<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended October 31, 1996
OR
[ ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from________________to_______________
Commission file number:33-06827-LA
KCD HOLDINGS INCORPORATED
-----------------------------------------------------------------
(Exact name of small business issuer as specified in its charter)
Nevada 95-4029439
----------------- --------------
(State or other jurisdiction of (I.R.S. employer
incorporation or organization number) identification number)
2835 Townsgate Road, Suite 110, Westlake Village, CA 91361
- -------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (805) 494-6687
not applicable
- -------------------------------------------------------------------------------
(former, name, address, and former fiscal year, if changed since last report)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 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
--- ----
State the number of shares outstanding of each of the Registrant's classes of
common equity, as of the latest practicable date.
<TABLE>
<CAPTION>
Outstanding at
Class of Common Stock November 30, 1996
--------------------- -----------------
<S> <C>
$.002 par value 14,606,874
</TABLE>
Transitional Small Business Disclosure Format Yes No X
--- ----
Number of sequentially numbered pages in the document: 29
<PAGE> 2
FORM 10-QSB
Securities and Exchange Commission
Washington, D.C. 20549
KCD HOLDINGS INCORPORATED
Index
<TABLE>
<CAPTION>
PART 1 - FINANCIAL INFORMATION Page
----
<S> <C>
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at F-3
January 31, 1996 and October 31, 1996 (unaudited)
Consolidated Statements of Operations for the three F-4
months and the nine months ended October 31, 1995 (unaudited)
and 1996 (unaudited)
Consolidated Statement of Stockholders' Investment F-5
for the nine months ended October 31, 1996 (unaudited)
Consolidated Statement of Cash Flows F-6
for the nine months ended October 31, 1995 (unaudited)
and 1996 (unaudited)
Notes to Consolidated Financial Statements F-7
Item 2. Management's Discussion and Analysis or Plan of 17
Operation.
PART II. - OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 2. Changes in Securities 28
Item 6. Exhibits and Reports on Form 8-K 28
Signatures 29
</TABLE>
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
KCD HOLDINGS INCORPORATED
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
OCTOBER 31, 1996 JANUARY 31, 1996
------------------ -----------------
(Unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash $548,725 $48,279
Accounts receivable, net 268,515 381,098
Accounts receivable - other 14,430 115,065
Inventory 2,254,295 864,547
Other 11,673 9,720
------------------ -----------------
Total current assets 3,097,638 1,418,709
------------------ -----------------
PROPERTY AND EQUIPMENT, net 146,915 184,357
------------------ -----------------
OTHER ASSETS:
Deposits 14,338 3,938
Intangibles, net 2,139 2,333
------------------ -----------------
Total other assets 16,477 6,271
------------------ -----------------
Total assets $3,261,030 $1,609,337
------------------ -----------------
LIABILITIES AND STOCKHOLDERS' INVESTMENT (DEFICIT)
CURRENT LIABILITIES:
Accounts payable $1,156,721 $836,484
Accrued expenses 173,976 224,011
Accrued advertising 150,000 173,417
Commissions payable 31,663 31,948
Royalties payable 0 150,515
Collateralized note payable-related party 0 621,018
Loans from stockholders 422,628 696,579
------------------ -----------------
Total current liabilities 1,934,988 2,733,972
------------------ -----------------
Commitments and contingencies (see Notes)
STOCKHOLDERS' INVESTMENT (DEFICIT)
Common stock, par value $.002 per share; 25,000,000 shares 29,214 33,204
authorized; issued and outstanding 14,606,874 as of October 31, 1996
and 16,602,000 as of January 31, 1996
Additional paid in capital 8,912,287 8,365,580
Accumulated deficit (6,576,278) (6,005,308)
Prepaid advertising and consulting fees (1,039,181) (3,518,111)
------------------ -----------------
Total stockholders' investment (deficit) 1,326,042 (1,124,635)
------------------ -----------------
Total liabilities and stockholders' investment (deficit) $3,261,030 $1,609,337
------------------ -----------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE> 4
KCD HOLDINGS INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS AND NINE MONTHS ENDED OCTOBER 31, 1996 AND 1995
<TABLE>
<CAPTION>
------THREE MONTHS ENDED----- -----NINE MONTHS ENDED-----
OCTOBER 31, 1996 OCTOBER 31, 1995 OCTOBER 31, 1996 OCTOBER 31, 1995
----------------- ------------ ----------------- -----------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Net Revenues $953,511 $990,345 $2,525,872 $5,110,546
Cost of Goods Sold 362,094 261,423 1,055,591 1,239,028
----------------- ------------ ----------------- -----------------
Gross Profit 591,417 728,922 1,470,281 3,871,518
----------------- ------------ ----------------- -----------------
Operating Expenses:
Advertising 605,952 87,192 863,459 2,136,194
Selling and marketing 284,855 191,958 691,160 1,815,331
General and administrative 357,698 436,267 1,261,615 1,189,802
Royalties - 92,868 - 432,858
----------------- ------------ ----------------- -----------------
1,248,505 808,285 2,816,234 5,574,185
----------------- ------------ ----------------- -----------------
Profit (Loss) from Operations (657,088) (79,363) (1,345,953) (1,702,667)
----------------- ------------ ----------------- -----------------
Non - Operating Income (Expense)
Interest expense (12,089) (103,342) (70,001) (267,124)
Interest income 23,788 35,257
----------------- ------------ ----------------- -----------------
(12,089) (79,554) (70,001) (231,867)
Litigation Settlements, net 151,245 - 916,727 -
Payments to Officer and Stockholder - - (70,143) -
----------------- ------------ ----------------- -----------------
Income (Loss) before Income Taxes (517,932) (158,917) (569,370) (1,934,534)
Provision for Income Taxes - - 1,600 1,600
----------------- ------------ ----------------- -----------------
Net Profit (Loss) ($517,932) ($158,917) ($570,970) ($1,936,134)
================= ============ ================= =================
Weighted average shares of
Common Stock Outstanding: 14,210,878 16,095,544 14,577,077 15,933,423
================= ============ ================= =================
Net Profit (Loss) per share: ($0.04) ($0.01) ($0.04) ($0.12)
================= ============ ================= =================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE> 5
KCD HOLDINGS INCORPORATED
CONSOLIDATED STATEMENT OF STOCKHOLDERS' INVESTMENT (DEFICIT)
FOR THE NINE MONTHS ENDED OCTOBER 31, 1996
<TABLE>
<CAPTION>
Common Stock
------------ Additional Accumulated Equity Stockholder's
Number of shares Par value Paid In Capital Deficit Reductions Investment (Deficit)
---------------- --------- --------------- ------------ ---------- --------------------
<S> <C> <C> <C> <C> <C> <C>
Balance January 31, 1996 16,602,000 $33,204 $8,365,580 $(6,005,308) $(3,518,111) $(1,124,635)
Common stock retired,
advertising settlement (640,000) (1,280) (1,918,720) - - (1,920,000)
Issuance of common stock
in litigation settlement 40,000 80 59,920 - - 60,000
Common stock retired,
consulting services (155,200) (310) (1,047,290) - - (1,047,600)
Common stock retired,
satisfaction of loan (3,800,000) (7,600) - - - (7,600)
Issuance of common stock
for services 540,047 1,080 349,815 - - 350,895
Issuance of common stock
in private placements 1,895,027 3,790 2,853,232 - - 2,857,022
Issuance of common stock
for satisfaction of debt 125,000 250 249,750 - - 250,000
Net loss for nine months
ended October 31, 1996 - - - (570,970) - (570,970)
Reduction in prepaid
advertising and consulting
fees - - - - 2,478,930 2,478,930
---------- ------- ---------- ------------ ------------ ------------
Balance October 31, 1996 14,606,874 29,214 8,912,287 (6,576,278) (1,039,181) 1,326,042
(Unaudited) ========== ======== =========== ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE> 6
KCD HOLDINGS INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED OCTOBER 31, 1996 and 1995
<TABLE>
<CAPTION>
1996 1995
-------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES: (Unaudited) (Unaudited)
<S> <C> <C>
Net Profit (Loss) ($570,970) ($1,936,134)
Adjustments to reconcile Net Profit (Loss)
to Cash used in operating activities:
Depreciation and amortization 373,728 38,544
Stock issued for advertising and other services 50,595 2,947,336
Litigation settlements - stock (retirement)/issuance (479,762) -
-------------- --------------
(626,409) 1,049,746
-------------- --------------
(Increase)/decrease in current assets:
Accounts receivable, net 213,218 23,657
Inventory (1,389,748) (465,425)
Other current assets (1,953) (1,936,139)
Increase/(decrease) in current liabilities:
Accounts payable 320,237 (5,403)
Accrued expenses (50,035) (113,120)
Accrued advertising (23,417) 98,562
Commissions payable (285) -
Royalties payable (150,515) (326,796)
-------------- --------------
(1,082,498) (2,724,664)
-------------- --------------
Net cash provided by (used in) operating activities (1,708,907) (1,674,918)
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment - (151,742)
Deposits (10,400) (33,938)
-------------- --------------
Net cash used in investing activities (10,400) (185,680)
CASH FLOWS FROM FINANCING ACTIVITIES:
Retirement of common stock (7,600) -
Proceeds from sale of common stock 2,872,322 1,007,500
Note payable (371,018) 295,454
Loans from stockholders (273,951) 606,368
-------------- --------------
Net cash provided by financing activities 2,219,753 1,909,322
NET INCREASE IN CASH 500,446 48,724
CASH, BEGINNING BALANCE 48,279 9,088
-------------- --------------
CASH, ENDING BALANCE $548,725 $57,812
============== ==============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE> 7
KCD HOLDINGS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 31, 1996 AND OCTOBER 31, 1996
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
KCD Holdings Incorporated (the "Company") is a Nevada corporation which was
incorporated in February 1986. The Company is a holding company which operates
primarily through its wholly-owned subsidiary, SeQuester Incorporated
("SeQuester"), formerly KCD Incorporated, which was incorporated in November
1993. The Company is a distributor and marketer of technically advanced health
products. The Company currently markets dietary aid products under the name
SeQuester(R). These products are sold to national drug and food chain
retailers, wholesalers and mass merchandisers throughout the United States
using several of the nations largest food brokerage firms.
In October 1994, in connection with the issuance of 14,100,000 shares of its
common stock, $0.002 par value, 100,000 shares to the stockholders of the
Company and 14,000,000 shares to the stockholders of SeQuester, the Company
acquired 100% of the ownership of SeQuester, as a reverse merger. The merger
was accounted for in a manner similar to a pooling-of-interests. SeQuester,
which is engaged in the business of marketing and distributing dietary aids,
commenced its operations in February 1994. For financial reporting purposes,
the operations of SeQuester have been included in the accompanying consolidated
financial statements since that date.
The accompanying consolidated financial statements of the Company and its
subsidiary have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to Form
10-QSB. Certain notes and other information have been condensed or omitted
from the interim financial statements presented in this report. Accordingly,
they do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the
opinion of management, the financial statements reflect all adjustments
considered necessary for a fair presentation. The results of operations for the
nine months ended October 31, 1996 are not necessarily indicative of the
results to be expected for the full year. For further information, refer to
the financial statements and footnotes thereto included in the Company's Annual
Report on Form 10-KSB for the year ended January 31, 1996 as filed with the
Securities and Exchange Commission. All significant intercompany balances and
transactions have been eliminated in consolidation.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect amounts reported and disclosed in the financial statements and
related notes. Actual results could differ from those estimates.
Certain reclassifications were made to the 1995 consolidated financial
statements to conform with the 1996 consolidated financial statement
presentation.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Revenue Recognition -- The Company recognizes revenue from
wholesalers, distributors and retailers at the time of shipment, net of sales
returns and allowances.
F-7
<PAGE> 8
KCD HOLDINGS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 31, 1996 AND OCTOBER 31, 1996
Significant customers accounting for 56.7% of revenues for the nine months
ended October 31, 1996 include Wal-Mart Stores 29.1%, Kmart 16% and American
Drug Stores 11.6%. Major customers accounting for 50% of revenues for the nine
months ended October 31, 1995 include Wal-Mart Stores 15%, McKesson Drug
Company 10%, Kmart Corp. 7.7%, Mark Stevens (CVS Inc.) 6%, Thrift Drug 5%,
Target 3.3% and Walgreen 3%.
(b) Fair Value of Financial Instruments and Credit Risk -- The carrying
value of cash, notes and loans from stockholders, approximates their fair
values.
(c) Allowance for Doubtful Accounts -- In determining the allowance to be
maintained, management evaluates many factors including industry and historical
loss experience. The allowance for doubtful accounts is maintained at an
amount management deems adequate to cover estimated losses. The allowance for
doubtful accounts at January 31, 1996 was $52,163 and at October 31, 1996 was
$29,835.
(d) Prepaid Advertising -- The Company expenses advertising costs as
incurred.
(e) Inventory -- Inventory is valued at the lower of cost or market value.
Cost is determined using the first-in, first-out method. Inventory consisted
of:
<TABLE>
<CAPTION>
October 31, 1996 January 31, 1996
---------------- ----------------
<S> <C> <C>
Product Units $ 2,121,724 $ 704,741
Packaging and Product Displays 184,945 153,578
Shipping Supplies 10,426 6,228
----------- ----------
2,317,095 864,547
Less: Allowance for Obsolesence ( 62,800) -
----------- ----------
$ 2,254,295 $ 864,547
=========== ==========
</TABLE>
(f) Property and Equipment -- The Company records property and equipment
at cost and depreciates it over the useful life of the asset using the
straight-line method of depreciation. Renewals and betterments are capitalized
while repairs and maintenance are charged to expense. Estimated useful lives
are as follows:
<TABLE>
<S> <C>
Product Tooling 2 years
Machinery and Equipment 5-10 years
Furniture and Fixtures 5-10 years
Computer Equipment 5 years
Leasehold Improvements 5-10 years
</TABLE>
(g) Income Taxes -- Deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases at enacted rates when such amounts are expected to be
realized or settled.
F-8
<PAGE> 9
KCD HOLDINGS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 31, 1996 AND OCTOBER 31, 1996
(h) Income (Loss) Per Common Share -- Income (Loss) per common share is
based on the weighted average number of common shares outstanding. Common
share equivalents have not been considered in determining the weighted average
number of shares outstanding as their effect would either be antidilutive or
result in no material dilution of earnings per share.
(i) Risks and Uncertainties -- In the normal course of business, the
Company is subject to certain risks and uncertainties as follows:
- The Company's primary source of revenue has been from a single
product, SeQuester(R) 1; however, the Company introduced two
new dietary aid products in December 1995 (SeQuester(R) 2 and
SeQuester(R) 3) and introduced a fourth product,
PhytoQuest(TM) in October 1996.
- The Company has a significant deficit and has incurred
substantial losses from operations for the period from
inception through October 31, 1996.
- The marketing of the Company's products are subject to the
rules and regulations of the Federal Trade Commission.
- The Company provides its product on unsecured credit to most
of its customers, the majority of which are national retail
outlets.
(j) Variable Stock Purchase Agreements -- The Company has various
agreements with certain key employees and an independent contractor which
provide options to purchase common stock. Under these agreements, the Company
has the right to repurchase (at the original purchase price) any shares
purchased. The Company retains this repurchase right for a period of two years
from the date of purchase. The Company will likely be required to recognize
significant compensation expense, based upon the then fair market value of the
shares, at the expiration of the repurchase period. The foregoing non-cash
compensation expense could have a material adverse impact on the Company's
statement of operations for the period during which the Company's repurchase
rights expire.
(k) Impact of Adoption of Recently Issued Accounting Standards -- In
October 1995, the Financial Accounting Standards Board issued "SFAS" No. 123,
"Accounting For Stock-based Compensation." The effective date of this
statement is for fiscal years beginning after December 15, 1995. The statement
will require the Company either to adopt SFAS No. 123 and recognize an expense
for stock compensation in the financial statements or continue accounting under
Accounting Principles Board Opinion No. 25, "Accounting For Stock Issued to
Employees" with additional pro forma footnote disclosure regarding the impact
on net earnings and net earnings per share had the Company adopted SFAS No.
123. The impact of adopting SFAS No. 123 to the Company has not yet been
determined.
F-9
<PAGE> 10
KCD HOLDINGS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 31, 1996 AND OCTOBER 31, 1996
3. REVENUES
In the normal course of business during the nine month periods ended October
31, 1996 and 1995, the Company granted its customers a variety of discounts.
The discounts granted were as follows:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Gross Revenues $ 3,477,124 $ 6,115,019
------------- ============
Discounts:
Refunds and Returns $ 441,509 $ 136,877
Introductory and Promotional 172,675 419,330
Co-op Advertising 268,305 331,598
Other 68,763 116,668
------------- -------------
Total Discounts $ 951,252 $ 1,004,473
------------- =============
Net Revenues $ 2,525,872 $ 5,110,546
============== ============
</TABLE>
4. PROPERTY AND EQUIPMENT
<TABLE>
<CAPTION>
October 31, 1996 January 31, 1996
---------------- ----------------
<S> <C> <C>
Product Tooling $ 43,900 $ 43,900
Machinery and Equipment 79,280 79,280
Furniture and Fixtures 6,231 6,231
Computer Equipment 31,198 31,198
Leasehold Improvements 54,291 54,291
--------- ------------
214,900 214,900
Less: Accumulated Depreciation ( 67,985) ( 30,543)
--------- ------------
$ 146,915 $ 184,357
========= ============
</TABLE>
5. LOAN RECEIVABLE FROM OFFICER AND STOCKHOLDER
On February 1, 1995 the Company agreed to loan Clark Holcomb, the President of
the Company at that time, up to the principal amount of $2,000,000 with
interest payable at the rate of 8% per annum on the unpaid balance. The loan
was payable on demand upon sixty days prior notice. In consideration for the
loan, Mr. Holcomb agreed and acted to retire 2,000,000 shares of the Company's
common stock owned by him and further agreed to personally guarantee and
collateralize future borrowings by the Company up to the principal balance of
the loan. No salary was paid or accrued for Mr. Holcomb for the twelve months
ended January 31, 1996. As of January 31, 1996, the balance of principal and
interest receivable on this loan of $2,145,964 was determined to be
uncollectible and was expensed during the twelve months ended January 31, 1996.
In April 1996, Mr. Holcomb retired 3,800,000 shares of Company common stock
personally owned by him in satisfaction of the Company's outstanding loan
receivable from him which was
F-10
<PAGE> 11
KCD HOLDINGS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 31, 1996 AND OCTOBER 31, 1996
$2,223,638 at that date. An additional $70,143 was expensed during the nine
months ended October 31, 1996.
6. LOANS PAYABLE TO STOCKHOLDERS AND COLLATERALIZED PROMISSORY NOTE
(a) On October 31, 1996, the Company owed stockholders the amount of
$422,628 including principal and interest. These loans are interest bearing,
at a rate of 9%, and have varying repayment terms over a one year period,
principally for the purpose of providing the Company with working capital.
These notes are subject to a security agreement which covers all of the
accounts receivable of the Company.
(b) On October 17, 1995, the Company executed a promissory note for the
sum of $750,000, or the aggregate unpaid principal amount of advances up to the
sum of $750,000, with interest payable at 10% per annum on the outstanding
balance with a stockholder. The note, principal plus interest, is payable
based upon 50% of net collections from product sales with any remaining balance
due in full on or before October 17, 1996. The note was subject to a security
agreement which covered all of the accounts receivable, contract rights and
inventory of the Company. As of October 31, 1996, the balance of principal and
interest outstanding of this note has been satisfied.
In August 1996, the Company entered into a stock purchase agreement with the
same stockholder wherein the Company issued 125,000 shares of common stock in
satisfaction of $250,000 of the principal balance of the secured promissory
note dated October 17, 1995 due to that stockholder. In connection with this
transaction, the Company entered into a put option agreement wherein that
stockholder has the right, upon his election, to sell to the Company a total of
125,000 shares of Company common stock at $2.00 per share at any time between
October 17, 1996 and April 17, 1997.
7. INCOME TAXES
No provision was made for Federal income tax since the Company has significant
net operating loss carryforwards. Through January 31, 1996, the Company
incurred net operating losses for tax purposes of approximately $4,941,000.
Differences between financial statement and tax losses consist primarily of
amortization, payments to an officer and stockholder, allowance for doubtful
accounts, certain interest expenses and termination of sub-chapter S status for
a subsidiary in connection with a merger in October, 1994. The net operating
loss carryforwards may be used to reduce taxable income through the year 2010.
The availability of the Company's net operating loss carryforwards are subject
to limitation if there is a 50% or more positive change in the ownership of the
Company's stock. During the taxable year ended January 31, 1995, the Company
incurred a 50% or more change in ownership. Therefore, the availability of
approximately $591,000 of the Company's net operating loss carryforwards may be
limited. Net operating loss carryforwards for the State of California are
approximately $1,318,000 and are generally available for use to reduce taxable
F-11
<PAGE> 12
KCD HOLDINGS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 31, 1996 AND OCTOBER 31, 1996
income through the year 2000. The provision for income taxes consists of the
California and New Jersey state minimum taxes imposed on corporations.
Significant components of the Company's net deferred tax assets, as of January
31, 1996 are as follows:
<TABLE>
<S> <C>
Litigation Accrual $ 24,000
Allowance for Doubtful Accounts 8,400
Net Operating Loss carry-forward 1,895,000
-----------
Gross Deferred Tax Assets 1,927,400
Valuation Allowance ( 1,927,400)
-----------
Net Deferred Tax Asset $ -
===========
</TABLE>
The Company's valuation allowance of $1,927,400, as of January 31, 1996, is
based on the Company's evaluation of the future realization of the deferred tax
assets.
8. CONTRACTS AND AGREEMENTS
(a) Advertising Agreement -- In May 1995, the Company entered into an
agreement with Premiere Radio Networks ("Premiere") for bartered advertising in
the amount of $1,000,000. As consideration for this advertising, the Company
issued 200,000 shares of restricted common stock to Premiere. As of October
31, 1996, $316,387 of unused advertising is currently available in connection
with this agreement.
(b) Supply and Packaging Agreements -- In April 1996, the Company entered
into a five year supply agreement with a major manufacturer to provide dietary
supplements for resale within the United States and Canada. This agreement
also provides for exclusive rights to sell products to certain retail stores
and wholesalers. In addition, in April 1996, the Company entered into a five
year packaging agreement which covers a significant portion of the Company's
packaging requirements.
9. STOCKHOLDERS' INVESTMENT
(a) Common Stock -- During the three months ended April 30, 1996, the
Company (i) retired 640,000 shares of common stock in connection with
settlement of certain advertising litigation (ii), retired 155,200 shares of
common stock in connection with termination of a consulting agreement and (iii)
retired 3,800,000 shares of common stock in satisfaction of the Company's
outstanding loan from Clark Holcomb. During the three months ended April 30,
1996, the Company issued 1,200,000 shares of common stock in a private
placement and issued 46,000 shares of common stock for other services.
During the three months ended July 31, 1996, the Company issued (i) 35,000
shares of common stock to commission sales brokers and (ii) 40,000 shares of
common stock in settlement of litigation.
F-12
<PAGE> 13
KCD HOLDINGS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 31, 1996 AND OCTOBER 31, 1996
In June 1996, the Company entered into a financing agreement pursuant to which
the Company agreed to issue a maximum of 1,000,000 shares of common stock
offered at a price per share equal to the lesser of (i) 50% below the closing
bid price of the Company's common stock or (ii) $2.00 per share. During the
period June 1996 through October 31, 1996, 695,027 shares were issued with the
balance of this financing currently scheduled to be completed by December 31,
1996. Upon completion of this financing, the Company agreed to issue, to the
placement agent, 300,000 warrants to purchase common stock at the offering
price. These warrants will have a five year life and contain certain
registration rights. In addition, upon completion of this financing, the
Company agreed to enter into certain investment relationship agreements for a
one year period which provide for aggregate payments of $4,000 per month and
the issuance of an aggregate of 200,000 warrants to purchase common stock at
the offering price. These warrants will have a five year life and contain
certain registration rights.
In February 1996, the Company amended and restated its Consulting Agreement and
Stock Plan with a consultant, dated February 15, 1995 to extend the term of
such agreement for an additional three (3) year period and, in June 1996,
issued an additional 300,000 shares of Company common stock, to such
consultant.
The Company has employment agreements with officers under which it is obligated
to issue up to an aggregate of 1,750,000 shares of Company common stock at a
purchase price of par value through June 1999. The shares are subject to
repurchase by the Company at par value for a period of two years from date of
purchase.
In connection with an agreement with an independent contractor to provide
certain advertising, design and marketing services, the Company also entered
into a common stock purchase agreement. Under the terms of the stock purchase
agreement, the Company is obligated to issue up to an aggregate of 250,000
shares of Company common stock at a purchase price of par value through August
1998. In August 1996, the Company issued 150,000 shares under this agreement.
The shares are subject to repurchase by the Company at par value for a period
of two years from date of purchase.
In August and October 1996, the Company issued an additional 9,047 shares of
common stock to commission sales brokers.
(b) Warrants -- The outstanding public warrants of the Company at October
31, 1996 are as follows:
<TABLE>
<CAPTION>
Warrant Class Amount Outstanding Exercise Price
------------- ------------------ --------------
<S> <C> <C>
A 398,850 $ 0.50
B 488,600 0.75
C 488,600 1.00
---------
1,376,050
=========
</TABLE>
F-13
<PAGE> 14
KCD HOLDINGS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 31, 1996 AND OCTOBER 31, 1996
In May 1996, the Company extended the date within which the outstanding
warrants could be exercised to June 30, 1997. Exercise of these warrants is
subject to an effective registration statement with the Securities and Exchange
Commission. No warrants were exercised during the twelve months ended January
31, 1996 or the nine months ended October 31, 1996.
The Company has an additional 300,000 warrants outstanding to purchase common
stock at $2.50 per share. These warrants have a five year life and contain
certain registration rights.
10. LITIGATION
The Company is involved in several legal actions. In the opinion of the
management, the Company has adequate legal defenses with respect to these
actions, as noted below:
Charles McClendon vs. Clark M. Holcomb and KCD
Charles McClendon ("McClendon") filed a complaint on October 12, 1995 in the
Superior Court of the State of California for the County of Los Angeles against
Clark M. Holcomb and SeQuester alleging breach of contract, fraud, fraudulent
misrepresentation, violation of California Corporate Securities Law, money had
and received and account stated. McClendon alleged that Holcomb fraudulently
breached a contract by and between McClendon and Holcomb pursuant to which
Holcomb agreed to sell shares of Interactive Medical Technologies Ltd. ("IMT")
stock to McClendon. Plaintiff named SeQuester as the alter-ego of Holcomb.
McClendon is seeking damages in a sum in excess of $50,000 as well as
attorneys' fees, exemplary and punitive damages. It is the Company's position
that it has no obligation or liability to McClendon in connection with this
matter. The Company has filed an answer denying the allegations in the
complaint and intends to vigorously defend this action.
Federal Trade Commission
The advertising and promotion of the Company's products is subject to
regulation by the Federal Trade Commission's ("FTC") under the Federal Trade
Commission Act ("FTCA"). Among other requirements, the FTC requires that all
claims made in advertising be truthful and substantiated in accordance with
standards that have been developed by the FTC. At present, the Company's
advertising claims for its SeQuester(R) products are the subject of an inquiry
by the Seattle Regional Office of the FTC. The Seattle Office of the FTC has
alleged that previous claims for the SeQuester(R) 1 product were false and/or
unsubstantiated in violation of the FTCA. The outcome of the current FTC
inquiry is uncertain. The inquiry may result in an administrative settlement
that would, among other things, impose restrictions on the Company's future
advertising claims for SeQuester(R) 1 and other Company products, and require
payment by the Company of an as yet undetermined sum of money as consumer
restitution. It is also possible that the inquiry will result in
administrative or federal court litigation between the Company and the FTC.
Any of these outcomes could have a material adverse effect on the Company.
F-14
<PAGE> 15
KCD HOLDINGS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 31, 1996 AND OCTOBER 31, 1996
KCD vs. Performance Financial Services, Inc. and Fed Funds, Incorporated
In January 1996, the Company filed a suit against Fed Funds, Incorporated and
Performance Financial Services, Inc. in the United States District Court for
the Eastern District of Virginia for unlawful conversion of Company funds held
under a factoring agreement in the amount of $136,608 plus compensatory damages
for interest and profits as well as punitive damages.
This action was settled, in July 1996, with respect to Fed Funds, Incorporated
resulting in a cash payment received by the Company, in the amount of $57,000.
The Company was awarded a judgment of $500,000 against Performance Financial
Services, Inc. Balances due from Performance Financial Services, Inc. were
deemed to be uncollectible and $58,065 was written off during the nine months
ended October 31, 1996.
EHI vs. KCD
In March 1996, Effective Health Inc. ("EHI"), a wholly-owned subsidiary of IMT,
filed an action against KCD in Los Angeles County Superior Court. This action
alleges causes of action against SeQuester for breach of the First Amended
License Agreement ("Amended License Agreement") by and between EHI and
SeQuester, declaratory relief and permanent injunction. The action is based
upon the alleged failure of SeQuester to pay royalties due pursuant to the
Amended License Agreement and use of advertising claims in connection with the
sale of the licensed products which were in excess of those which EHI
authorized SeQuester to make. SeQuester has denied all of the allegations in
the complaint and, in April 1996, filed an answer and cross-complaint. The
cross-complaint is based on the Company's belief that the patent for the
licensed product under the Amended License Agreement does not appear to
infringe any of the Company's products, as set forth in the Company's letter to
IMT and EHI, dated February 29, 1996, which demanded repayment of approximately
$828,980 in royalties and licensing fees previously paid and the return of
100,000 shares of the Company's common stock issued to IMT thereunder. This
cross-complaint names EHI and IMT, as well as Dr. Shell and William Pelzer as
former officers of IMT and alleges breach of contract, breach of good faith and
fair dealing, negligence, intentional misrepresentation, negligent
misrepresentation, conversion, securities fraud, rescission, accounting and
constructive trust. The Company has requested, injunctive relief, damages and
return of all Company stock issued and monies paid to cross-defendants under
the Amended License Agreement. In October 1996, EHI dismissed its complaint,
with prejudice, and the Company dismissed its cross-complaint, with prejudice,
in accordance with the terms of a Settlement Agreement and Mutual Release (the
"Settlement Agreement") resolving the foregoing actions. The terms of the
Settlement Agreement provide that: (i) EHI will retain all royalties and
license fees previously paid by the Company, with all accounts and obligations
between KCD and EHI and its parent Interactive Medical Technologies, Ltd.
("IMT") deemed paid in full; (ii) IMT will retain the 100,000 shares of the
Company's stock previously issued to it; (iii) to the extent EHI or IMT has any
intellectual property rights or patent interests relative to any fat
sequestrant product, the Company is granted an exclusive worldwide perpetual
royalty free license to such rights; (iv) the parties agree not to interfere in
any manner with the other parties' relationships with manufacturers, marketers
or vendors; and (v) the parties agreed to mutual general releases.
F-15
<PAGE> 16
KCD HOLDINGS INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JANUARY 31, 1996 AND OCTOBER 31, 1996
KCD Holdings, Incorporated vs. Peter D. Bistrian and Horowitz, Cutler & Beam
In December 1995, the Company entered into a Management Consulting Agreement
("Consulting Agreement") with Peter D. Bistrian Consulting, Inc. ("PBC") for
management and marketing consulting services. As compensation for the
foregoing consulting services PBC received 225,000 shares of the Company's
common stock (the "Consulting Shares"). The Company acted to register the
offer and sale of the Consulting Shares on Form S-8 which was filed in January
1996. In January 1996, the Company terminated the Consulting Agreement as a
result of PBC's use of the Company's confidential information for PBC's own
benefit. The Company requested in such notice of termination that PBC
immediately return the Consulting Shares for cancellation and that PBC
immediately cease and desist from trading in the Company's securities.
Notwithstanding the Company's notice it appears that PBC subsequently acted to
sell a substantial portion of the Consulting Shares in the open market and in
violation of a lock-up agreement prohibiting the sale of the Consulting Shares.
In an attempt to resolve this matter in an expeditious manner and to secure the
Consulting Shares for cancellation, the Company entered into a conditional
settlement agreement, contingent upon the return to the Company of all of the
Consulting Shares, which required PBC to deliver the Consulting Shares to an
escrow account maintained by the law firm of Horowitz, Cutler & Beam ("HC&B")
for delivery to the Company. In February 1996, HC&B delivered 155,200 of the
225,000 Consulting Shares to the Company. In May of 1996, the Company filed a
Complaint in the Superior Court of the State of California for the County of
Los Angeles against Peter D. Bistrian Consulting, Inc.; Peter D Bistrian;
Horowitz, Cutler & Beam; M. Richard Cutler; Gateway Financial Group, Inc.; and
Lisa Paige for breach of written contract; legal malpractice; intentional
misrepresentation; negligent misrepresentation; securities fraud; conversion;
constructive fraud; breach of fiduciary duty; insider trading; breach of
covenant of good faith and fair dealing; and violation of the racketeer
influenced and corrupt organizations act.
Except as otherwise specifically indicated above, management believes that the
Company does not have any material liability for any lawsuits, settlements,
judgments or fees of defense counsel which have not been paid or accrued as of
October 31, 1996.
As there is no assurance that the Company will prevail in any of the foregoing
lawsuits, the Company may incur substantial expense in connection with this
litigation. Any unfavorable settlement or judgment against the Company, in
which the Company is a defendant, could have a material adverse effect upon the
financial condition and operational results of the Company.
F-16
<PAGE> 17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
General
KCD Holdings Incorporated, formerly Commonwealth Associates, Inc., was
incorporated in the state of Nevada on February 13, 1986 ("the Company"). The
Company's activities from inception until 1993 consisted primarily of reviewing
possible business opportunities and acquisitions, and maintaining the business
entity. The Company had no operational activities from the fiscal years 1989
through 1993 and all expenses incurred were solely related to maintaining the
entity and reviewing potential business opportunities.
In October 1994, the Company entered into a Plan and Agreement of
Reorganization and acquired 100% of the issued and outstanding equity shares of
SeQuester Incorporated ("SeQuester"), formerly KCD Incorporated, which had
commenced operations in 1994. SeQuester became a wholly owned subsidiary of the
Company. The Company's activities through 1995 consisted primarily of the
development, and marketing of its fat sequestrant product, SeQuester(R) 1.
The Company introduced an appetite suppressant (SeQuester(R) 2) and a
chromium based dietary supplement (SeQuester(R) 3) in addition to its fat
sequestrant product (SeQuester(R) 1) in December 1995. Additionally, the
Company introduced its fourth product, PhytoQuest(TM), in October 1996. It is
composed of phytosterols, which in recent research shows potential to inhibit
the gastrointestinal absorption of cholesterol. Additional new health products
are scheduled for introduction in 1997, all under the trademark SeQuester(R).
To date, the Company has developed access to major domestic retail, pharmacy
and mass merchandiser chains in the United States.
The weight loss industry represents an estimated 1 billion dollars in
revenues. Millions of Americans begin diets every year and buy diet
supplements.
The primary target for the Company's SeQuester(R) product line appears
to be relatively sophisticated females, 24 to 49 years old with a history of
weight loss efforts. These women are interested in products that are natural,
sensible and effective in aiding their struggle to lose unwanted weight. They
understand that reduced caloric intake is part of any effective weight loss
plan and they are inclined to use the product as directed.
Market leaders in the weight reduction industry include Dexatrim(TM)
and Acutrim(TM), with several additional smaller product marketers. However,
there are no other products available in wide spread distribution that
accomplish weight loss through the sequestration of dietary fat.
SeQuester(R) 1 and 3 do not contain any diuretics, stimulants, or
drugs. SeQuester(R) 2, an appetite suppressant, does not contain any caffeine,
diuretic, or sodium. SeQuester(R) 2 is an FDA approved over-the-counter drug
formulation for appetite control to aid weight reduction, containing
Phenylpropanolamine Hydrochloride. Market research indicates that there is a
substantial market for dietary supplements that are natural, drug-free
products. All of the ingredients comprising the fat sequestrant product are
included in a published Food and Drug Administration guidelines for food
additives generally recognized as safe ("GRAS"). Therefore, the Company
believes that there is a
17
<PAGE> 18
tremendous possibility to assume the lead in the fat sequestrant market, well
ahead of any other participants who may attempt to enter the market.
SeQuester(R) 3, now called ChromaQuest(TM), consists of a synergistic
combination of 5 different sources of Chromium, as well as Amino Acids, Vitamin
C and Potassium. Chromium is an essential trace mineral which is necessary for
proper carbohydrate metabolism.
Results of Operations
The Company commenced operations for the marketing and distribution of
SeQuester(R) in the first calendar months of 1994. Certain costs and necessary
expenditures were incurred that have delayed results on sales, such as sales
travel calls and re-visits to wholesalers, brokers and retailers across the
nation, as well as a national media advertising campaign. It is now clear that
the effects of these efforts have brought the SeQuester(R) products to national
attention.
For the three month period ended October 31, 1996 compared to the three month
period ended October 31, 1995:
Revenues are derived from sales of the dietary fat sequestrant
product, an appetite suppressant and a chromium based dietary supplement all
under the name SeQuester(R) and, commencing in October 1996, from
PhytoQuest(TM), a dietary supplement designed to reduce cholesterol from the
food you eat. Gross Revenues for the three months ended October 31, 1996
increased to $1,410,685 from $1,265,917 for the three months ended October 31,
1995 or an 11% increase.
Gross Revenues have been reduced for a variety of discounts to provide
Net Revenues of $953,511 for the three months ended October 31, 1996 and
$990,345 for the three months ended October 31, 1995 or a 4% decrease.
The increase in Gross Revenues resulted from commencement of the
Company's new marketing campaign and from initial sales of PhytoQuest(TM). The
decrease in Net Revenues resulted from an increase in refunds and returns.
The Company is currently rebuilding its marketing campaign. Newspaper
advertising commenced in major markets in July 1996 and was supported by radio
advertising which commenced in August 1996. Increases in Gross Revenues are
forecasted for the fourth quarter of the fiscal year.
18
<PAGE> 19
<TABLE>
<CAPTION>
Three Months Ended
------------------
October 31, 1996 October 31, 1995
---------------- ----------------
<S> <C> <C>
Gross Revenues $ 1,410,685 $ 1,265,917
----------- -----------
Discounts:
Refunds and Returns $ 309,730 $ 114,295
Introductory and Promotional 52,042 68,571
Co-op Advertising 66,168 63,492
Other 29,234 29,214
----------- -----------
Total Discounts $ 457,174 $ 275,572
----------- -----------
Net Revenues $ 953,511 $ 990,345
=========== ===========
</TABLE>
Gross Profits are comprised of Net Revenues less direct costs of
products, packaging and services. The Cost of Sales of the dietary products
for the three month period ended October 31, 1996 was $362,094 or 38% of Net
Revenues which provided a Gross Profit of $591,417 or 62% of Net Revenues. For
the three month period ended October 31, 1995 the Cost of Sales was $261,423 or
26% of Net Revenues, which provided a Gross Profit for the same three month
period of the previous year of $728,922 or 74% of Net Revenues. The decrease
in Gross Profit percent resulted primarily from continuation of fixed co-op
advertising costs and an increase in refunds and returns. In addition, the
Company recorded an allowance for obsolescence of $62,800 which was charged to
cost of goods sold during the three months ended October 31, 1996. Increases
in Gross Revenues, forecasted for the fourth quarter of the fiscal year, should
improve Gross Profit percentages.
<TABLE>
<CAPTION>
Three Months Ended
------------------
October 31, 1996 October 31, 1995
----------------- ----------------
<S> <C> <C> <C> <C>
$ % $ %
- - - -
Net Revenues 953,511 100 990,345 100
Cost of Goods Sold 362,094 38 261,423 26
------- -- ------- --
Gross Profit 591,417 62 728,922 74
======= == ======== ==
</TABLE>
Advertising expenses consist of a multi-media advertising campaign
which included newspaper, radio and other displays. Selling and marketing
expenses consist of sales commissions and salaries, coupon redemption,
warehouse, freight, supplies and travel expenses. General and administrative
expenses consist of salaries and benefits of officers and staff, accounting,
legal and other professionals, rent and occupancy costs, factoring commissions
and fees, bad debt expense, travel expenses and other administrative costs.
Advertising expense increased to $605,952 for the three months ended
October 31, 1996 from $87,192 for the same three months of 1995. The Company
placed a hold on its marketing campaign through June 1996 pending (i)
preparation of advertising materials which could be utilized pending
19
<PAGE> 20
completion of clinical trials for the SeQuester(R) 1 product (ii) the
settlement of certain advertising litigation and (iii) adequate financing. The
Company also experienced difficulties in maintaining adequate inventory levels
of the SeQuester(R) 2 and SeQuester(R) 3 products. Inventory financing became
available beginning in April 1996 and inventory buildups to adequate levels
occurred by August of 1996. Newspaper advertising commenced in major markets
in July 1996 and was supported by radio advertising which commenced in August
1996. Pending advertising litigation was settled in April 1996. The Company
is currently evaluating all of its marketing programs and anticipates
significant advertising expenses during the fourth quarter of the fiscal year.
Selling and Marketing expenses increased to $284,855 for the three
months ended October 31, 1996 from $191,958 for the same three months of 1995.
The Company experienced decreases in coupon expense and sales commissions due
to a reduction in rates for the 1996 period. The decreases were offset by
increases in salaries, consulting fees and travel expenses. Selling and
marketing expenses are expected to continue to increase during the fourth
quarter of the fiscal year.
General and Administrative expenses decreased to $357,698 for the
three months ended October 31, 1996 from $436,267 for the same three months of
1995. The Company experienced increases in legal and consulting fees offset by
decreases in salaries, travel expenses, factoring fees and interest in
connection with accounts receivable financing.
No royalty expense was incurred for the three months ended October 31,
1996 compared with $92,868 for the same three months of 1995. Royalties had
been due under the terms of a license agreement which was terminated in March
1996. No royalty expenses are anticipated for the remainder of the fiscal
year.
Interest expense decreased to $12,089 for the three months ended
October 31, 1996 from $103,342 for the same three months of 1995. Interest
expense for the 1996 period reflects a reduced rate of interest and reduced
principal balances on short term loans from stockholders.
Interest income for the three months ended October 31, 1995 was
$23,788 which resulted from interest accrued on a loan receivable from Clark
Holcomb.
In August 1996, the Company settled certain litigation regarding a
license agreement and royalties with Effective Health Inc., a wholly-owned
subsidiary of Interactive Medical Technologies Ltd., which resulted in a net
gain of $151,245.
The net loss for the three month period ended October 31, 1996 of
$517,932 was the result of increased advertising, selling and marketing
expenditures which were partially offset by a reduction in general and
administrative costs combined with a continuation of fixed co- op advertising
costs and an increase in returns. The net loss for the three month period
ended October 31, 1995 of $158,917 was incurred principally as a result of the
significant expenditures made by the Company for its initial introduction of
the SeQuester(R) products to major retail pharmacy and mass merchandiser
chains.
20
<PAGE> 21
Net (loss) per common share was ($0.04) for the three months ended
October 31, 1996 and ($0.01) for the three months ended October 31, 1995
based on the weighted average shares of common stock outstanding.
For the nine month period ended October 31, 1996 compared to the nine month
period ended October 31, 1995:
Revenues are derived from sales of the dietary fat sequestrant product, an
appetite suppressant and a chromium based dietary supplement product all under
the name SeQuester(R) and, commencing October 1996, from PhytoQuest(TM), a
dietary supplement designed to reduce cholesterol from the food you eat. Gross
revenues for the first nine months ended October 31, 1996 were $3,477,124 vs.
$6,115,019 for the nine months ended October 31, 1995, or a 43% decrease.
Gross Revenues have been reduced for a variety of discounts to provide Net
Revenues of $2,525,872 for the nine months ended October 31, 1996 and
$5,110,546 for the nine months ended October 31, 1995 or a 51% decrease.
The significant decrease in Gross Revenues resulted from a hold on the
Company's marketing campaign pending (i) preparation of advertising materials
which could be utilized pending completion of clinical trials for the
SeQuester(R) 1 product (ii) the settlement of certain advertising litigation
and (iii) adequate financing. The Company also experienced difficulties in
maintaining adequate inventory levels of the SeQuester(R) 2 and SeQuester(R) 3
products. During April 1996, the pending advertising litigation was settled
and the initial phase of financing was completed. Clinical trials for the
SeQuester(R) 1 product were extended through the third quarter of 1996.
The Company is currently rebuilding its marketing campaign. Newspaper
advertising commenced in major markets in July 1996 and was supported by radio
advertising which commenced in August 1996. Increases in Gross Revenues are
forecasted for the fourth quarter of the fiscal year. The decrease in Net
Revenues resulted from an increase in refunds and returns.
<TABLE>
<CAPTION>
Nine Months Ended
-----------------
October 31, 1996 October 31, 1995
---------------- ----------------
<S> <C> <C>
Gross Revenues $ 3,477,124 $ 6,115,019
------------ --------------
Discounts:
Refunds and Returns $ 441,509 $ 136,877
Introductory and Promotional 172,675 419,330
Co-op Advertising 268,305 331,598
Other 68,763 116,668
----------- ------------
Total Discounts $ 951,252 $ 1,004,473
----------- ------------
Net Revenues $ 2,525,872 $ 5,110,546
=========== ============
</TABLE>
21
<PAGE> 22
Gross profits are comprised of Net Revenues less direct costs of products,
packaging and services. The Cost of Sales of the dietary product for the nine
month period ended October 31, 1996 was $1,055,591 or 42% of Net Revenues which
provided a Gross Profit of $1,470,281 or 58% of Net Revenues. For the nine
month period ended October 31, 1995, the Cost of Sales was $1,239,028 or 24% of
Net Revenues, which provided a Gross Profit for the first nine month period of
the previous year of $3,871,518 or 76% of Net Revenues. The decrease in Gross
Profit percent resulted primarily from continuation of fixed co-op advertising
costs and an increase in returns. In addition, the Company recorded an
allowance for obsolescence of $62,800 which was charged to cost of goods sold
during the nine months ended October 31,1996. Increases in Gross Revenues,
forecasted for the fourth quarter of the fiscal year, should improve Gross
Profit percentages.
<TABLE>
<CAPTION>
Nine Months Ended
-----------------
October 31, 1996 October 31, 1995
---------------- ----------------
$ % $ %
- - - -
<S> <C> <C> <C> <C>
Net Revenues 2,525,872 100 5,110,546 100
Cost of Goods Sold 1,055,591 42 1,239,028 24
--------- -- --------- --
Gross Profit 1,470,281 58 3,871,518 76
========= == ========= ==
</TABLE>
Advertising expenses consist of a multi-media advertising campaign
which included newspaper and radio, signage and other displays. Selling and
marketing expenses consist of sales commissions and salaries, coupon
redemption, warehouse, freight, supplies and travel expenses. General and
administrative expenses consist of salaries and benefits of officers and staff,
accounting, legal and other professionals, rent and occupancy costs, factoring
commissions and fees, bad debt expense, travel expenses and other
administrative costs.
Advertising expense decreased significantly to $863,459 for the nine
months ended October 31, 1996 from $2,136,194 for the first nine months of
1995. The Company placed a hold on its marketing campaign through June 1996
pending (i) preparation of advertising materials which could be utilized
pending completion of clinical trials for the SeQuester(R) 1 product (ii) the
settlement of certain advertising litigation and (iii) adequate financing. The
Company also experienced difficulties in maintaining adequate inventory levels
of the SeQuester(R) 2 and SeQuester(R) 3 products. Inventory financing became
available beginning in April 1996 and inventory buildups to adequate levels
occurred by August of 1996. Newspaper advertising commenced in major markets
in July 1996 and was supported by radio advertising which commenced in August
1996. Pending advertising litigation was settled in April 1996. A significant
portion of the 1995 expense was paid by issuance of restricted shares of
Company common stock. In April 1996, the Company reached a settlement of the
advertising litigation which resulted in a gain of $845,482. The Company is
currently evaluating all of its marketing programs and anticipates significant
advertising expenses during the fourth quarter of the fiscal year.
Selling and Marketing expenses decreased significantly to $691,160 for
the nine months ended October 31, 1996 from $1,815,331 for the first nine
months of 1995. The Company experienced
22
<PAGE> 23
decreases in sales commissions due to reduced sales volumes and a reduction in
rates for the 1996 period and decreases in coupon redemption, freight and
travel expenses. The decreases were partially offset by increases in salaries,
consulting fees, marketing supplies and rent expense. Selling and marketing
expenses are expected to increase during the fourth quarter of the fiscal year.
General and Administrative expenses increased to $1,261,615 for the
nine months ended October 31, 1996 from $1,189,802 for the same nine months of
1995. The Company experienced increases in legal and accounting fees,
consulting fees, bad debt expense, salaries, rent, insurance and depreciation
offset by decreases in travel expenses, factoring fees and interest in
connection with accounts receivable financing.
No royalty expense was incurred for the nine months ended October 31,
1996 compared with $432,858 for the same nine months of 1995. Royalties had
been due under the terms of a license agreement which was terminated in March
1996. No royalty expenses are anticipated for the remainder of the fiscal
year.
Interest expense decreased to $70,001 for the nine months ended
October 31, 1996 from $267,124 for the same nine months of 1995. Interest
expense for the 1996 period reflects a reduced rate of interest and reduced
principal balances on short term loans from stockholders.
Interest income for the nine months ended October 31, 1995 was $35,257
which resulted from interest accrued on the loan receivable from Clark Holcomb.
In April 1996, the Company settled certain advertising litigation
resulting in a gain of $845,482 and settled certain litigation, resulting in a
loss of $80,000, regarding a former sales broker in order to avoid the costs
inherent in defending the action. In August 1996, the Company settled certain
litigation regarding a license agreement and royalties with Effective Health
Inc., a wholly-owned subsidiary of Interactive Medical Technologies Ltd., which
resulted in a net gain of $151,245.
In April 1996, Clark Holcomb resigned as a Director and President of
the Company and retired 3,800,000 shares of Company common stock personally
owned by him in satisfaction of the Company's outstanding loan receivable from
him in the amount of $2,223,638. As of January 31, 1996, the balance of
principal interest receivable on this loan was $2,145,964 which was expensed
for the twelve months ended January 31, 1996. An additional $70,143 was
expensed during the six months ended July 31, 1996.
The provision for income taxes is the minimum for the States of New
Jersey and California Franchise taxes. No provision was made for Federal
income tax since the Company has significant net operating loss carryforwards.
The net loss for the nine month period ended October 31, 1996 of
$570,970 was the result of gains on settlement of certain litigation matters
which were offset by a loss from operations. The net loss for the nine month
period ended October 31, 1995 of $1,936,134 was incurred principally as a
result of the significant expenditures made by the Company for its multi-media
advertising campaign
23
<PAGE> 24
and initial introduction of the SeQuester(R) products to major retail pharmacy
and mass merchandiser chains.
Net (loss) per common share was ($0.04) for the nine months ended
October 31, 1996 and ($0.12) for the nine months ended October 31, 1995 based
on the weighted average shares of common stock outstanding.
The Company believes that net losses for the period from inception
through October 31, 1996 are consistent with the initial development of the
Company, the major advertising campaign and its introduction of the
SeQuester(R) products. The Company believes that the significant expenditures
planned for the advertising campaign for the fourth quarter of the fiscal year
will result in future revenues which should enable the Company to achieve
profitable operations for the twelve months ended January 31, 1997.
Liquidity and Capital Resources
Since inception, the Company has received capital for operations and
development from private investors in the Company's securities, issuance of
private party debt, loans from stockholders and financing from factors as well
as revenues from operations. Through October 31, 1996, revenues from
operations have been insufficient to satisfy operating expenses, product
development and legal costs. The Company, therefore has been dependent on
private placement of securities and loans from private investors and
stockholders.
There are no assurances that private capital will continue to be
available or that revenues from operations will increase to meet the Company's
cash needs, particularly as these needs relate to funding manufacturing costs
and advertising campaigns and the development of new products which the Company
believes represents its most significant long-term growth opportunities.
As shown in the accompanying financial statements, the Company has
incurred net losses from inception to October 31, 1996 of $6,576,278 including
a net loss of $570,970 during the nine months ended October 31, 1996.
Management devoted considerable effort during the first three quarters
of 1996 towards (i) obtaining additional equity financing (ii) settlement of
remaining litigation matters (iii) building adequate product inventories and
(iiii) rebuilding its marketing campaign and customer/broker relationships.
Newspaper advertising commenced in major markets in July 1996 and was supported
by radio advertising commencing in August 1996.
Management anticipates growth of revenues from its SeQuester(R)
products during the remainder of the fiscal year. The Company introduced an
appetite suppressant and a chromium based dietary supplement in December, 1995
and a phytosterol based dietary supplement in October 1996. Additional new
health products are scheduled for introduction in 1997 all under the trademark
SeQuester(R).
24
<PAGE> 25
For the fiscal year ended January 31, 1994, the Company had 545,500
shares issued and outstanding. During the year ended January 31, 1995 in the
acquisition of 100% of the outstanding common stock of SeQuester, the Company
issued 14,100,000 shares of its common stock, $0.002 par value, 100,000 shares
to the stockholders of the Company and 14,000,000 shares to the stockholders of
SeQuester. The Company also issued 1,181,500 additional shares of common stock
at various prices during the year ended January 31, 1995.
During the twelve months ended January 31, 1996, the Company issued an
aggregate of 1,267,500 shares of restricted Company stock as consideration for
approximately $4,135,000 of advertising. In April 1996, the Company reached a
settlement of certain advertising litigation which resulted in return and
retirement of 640,000 of these previously issued shares.
In May 1995, the Company issued 275,000 shares of common stock to a
consultant for services and cash consideration of $55,000.
The Company retired 2,000,000 shares of common stock previously held
by an officer and stockholder of the Company as partial consideration for a
loan by the Company to that officer.
In May 1995, the Company issued 100,000 shares of restricted common
stock to IMT as consideration for past due royalties and interest in the amount
of $217,243.
In January 1996, the Company issued 225,000 shares of common stock to
a consultant, for services which were subsequently terminated.
During the twelve months ended January 31, 1996, the Company issued an
aggregate of 172,500 shares of common stock for other services.
During the twelve months ended January 31, 1996, the Company completed
private placements for an aggregate of 735,000 shares of restricted common
stock for cash consideration of $952,500.
In April 1996, the Company (i) retired 640,000 shares of common stock
in connection with settlement of certain advertising litigation (ii), retired
155,200 shares of common stock in connection with the termination of a
consulting agreement and (iii) issued 46,000 shares of common stock for other
services.
In April 1996, the Company issued 1,200,000 shares of common stock for
net proceeds of $1,665,000 in a private placement. Upon completion of this
financing, the Company issued to the placement agent 300,000 warrants to
purchase additional shares of common stock at $2.50 per share. These warrants
have a five year life and contain certain registration rights.
In connection with this financing, Clark Holcomb resigned as a
Director and President of the Company and agreed to manage the sales and
marketing programs on the following terms: (1) an annual base salary of
$100,000; (2) a sales incentive equal to 2% of net sales over the prior base
quarter; provided that, the Company has net income during the subject quarter;
and (3) an equity
25
<PAGE> 26
incentive equal to the sales incentive, and subject to the same conditions,
based on the average bid price during the subject quarter. The Company will
not increase the salaries of any of its officers or make any loan to any
officer, director or shareholder for a period of twelve months. Clark Holcomb
retired 3,800,000 shares of Company common stock personally owned by him in
satisfaction of the Company's outstanding loan receivable from him in the
amount of $2,223,638.
In May 1996, the Company issued 35,000 shares of common stock to
commission sales brokers and 40,000 shares of common stock in settlement of
litigation.
In June 1996, the Company issued 300,000 shares of common stock to a
consultant for services and cash consideration of $15,000.
In June 1996, the Company entered into a financing agreement pursuant
to which the Company agreed to issue a maximum of 1,000,000 shares of common
stock offered at a price per share equal to the lesser of (i) 50% below the
closing bid price of the Company's common stock or (ii) $2.00 per share.
During the period June 1996 through October 31, 1996, 695,027 shares were
issued for net proceeds of $1,192,022 with the balance of this financing
currently scheduled to be completed by December 31, 1996.
In August and October 1996, the Company issued (i) 150,000 shares of
common stock under the terms of an independent contractor agreement for
advertising, design and marketing services and (ii) 9,047 shares of common
stock to commission sales brokers.
From February to October 1995, the Company factored a substantial
portion of its accounts receivable to accelerate cash flow for operations. An
agreement with the factor was terminated in October 1995, and the Company
executed a promissory note for the sum of $750,000, or the aggregate unpaid
principal amount of advances up to the sum of $750,000, with interest payable
at 10% per annum on the outstanding balance, with a current shareholder. The
note plus interest is payable based upon 50% of net collections from product
sales with any remaining balance due in full on or before October 17, 1996.
The note was subject to a security agreement which covers all of the accounts
receivable, contract rights and inventory of the Company. As of October 31,
1996, the balance of principal and interest outstanding of this note has been
satisfied. In August 1996, the Company entered into a stock purchase agreement
with the same stockholder wherein the Company issued 125,000 shares of common
stock for satisfaction of $250,000 of the principal balance of the secured
promissory dated October 17, 1995 due to that stockholder. In connection with
this transaction, the Company entered into a put option agreement wherein that
stockholder has the right, upon his election, to sell to the Company a total of
125,000 shares of Company common stock at $2.00 per share at any time between
October 17, 1996 and April 17, 1997.
As of October 31, 1996, the Company's working capital position
increased from a negative $1,315,263 at January 31, 1996 to a positive
$1,162,650 at October 31, 1996. Increases in current assets include increases
in cash of $500,446, inventory of $1,389,748 and other assets of $1,953 offset
by a decrease in accounts receivable of $213,218. Changes in current
liabilities include decreases in accrued expenses of $50,035, accrued
advertising of $23,417, and commissions payable of $285. Notes payable and
loans from stockholders decreased $894,969. Royalties payable
26
<PAGE> 27
decreased $150,515 as a result of a litigation settlement. Accounts payable
increased $320,237. Current assets increased a net of $1,678,929 and current
liabilities decreased a net of $798,984 for the nine month period ended October
31, 1996, primarily as a result of private placements. Negative cash flows
from operations of $570,970 were reduced by non-cash charges for depreciation
and amortization of $373,728 and issuance of common stock for advertising and
other services of $50,595 and were increased by retirement/issuance of stock of
$479,762 in connection with settlements of litigation.
The Company currently has no firm commitments for material capital
expenditures. The Company does not anticipate that future compliance with
existing environmental and occupational safety regulations will have a
significant impact on its financial condition or future operating results.
The Company does not believe that general inflation would have a
material effect on its operations.
Included in the Notes to the Interim Financial Statements and in this
Item 2. Management's Discussion and Analysis or Plan of Operation are certain
forward-looking statements reflecting the Company's current expectations.
Although the Company believes that its expectations are based on reasonable
assumptions, there can be no assurance that the Company's financial goals or
expectations will be realized. Numerous factors (such as the availability of
capital and the effectiveness of advertising) may affect the Company's actual
results and may cause results to differ materially from those expressed in
forward-looking statements made by the Company.
27
<PAGE> 28
PART II. OTHER INFORMATION
Item 1. - Legal Proceedings:
The Company is involved in several legal actions. For a description of this
litigation and certain other pending legal matters involving the Company refer
to the Company's Form 10-QSB - Part I for the quarterly period ended October
31, 1996 which are incorporated herein by reference.
Item 2. - Changes in Securities:
(c) In August 1996, the Company issued 150,000 shares (the
"Shares") of its $.002 par value Common Stock (the "Common
Stock") to an independent contractor pursuant to an agreement
between the Company and the independent contractor to provide
certain advertising, design and marketing services at a
purchase price of par value. The Shares are subject to
repurchase by the Company at par value for a period of two (2)
years from the date of purchase. The Company relied on the
exemption from registration contained in Section 4(2) of the
Securities Act of 1933, as amended (the "1933 Act"), on the
basis that the offer and sale of the Shares did not involve
any public offering. All of the Shares issued contained the
appropriate restrictive legend.
In August and October 1996, the Company issued an aggregate of
9,047 shares of its Common Stock to two (2) of the Company's
commission sales brokers in partial satisfaction of cash sales
commissions due, at a purchase price of $2.00 per share. The
Company relied on the exemption from registration contained in
Section 4(2) of the 1933 Act on the basis that the offer and
sale of these shares did not involve any public offering. The
shares issued contained the appropriate restrictive legend.
Item 6. - Exhibits and Reports on Form 8-K:
(b) On October 31, 1996, the Company filed a report on Form 8-K
which reported under Item 5 of such form.
(27) Financial Data Schedule (included only in EDGAR filing).
28
<PAGE> 29
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
KCD HOLDINGS INCORPORATED
-------------------------
(Registrant)
Dated December 13, 1996 By: /s/ Wellington A. Ewen
------------------------------
Wellington A. Ewen
President
Pursuant to the requirements of Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ Wellington A. Ewen President, Chief Financial Officer, December 13, 1996
- -------------------------- and Director
Wellington A. Ewen
/s/ Bonnie L. Richards Vice President, Secretary, and Director December 13, 1996
- --------------------------
Bonnie L. Richards
</TABLE>
29
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE
SHEET AND STATEMENT OF OPERATIONS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH 10-QSB.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-31-1997
<PERIOD-START> FEB-01-1996
<PERIOD-END> OCT-31-1996
<CASH> 548,725
<SECURITIES> 0
<RECEIVABLES> 298,350
<ALLOWANCES> 29,835
<INVENTORY> 2,254,295
<CURRENT-ASSETS> 3,097,638
<PP&E> 214,900
<DEPRECIATION> 67,985
<TOTAL-ASSETS> 3,261,030
<CURRENT-LIABILITIES> 1,934,988
<BONDS> 0
0
0
<COMMON> 29,214
<OTHER-SE> 1,296,828
<TOTAL-LIABILITY-AND-EQUITY> 3,261,030
<SALES> 2,525,872
<TOTAL-REVENUES> 2,525,872
<CGS> 1,055,591
<TOTAL-COSTS> 1,055,591
<OTHER-EXPENSES> 1,969,650
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 70,001
<INCOME-PRETAX> (569,370)
<INCOME-TAX> 1,600
<INCOME-CONTINUING> (570,970)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (570,970)
<EPS-PRIMARY> (.04)
<EPS-DILUTED> (.04)
</TABLE>
