various other
statutory and regulatory requirements applicable to the manufacture and sale
of
medical devices. Avitar is subject to inspections by the FDA at all
times. See “Government Regulation”.
The
Company does not have written
agreements with most of its suppliers of raw materials and laboratory
supplies. While the Company purchases some product components from
single sources, most of the supplies used can be obtained from more than one
source. Avitar acquires the same key component for its customized
foam products and Hydrasorb wound dressings from a single
supplier. The Company also purchases several components of
its ORALscreen product from single sources. Avitar’s current
suppliers of such key components are the only vendors which presently meet
Avitar’s specifications for such components. The loss of these
suppliers would, at a minimum, require the Company to locate other satisfactory
vendors, which would result in a period of time during which manufacturing
and
sales of products utilizing such components may be suspended and could have
a
material adverse effect on Avitar’s financial condition and
operations. Avitar believes that alternative sources could be found
for such key components and expects that the cost of such components from an
alternative source would be similar. The Company also believes that
alternative sources of supply are available for its remaining product components
and that the loss of any such supplier would not have a material adverse effect
upon Avitar’s business.
As
discussed below in the Management
Discussion and Analysis, funding constraints have resulted in the Company having
difficulty in maintaining raw material inventories at sufficient levels for
manufacturing products to meet anticipated sales volumes.
Government
Regulation
Avitar
and many of its products are subject to regulation by the FDA and the
corresponding agencies of the states and foreign countries in which the Company
sells its products. Accordingly, the Company is required to comply
with the FDA’s Current Good Manufacturing Practice (CGMP) requirements for
medical devices, ISO rules and similar other state and foreign country
requirements governing the manufacture, marketing, distribution, labeling,
registration, notification, clearance and/or pre-market approval of drugs,
medical and dental devices and cosmetics, as well as record keeping and
reporting requirements applicable to such products. Specifically, the
CGMP requirements govern the methods used in, and the facilities and controls
used for, the design, manufacture, packaging, labeling, storage, installation
and servicing of all finished medical devices intended for human
use. These requirements are intended to ensure that the finished
devices will be safe and effective and otherwise in compliance with the Federal
Food, Drug and Cosmetic Act. Avitar’s wound dressing products have
been classified as Class I devices for these regulations. The Company believes
that it is in compliance with all such requirements. In addition, the
Company is subject to inspections by the FDA at all times, and may be subject
to
inspections by state and foreign agencies. If the FDA believes that
its legal requirements have not been fulfilled, it has extensive enforcement
powers, including the ability to initiate action to physically seize products
or
to enjoin their manufacture and distribution, to require recalls of certain
types of products, and to impose or seek to impose civil or criminal sanctions
against individuals or companies violating applicable statutes.
In
addition, there can be no assurance
that the FDA or the U.S. Federal Government will not enact further changes
in
the current rules and regulations with respect to products, which Avitar already
markets or may plan to market in the future. If Avitar is unable to
demonstrate compliance with such new or modified requirements, sales of affected
products may be significantly limited or prohibited until and unless such
requirements are met.
Competition
The
Company believes that the principal competitive factors in Avitar’s markets are
innovative product design, product quality, established strategic customer
relationships, name recognition, distribution and price. At least 20
companies of all sizes, including major diagnostic test and health care
companies, are engaged in activities similar to those of Avitar. Most
of Avitar’s competitors have substantially greater financial, marketing,
administrative and other resources and larger research and development
staffs.
Although
Avitar may not have the
development resources of many of its competitors, the Company believes its
product design and development experience allows it to compete favorably in
providing innovative products and services in Avitar’s markets. Of
the approximately five instant oral fluid based drugs of abuse
testing products currently being offered, Avitar’s ORALscreen represents one of
the most comprehensive, state-of-the-art test for drugs of
abuse. Furthermore, the Company believes that its Hydrasorb wound
dressings and custom foam products possess qualities with significant advantages
over competing products, including cost effectiveness. In addition to
the Company’s national sales force, ChoicePoint, Quest and many smaller, local
companies are marketing and distributing the Company’s ORALscreen products.
Dukal, Abbott and mediBayreuth (“Medi”) are distributing the Company’s Hydrasorb
wound dressings. See “Products”, “Sales and Marketing”.
The
Company believes that its product
markets are highly fragmented with many different companies competing with
regard to a specific product or product category. As a result,
Avitar’s competition varies from product to product. Avitar’s primary
competitors in the wound dressing market include Bristol Meyers Squibb, Johnson
& Johnson, Smith and Nephew, 3M and Acme United. In the drugs of
abuse test market, the largest competitors are Varian Instruments, American
BioMedica Corp., OraSure Technologies, Inc., Novacon, Concateno, PLC (formerly
Cozart Bioscience Ltd.), Branan, Securetec Detektions-Systeme, AG.
Intellectual
Property
Trade
secrets, proprietary information and know-how are important to the Company’s
scientific and commercial success. Avitar currently relies on a
combination of patents, trade secrets, trademark law and non-disclosure
agreements to establish and protect its proprietary rights in its
products. Avitar currently holds numerous United States patents, has
applications pending for additional patents and has licenses to use certain
patents. In addition, the Company has certain registered and other
trademarks.
The
Company believes that its products,
trademarks and other proprietary rights do not infringe upon the proprietary
rights of third parties.
Product
Liability; Insurance Coverage
The
testing, marketing and sales of diagnostic test and medical products and
services entail a high risk of product liability and professional liability
claims by consumers and others. Claims may be asserted against the
Company by end users of any of Avitar’s products. As of September 30,2007, the Company had product liability insurance coverage in the amount of
$5,000,000. No claims had been asserted against this
coverage. This insurance will not cover liabilities caused by events
occurring prior to the time such policy was purchased by the Company or
liabilities caused by events occurring after such policy is terminated or for
claims made after 60 days following termination of the
policy. Further, certain distributors of diagnostic test, medical and
dental products require minimum product liability insurance coverage as a
condition precedent to purchasing or accepting products for
distribution.
Employees
At
September 30, 2007, the Company had 36 full-time employees, including 3 in
research and development, 21 in manufacturing, supply, and direct service
operations, 6 in sales and marketing and 6 in administration. None of
the employees is subject to a collective bargaining agreement. The
Company believes its relationship with its employees to be
satisfactory.
Item
2. Description of Property
The
Company leases approximately 37,000
square feet of space that includes 37,000 square feet in Canton, Massachusetts
for its manufacturing facility and administrative offices until June
2010. The current annual rent is approximately $337,000 for the
Canton facility (excluding assessment for operating expenses). The
facility is in satisfactory condition for its purposes.
Item
3. Legal Proceedings
On
August 16, 2006, a Complaint was
filed in United States District Court, District of New Jersey, by Sun Biomedical
Laboratories, Inc., Plaintiff, against Avitar Technologies, Inc., Defendant,
a
wholly-owned subsidiary of Avitar. In the Complaint, Plaintiff
alleged among other things breaches of contract, patent infringement and unfair
competition and it seeks damages and injunctions. A Summons in this
case was not issued until September 22, 2006 and the Summons was not delivered
to Avitar until October 13, 2006.
The
alleged breach of contract is based upon an agreement made in 1999 related
to
the development of products and sales of goods. The last invoice
issued to the Defendant was sent by Plaintiff in August 2002. In
September 2002, Avitar advised the Plaintiff that the Defendant owes nothing
to
the Plaintiff and that the Plaintiff would owe substantial amounts for its
failures to perform in accordance with their agreement.
In
its
answer to this Complaint filed with the court on December 4, 2006, the Company
denied substantially all allegations of the Plaintiff and made a significant
counter claim against the Plaintiff for damages suffered by the Company as
a
result of the Plaintiff’s failure to perform in accordance with the 1999 Product
Development Agreement. In January 2007, the Plaintiff denied
substantially all of the allegations included in the Company’s counterclaim
against the Plaintiff. In April and October 2007, conferences were
held with the Judge assigned to this case and schedules were established and
revised for the discovery process and the trial.
Item
4. Submission of Matters to a Vote of Security
Holders
Not
applicable
Part
II
Item
5. Market for Common Equity and Related Stockholder
Matters
Market
Price
Data. The Company’s Common Stock is quoted on the Over The
Counter Bulletin Board (“OTCBB”) under the symbol AVTI.OB. A one for
fifty (1 for 50) reverse split of the Company’s common stock was authorized by
the Company’s shareholders at their annual meeting held on January 18, 2006 and
became effective on February 17, 2006. The table below sets forth the
high and low sales prices for the Company's Common Stock as quoted on OTCBB
for
the periods indicated. The reverse stock split was applied
retroactively in the following table.
Holders. The
Company had approximately 550 owners of record and, it believes, in excess
of
7,500 beneficial owners of the Company Common Stock as of December 12,2007.
Dividends. Since
its inception, the Company has not paid or declared any cash dividends on its
Common Stock. The Company intends to retain future earnings, if any,
that may be generated from its operations to help finance the operations and
expansion of the Company and accordingly does not plan, for the reasonably
foreseeable future, to pay cash dividends to holders of its Common
Stock. Any decisions as to the future payment of dividends will
depend on the earnings, if any, and financial position of the Company and such
other factors as its Board of Directors may deem relevant.
Securities
authorized for issuance
under equity compensation plans. See Equity Compensation Plan
Information in Item 11, Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters, below.
Issuances
of securities without
registration during the fourth quarter of Fiscal 2007. During
the quarter ended September 30, 2007the Company issued 4,805,763 shares of
common stock to holders of long-term convertible debt upon the conversion of
their notes and issued 9,103,354 shares of common stock to holders of Series
E
Redeemable Convertible Preferred Stock upon the conversion of their preferred
stock. The exemption for registration of these securities is based
upon Section 4(2) of the Securities Act because the issuances were made to
accredited investors in private placements.
Item
6. Management's Discussion and Analysis or Plan of
Operation
The
following discussion and analysis
should be read in conjunction with the Company's consolidated financial
statements and the notes thereto appearing elsewhere in this
report.
Results
of Operations
Revenues
Sales
for the fiscal year ended
September 30, 2007 (“Fiscal 2007”) decreased $1,412,814, or approximately 31%,
to $3,106,232 from $4,519,046 for the fiscal year ended September 30, 2006
(“Fiscal 2006”). The change for Fiscal 2007 primarily reflects a
decrease in the volume of sales for its Foam Products resulting mainly from
the
change to a new US distributor on January 1, 2007 for Hydrasorb® wound
dressings. The Company expects sales volume of the Foam Products to
improve when and if a new primary distributor for Hydrasorb® is appointed as a
replacement for Dukal and additional orders for new products are
received.
Operating
Expenses
Cost
of
sales for Fiscal 2007 was approximately 73% of sales compared to the cost of
sales of approximately 70% of sales for Fiscal 2006. The change for
Fiscal 2007 occurred primarily as a result of the reduction in sales described
above, offset in part by the impact of the expense reduction program put in
place by the Company in April 2007.
Sales,
general and administrative
expenses for Fiscal 2007 decreased $513,981, or
approximately 14%, to $3,259,876 from $3,773,857 for Fiscal 2006. The
decrease for Fiscal 2007 primarily resulted from expense reductions of
approximately $52,000 for consulting fees, $390,000 for salary and payroll
related costs for various sales, marketing and other administrative positions,
$57,000 for insurance premiums, $55,000 for travel expenses, $43,000 for trade
shows and promotion materials, $41,000 for annual meeting and report costs,
and
$164,000 for various other administrative items; offset in part by an increase
of approximately $93,000 for legal fees, $73,000 for investor relations and
$122,000 for stock-based compensation. In order to achieve revenue
growth, the Company will need to incur increased expenses to hire additional
direct sales staff and expand marketing programs as sufficient additional
funding becomes available.
Research
and development expenses for Fiscal 2007 were $309,637 compared to $493,943
for
Fiscal 2006. The decrease of approximately $184,000 resulted
primarily from reduced salary and fringe benefit expenses of $152,000,
consulting expense of $7,000, and material and various development related
expenses of $25,000. Although research and development expenses were
lower for Fiscal 2007, the Company must continue developing and enhancing its
ORALscreen products and therefore will most likely incur increased expenses
for
research and development beyond Fiscal 2007 as sufficient additional funding
becomes available.
Other
Income and Expense
Other
income for Fiscal 2007 was $1,966,739 as compared to other income of $876,939
for the fiscal year ended September 30, 2006. The change for Fiscal
2007 resulted primarily from the changes in the fair market value of embedded
derivative securities and warrants.
Interest
expense and financing costs were $1,436,301 for Fiscal 2007 compared to
$1,532,711 incurred during Fiscal 2006. The decrease for the fiscal
year ended September 30, 2007 resulted primarily from the $605,000 non-cash
interest expense recorded in Fiscal 2006 for the fair value of the warrants
issued as replacement for the outstanding warrants in May 2006 (see Note 9
to
the accompanying consolidated financial statements); offset in part by the
interest, amortization of deferred financing costs and amortization of debt
discount associated with the additional long-term note borrowings totaling
approximately $1,895,000 that were completed by the Company from December 2006
through August 2007.
Discontinued
Operations
On
May 1, 2007, the Company consummated a sale of the business of its BJR
subsidiary. For the fiscal year ended September 30, 2007, the
loss from discontinued operations was $57,256 solely related to the operations
of BJR compared to a loss of $154,214 for Fiscal 2006. The loss for
Fiscal 2006 was composed of the loss from operations of BJR of $136,094 and
a
goodwill impairment charge of $138,120 for BJR; offset in part by income of
$120,000 from the disposal of USDTL. See Note 3 to the accompanying
consolidated financial statements.
Net
Loss
Primarily
as a result of the factors
described above, the Company had a net loss of $2,259,629 or $.09 per basic
and
diluted share for Fiscal 2007, compared to a net loss of $3,703,165 or $.80
per
basic and diluted share for Fiscal 2006.
Financial
Condition and Liquidity
At
September 30, 2007, the Company had
a working capital deficit of $3,823,193 and cash and cash equivalents of
$94,069. Cash flows from financing activities provided the primary
source of funding during the year ended September 30, 2007 and the Company
will
continue to rely on this type of funding until profitability is
reached. The following is a summary of cash flows for the year ended
September 30, 2007:
September 30,
Sources
(use) of cash
flows
2007
Operating
activities $(1,768,713)
Investing
activities
(21,011)
Financing
activities 1,603,250
Net
decrease in cash and
equivalents $ (186,474)
Operating
Activities. The net loss of $2,259,629 (composed of expenses
totaling $7,332,600 less sales and other income of $5,072,971) was the major
use
of cash by operations. When the net loss is adjusted for non-cash
expenses such as depreciation and amortization, amortization of debt discounts,
deferred financing costs and deferred lessor incentive, common stock issued
for
services, stock-based compensation, and income from the changes in the fair
market value of derivative securities and warrants, the cash needed to finance
the net loss was $2,957,340. Working capital changes lowered
operating cash requirements as a result of a decrease in accounts receivable
of
$332,073 due to the lower sales volume, a reduction in inventory levels of
$46,642, a decrease in prepaid expenses and other current assets of $62,741,
an
increase in accounts payable and accrued expenses of $740,928 primarily from
the
deferral of vendor payments and interest payments on long-term convertible
debt
and a decrease in the net assets of discontinued operations of
$10,643. In addition, there was a decrease in deferred revenue that
became recognized revenue in Fiscal 2007 of $4,400.
Investing
and Financing Activities. Cash of $21,011 was used for additions
to property, plant and equipment. To fulfill the major financing
requirements of the business, the Company generated $1,628,400 through the
issuance of long-term convertible notes (as described in Note 9 to the
accompanying consolidated financial statements) and $109,807 in proceeds from
issuance of short-term notes payable; of which $134,957 was used to repay
various short-term notes payable and capital lease obligations.
During
Fiscal 2008, the Company's cash requirements are expected to include primarily
the funding of operating losses, the payment of outstanding accounts payable,
the repayment of certain notes payable, the funding of operating capital to
grow
the Company’s drugs of abuse testing products and services, and the continued
funding for the development of its ORALscreen product line.
In
November and December 2007, the
Company executed additional notes payable with AJW Partners, LLC, AJW Master
Fund, Ltd. and New Millennium Capital Partners II, LLC in the total principal
amount of $650,000. Interest on these notes is at 8% per annum and is
payable quarterly in cash or the Company’s common stock at the option of the
Company. The Company issued warrants to purchase 55,000,000 shares of
common stock at $.01 per share for seven years in connection with these
notes. The entire principal plus any accrued and unpaid interest
associated with these notes is convertible, at the holder’s option, into the
Company’s common stock at a conversion price of 40% of the average of the three
lowest intraday trading prices of the common stock for the twenty trading days
preceding the date that the holders elect to convert. As part of this
financing, the conversion price related to all previously issued and outstanding
notes to AJW Partners, AJW Master Fund, Ltd., AJW Qualified Partners, and New
Millennium Capital Partners II, LLC (as described in following paragraph) was
changed from 55% or 65% to 40%.
From
September 2005 through
August 2007 the Company executed notes payable with AJW Partners, LLC, AJW
Offshore, Ltd., AJW Qualified Partners, LLC, New Millennium Capital Partners
II,
LLC and AJW Master Fund in the total principal amount of $6,165,000 which are
payable at maturity dates from September 2008 to August
2010. Interest on these notes is at 8% per annum and is payable
quarterly in cash or the Company’s common stock at the option of the
Company. The Company originally issued warrants to purchase 100,000
shares of common stock at $12.50 per share for five years in connection with
the
notes executed from September 2005 to April 2006. In conjunction with
the notes executed in May 2006, the outstanding warrants were cancelled and
replaced with warrants to purchase 3,000,000 shares of common stock at $1.25
per
share for seven years. For the notes executed from July 2006
through August 2007, the Company issued warrants to purchase a total of
65,500,000 shares of common stock at $.01 to $.22 per share for seven years.
Non-cash interest expense of $605,000 representing the fair value of the
warrants issued as replacement for the outstanding warrants in May 2006 was
recorded in fiscal 2006. Fees of approximately $1,202,000 incurred in connection
with securing these loans were recorded as a deferred financing charge. In
addition, the entire unpaid and unconverted principal plus any accrued and
unpaid interest associated with these notes was convertible, at the holder’s
option, into the Company’s common stock at a conversion price of 65% for notes
issued through February 2006 and 55% for notes executed after February 2006
of
the average of the three lowest intraday trading prices of the common stock
for
the twenty trading days preceding the date that the holders elect to
convert. A discount to debt totaling $2,288,222 ($1,477,616 for the
fair value of the conversion feature of these notes and $810,606 for the
incremental fair value of the warrants issued in connection with these notes)
was recorded during fiscal 2005, 2006 and 2007 and is being amortized over
the
terms of the notes. The unamortized discount was $1,332,072 ($63,524
for notes maturing September 2008 and $1,268,548 for the remainder of the notes)
as of September 30, 2007. The collateral pledged by the Company to
secure these notes includes all assets of the Company. Through
September 30, 2007, notes totaling $393,873 were converted into 25,305,763
shares of common stock.
As
security for full and faithful performance of all provisions of the lease
renewal for the
facility
at Canton, MA in Fiscal 2005, the Company furnished the landlord an irrevocable
letter of credit in the amount of $150,000. The letter of credit was
obtained from a bank that requires the Company to maintain $150,000 on deposit
with the bank as full collateral for the letter of credit.
The
cash
available at September 30, 2007, the proceeds received in November and December
2007 from the financing described above and the anticipated customer receipts
are expected to be sufficient to fund the operations of the Company through
early January 2008. Beyond that time, the Company will require
significant additional financing from outside sources to fund its
operations. The Company plans to continue working with placement
agents and/or investment fund managers in order to raise additional capital
during Fiscal 2008 from the sales of equity and/or debt
securities. The Company plans to use the proceeds from these
financings to provide working capital and capital equipment funding to operate
the Company, to expand the Company’s business, to further develop and enhance
the ORALscreen drug screening systems and to pursue the development of in-vitro
oral fluid diagnostic testing products. However, there can be no
assurance that these financings will be achieved.
Required
payments for debt and minimum
rentals as of September 30, 2007 are as follows:
Fiscal
Year
Operating
Leases
Short-Term
Debt
*
Term
Debt*
Total
2008
$
330,781
$
2,263,215
$
413,200
$
3,007,196
2009
348,906
-
3,546,946
3,895,852
2010
271,875
-
1,977,913
2,249,788
Total
minimum payments
$
951,562
$
2,263,215
$
5,938,059
$
9,152,836
* Includes
interest.
Management
expects that operating revenues will grow during Fiscal 2008 as employers expand
their use of random drug testing utilizing Avitar’s ORALscreen, which, as an
instant on-site diagnostic test, is part of the fastest growing segment of
the
diagnostic test market and if the Company is able to find a major US distributor
for its Hydrasorb wound dressing products. However, due to the
funding constraints described above, the Company in April 2007 initiated an
expense reduction program which resulted in a decrease in its direct sales
force
and delayed the implementation of an expanded, targeted marketing program.
ORALscreen, as an instant on-site diagnostic test, is part of the fastest
growing segment of the diagnostic test market. Funding constraints
have also resulted in the Company having difficulty in maintaining raw material
inventories at sufficient levels for manufacturing products to meet anticipated
sales volumes. Based on current sales, expense and cash flow
projections, the Company believes that the current level of cash and cash
equivalents on hand and, most importantly, the anticipated net proceeds from
the
future financings mentioned above would be sufficient to fund operations until
the Company achieves profitability. There can be no assurance that
the Company will consummate the above-mentioned future financings, or that
any
or all of the net proceeds sought thereby will be
obtained. Furthermore, there can be no assurance that the Company
will find a major US distributor for its Hydrasorb products or have sufficient
resources to achieve the anticipated growth. Once the Company
achieves profitability, the longer-term cash requirements of the Company to
fund
operating activities, purchase capital equipment, expand the existing business
and develop new products are expected to be met by the anticipated cash flow
from operations and proceeds from the financings described above. However,
because there can be no assurances that sales will materialize as forecasted,
management will continue to closely monitor and control discretionary
costs at the Company and will continue to actively seek the needed additional
capital.
As
a result of the Company’s recurring
losses from operations and working capital deficit, the report of its
independent registered public accounting firm relating to the financial
statements for Fiscal 2007 contains an explanatory paragraph expressing
substantial doubt about the Company’s ability to continue as a going
concern. Such report states that the ultimate outcome of this matter
could not be determined as of the date of such report (December 24,2007). The Company’s plans to address the situation are presented
above. However, there are no assurances that these endeavors will be
successful or sufficient.
Recent
Accounting Pronouncements
In
July 2006,
the Finance Accounting Standards Board (“FASB”) issued Interpretation No. 48,
“Accounting for Uncertainty in Income Taxes - an Interpretation of FASB
Statement No. 109”. FIN 48 clarifies the accounting for uncertainty in
income taxes recognized in a company’s financial statements in accordance with
FASB Statement No. 109, “Accounting for Income Taxes”. FIN 48
prescribes the recognition and measurement of a tax position taken or expected
to be taken in a tax return. It also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure and transition. FIN 48 is effective for the Company’s
fiscal year beginning October 1, 2007. The Company is currently
evaluating the effect that the adoption of FIN 48 will have on its consolidated
financial statements but does not expect that it will have a material
impact.
In
February 2006, the FASB issued SFAS 155, “Accounting for Certain Hybrid
Financial Instruments” which amends SFAS 133, “Accounting for Derivative
Instruments and Hedging Activities” and SFAS 140, “Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities.”
SFAS 155 simplifies the accounting for certain derivatives embedded in
other financial instruments by allowing them to be accounted for as a whole
if
the holder elects to account for the whole instrument on a fair value basis.
SFAS 155 also clarifies and amends certain other provisions of
SFAS 133 and SFAS 140. SFAS 155 is effective for all financial
instruments acquired, issued or subject to a remeasurement event occurring
in
fiscal years beginning after September 15, 2006 and therefore, was
effective for the Company beginning October 1, 2006. The adoption of
SFAS 155 by the Company has not had a material impact on its consolidated
financial statements.
In
March
2006, the FASB issued EITF 06−03, “How Taxes Collected from Customers and
Remitted to Governmental Authorities Should Be Presented in the Income Statement
(That is, Gross versus Net Presentation)” that clarifies how a company discloses
its recording of taxes collected that are imposed on revenue-producing
activities. EITF 06−03 was effective for the Company beginning October 1,2006. The adoption of EITF 06-03 has not had a material impact on its
consolidated financial statements.
In
September 2006, the FASB issued SFAS No. 157, “Fair Value
Measurements”.SFAS No. 157 defines fair value, establishes a
framework for measuring fair value in U.S. generally accepted accounting
principles, and expands disclosures about fair value
measurements. SFAS 157 is effective for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal
years. The FASB has issued a one-year deferral of SFAS 157’s fair
value measurement requirement for non-financial assets and liabilities that
are
not required or permitted to be measured at fair value on a recurring
basis. The Company is currently evaluating the impact that SFAS
No. 157 will have on its results of operations or financial
position.
In
December 2006, the FASB issued FASB Staff Position Number 00-19-2, “Accounting
for Registration Payment Arrangements” ("FSP EITF 00-19-2"). FSP EITF
00-19-2 addresses an issuer’s accounting for registration payment arrangements.
FSP EITF 00-19-2 specifies that the contingent obligation to make future
payments or otherwise transfer consideration under a registration payment
arrangement, whether issued as a separate agreement or included as a provision
of a financial instrument or other agreement, should be separately recognized
and measured in accordance with FASB Statement No. 5, “Accounting for
Contingencies”. FSP EITF 00-19-2 is effective immediately for registration
payment arrangements and the financial instruments subject to those arrangements
that are entered into or modified subsequent to the date of issuance of FSP
EITF
00-19-2 (December 21, 2006). For registration payment
arrangements and financial instruments subject to those arrangements that were
entered into prior to the issuance of FSP EITF 00-19-2, this guidance shall
be
effective for financial statements issued for fiscal years beginning after
December 15, 2006, and interim periods within those fiscal years. The
adoption of FSP EITF 00-19-2 by the Company has not had an impact on its
consolidated financial statements.
In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option
for Financial Assets and Financial Liabilities — Including an Amendment of FASB
No 115”. This Statement provides companies with an option to measure,
at specified election dates, many financial instruments and certain other items
at fair value that are not currently measured at fair value. The standard also
establishes presentation and disclosure requirements designed to facilitate
comparison between entities that choose different measurement attributes for
similar types of assets and liabilities. SFAS No. 159 is effective for
fiscal years beginning after November 15, 2007. The Company is currently
evaluating the effect that the adoption of SFAS No. 159 will have on its
consolidated financial statements but does not expect that it will have a
material impact.
Critical
Accounting Policies
The
Company’s significant accounting policies are listed in Note 2 to the
accompanying consolidated financial statements for the year ended September30,2007. However, certain of its accounting policies require the application of
significant judgment by its management, and such judgments are reflected in
the
amounts reported in the consolidated financial statements. The Company considers
its accounting policies with respect to revenue recognition, use of estimates,
long-lived assets and goodwill as the most critical to its results of operations
and financial condition.
Revenue
Recognition
The
Company recognizes revenue from product sales upon shipment and delivery with
delivery being made F.O.B. to the carrier. Revenues from the sales of
services are recognized in the period the services are
provided. These revenues are recognized provided that a purchase
order has been received or a contract has been executed, there are no
uncertainties regarding customer acceptance, the sales price is fixed or
determinable and collection is reasonably assured. If uncertainties regarding
customer acceptance exist, the Company recognizes revenue when those
uncertainties are resolved. Amounts collected or billed prior to satisfying
the
above revenue recognition criteria are recorded as deferred
revenue.
The
Company does not offer its customers or distributors the right to return product
once it has been delivered in accordance with the terms of
sale. Product returns, which must be authorized by the Company, occur
mainly under the warranties associated with the product. The Company
maintains sufficient reserves for warranty costs. Price discounts for
products are reflected in the amount billed to the customer at the time of
delivery. Rebates and payments have not been material and are
adequately covered by established allowances.
Use
of Estimates
The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that
affect the reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities at the date of the financial statements, and reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
Valuation
of Derivative
Securities
The
Company accounts for the value of
warrants issued and conversion and put features granted to investors as part
of
the private placement of securities or debt in accordance with the provisions
of
SFAS No. 133 and EITF Issue No. 00-19. When required, the
amount of the liability is calculated on the date of sale or issuance of the
securities or debt based on a valuation utilizing a market value
approach. This approach determines the fair value of the securities
sold by the Company by using one or more methods that compare these securities
to similar securities that have been sold. The liability is marked-to-market
adjusted to fair value at the end of each quarter and the change recorded to
other income (expense).
Forward-Looking
Statements and Associated Risks
Except
for the historical information contained herein, the matters set forth herein
are "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934
and
the Private Securities Litigation Reform Act of 1995. We intend that such
forward-looking statements be subject to the safe harbors created thereby to
the
extent applicable.
Such
forward-looking statements involve known and unknown risks, uncertainties and
other factors, which may cause our actual results, performance or achievements
to be materially different from any future results, performance or achievement
expressed or implied by such forward-looking statements. Such factors include,
but are not limited to the following: product demand and market
acceptance risks, the availability of an appropriate replacement for
the primary distributor in the U.S. for Hydrasorb® wound dressings,
the effect of economic conditions, results of pending or future litigation,
the
impact of competitive products and pricing, product development and
commercialization, technological difficulties, government regulatory environment
and actions, trade environment, capacity and supply constraints or difficulties,
the result of financing efforts, actual purchases under agreements and the
effect on the Company’s accounting policies.
We
base our forward-looking
statements on our current expectations and projections about
future events. These forward-looking statements are not guarantees
of
future
performance and, as noted above are subject to risks, uncertainties and
assumptions including
in addition, among other things:
- continued
losses and cash flow deficits;
- the
continued availability of financing in the amounts, at the
times
and
on the terms required to support our future business;
- uncertain
market acceptance of our products;
- accuracy,
reliability and patent concerns regarding our products
and
technology;
- competition;
and
- reliance
on key personnel.
Words
such as
"expect,""anticipate,""intend,""plan,""believe,""estimate" and variations
of such words and similar expressions are intended to
identify such
forward-looking statements. We undertake no obligation to
publicly update or revise any forward-looking statements, whether as a result of new
information, future
events or otherwise. Because of these risks, uncertainties
and assumptions, the forward-looking events discussed or incorporated by
reference
in this document may not occur.
Item
7. Financial Statements
Reference
is made to the Index on page
F-1 of the Consolidated Financial Statements, included herein.
Item
8. Changes in and Disagreements with Accountants on Accounting
and
Financial Disclosure
Not
applicable.
Item
8A. Controls and Procedures
(a)
Evaluation of Disclosure Controls
and Procedures
Our
management, including our chief
executive officer and chief financial officer, have carried out an evaluation
of
the effectiveness of our disclosure controls and procedures as of September30,2007, pursuant to Exchange Act Rules 13a-15(e) and 15(d)-15(e). Based upon
that
evaluation, our chief executive officer and chief financial officer have
concluded that as of such date, our disclosure controls and procedures in place
are adequate and effective to ensure material information and other information
requiring disclosure is identified and communicated on a timely
basis.
(b)
Changes in Internal Control Over
Financial Reporting
There
was no
change in our internal control over financial reporting (as defined in Rule
13a-15(f) of the Exchange Act) that occurred during the fourth quarter of the
period covered by this Annual Report on Form 10-KSB that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
Part
III
Item
9. Directors, Executive Officers, Promoters and Control Persons
And Corporate
Governence Compliance with Section 16(a) of the Exchange Act
The
directors and executive officers of
the Company and their respective ages and positions with the Company, as of
September 30, 2007, along with certain biographical information (based solely
on
information supplied by them), are as follows:
Name
Age
Title
Peter
P. Phildius
77
Chairman
of the Board and Chief Executive Officer/Director
Mr.
Phildius has been Chairman of the
Company's Board of Directors since October 1990 and Chief Executive Officer
since July 1996. He has been a general partner in Phildius, Kenyon
& Scott (“PK&S”) since the firm's founding in 1985. Prior to
1985, Mr. Phildius was an independent consultant and Chairman and co-founder
of
Nutritional Management, Inc., a company that operates weight loss clinics (1983
- 1985), President and Chief Operating Officer of Delmed, Inc., a medical
products company (1982 - 1983), President and Chief Operating Officer of
National Medical Care, Inc., a dialysis and medical products company (1979
-
1981), and held a variety of senior management positions with Baxter
Laboratories Inc. ("Baxter"), a hospital supply company and the predecessor
of
Baxter Healthcare Corporation. During the last eight years of his 18
year career at Baxter (1961 - 1979), Mr. Phildius was Group Vice President
and
President of the Parenteral Division, President of the Artificial Organs
Division and President of the Fenwal Division.
Douglas
W. Scott
Mr.
Scott has been the Chief Operating
Officer since July 1996, was the Chief Executive Officer from August 1989 until
July 1996 and has been a director of the Company since August
1989. Mr. Scott has been a general partner in PK&S since its
founding in 1985. Prior to 1985, Mr. Scott was Executive Vice
President of Nutritional Management, Inc. (1983 - 1985); Senior Vice President,
Operations of Delmed, Inc. (1982 - 1983); Vice President, Quality Assurance
of
Frito-Lay, Inc., a consumer products company (1980 - 1982); and held several
senior positions at Baxter from 1970 - 1980. The last two of these
senior positions at Baxter were General Manager of the Vicra Division and
General Manager of Irish Operations. Mr. Scott is also a director of
Candela Corporation, a publicly-traded company in the business of
manufacturing and marketing medical lasers. Mr. Scott received an
M.B.A. from Harvard Business School.
Jay
C.
Leatherman, Jr.
Mr.
Leatherman has served as the
Company's Chief Financial Officer since October 1992 and its Secretary since
July 1994. He has over 20 years experience in financial management in
the health care field. Mr. Leatherman served as Vice President and
Chief Financial Officer of 3030 Park, Inc. and 3030 Park Management Company
from
1985 to 1992, responsible for financial, management information services and
business development functions for this continuing care retirement complex
and
management services and consulting company. He served as Director of
Finance and Business Services for the Visiting Nurses Association of New Haven,
Inc. from 1977 to 1985. In addition, he served in a variety of
accounting and financial positions with Westinghouse Electric Corporation from
1969 to 1977. Mr. Leatherman has a Bachelor's Degree in Business
Administration from the University of Hawaii.
Peter
Cholakis
Mr.
Cholakis has served as the Company’s Vice President of Marketing since February
2004. He has over 20 years of senior marketing experience and is
leading Avitar’s marketing campaign in penetrating the $1.5 billion
drugs-of-abuse market with its point-of-care oral fluid drugs-of-abuse test,
ORALscreen®Before
joining
Avitar, Mr. Cholakis worked for VFA, a Boston-based enterprise software and
services firm as vice president of marketing. Prior to that, he held key
marketing and sales positions in the high technology product and consultative
service markets.
Neil
R.
Gordon
Mr.
Gordon has served as a director
since June 1997. He has been President of N.R. Gordon & Company,
Inc., a company that provides a broad range of financial consulting services,
since 1995. From 1981 to 1995, he was associated with Ekco Group,
Inc. and served as its Treasurer from 1987 to 1995. Mr. Gordon has
also served as Director of Financing and Accounting for Empire of Carolina,
Inc. He received a Bachelor of Science Degree from Pennsylvania State
University. Mr. Gordon is also a director of Datameg Corporation, a
publicly-traded company focused on supplying products and related services
that
support critical network performance requirements in the voice, data and video
communications industry.
Charles
R. McCarthy, Jr.
Mr.
McCarthy has served as a director
since February 1999. He has been counsel in the Washington D.C. law
firm, O’Connor & Hannan, since 1993. He is currently a director
of Interactive Technology.Com, Limited. Previously, Mr. McCarthy was
General Counsel to the National Association of Corporate Directors, served
as a
trial attorney with the Securities and Exchange Commission, was Blue Sky
Securities Commissioner for the District of Columbia and was a law professor
teaching securities law topics and served as a Board member of and counsel
to a
number of public companies over the last 30 years.
Section
16(a) of the Securities
Exchange Act (“SEC”) of 1934 requires the Company’s officers and directors, and
persons who own more than ten percent of a registered class of the Company’s
equity securities to file reports of ownership and changes in ownership with
the
Securities and Exchange Commission. Officers, directors and greater
than ten percent shareholders are required by SEC regulation to furnish the
Company with copies of all Section 16(a) forms they file.
Based
on
its review of the copies of such forms received by it, the Company believes
that, during Fiscal 2007, all filing requirements applicable to its officers,
directors and greater than ten percent shareholders were met.
Audit
Committee Financial Expert
The
Board of Directors has determined
that each of the members of the Audit Committee is independent as determined
in
accordance with the listing standards of the American Stock Exchange and Item
7(d)(3)(iv) of Schedule 14A of the Exchange Act. In addition, the
Board of Directors has determined that Neil R. Gordon is an audit committee
financial expert as defined by SEC rules.
Code
of Ethics
The
Company adopted a written code of
ethics as of June 2004.
Item
10. Executive Compensation
Summary
Compensation
Table. The following table sets forth
compensation earned by or paid to the Chief Executive Officer, Chief Operating
Officer and other executive officers for Fiscal 2007 and, to the extent required
by applicable Commission rules, the preceding two fiscal years.
Name/Position
Year
Salary
Stock
Options
Total
Compensation
Peter
P. Phildius
2007
$
190,000
$
5,277
$
195,277
(Chairman
of the Board/
2006
$
200,000
$
5,277
$
205,277
Chief
Executive Officer)
2005
$
200,000
$
5,277
$
205,277
Douglas
W. Scott
2007
$
171,000
$
2,763
$
173,763
(President/
2006
$
180,000
$
2,763
$
182,763
Chief
Operating Officer)
2005
$
180,000
$
2,763
$
182,763
Jay
C. Leatherman, Jr
2007
$
133,000
$
1,812
$
134,812
(Chief
Financial Officer)
2006
$
140,000
$
1,812
$
141,812
2005
$
140,000
$
1,812
$
141,812
Richard
Anderson(2)
2007(1)
-
-
-
(Vice
President of Research
2006
$
140,000
$
8,515
$
148,515
&
Development)
2005
$
140,000
$
8,515
$
148,515
Peter
Cholakis
2007
$
144,227
$
19,652
$
163,879
(Vice
President of
2006
$
149,955
$
19,652
$
169,607
Marketing)
2005
$
143,747
$
19,652
$
163,399
(1)
Compensation
was less than $100,000.
(2)
Resigned
in October 2006
Stock
Option Grants in Last Fiscal Year. No stock options
were granted to executive officers during Fiscal 2007.
Option
Exercises in Last
Fiscal Year and Year-Ended Option
Values. No stock options were
exercised by the executive officers in Fiscal 2007.
As
of
September 30, 2007, the executive officers held options as follows, none of
which are in the money:
Option
Awards
Equity
Incentive
Plan
Awards
Number
of
Number
of
Number
of
Securities
Securities
Securities
Underlying
Underlying
Underlying
Unexercised
Unexercised
Unexercised
Option
Option
Options
Options
Unearned
Exercise
Expiration
Name
and Title
(exercisable)
(unexercisable)
Options
Price
Date
Peter
Phildius
2,000
-
-
$12.50
2/4/2008
(Chairman
and Chief
16,400
12,600
-
$17.25
1/18/2009
Executive
Officer)
5,040
-
-
$33.00
6/27/2011
2,520
-
-
$67.00
1/18/2012
5,443
3,629
-
$3.50
10/4/2014
Total
31,403
16,229
Douglas
Scott
2,000
-
-
$12.50
2/4/2008
(President
and Chief
10,400
6,600
-
$17.25
1/18/2009
Operating
Officer)
2,640
-
-
$33.00
6/27/2011
1,320
-
-
$67.00
1/18/2012
2,851
1,901
-
$3.50
10/4/2014
Total
19,211
8,501
Jay
Leatherman
1,000
-
-
$10.00
2/4/2008
(Chief
Financial
4,975
4,375
-
$17.25
2/4/2008
Officer)
1,750
-
-
$33.00
6/27/2011
875
-
-
$67.00
1/18/2012
1,890
1,310
-
$3.50
10/4/2014
Total
10,490
5,685
Peter
Cholakis
6,400
1,600
-
$15.00
2/2/2014
(Vice
President of
Marketing)
Employment
Agreements. Messrs. Phildius and Scott are covered by Employment
Agreements (the “Employment Agreements”) which commenced on May 19,1995. Pursuant to the Employment Agreements, if Messrs.
Phildius and/or Scott are terminated without "Cause" (as such term is defined
in
the Employment Agreements) by the Company or if Messrs. Phildius and/or Scott
terminate their employment as a result of a breach by the Company of its
obligations under such Agreements, he will be entitled to receive his annual
base salary ($200,000 for Mr. Phildius and $180,000 for Mr. Scott) for a period
of up to 18 months following such termination. In addition, if there
is a "Change of Control" of the Company (as such term is defined in the
Employment Agreements) and, within two years following such "Change of Control",
either of Messrs. Phildius or Scott is terminated without cause by the Company
or terminates his employment as a result of a breach by the Company, such
executive will be entitled to certain payments and benefits, including the
payment, in a lump sum, of an amount equal to up to two times the sum of (i)
the
executive's annual base salary and (ii) the executive's most recent annual
bonus
(if any). In addition, pursuant to the Employment Agreements, which
have a three-year term (subject to extension), Messrs. Phildius and Scott are
each entitled to annual bonus payments of up to $150,000 if the Company achieves
certain levels of pre-tax income (as such term is defined in such Agreements)
or
alternative net income objectives established by the Board of
Directors.
Director Compensation. During Fiscal 2007 in accordance with a
plan approved by the Company on September 25, 2001, the Company compensated
its
non-management directors with a $5,000 annual retainer, $1,000 for each board
meeting attended and $500 for each committee meeting attended. In addition,
a
plan approved by the Company on August 3, 2004 provides for each non-management
director to be granted options covering 100,000 shares of the Company's common
stock upon initial election to the Board and options covering 75,000 shares
of
the Company's common stock per year for each year in which he/she was selected
to serve as a director. No options were granted during Fiscal
2007. The following table sets forth the compensation paid to
non-management directors in Fiscal 2007:
Fees
Earned
or
Paid
in
Option
Total
Name
Cash
Awards
Compensation
Neil
Gordon
$
6,500
-
$
6,500
Charles
McCarthy
$
6,500
-
$
6,500
Item
11. Security Ownership of Certain Beneficial Owners and Management
The
following table sets forth the number of shares of the Common Stock beneficially
owned as of December 12, 2007 by (i) each person believed by Avitar to be the
beneficial owner of more than 5% of the Common Stock; (ii) each director; (iii)
the Chief Executive Officer and its four most highly compensated executive
officers (other than the Chief Executive Officer) who earn over $100,000 a
year;
and (iv) all directors and executive officers as a group. Beneficial
ownership by the stockholders has been determined in accordance with the rules
promulgated under Section 13(d) of the Securities Exchange Act of 1934, as
amended. All shares of the Common Stock are owned both of record and
beneficially, unless otherwise indicated.
Name
and Address of Beneficial Owner (1)
No.
Owned
%
Peter
P. Phildius (2)(3)(8)(9)
99,417
*
Douglas
W. Scott (2)(4)(8)(10)
68,173
*
Phildius,
Kenyon & Scott("PK&S") (2)(9)
34,652
*
Jay
C. Leatherman, Jr.(2)(5)
10,490
*
Peter
Cholakis (2)(11)
6,400
*
Neil
R.Gordon (2)(6)
6,682
*
Charles
R. McCarthy (2)(7)
8,403
*
All
directors and executive officers as a group
(3)(4)(5)(6)(7)(8)(9)(10)(11)
165,206
*
* Indicates
beneficial ownership of less than one (1%) percent.
(1) Information with respect
to holders of more than five (5%) percent of the outstanding shares
of the Company's Common Stock was derived from, to the extent
available, Schedules 13D and the amendments thereto on file with the Commission
and the Company's records regarding stock issuances.
(2) The
business address of such persons, for the purpose hereof, is c/o Avitar, Inc.,
65 Dan Road, Canton, MA02021.
(3) Includes
33,362 shares of the Company's
Common Stock, options and warrants to purchase
31,403 shares of the Company's Common
Stock. Also includes the securities of the Company beneficially owned
by PK&S as described below in Note 9.
(4) Includes
14,310 shares of the Company's Common Stock and options to purchase 19,211
shares of the Company's Common Stock. Also includes the securities of
the Company beneficially owned by PK&S as described below in Note
9.
(5) Includes
113 shares of the Company's Common Stock and options to purchase 10,490 shares
of the Company’s Common Stock.
(6) Includes
1,812 shares of the Company's Common Stock and options to purchase 5,050 shares
of the Company's Common Stock.
(7) Includes
3,453 shares of the Company’s Common Stock and options to purchase 4,950 shares
of the Common Stock.
(8)
Represents ownership of 34,652 shares of the Company's Common Stock. PK&S is
a partnership of which Mr. Phildius and Mr. Scott are general
partners.
(9)
Does
not include 682 shares of the Common Stock owned by Mr. Phildius' wife, all
of
which he disclaims beneficial ownership.
(10)
Does
not include 300 shares of the Common Stock owned by Mr. Scott's children, all
of
which he disclaims beneficial ownership.
(11) Includes
options to purchase 6,400 shares of the Company’s Common Stock.
Securities
authorized for issuance under equity compensation plans.
for
future issuance under equity compensation plans (excluding securities
reflected in column (a)
Plan
category
(a)
(b)
(c)
Equity
compensation plans approved by security holders
11,869
$13.11
738,131
Equity
compensation plans not approved by security holders
146,759
$21.85
153,241
Total
158,628
$21.20
891,372
See
information concerning compensation
plans not approved by shareholders in Consolidated Financial Statements, Note
13, Stockholders’ Equity, Common Stock Purchase Warrants and Stock
Options.
Item
12. Certain
Relationships and Related Transactions
PK&S,
a less than 1 % beneficial
owner of the Company, provided consulting services to the Company from September
1989 to May 1995. On May 28, 1992, the Company entered into a written
consulting agreement with PK&S, which reflected the provisions of a previous
oral agreement approved by the Company's Board of Directors in October
1990. Pursuant to its arrangement with the Company, PK&S provided
the services of each of Messrs. Phildius and Scott to the Company.
On
May19, 1995, the Company's Consulting Agreement ended and was replaced by the
Employment Agreements with Messrs. Phildius and Scott (See "Employment
Agreements"). As requested by Messrs. Phildius and Scott and approved
by the Company's Board of Directors, the salary and benefits provided under
the
Employment Agreements will be paid directly to PK&S. Under the
terms of the current employment agreements with Peter Phildius and Douglas
Scott
described above, the Company pays their salaries and related expenses directly
to PK&S. The aggregate of salaries, fringe benefits and
reimbursement of expenses paid to PK&S by the Company on behalf of Messrs.
Phildius and Scott for fiscal years 2007 and 2006 totaled $389,578 and $408,628
respectively.
(A)
Previously filed with the Securities and Exchange Commission as an Exhibit
to
the Company's
Registration Statement on Form S-4 (Commission File No. 33-71666),
(B)
Previously filed with the Securities and Exchange Commission as an Exhibit
to MHB's
Amendment No. 1 to the Registration Statement on Form S-4
(Commission
(C)
Previously filed with the Securities and Exchange Commission as an Exhibit
to
the Company’s
Annual Report for the fiscal year ended September 30, 1999 (Commission File
No.
0-
(D)
Previously filed with the Securities and Exchange Commission as an Exhibit
to
the Company’s
Annual Report for the fiscal year ended September 30, 2000 (Commission File
No.
1-
(F)
Previously filed with the Securities and Exchange Commission as an Exhibit
to
the Company’s
Annual Report for the fiscal year ended September 30, 2002
(G)
Previously filed with the Securities and Exchange Commission as an Exhibit
to
the Company’s
Current Report for the event occurred on May 25, 2004 (Commission
File
(H)
Previously filed with the Securities and Exchange Commission as an Exhibit
to
the Company’s
Annual Report for the fiscal year ended September 30, 2004 (Commission File
No.
1-
(I) Previously
filed with the Securities and Exchange Commission as an Exhibit to
the Company’s
Current Report for the event occurred on April 19, 2005 (Commission
(J) Previously
filed with the Securities and Exchange Commission as an Exhibit to
the Company’s
Current Report for the event occurred on September 23, 2005
During
Fiscal 2007 and Fiscal 2006, the
Company retained its principal auditor, BDO Seidman, LLP to provide services
in
the following categories and amounts:
2007
2006
Audit
Fees (services in connection with the audit of the Company’s
financial statements, review of the Company’s quarterly reports on
Form 10-QSB and statutory or regulatory filings or
engagements)
$
155,563
$
154,000
Audit
Related Fees (assurance and related services
$
-
$
-
Tax
Fees (services in connection with the Preparation of the
Company’s tax returns)
$
15,480
$
14,700
All
Other Fees
$
-
$
-
Our
Audit
Committee’s policy is to pre-approve all audit and permissible non-audit
services performed by the independent accountants. These services may
include audit services, audit-related services, tax services and other services.
Under our Audit Committee’s policy, pre-approval is generally provided for
particular services or categories of services, including planned services,
project-based services and routine consultations. In addition, the
Audit Committee may also approve particular services on a case-by-case basis.
Our
Audit
Committee pre-approved all services that our independent accountants provided
to
us in the past two fiscal years. It considered whether the provision
of non-audit services by the Company's principal auditor was compatible with
maintaining auditor independence and has determined such services were not
incompatible with maintaining auditor independence.
Signatures
In
accordance with Section 13 of the
Exchange Act, the Registrant caused this Report to be signed on its behalf
by
the undersigned, thereunto duly authorized.
In
accordance with the Exchange Act,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Name
Title
Date
/s/ Peter
P. Phildius
Peter
P. Phildius
Chairman
of the Board and
Chief
Executive Officer (Principal Executive Officer); and Director
(A)
Previously filed with the Securities and Exchange Commission as an Exhibit
to
the Company's
Registration Statement on Form S-4 (Commission File No. 33-71666),
(B)
Previously filed with the Securities and Exchange Commission as an Exhibit
to MHB's
Amendment No. 1 to the Registration Statement on Form S-4
(Commission
(C)
Previously filed with the Securities and Exchange Commission as an Exhibit
to
the Company’s
Annual Report for the fiscal year ended September 30, 1999 (Commission File
No.
0-
(D)
Previously filed with the Securities and Exchange Commission as an Exhibit
to
the Company’s
Annual Report for the fiscal year ended September 30, 2000 (Commission File
No.
1-
(F)
Previously filed with the Securities and Exchange Commission as an Exhibit
to
the Company’s
Annual Report for the fiscal year ended September 30, 2002
(G)
Previously filed with the Securities and Exchange Commission as an Exhibit
to
the Company’s
Current Report for the event occurred on May 25, 2004 (Commission
File
(H)
Previously filed with the Securities and Exchange Commission as an Exhibit
to
the Company’s
Annual Report for the fiscal year ended September 30, 2004 (Commission File
No.
1-
(I) Previously
filed with the Securities and Exchange Commission as an Exhibit to
the Company’s
Current Report for the event occurred on April 19, 2005 (Commission
(J) Previously
filed with the Securities and Exchange Commission as an Exhibit to
the Company’s
Current Report for the event occurred on September 23, 2005
Report
of independent registered public accounting firmF-2
Consolidated
financial statements:
Balance
sheet F-3
to F-4
Statements
of
operations F-5
Statements
of stockholders’
deficit
F-6
Statements
of cash
flows
F-7 to F-9
Notes
to consolidated financial
statements
F-10 to F-34.
Report
of Independent Registered Public Accounting Firm
To
the
Board of Directors and Stockholders
Avitar,
Inc.
We
have
audited the accompanying consolidated balance sheet of Avitar, Inc. and
subsidiaries as of September 30, 2007, and the related consolidated
statements of operations, stockholders’ deficit and cash flows for each of the
two years in the period ended September 30, 2007. These
consolidated financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (“United States”). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the consolidated financial statements are free of material
misstatement. The Company is not required to have, nor were we
engaged to perform, an audit of its internal control over financial
reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An
audit also includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating
the
overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In
our
opinion, the consolidated financial statements referred to above present
fairly,
in all material respects, the financial position of Avitar, Inc. and
subsidiaries as of September 30, 2007, and the results of their operations
and their cash flows for each of the two years in the period ended
September 30, 2007, in conformity with accounting principles generally
accepted in the United States of America.
As
described in Note 2 of the consolidated financial statements, the Company
adopted Statement of Financial Accounting Standards No. 123 (R), “Share-Based
Payment”, effective October 1, 2006.
The
accompanying consolidated financial statements have been prepared assuming
that
the Company will continue as a going concern. As discussed in
Note 1 to the consolidated financial statements, the Company has suffered
recurring losses from operations and has working capital and stockholder
deficits as of September 30, 2007. These matters raise
substantial doubt about its ability to continue as a going
concern. Management’s plans in regard to these matters are also
described in Note 1. The consolidated financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.
1. Description
of Business and Basis of Presentation
Avitar,
Inc. (“Avitar” or the “Company”), through its wholly-owned subsidiary Avitar
Technologies, Inc. (“ATI”) designs, develops, manufactures markets and sells
diagnostic test products and proprietary hydrophilic polyurethane foam
disposables for medical, diagnostic and consumer use. Avitar sells its products
and services to employers, diagnostic test distributors, large medical supply
companies, governmental agencies, and corporations. Through
its wholly owned subsidiary, BJR Security, Inc. (‘BJR”), the Company provided,
until April 30, 2007, specialized contraband detection and education
services. The Company operates in one reportable segment.
The
Company’s one for fifty (1 for 50) reverse split of its common stock that was
authorized by the Company’s shareholders at their annual meeting held on January18, 2006 became effective on February 17, 2006. Accordingly, the
numbers of common stock shares and related data presented herein reflect
the
results of the reverse split for current and prior reporting
periods.
In
December 2003, Avitar consummated the sale of the business and net assets,
excluding cash, of its wholly-owned subsidiary, United States Drug Testing
Laboratories, Inc. (“USDTL”). The Company received $500,000 in cash
upon the closing of the sale and was entitled to receive an additional $500,000
if the buyer of USDTL achieved certain revenue targets. In November
2005, the Company negotiated an agreement with the new owners of USDTL to
settle
all outstanding matters related to the sale of USDTL (see Note 3). The USDTL
business has been treated as a discontinued operation.
Due
to the current financial condition at Avitar, the Company has been considering
selling assets and/or operations. On May 1, 2007, Avitar consummated a sale
of
the business of its BJR subsidiary for $40,000, payable no later than April30,2012. Due to the length of the payment period, payments will be
recorded as income when they are received (see Note 3). The USDTL and
BJR businesses have been treated as discontinued operations.
The
Company’s consolidated financial statements have been presented on the basis
that it is a going concern, which contemplates the realization of assets
and the
satisfaction of liabilities in the normal course of business. The
Company has suffered recurring losses from operations and has a working capital
deficit of $3,823,193 and a stockholders’ deficit of $9,845,711 as of
September 30, 2007. During fiscal 2007, the Company raised gross
proceeds of $1,895,000 from long-term
convertible notes. Subsequent
to September 30, 2007, the Company raised gross proceeds of $650,000 from
long-term convertible notes executed in November and December 2007 (see Note
19). The Company is working with placement agents and investment fund
mangers to obtain additional equity or debt financing. Based upon
cash flow projections, the Company believes the anticipated cash flow from
operations and most importantly, the expected net proceeds from future equity
financings will be sufficient to finance the Company's operating needs until
the
operations achieve profitability. There can be no assurances that
forecasted results will be achieved or that additional financing will be
obtained. The financial statements do not include any adjustments
relating to the recoverability and classification of asset amounts or the
amounts and classification of liabilities that might be necessary should
the
Company be unable to continue as a going concern.
2. Summary
of Significant Accounting Policies
Concentration
of Credit Risk and Significant
Customers. Financial
instruments that subject the Company to credit risk consist primarily of
cash,
cash equivalents and trade accounts receivable. The Company places its cash
and
cash equivalents in established financial institutions. The Company has no
significant off-balance-sheet concentration of credit risk such as foreign
exchange contracts, options contracts or other foreign hedging arrangements.
The
Company’s accounts receivable credit risk is not concentrated within any one
geographic area. The Company has not experienced any significant losses related
to receivables from any individual customers or groups of customers in any
specific industry or by geographic area. Due to these factors, no additional
credit risk beyond amounts provided for collection losses is believed by
management to be inherent in the Company’s accounts receivable.
Accounts
receivable are customer obligations due under normal trade terms. The Company
sells its products to employers, distributors and OEM customers. The Company
generally requires signed sales agreements, non-refundable advance payments
and
purchase orders depending upon the type of customer, and letters of credit
may
be required in certain circumstances. Accounts receivable is stated at the
amount billed to the customer less a valuation allowance for doubtful
accounts.
Senior
management reviews accounts receivable on a monthly basis to determine if
any
receivables could potentially be uncollectible. The Company includes specific
accounts receivable balances that are determined to be uncollectible in its
overall allowance for doubtful accounts. After all attempts to collect a
receivable have failed, the receivable is written off against the allowance.
Based on available information, the Company believes its allowance for doubtful
accounts as of September 30, 2007 of $4,700 is adequate.
See
Note
15 for information on customers that individually comprise greater than 10%
of
total revenues.
Estimates
and Assumptions. The preparation of financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported amounts
of
assets and liabilities and disclosure of contingent assets and liabilities
at
the date of the financial statements and the reported amounts of revenues
and
expenses during the reporting period. Actual results could differ
from those estimates.
Principles
of Consolidation. The consolidated financial statements
include the accounts of the Company and its wholly owned subsidiaries. All
significant inter-company balances and transactions have been
eliminated.
Revenue
Recognition. The Company recognizes revenue from
product sales upon shipment and delivery with delivery being made F.O.B.
to the
carrier. Revenue from the sales of services is recognized in the
period the services are provided. These revenues are recognized
provided that a purchase order has been received or a contract has been
executed, there are no uncertainties regarding customer acceptance, the sales
price is fixed or determinable and collection is reasonably assured. If
uncertainties regarding customer acceptance exist, the Company recognizes
revenue when those uncertainties are resolved. Amounts collected or billed
prior
to satisfying the above revenue recognition criteria are recorded as deferred
revenue. The Company does not offer its customers or distributors the
right to return product once it has been delivered in accordance with the
terms
of sale. Product returns, which must be authorized by the Company,
occur mainly under the warranties associated with the product. The
Company maintains sufficient reserves to handle warranty costs. Price
discounts for products are reflected in the amount billed to the customer
at the
time of delivery. Rebates and payments have not been material and are
adequately covered by established allowances.
Cash
Equivalents.The Company considers all highly liquid investments
and interest-bearing certificates of deposit with original maturities of
three
months or less to be cash equivalents
Inventories. Inventories
are recorded at the lower of cost (determined on a first-in, first-out basis)
or
market. The inventories of the ORALscreen products and some
components of the foam products are subject to expiration
dating. Senior management reviews the inventories on a periodic basis
to insure that adequate reserves have been established to cover product
obsolescence and unusable inventory. These decisions are based on the
levels of inventories on hand in relation to the estimated forecast of product
demand, production requirements over the next twelve months and the expiration
dates of the raw materials and finished goods. Forecasting of product
demand can be a complex process, especially for ORALscreen instant drug
tests. Although every effort is made to insure the accuracy of these
forecasts of future product demand, any significant unanticipated changes
in
demand could have a significant impact on the carrying value of the Company’s
inventories and reported operating results.
Property
and Equipment. Property and equipment (including
equipment under capital leases) is recorded at cost at the date of
acquisition. Depreciation is computed using the straight-line method
over the estimated useful lives of the assets (three to seven
years). Leasehold improvements are amortized over the shorter of
their estimated useful life or lease term. Expenditures for repairs
and maintenance are expensed as incurred.
Goodwill
and Long-lived Assets. The Company evaluates its
long-lived assets under the provisions of Statement of Financial Accounting
Standards (“SFAS”) No. 144, “Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of.” SFAS No. 144
establishes accounting standards for the impairment of long-lived assets
and
certain identifiable intangibles to be held and used and for long-lived assets,
and certain identifiable intangibles to be disposed of.
In
assessing the recoverability of its long-lived assets, the Company must make
assumptions in determining the fair value of the asset by estimating future
cash
flows and considering other factors, including significant changes in the
manner
or use of the assets, or negative industry reports or economic conditions.
If
those estimates or their related assumptions change in the future, the Company
may be required to record impairment charges for those assets.
Effective
October 1, 2002, the Company adopted SFAS No. 142, “Goodwill and Other
Intangible Assets”. SFAS No. 142 requires among other things, that
companies no longer amortize goodwill, but test goodwill for impairment at
least
annually. In addition, SFAS 142 requires that the Company identify reporting
units for the purpose of assessing potential future impairments of goodwill,
reassess the useful lives of other existing recognized intangible assets,
and
cease amortization of intangible assets with an indefinite useful
life. An intangible asset with an indefinite useful life should be
tested for impairment in accordance with guidelines in SFAS 142. SFAS
142 is required to be applied to all goodwill and other intangible assets
regardless of when those assets were initially recognized. The
Company
recognizes impairments of goodwill when the fair value of the acquired business
is determined to be less than the carrying amount of the goodwill. If
the Company determines that the goodwill has been impaired, the measurement
of
the impairment is equal to the excess of the carrying amount of the goodwill
over the amount of the fair value of the asset. The Company reflects
the impairments through a reduction in the carrying value of
goodwill. Based on the limited operating results of the
acquired BJR business and the estimates of its fair value, the Company recorded
an impairment of goodwill for $138,120 in fiscal 2006 (see Note
6). At September 30, 2007, goodwill was $0.
Patents. Patent
costs are being amortized over their estimated useful lives of 5 – 7 years by
the straight-line method.
Research
and Development. Research and development costs are
expensed as incurred.
Stock
Options.The Company adopted SFAS No. 123 (Revised
2004), “Share-Based Payment” (‘SFAS 123R”), effective October 1,2006. SFAS 123R requires the recognition of fair value of stock-based
compensation as an expense in the calculation of net loss. The
Company recognizes stock-based compensation ratably over the vesting period
of
the individual equity instruments. All unvested stock awards
outstanding on October 1, 2006, or issued after that date, have been
accounted for as equity instruments based on the provisions of SFAS
123R. Prior to October 1, 2006, the Company followed the Accounting
Principles Board (“APB”) Opinion 25, “Accounting for Stock Issued to Employees”,
and the related interpretations in accounting for stock-based
compensation.
The
Company elected the modified prospective transition method for adopting SFAS
123R. Under this method, the provisions of SFAS 123R apply to all
stock-based awards granted or other awards granted that are subsequently
reclassified into equity. The unrecognized expense of awards not yet
vested as of September 30, 2006, the date of adoption of SFAS 123R by the
Company, is now being recognized as expense in the calculation of net income
(loss) using the same valuation method (Black-Scholes) and assumptions used
prior to the adoption of SFAS 123R.
Under
the
provisions of SFAS 123R, the Company recorded $122,007 of stock based
compensation expense on its consolidated statement of operations for the
year
ended September 30, 2007.
During
the year ended September 30, 2007, no options were granted under stock option
plans and no shares subject to purchase under the employee stock purchase
plan
were issued.
The
unamortized fair value of stock options as of September 30, 2007 was
$146,388
which
is
expected to be recognized over the weighted average remaining period of 1.9
years.
The
following table summarizes activity under all stock option plans for the
year ended September 30, 2007:
SFAS
123R
requires the presentation of pro forma information for the comparative period
prior to the adoption as if the Company had accounted for all employee stock
options under the fair value method of the original SFAS 123. The
following table illustrates the effect on net loss and loss per share if the
Company had applied the fair value recognition provisions of SFAS 123R for
stock-based employee compensation to the prior-year period.
2006
Net
loss
$
(3,703,165
)
Add:
stock based employee compensation expense
included in reported net loss,
net of tax
-
Deduct:
total stock based employee compensation
expense determined
under
the fair value based method for all
awards, net of tax
(111,766
)
Pro forma net loss
$
(3,814,931
)
Loss per share:
Basic and diluted - as reported
$
(.80
)
Basic and diluted - pro forma
$
(.79
)
In
determining the pro forma amounts above, the Company estimated the fair value
of
each option granted using the Black-Scholes option pricing model with the
following assumptions:
2006
Risk
free interest
rate 4.3%
Expected
dividend
yield -
Expected
lives
10 years
Expected
volatility
80%
Options
granted during year ended September 30, 2006 totaled 7,000. The
weighted average fair value of options granted in fiscal 2006 was
$.42.
Income
Taxes. Income taxes are accounted for using the
liability method as set forth in SFAS No. 109, “Accounting for Income
Taxes.” Under this method, deferred income taxes are provided on the
differences in basis of assets and liabilities between financial reporting
and
tax returns using enacted rates. Valuation allowances have been
recorded (see Note 14).
Fair
Value of Financial Instruments. The carrying amounts of
cash, accounts receivable and accounts payable approximate fair value because
of
the short-term nature of these items. The current fair values of the
short-term and long-term debt approximate fair value because their interest
rates approximate prevailing market rates. The fair value of
derivative instruments is based on valuations using a market value
approach. This approach determines the fair value of the securities
sold by the Company by using one or more methods that compare these securities
to similar securities that have been sold.
Advertising.The Company expenses advertising costs as incurred. No
advertising
expense
was recorded in fiscal 2007 or 2006
Principal
Supplier Risk. The
Company does not have written agreements with most of its suppliers of raw
materials and laboratory supplies. While the Company purchases some
product components from single sources, most of the supplies used can be
obtained from more than one source. Avitar acquires the same key
component for its customized foam products and Hydrasorb wound dressings from
a
single supplier. The Company also purchases a main component of its
ORALscreen products from one source. Avitar’s current suppliers
of such key components are the only vendors
which presently meet Avitar’s specifications for such
components. The loss of these suppliers would, at a minimum, require
the Company to locate other satisfactory vendors, which would result in a period
of time during which manufacturing and sales of products utilizing such
components may be suspended and could have a material adverse effect on Avitar’s
financial condition and operations. Avitar believes that alternative
sources could be found for such key components and expects that the cost of
such
components from an alternative source would be similar. The Company
also believes that alternative sources of supply are available for its remaining
product components and that the loss of any such supplier would not have a
material adverse effect upon Avitar’s business.
Derivatives. The
Company has issued and outstanding convertible debt and certain convertible
equity instruments with embedded derivative features. The Company
analyzes these financial instruments in accordance with SFAS No. 133 and EITF
Issue Nos. 00-19 and 05-02 to determine if these hybrid contracts have embedded
derivatives which must be bifurcated. In addition, free-standing
warrants are accounted for as equity or liabilities in accordance with the
provisions of EITF Issue No. 00-19. As of September 30, 2007,
the Company could not be sure it had adequate authorized shares for the
conversion of all outstanding instruments due to certain conversion rates which
vary with the fair value of the Company’s
common stock and therefore all embedded derivatives and freestanding warrants
are recorded at fair value, marked-to-market at each reporting period, and
are
carried on separate lines of the accompanying balance sheet. If there
is more than one embedded derivative, their value is considered in the
aggregate. As of September 30, 2007, the fair value was $388,653 for
the embedded derivatives and $296,599 for the warrants.
New
Accounting Pronouncements. In July 2006, the
Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48,
“Accounting for Uncertainty in Income Taxes - an Interpretation of FASB
Statement No. 109”. FIN 48 clarifies the accounting for uncertainty in
income taxes recognized in a company’s financial statements in accordance with
FASB Statement No. 109, “Accounting for Income Taxes”. FIN 48
prescribes the recognition and measurement of a tax position taken or expected
to be taken in a tax return. It also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure and transition. FIN 48 is effective for fiscal years
beginning after December 15, 2006. The Company is currently
evaluating the effect that the adoption of FIN 48 will have on its consolidated
financial statements but does not expect that it will have a material
impact.
In
February 2006, the FASB issued SFAS 155, “Accounting for Certain Hybrid
Financial Instruments” which amends SFAS 133, “Accounting for Derivative
Instruments and Hedging Activities” and SFAS 140, “Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities.”
SFAS 155 simplifies the accounting for certain derivatives embedded in
other financial instruments by allowing them to be accounted for as a whole
if
the holder elects to account for the whole instrument on a fair value basis.
SFAS 155 also clarifies and amends certain other provisions of
SFAS 133 and SFAS 140. SFAS 155 is effective for all financial
instruments acquired, issued or subject to a remeasurement event occurring
in
fiscal years beginning after September 15, 2006 and therefore, was
effective for the Company beginning October 1, 2006. The adoption of
SFAS 155 by the Company has not had a material impact on its consolidated
financial statements.
In
March
2006, the FASB issued EITF 06−03, “How Taxes Collected from Customers and
Remitted to Governmental Authorities Should Be Presented in the Income Statement
(That is, Gross versus Net Presentation)” that clarifies how a company discloses
its recording of taxes collected that are imposed on revenue-producing
activities. EITF 06−03 was effective for the Company beginning January 1,2007. The adoption of EITF 06-03 has not had a material impact on its
consolidated financial statements.
In
September 2006, the FASB issued SFAS No. 157, “Fair Value
Measurements”.SFAS No. 157 defines fair value, establishes a
framework for measuring fair value in U.S. generally accepted accounting
principles, and expands disclosures about fair value
measurements. SFAS 157 is effective for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal
years. The FASB has issued a one-year deferral of SFAS 157’s fair
value measurement requirement for non-financial assets and liabilities that
are
not required or permitted to be measured at fair value on a recurring
basis. The Company is currently evaluating the impact that SFAS
No. 157 will have on its results of operations or financial
position.
In
December 2006, the FASB issued FASB Staff Position Number 00-19-2, “Accounting
for Registration Payment Arrangements” ("FSP EITF 00-19-2"). FSP EITF
00-19-2 addresses an issuer’s accounting for registration payment arrangements.
FSP EITF 00-19-2 specifies that the contingent obligation to make future
payments or otherwise transfer consideration under a registration payment
arrangement, whether issued as a separate agreement or included as a provision
of a financial instrument or other agreement, should be separately recognized
and measured in accordance with FASB Statement No. 5, “Accounting for
Contingencies”. FSP EITF 00-19-2 is effective immediately for registration
payment arrangements and the financial instruments subject to those arrangements
that are entered into or modified subsequent to the date of issuance of FSP
EITF
00-19-2 (December 21, 2006). For registration payment arrangements and
financial instruments subject to those arrangements that were entered into
prior
to the issuance of FSP EITF 00-19-2, this guidance shall be effective for
financial statements issued for fiscal years beginning after December 15, 2006,
and interim periods within those fiscal years. The adoption of FSP EITF
00-19-2 by the Company has not had an impact on its consolidated financial
statements.
In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option
for Financial Assets and Financial Liabilities — Including an Amendment of FASB
No 115”. This Statement provides companies with an option to measure,
at specified election dates, many financial instruments and certain other items
at fair value that are not currently measured at fair value. The standard also
establishes presentation and disclosure requirements designed to facilitate
comparison between entities that choose different measurement attributes for
similar types of assets and liabilities. If the fair value option is elected,
the effect of the first remeasurement to fair value is reported as a cumulative
effect adjustment to the opening balance of retained earnings. The statement
is
to be applied prospectively upon adoption. SFAS No. 159 is effective for
fiscal years beginning after November 15, 2007. The Company is currently
evaluating the effect that the adoption of SFAS No. 159 will have on its
consolidated financial statements but does not expect that it will have a
material impact.
3. Discontinued
Operations
On
December 16, 2003, the Company consummated a sale of USDTL’s business and net
assets, excluding cash. Under the terms of that sale, the Company
received $500,000 in cash upon the closing of the sale and was entitled to
receive an additional $500,000 if the buyer of USDTL achieved certain revenue
targets. In November 2005, the Company negotiated an agreement with the new
owners of USDTL to settle all outstanding matters related to the sale of
USDTL. Under the terms of this settlement, the Company received an
immediate lump sum payment of $120,000 rather than waiting for the 10 to 14
years that the Company believed it would take to collect the entire $500,000
from uncertain future revenues of USDTL. The accompanying financial statements
reflect USDTL as a discontinued operation. The $120,000 was recorded
as income from discontinued operations in 2006.
On
May 1, 2007, the
Company consummated the sale of BJR’s business. Under the terms
of
the sale, the Company will be paid $40,000 no later than April 30,2012. Due
to
the
length of the payment period, payments will be recorded as income when they
are
received.
The
following is a summary of the
results of discontinued operations for the year ended September 30, 2007 and
2006:
Depreciation
expense was $113,711 and $118,964 for fiscal 2007 and fiscal 2006,
respectively.
6. Goodwill
As
of
October 1, 2005, the Company’s goodwill was $138,120 which was associated with
the acquisition of BJR in 2001. In fiscal 2006, an impairment
adjustment to eliminate the remaining goodwill associated with the BJR
acquisition was deemed necessary. Based on the limited operating
results of the business and the estimates of its fair value, the Company
recorded an impairment of goodwill for $138,120 in fiscal 2006.
7. Other
Assets
Other
assets consist of the following:
September
30,
2007
Patents
$
149,966
Deposits
1,333
Deposit
for Letter of Credit (Note 12)
150,000
Deferred
Financing Costs
1,201,899
Deferred
Financing Costs
1,503,198
Less
accumulated amortization
611,690
Other
assets, net
$
891,508
Included
in the above are patent costs of $149,966 with related accumulation
amortization costs of $148,995. The patents have a weighted average
amortization period of 7 years. Amortization expense related to the
patents was $4,800 and $24,974 for fiscal 2007 and 2006,
respectively. Also included in the above are deferred financing costs
of $1,201,899 for the convertible notes executed from September 2005 through
August 2007 (see Note 9 and 11). Amortization expense related to the
deferred financing costs amounted to $332,535 for fiscal 2007 and $212,304
for
fiscal 2006.
Estimated
amortization expense for the next three years is as follows:
September
30,
Patents
Deferred
Financing
Costs
Total
2008
$
971
$
373,359
$
374,330
2009
-
283,213
283,213
2010
-
82,624
82,632
Thereafter
-
-
-
8. Short-Term
Debt
Short-term
debt consists of the following:
September
30,
2007
Note
payable to insurance company, interest at 8.5%, payable in
monthly
principal installments of $2,935 plus accrued interest
through
October 2007.
$
2,935
Notes
payable to insurance company, interest at 8.00%,
payable
in monthly principal installments of $6,844 plus
accrued
interest through April 2008.
48,236
Notes
payable to individual, interest at 1% per month
that
were due in installments of $25,000 per month
from
January 2006 to February 2006 and $16,667 per
month
from April 2006 to September 2006
125,000
Total
notes payable
$
176,171
These
notes are
past due and the Company is still accruing interest on the outstanding balance.
Under the terms of the $125,000 notes payable to individual, the entire
unpaid principal balance and accrued interest shall become due and payable
upon
the occurrence of any default by the Company in the payment of interest and
principal on the due date thereof and any such default that remains unremedied
for twenty business day following written notice to the Company by the
holder. No written notice of default from the holder of these notes
has been received by the Company.
Convertible
notes payable to individual, interest at
10%,
that were due in variable monthly installments plus
From
April to August 2005, the Company executed convertible notes with
an
individual in the total principal amount of $650,000 with interest at
10%. Each note has a maturity date of six months from the date of the
note and is payable in ten monthly installments plus accrued interest commencing
on the maturity date of the note. These notes are past due and the
Company is still accruing interest on the outstanding balance. Under
the terms of the notes, the entire unpaid principal balance and accrued interest
shall become due and payable upon the occurrence of any default by the Company
in the payment of interest and principal on the due date thereof and any such
default that remains unremedied for twenty business day following written notice
to the Company by the holder. No written notice of default from the
holders of these notes has been received by the Company. The Company issued
warrants to purchase 650,000 shares of common stock at $1.65 to $.4.95 per
share
for three years in connection with these notes. In addition, the
entire principal plus accrued interest associated with these notes is
convertible into the Company’s common stock at a conversion price of
the
lesser of the closing price of the common stock on the date of the loan or
85%
of the average closing price of the common stock for the five trading days
preceding the notice of conversion. In no event shall the conversion
price be lower than 50% of the closing price of the common stock on the date
of
the loan. A discount to debt totaling $172,930 ($156,800 for the value of the
conversion feature of these notes and $16,130 for the value of the warrants
issued in connection with these notes) was recorded during fiscal year 2005
and
was fully amortized over the term of the notes. A liability of
approximately $173,000 was recorded for the fair value of the warrants issued
in
connection with the $650,000 of notes and the conversion feature, which was
reduced to its market value of $0 at September 30, 2007.
Current
portion of convertible long-term notes payable (face value of
$606,127
less unamortized discount of $63,524) to investors maturing
September
2008, outstanding principal payable at maturity, interest
Convertible
notes payable (face value of $5,165,000 less
unamortized
discount of $1,268,548) to investors, maturing
from
October 2008 through August 2010, outstanding
principal
payable at maturity, interest at 8%, payable quarterly.
$3,896,452
Long-term
debt
$3,896,452
From
September 2005 through August 2007 the Company executed notes payable
with
AJW Partners, LLC, AJW Offshore, Ltd., AJW Qualified Partners, LLC,
New
Millennium Capital Partners II, LLC and AJW Master Fund in the total
principal amount of $6,165,000 which are payable at maturity dates
from
September 2008 to August 2010. Interest on these notes is at 8%
per annum and is payable quarterly in cash or the Company’s common stock
at the option of the Company. The total amount of these notes
issued in fiscal 2007 amounted to $1,895,000. The Company
originally issued warrants to purchase 100,000 shares of common stock
at
$12.50 per share for five years in connection with the notes executed
from
September 2005 to April 2006. In conjunction with the notes
executed in May 2006, the outstanding warrants were cancelled and
replaced
with warrants to purchase 3,000,000 shares of common stock at $1.25
per
share for seven years. For the notes executed from July
2006 through September 2006, the Company issued warrants to purchase
a
total of 3,000,000 shares of common stock at $.15 to $.22 per share
for
seven years. For the notes executed during fiscal 2007, the Company
issued
warrants to purchase a total of 62,500,000 shares of common stock
at $.01
to $.15 per share for seven years. Non-cash interest expense of
$605,000 representing the fair value of the warrants issued as replacement
for the outstanding warrants in May 2006 was recorded in fiscal 2006.
Fees
of approximately $1,202,000 incurred in connection with securing
these
loans were recorded as a deferred financing charge. In addition,
the
entire unpaid and unconverted principal plus any accrued and unpaid
interest associated with these notes is convertible, at the holder’s
option, into the Company’s common stock at a conversion
price of
65% for notes issued through February 2006 and 55% for notes executed
after February 2006 of the average of the three lowest intraday trading
prices of the common stock for the twenty trading days preceding
the date
that the holders elect to convert. A discount to debt totaling
$2,288,222 ($1,477,616 for the fair value of the conversion feature
of
these notes and $810,606 for the incremental fair value of the warrants
issued in connection with these notes) was recorded during fiscal
2005,
2006 and 2007 and is being amortized over the terms of the
notes. The unamortized discount was $1,332,072 ($63,524 for
note maturing September 2008 and $1,268,548 for the remainder of
the
notes) as of September 30, 2007. The collateral pledged by the
Company to secure these notes includes all assets of the Company.
A
liability of approximately $2,893,000 was recorded for the fair value
of
the warrants issued in connection with the $6,165,000 of notes and
the
conversion feature, which was reduced to its market value of approximately
$471,000 at September 30, 2007. Through September 30, 2007,
notes totaling $393,873 were converted into 25,305,763 shares of
common
stock.
10. Deferred
Lessor Incentive
As
an incentive to renew the lease of its facility in Canton, MA for
a period
of five years (see Note 12), the Lessor provided the Company with
leasehold improvements of approximately $67,000. Accordingly,
the Company recorded a deferred lessor incentive and is amortizing
it as a
reduction to rent expense over the term of the lease. In 2007,
$13,400 of the deferred incentive was amortized. As of
September 30, 2007, the remaining balance was $36,850, of which $13,400
was classified as current.
11. Redeemable
Convertible Preferred Stock and Convertible Preferred
Stock
The
Series C and 6% Convertible preferred stock is carried on the balance
sheet outside permanent equity as the Company cannot be sure it has
adequate authorized shares for their conversion as of September 30,2007. Upon the occurrence of specific events, the holders of
the Series E Redeemable Convertible Preferred Stock are entitled
to redeem
these shares under certain provisions of the agreement covering the
purchase of the preferred stock. Accordingly, these securities
were not classified as permanent equity.
In
April and June 2005, the Company raised net proceeds of approximately
$1,335,000 from the sale of 1,500,000 shares of Series E Redeemable
Convertible Preferred Stock with a face value of $1,500,000 and warrants
to purchase 3,000 shares of the Company’s common stock. The
1,500,000 shares of Series E Preferred Stock are convertible into
Common
Stock at the lesser of $4.00 per share or 80% of the average of the
three
lowest closing bid prices for the ten trading days immediately prior
to
the notice of conversion, subject to adjustments and limitations,
and the
warrants are exercisable at $4.20 per share for a period of three
years. The warrants and the conversion feature resulted in a
deemed dividend of $1,087,000 being recorded and included in the
earnings
per share calculation for the year ended September 30, 2005. A liability
of approximately $1,087,000 was recorded for the original fair value
of
the warrants and the conversion feature, which was reduced to its
market
value of approximately $124,000 at September 30, 2007. As of
September 30, 2007, 961,650 shares of this preferred stock had been
converted into 18,778,346 shares of common stock and 538,350 were
outstanding.
In
December 2004, the Company sold 1,285 shares of Series A Redeemable
Convertible Preferred Stock and warrants to purchase 12,000 shares
of
common stock for which it received net proceeds of approximately
$1,160,000. The Series A Redeemable Convertible Preferred Stock,
with a
face value of $1,285,000, was convertible into common stock at the
lesser
of $6.00 per share or 85% of the average of the three lowest closing
bid
prices, as reported by Bloomberg, for the ten trading days immediately
prior to the notice of conversion subject to adjustments and floor
prices. The warrants are exercisable at $6.30 per
share. The warrants and the conversion feature resulted in a
deemed dividend of $1,058,260 being recorded and included in the
earnings
per share calculation for the year ended September 30, 2005. A liability
of approximately $1,058,260 was recorded for the original fair value
of
the warrants and the conversion feature, which was reduced to its
market
value of $36 at September 30, 2007. As of September 30, 2007, 1,135
shares
of this preferred stock had been converted into 452,156 shares of
common
stock and the remaining 150 shares of Series A redeemable convertible
preferred stock, with a face value of $150,000, were redeemed by
the
Company in October 2005 for $155,417 which included accrued dividends
of
$5,417.
The
28,608 shares of Series C convertible preferred stock entitle the
holder
of each share, on each anniversary date of the investment, to convert
into
the number of shares of common stock derived by dividing the purchase
price paid for each share of the preferred stock by the average price
of
the Company’s common stock for the five trading days prior to conversion
subject to anti-dilution provisions and receive royalties of 5% of
revenues related to disease diagnostic testing from the preceding
fiscal
year. There were no royalties earned for the years ended
September 30, 2007 or 2006. After one year from the date
of issuance, the Company may redeem all or any portion of this preferred
stock by the issuance of the Company’s common stock, the number of shares
of which shall be derived by dividing the redemption price, as defined,
by
the average closing price of the Company’s common stock for the five
trading days prior to the redemption date, and liquidating distributions
of an amount per share equal to the amount of unpaid royalties due
to the
holder in the event of liquidation. During 2006, 8,333 of these
shares were converted into 90,910 shares of common stock. None
of these shares was converted into common stock during 2007.
The
2,000 shares of 6% convertible preferred stock entitle the holder
to
convert, at any time, $1,000,000 invested in 2004 and $1,000,000
invested
in 2003 into shares of common stock at a conversion price of $10.80
and
$7.50 per share, respectively, subject to anti-dilution provisions
and to
receive annual cash dividends of 6%, payable semi-annually when,
as and if
declared by the Company’s Board of Directors. Warrants to purchase 92,593
and 133,333 shares of common stock at exercise prices of $6.75 and
$2.50
per share, respectively, that were issued in connection with the
preferred
stock and the beneficial conversion feature resulted in a deemed
dividend
totaling $2,000,000, of which $1,000,000 was recorded and included
in the
loss per share calculation for each of the years ended September30, 2004
and September 30, 2003. At September 30, 2004, all the warrants
issued in connection with the 6% convertible preferred stock were
exercised on a cashless basis into 135,802 shares of common stock.
Undeclared and unpaid dividends totaled $454,344 at September 30,2007. No dividends were paid on these shares in 2007 or
2006.
12. Commitments
Leases. ATI
leases office space under a non-cancelable operating lease which
expires
in 2010. In July 2005, the Company renewed the lease for ATI’s
facility at Canton, MA for a period of five (5) years. Under the
terms of
the renewal, the lessor provided the Company with leasehold improvements
of approximately $67,000 (see Note 10). In addition, the
Company spent $18,243 for leasehold improvements. Certain additional
costs
are incurred in connection with the leases and the leases may be
renewed
for additional periods.
Rental
expense under all operating leases charged to operations for the
years
ended September 30, 2007 and 2006 totaled approximately $312,855 in
each year.
2008
$
330,781
2009
348,906
2010
271,875
Total minimum lease payments
$
951,562
Employment
Agreements. The Company entered into Employment Agreements (the
“Employment Agreements”) with its two principal executives, which payments
thereunder were subsequently assigned to a related party. Pursuant to
the Employment Agreements, if Messrs. Phildius and/or Scott are terminated
without "Cause" (as such term is defined in the Employment Agreements)
by the
Company or if Messrs. Phildius and/or Scott terminate their employment
as a
result of a breach by the Company of its obligations under such Agreements,
he
will be entitled to receive his annual base salary ($200,000 for Mr. Phildius
and $180,000 for Mr. Scott) for a period of up to 18 months following such
termination. In addition, if there is a "Change of Control" of the
Company (as such term is defined in the Employment Agreements) and, within
two
years following such "Change of Control", either of Messrs. Phildius or
Scott is
terminated without cause by the Company or terminates his employment as
a result
of a breach by the Company, such executive will be entitled to certain
payments
and benefits, including the payment, in a lump sum, of an amount equal
to up to
two times the sum of (i) the executive's annual base salary and (ii) the
executive's most recent annual bonus (if any). In addition, pursuant
to the Employment Agreements, Messrs. Phildius and Scott are each entitled
to
annual bonus payments of up to $150,000 if the Company achieves certain
levels
of pre-tax income (as such term is defined in such Agreements) or alternative
net income objectives established by the Board of
Directors. The agreements renew automatically on an
annual basis and may be terminated upon 60 days written notice by either
party. Expenses under these agreements totaled approximately $361,000
in fiscal 2007 and $380,000 in fiscal 2006. The lower amount for
fiscal 2007 reflects a salary reduction program for all salaried personnel
implemented in April 2007.
Retirement
Plan. In February 1998, the Company adopted a defined
contribution retirement plan which qualifies under Section 401(k) of the
Internal Revenue Code, covering substantially all
employees. Participant contributions are made as defined in the Plan
agreement. Employer contributions are made at the discretion of the
Company. No Company contributions were made in 2007 or
2006.
Letter
of Credit. As security for full and faithful
performance of all provisions of the lease renewal for the facility at Canton,
MA, the Company furnished the landlord an irrevocable letter of credit in
the
amount of $150,000. The letter of credit was obtained from a bank
that requires the Company to maintain $150,000 on deposit with the bank as
full
collateral for the letter of credit.
13. Stockholders’
Equity (Deficit)
Preferred
Stock. Preferred stock shares outstanding consist
of the following:
The
5,689 shares of Series B
convertible preferred stock issued and outstanding entitle the holder of each
share to: convert it, at any time, at the option of the holder, into ten shares
of common stock subject to antidilution provisions and receive dividends
amounting to an annual 8% cash dividend or 10% stock dividend payable in shares
of Series B preferred stock computed on the amount invested, at the discretion
of the Company. After one year from the date of issuance, the Company
may redeem, in whole or in part, the outstanding shares at the offering price
in
the event that the average closing price of ten shares of the Company’s common
stock shall equal or exceed 300% of the offering price for any 20 consecutive
trading days prior to the notice of redemption; and liquidating distributions
of
an amount per share equal to the offering price. During 2007 and
2006, none of these shares was converted into shares of common stock. Undeclared
and unpaid dividends amounted to $9,981 and $8,203 at September 30, 2007
and 2006, respectively. No dividends were paid in 2007 or
2006.
Common
Stock Purchase Warrants. The Company has
outstanding warrants entitling the holders to purchase common stock at the
applicable exercise price. In fiscal 2007, no warrants were exercised
and warrants covering 27,500 shares expired. During fiscal 2006, no
warrants were exercised and warrants covering 201,889 shares expired or were
cancelled. In fiscal 2007 and 2006, warrants covering 83,665,501 and
9,138,205 shares were issued, respectively, primarily in connection with
convertible notes. The fair value of the warrants for the right to purchase
shares of common stock issued in 2007 and 2006 related to debt transactions
amounted to approximately $736,336 and $547,304, respectively, and was recorded
as debt discount and deferred financing costs. The fair value of these
outstanding warrants is included on a separate line on the accompanying balance
sheets. The following is a summary of outstanding warrants (all of
which are exercisable) at September 30, 2007. At September 30,2007, the Company did not have enough authorized shares for all of these
warrants.
Exercise
Price
Shares
Issuable
Expiration
Date
Fair
Value
Warrants issued to placement agent in connection
with sales of preferred stock in 2003
$
10.00
2,000
2008
$
0
Warrants
issued in connection with deferred rent
costs associated with restructure of facility lease in
2003
$
10.00
30,000
2013
83
Warrants
issued in connection with preferred stock
sales in 2004
$
4.75-$6.30
4,500
2009
1
Warrants
issued to placement agent in connection
with sales of preferred stock in 2004
$
4.75-$6.30
2,700
2009
0
Warrants
issued in connection with preferred stock
sales in 2005
$
4.20-6.30
15,000
2008-2009
36
Warrants
issued to placement agent in connection
with sales of preferred stock in 2005
$
6.30
1,542
2009
0
Warrants issued in connection with issuance of
notes payable and convertible notes payable
$
1.65-$5.50
18,000
2008
0
Warrants
issued in connection with issuance of
long-term
convertible notes payable from 2005 o
2007
$
.01-$1.25
68,500,00
2013-2014
205,500
Warrants
issued to placement agent in connection
with
issuance of long-term convertible notes payable from
2005-2007
$
.01-$12.50
24,287,039
2012-2014
90,979
Total Shares Issuable
92,860,781
$
296,599
Stock
Options. The Company has stock option plans providing for
the granting of incentive
stock options for up to 750,000 shares of common stock to certain
employees to
purchase
common stock at not less than 100% of the fair market value on the
date of
grant. Each
option granted under the plan may be exercised only during
the
continuance
of the optionee’s employment with the Company or during certain additional
periods
following the death or termination of the optionee. Options
granted before fiscal
1999
under the Plan vest after the completion of two years of continuous
service to the Company
or at a rate of 50% per year. Beginning in fiscal 1999, options
granted vest at
a
rate of 20% per year. As of September, there were 1,042,000
shares available for future grants.
During
fiscal 1995, the Company adopted a directors’ plan, (the “Directors’
Plan”). Under the Directors’ Plan, each non-management director
is to be granted options covering 5,000 shares of common stock initially
upon election to the Board, and each year in which he/she is elected
to
serve as a director. In fiscal 2001, the Company adopted a
compensation plan for outside directors that provides for each
non-management director to receive options covering 100,000 shares
of
common stock upon initial election to the Board and to receive annual
grants of options covering 30,000 shares of common stock at the fair
market value on the date of grant which vest over three years. In
September 2004, the Company increased the annual grants to 75,000
per year
for a non-management director. There were no options issued to
outside directors in fiscal 2007 and 2006.
During
fiscal 2007 and 2006, options to purchase 0 and 7,000 common shares,
respectively,
were granted primarily to employees of the Company with exercise
prices
equal
to the stock’s fair value on the grant date. During fiscal 2007
and 2006, options to purchase
20,451 and 22,036 shares, respectively, held by employees of the
Company
were
forfeited
or expired and no options held by employees were
exercised.
Loss
Per
Share. The following data shows the amounts used
in computing loss per share:
The following table summarizes securities that were
outstanding as of September 30, 2007 and 2006 but not reflected in the
calculation of diluted net loss per share because such shares are
anti-dilutive:
The calculation of the shares above for the
redeemable convertible
preferred stock and convertible preferred stock and the convertible notes were
based on the market price of the common stock as of September 30,2007. The number of shares required exceeds the number of authorized
shares as of September 30, 2007
14. Income
Taxes
No
provision for federal income taxes has been made for the years ended
September 30, 2007 or 2006, due to the Company’s operating
losses. At September 30, 2007, the Company has unused net
operating loss carryforwards of approximately $56,000,000 including
approximately $11,000,000 acquired from ATI which expire at various dates
through 2024. Most of this amount is subject to annual limitations
due to various “changes in ownership” that have
occurred. Accordingly, most of the net operating loss carryforwards
will not be available to use in the future.
As
of
September 30, 2007, the deferred tax assets related to the net operating
loss carryforwards have been fully offset by valuation allowances, since the
utilization of such amounts is uncertain.
At
September 30, 2007, accounts receivable from customers in excess of 10% of
total
accounts receivable were approximately $0 from Customer A and $62,000 from
two
other customers.
16. Interest
Expense and Financing Costs
2007
2006
Interest
on short-term and long-term debt
$
476,594
$
331,342
Deferred
financing costs on equity credit line
-
83,325
Discount
and deferred financing costs on long-term
debt (Notes 8 & 9)
959,707
441,146
Discount
on short-term notes payable
-
71,898
Replacement
of warrants for long-term debt
-
605,000
Total
interest and financing costs
$
1,436,301
$
1,532,711
17. Related
Party Payable
At
September 30, 2007, the Company owed approximately $123,000 to Phildius, Kenyon
and Scott that represents the Company’s payroll tax and fringe benefit
obligation for Peter Phildius and Douglas Scott, officers of the Company, for
the past sixty months. The aggregate of salaries, fringe benefits and
reimbursement of expenses paid to PK&S by the Company on behalf of Messrs.
Phildius and Scott for fiscal years 2007 and 2006 totaled $389,578 and $408,628
respectively.
From
October 1 through December 11, 2007, $55,838 of long-term convertible debt
was
converted into 35,940,971 shares of common stock.
On
November 14, 2007 and December 13, 2007, the Company executed additional notes
payable with AJW Partners, AJW Master Fund, Ltd. and New Millennium Capital
Partners II, LLC in the total principal amount of $650,000. Interest
on these notes is at 8% per annum and is payable quarterly in cash or the
Company’s common stock at the option of the Company. The Company
issued warrants to purchase 55,000,000 shares of common stock at $.01 per share
for seven years in connection with these notes. The entire principal
plus any accrued and unpaid interest associated with these notes is convertible,
at the holder’s option, into the Company’s common stock at a conversion price of
40% of
the average of the three lowest intraday trading prices of the common stock
for
the twenty trading days preceding the date that the holders elect to
convert. As part of this financing, the conversion price related to
all previously issued and outstanding notes to AJW Partners, AJW Master Fund,
Ltd., AJW Qualified Partners, and New Millennium Capital Partners II, LLC was
changed to from 55% or 65% to 40%. This will result in a new
measurement date and an interest charge that could be material.
On
December 18, 2007, the shareholders approved an increase in authorized shares
of
common stock from 100 million to 800 million shares.
Dates Referenced Herein and Documents Incorporated by Reference
