<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, 1997
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
SEQUESTER HOLDINGS, INCORPORATED
(Exact name of small business issuer as specified in its charter)
Nevada 95-4532103
--------------------------------------- ------------------------
(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.
Outstanding at
Class of Common Stock December 10, 1997
--------------------- -----------------
$.002 par value 20,623,226
Transitional Small Business Disclosure Format Yes No X
----- -----
Number of sequentially numbered pages in the document: 30
<PAGE> 2
FORM 10-QSB
Securities and Exchange Commission
Washington, D.C. 20549
SEQUESTER HOLDINGS, INCORPORATED
Index
<TABLE>
<CAPTION>
PART 1 - FINANCIAL INFORMATION Page
----
<S> <C> <C>
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets at F-3
October 31, 1997 (unaudited) and January 31, 1997
Consolidated Statements of Operations for the three F-4
months and the nine months ended October 31, 1997 (unaudited)
and 1996 (unaudited)
Consolidated Statement of Stockholders' Investment F-5
for the nine months ended October 31, 1997 (unaudited)
Consolidated Statement of Cash Flows F-6
for the nine months ended October 31, 1997 (unaudited)
and 1996 (unaudited)
Notes to Consolidated Financial Statements F-7
Item 2. Management's Discussion and Analysis of Operations 19
PART II. - OTHER INFORMATION
Item 1. Legal Proceedings 29
Item 2. Changes in Securities 29
Item 6. Exhibits and Reports on Form 8-K 29
Signatures 30
</TABLE>
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SEQUESTER HOLDINGS, INCORPORATED
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
OCTOBER 31, JANUARY 31,
1997 1997
------------ ------------
(Unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash (including restricted cash of $47,920 as of October 31, 1997) $ 80,814 $ 409,117
Accounts receivable, net 267,246 195,337
Accounts receivable - other, net - 5,650
Due from officers and employees - 6,117
Inventory 1,573,289 2,148,390
Other 1,173 7,173
------------ ------------
Total current assets 1,922,522 2,771,784
------------ ------------
PROPERTY AND EQUIPMENT, net 59,683 101,256
------------ ------------
OTHER ASSETS:
Deposits 5,328 4,888
Intangibles, net 1,879 2,074
------------ ------------
Total other assets 7,207 6,962
------------ ------------
Total assets $ 1,989,412 $ 2,880,002
============ ============
LIABILITIES AND STOCKHOLDERS' INVESTMENT
CURRENT LIABILITIES:
Accounts payable 1,024,708 $ 1,086,183
Accrued expenses 293,492 300,420
Accrued advertising 100,000 225,849
Commissions payable 46,165 37,544
FTC payable 72,920 125,000
Loans from stockholders 15,500 356,999
------------ ------------
Total current liabilities 1,552,785 2,131,995
------------ ------------
Commitments and contingencies (see Notes)
STOCKHOLDERS' INVESTMENT
Convertible Preferred stock, par value $1,000 per share; 5000 shares 460,000 375,000
authorized; issued and outstanding 460 series A as of October 31, 1997
and 375 series A as of January 31, 1997
Common stock, par value $.002 per share; 25,000,000 shares 39,295 29,247
authorized; issued and outstanding 19,647,411 shares as of October 31,1997
and 14,623,725 shares as of January 31, 1997
Additional paid in capital 10,424,005 9,341,004
Accumulated deficit (9,825,200) (7,857,673)
Prepaid advertising and consulting fees (661,473) (1,139,571)
------------ ------------
Total stockholders' investment 436,627 748,007
------------ ------------
Total liabilities and stockholders' investment $ 1,989,412 $ 2,880,002
============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
<PAGE> 4
SEQUESTER HOLDINGS, INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED OCTOBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
NINE MONTHS ENDED NINE MONTHS ENDED
----------------------------- -----------------------------
OCTOBER 31, OCTOBER 31, OCTOBER 31, OCTOBER 31,
1997 1996 1997 1996
------------ ------------ ------------ ------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Net Revenues $ 156,725 $ 953,511 $ 708,741 $ 2,525,872
Cost of Goods Sold 421,703 362,094 645,485 1,055,591
------------ ------------ ------------ ------------
Gross Profit (264,978) 591,417 63,256 1,470,281
------------ ------------ ------------ ------------
Operating Expenses:
Advertising - 605,952 317,828 863,459
Selling and marketing 174,541 284,855 532,594 726,160
General and administrative 323,921 395,198 937,324 1,374,115
------------ ------------ ------------ ------------
498,462 1,286,005 1,787,746 2,963,734
------------ ------------ ------------ ------------
Loss from Operations (763,440) (694,588) (1,724,490) (1,493,453)
------------ ------------ ------------ ------------
Non - Operating Income (Expense)
Interest expense - (12,089) (5,142) (70,001)
Interest income - - 5,055 -
Litigation Settlements, net (241,150) 151,245 (241,150) 916,727
Payments to Officer and Stockholder - - - (70,143)
------------ ------------ ------------ ------------
(241,150) 139,156 (241,237) 776,583
------------ ------------ ------------ ------------
Loss before Income Taxes (1,004,590) (555,432) (1,965,727) (716,870)
Provision for Income Taxes - - 1,800 1,600
------------ ------------ ------------ ------------
Net Loss $ (1,004,590) $ (555,432) $ (1,967,527) $ (718,470)
============ ============ ============ ============
Weighted average shares of
Common Stock Outstanding: 19,275,020 14,210,878 17,279,722 14,577,077
============ ============ ============ ============
Net Loss per share: $ (0.05) $ (0.04) $ (0.11) $ (0.05)
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
<PAGE> 5
SEQUESTER HOLDINGS, INCORPORATED
CONSOLIDATED STATEMENT OF STOCKHOLDERS' INVESTMENT
FOR THE NINE MONTHS ENDED OCTOBER 31, 1997
<TABLE>
<CAPTION>
Preferred Stock Common Stock Additional
----------------------- ---------------------------
Number of Number of
shares Par value shares Par value
--------- ------------ ---------- ------------
<S> <C> <C> <C> <C>
Balance January 31, 1997 375 $ 375,000 14,623,725 $ 29,247
Issuance of convertible
preferred stock in
private placement 375 375,000 - -
Conversion of preferred
stock (290) (290,000) 1,626,444 3,253
Issuance of common stock
for consulting services - - 2,000,000 4,000
Common stock retired,
consulting services - - (150,000) (300)
Issuance of common stock 0
in litigation settlement - - 20,000 40
Conversion of debt to
common stock - - 1,047,242 2,095
Issuance of common stock
for preferred stock option - - 300,000 600
Issuance of common stock
under subscription agreement
dated October 26, 1994 - - 180,000 360
Amortization of prepaid
advertising and consulting
fees - - - -
Reduction of prepaid consulting
fees - litigation settlement - - - -
Net loss for nine months
ended October 31, 1997 - - - -
Balance October 31, 1997
--- ------------ ---------- ------------
(Unaudited) 460 $ 460,000 19,647,411 $ 39,295
=== ============ ============ ============
</TABLE>
<TABLE>
<CAPTION>
Total
Additional Accumulated Equity Stockholder's
Paid In Capital Deficit Reductions Investment
--------------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
Balance January 31, 1997 $ 9,341,004 $(7,857,673) $(1,139,571) $ 748,007
Issuance of convertible
preferred stock in
private placement (56,250) - - 318,750
Conversion of preferred
stock 286,747 - - -
Issuance of common stock
for consulting services 426,000 - (430,000) -
Common stock retired,
consulting services - - - (300)
Issuance of common stock
in litigation settlement 25,584 - - 25,624
Conversion of debt to
common stock 341,505 - - 343,600
Issuance of common stock
for preferred stock option 37,275 - - 37,875
Issuance of common stock
under subscription agreement
dated October 26, 1994 22,140 - - 22,500
Amortization of prepaid
advertising and consulting
fees - - 436,948 436,948
Reduction of prepaid consulting
fees - litigation settlement - - 471,150 471,150
Net loss for nine months
ended October 31, 1997 - (1,967,527) - (1,967,527)
Balance October 31, 1997
============ ============ ============ ============
(Unaudited) $ 10,424,005 ($ 9,825,200) ($ 661,473) $ 436,627
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
<PAGE> 6
SEQUESTER HOLDINGS, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED OCTOBER 31, 1997 AND 1996
<TABLE>
<CAPTION>
1997 1996
----------- -----------
(Unaudited) (Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss ($1,967,527) ($ 718,470)
Adjustments to reconcile Net Loss to net cash used in operating
activities:
Depreciation and amortization 478,716 486,228
Reduction of prepaid consulting fees 471,150 -
Stock issued for advertising and other expenses 60,375 85,595
Litigation settlements 25,624 (479,762)
----------- -----------
(931,662) (626,409)
----------- -----------
(Increase) / decrease in current assets:
Accounts receivable, net (60,142) 213,218
Inventory 575,101 (1,389,748)
Other current assets 6,000 (1,953)
Increase / (decrease) in current liabilities:
Accounts payable (61,475) 320,237
Accrued expenses (6,928) (50,035)
Accrued advertising (125,849) (23,417)
Commissions payable 8,621 (285)
FTC payable (52,080) (150,515)
----------- -----------
283,248 (1,082,498)
----------- -----------
Net cash used in operating activities (648,414) (1,708,907)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Deposits (440) (10,400)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Retirement of common stock (300) (7,600)
Proceeds from sale of common stock - 2,872,322
Proceeds from sale of preferred stock 318,750 -
Note payable - (371,018)
Loans from stockholders, net 2,101 (273,951)
----------- -----------
Net cash provided by financing activities 320,551 2,219,753
NET INCREASE (DECREASE) IN CASH (328,303) 500,446
CASH, BEGINNING BALANCE 409,117 48,279
----------- -----------
CASH, ENDING BALANCE $ 80,814 $ 548,725
=========== ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
<PAGE> 7
SEQUESTER HOLDINGS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1997 AND JANUARY 31, 1997
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
SeQuester Holdings, Incorporated ("the Company"), formerly KCD Holdings
Incorporated, was incorporated in the state of Nevada on February 13, 1986. 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 only nominal net assets and no operational activities
from the fiscal years 1986 through 1993 and all expenses incurred were solely
related to maintaining the entity and reviewing potential business
opportunities.
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 technologically advanced health products. The
Company currently markets dietary aid products under the names SeQuester(R),
ChromaQuest(TM) and PhytoQuest(TM). These products are sold to national drug and
food chain retailers, wholesalers and mass merchandisers throughout the United
States using several of the nation's 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, which consisted of 100,000 shares to the
stockholders of the Company for cancellation of indebtedness then outstanding
and 14,000,000 shares to the stockholders of SeQuester when unrestricted shares
were trading at approximately $1.00 per share, the Company acquired 100% of the
ownership of SeQuester, as a reverse merger. The stock exchange was recorded as
a recapitalization of SeQuester using the Company's historical cost. 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 Company's activities through 1995 consisted primarily of the development and
marketing of its dietary supplement product, SeQuester(R) 1. In December 1995,
the Company introduced an appetite suppressant, SeQuester(R) 2 and a chromium
based dietary supplement, ChromaQuest(TM) in addition to SeQuester(R) 1.
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. The
preceding products are collectively known as the SeQuester(R) brand products. To
date, the Company has developed access to major domestic retail, pharmacy, food
and mass merchandiser chains in the United States.
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 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.
Certain reclassifications were made to the 1996 consolidated financial statement
presentation to conform with the 1997 consolidated financial statement
presentation.
F-7
<PAGE> 8
SEQUESTER HOLDINGS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1997 AND JANUARY 31, 1997
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, 1997 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, 1997 as filed with the Securities and
Exchange Commission. All significant intercompany balances and transactions have
been eliminated in consolidation.
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. The Company maintains a reserve for returns which management
considers adequate to cover estimated losses. In determining the reserve to be
maintained, management evaluates many factors including items which may be
resold and historical loss experience. The reserve for returns was $275,000 at
October 31, 1997 and $207,215 at January 31, 1997 which has been recorded as
accrued expenses.
Significant customers accounting for 57% of gross revenues for the nine months
ended October 31, 1997 include Wal-Mart Stores 17.3%, Walgreens 12.7%, Rite Aid
Corp. 10.3%, Eckerd Drug 8.6%, and Target Stores 8.1%.
Significant customers accounting for 56.7% of gross revenues for the nine months
ended October 31, 1996 include Wal-Mart Stores 29.1%, Kmart 16% and American
Drug Stores 11.6%.
(b) Fair Value of Financial Instruments and Credit Risk -- The carrying value of
cash, receivables and payables approximates their fair values due to the
relatively short maturity of these instruments.
(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 was $67,494 at October 31, 1997 and $47,820 at January 31, 1997 for
trade receivables and was $5,650 at October 31, 1997 for other receivables.
(d) 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:
F-8
<PAGE> 9
SEQUESTER HOLDINGS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1997 AND JANUARY 31, 1997
<TABLE>
<CAPTION>
October 31, January 31,
1997 1997
----------- -----------
<S> <C> <C>
Product Units $ 1,718,552 $ 2,030,635
Packaging and Product Displays 195,6312 212,035
Shipping Supplies 9,106 10,666
Consignment - 16,589
----------- -----------
1,923,289 2,269,925
Less: Allowance for Obsolescence (350,000) (121,535)
----------- -----------
$ 1,573,289 $ 2,148,390
=========== ===========
</TABLE>
The allowance for obsolescence is maintained at an amount management deems
adequate to cover unsaleable inventory. In determining the allowance to be
maintained, management evaluates many factors including alternate uses and a
specific review for items no longer saleable.
(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. Leasehold improvements are amortized
over their expected useful life, or the term of the lease, whichever is shorter.
Estimated useful lives are as follows:
Product Tooling 2 years
Machinery and Equipment 5-10 years
Furniture and Fixtures 5 years
Computer Equipment 5 years
(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.
(h) Loss Per Common Share -- 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 had been from a single
product, SeQuester(R) 1; however, the Company introduced two new
dietary aid products in December 1995 (SeQuester(R) 2 and
ChromaQuest(TM)) and introduced a fourth product, PhytoQuest(TM) in
October 1996.
F-9
<PAGE> 10
SEQUESTER HOLDINGS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1997 AND JANUARY 31, 1997
- The Company has a significant accumulated deficit and has incurred
substantial losses from operations for the period from inception
through October 31, 1997.
- The marketing of the Company's products is 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) Compensation Plan -- The Company accounts for stock-based employee
compensation as prescribed by APB Opinion 25, and has adopted the disclosure
provisions of FAS 123. FAS 123 requires pro forma disclosures of net income and
earnings per share as if the fair value based method of accounting for
stock-based awards had been applied. The adoption of FAS 123 disclosure
provisions has no effect on either the Company's balance sheet or its results of
operations.
3. REALIZATION OF ASSETS
The accompanying financial statements have been prepared in conformity with
generally accepted accounting principles which contemplate continuation of the
Company as a going concern. However, the Company has incurred net losses from
inception to October 31, 1997 of $9,825,200 including a loss of $1,967,527 for
the nine months ended October 31, 1997 and net losses of $1,852,365 and
$4,317,833 during the fiscal years ended January 31, 1997 and 1996,
respectively. The continuing losses have adversely affected the liquidity of the
Company. Losses are expected to continue for the immediate future. The Company
faces continuing significant business risks, including but not limited to, its
ability to maintain vendor and supplier relationships by making timely payments
when due.
In view of the matters described in the preceding paragraph, recoverability of a
major portion of the recorded asset amounts shown in the accompanying balance
sheet is dependent upon continued operations of the Company, which in turn is
dependent upon the Company's ability to raise additional capital, obtain
financing and to succeed in its future operations. The financial statements do
not include any adjustments relating to the recoverability and classification of
recorded asset amounts or amounts and classification of liabilities that might
be necessary should the Company be unable to continue as a going concern.
Management has taken the following steps to revise its operating and financial
requirements, which it believes are sufficient to provide the Company with the
ability to continue as a going concern. Management devoted considerable effort
during the nine months ended October 31, 1997 and the fiscal year ended January
31, 1997, towards (i) obtaining additional equity financing (ii) settlement of
remaining litigation matters (iii) reduction of salaries and general and
administrative expenses (iv) reduction of inventories (v) management of accounts
payable and (vi) evaluation of its distribution and marketing methods. In
addition, subsequent to January 31, 1997, the Company sold additional shares of
preferred stock and exchanged debt for equity; however, there are no assurances
that private capital will continue to be available.
F-10
<PAGE> 11
SEQUESTER HOLDINGS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1997 AND JANUARY 31, 1997
4. REVENUES
In the normal course of business during the nine month periods ended October 31,
1997 and 1996, the Company granted its customers a variety of discounts. The
discounts granted were as follows:
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Gross Revenues $1,423,358 $3,477,124
Discounts:
Refunds and Returns $ 627,092 $ 441,509
Introductory and Promotional 34,697 172,675
Co-op Advertising 35,607 268,305
Other 17,221 68,763
---------- ----------
Total Discounts $ 714,617 $ 951,252
---------- ----------
Net Revenues $ 708,741 $2,525,872
========== ==========
</TABLE>
5. ACCOUNTS RECEIVABLE
Accounts receivable are recorded net of credit balances of approximately
$187,000 as of October 31, 1997. Credit balances consist of pending customer
claims for co-op advertising, refunds and returns and other discounts.
6. PROPERTY AND EQUIPMENT
<TABLE>
<CAPTION>
October 31, January 31,
1997 1997
--------- ---------
<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 (155,217) (113,644)
--------- ---------
$ 59,683 $ 101,256
========= =========
</TABLE>
7. 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, from the
Company's cash flow from operations, with
F-11
<PAGE> 12
SEQUESTER HOLDINGS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1997 AND JANUARY 31, 1997
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
certain advertising agreements and 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 further satisfaction of the Company's
outstanding loan receivable from him which was $2,223,707 at that date. An
additional $70,143 was expensed during the nine months ended October 31, 1996.
8. LOANS PAYABLE TO STOCKHOLDERS
In March 1997, the Company entered into an agreement with certain stockholders
to convert the outstanding principal balance of their loans as of March 31,
1997, which was $343,600, to 1,047,242 restricted common shares of Company
stock. The principal balance of such loans was converted at a price 25% below
the closing bid price of the Company's common stock as of March 31, 1997
(approximately $0.328). These restricted shares were issued in May 1997 and
contain certain registration rights. In December 1997, the Company reached an
agreement with these stockholders to waive their registration rights and release
a lien on accounts receivable in exchange for an additional 523,621 shares of
restricted common shares of Company stock.
9. INCOME TAXES
No provision was made for Federal income tax since the Company has significant
net operating loss carryforwards. Through January 31, 1997, the Company incurred
net operating losses for tax purposes of approximately $6,596,000. Differences
between financial statement and tax losses consist primarily of amortization,
allowance for doubtful accounts, 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 2011. Net
operating loss carryforwards for the State of California are approximately
$2,735,000 and are generally available to reduce taxable income through the year
2001. Net operating loss carryforwards for the State of New Jersey are
approximately $1,027,000 and are generally available to reduce taxable income
through 2003. 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 three taxable years ended January
31, 1997, the Company incurred a 50% or more change in ownership. Therefore, the
availability of the Company's net operating loss carryforwards is limited. The
provision for income taxes consists of the California and New Jersey state
minimum taxes imposed on corporations.
F-12
<PAGE> 13
The gross deferred tax asset balance as of January 31, 1997 was approximately
$2,577,000. A 100% valuation reserve has been established against the deferred
tax assets, as the utilization of the loss carryforwards can not reasonably be
assured.
10. 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, 1997, $96,254
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 exclusive rights for the Company 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.
(c) Stock Compensation Plan -- In March 1997, the Company established the 1997
Stock Plan ("Plan") and reserved 3,000,000 shares of Company common stock for
issuance to key employees and consultants under the Plan with a grant limit per
participant of 1,750,000 shares. Pursuant to the Plan, the Company granted an
aggregate of 1,500,000 non-qualified stock options during the three months ended
April 30, 1997. On July 31, 1997, the Company canceled previously issued options
and granted an equal amount of options to the same key employees and consultants
at fair market value on that date which was $0.12 per share.
The exercise price for all options granted was fair market value on the date of
grant. All such options vest on the date of grant, contain registration rights,
and terminate ten years from date of grant. No options have been exercised
through October 31, 1997. During October 1997, 500,000 previously issued options
terminated.
(d) Other Agreements -- In January 1997 (amended in March 1997), the Company
entered into an agreement with Mike Ditka to render services as a performer in
television commercials endorsing Company products and to provide other marketing
services for a one-year period. In consideration for his services, Mr. Ditka
received (i) a cash payment of $75,000 in January 1997 and (ii) 1,000,000 shares
of the Company's restricted common stock in March 1997.
(e) Consulting Agreement -- In August 1997, the Company restated its Consulting
Agreement and Stock Plan with a consultant, dated February 1, 1996 to extend the
term of such agreement for a three-year period commencing August 1, 1997 and
issued 1,000,000 shares of registered Company common stock to such consultant.
F-13
<PAGE> 14
SEQUESTER HOLDINGS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1997 AND JANUARY 31, 1997
(f) Leases -- The Company leases its office and warehouse facilities in Westlake
Village, California under noncancelable operating leases, both of which expire
in December 1997. The Company also leases warehouse space on a month to month
basis in Pine Brook, New Jersey. Rent expense incurred under all of these lease
agreements is approximately $9,500 per month.
11. STOCKHOLDERS' INVESTMENT
(a) Common Stock -- In June 1996, the Company entered into a stock purchase
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 January 31, 1997, 695,027 shares were
issued for net proceeds of $1,192,022. Upon completion of this agreement, 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
agreement, 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 connection with an agreement with a consultant 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 was 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 were subject to repurchase by the Company at par value for a period
of two years from date of purchase. In April 1997, this common stock agreement
was canceled and the previously issued shares thereunder were returned to the
Company and retired.
In February 1997, the Company issued 20,000 shares of common stock and paid
$11,858 in cash in settlement of fees due to a former attorney.
In October 1997, the Company issued an additional 180,000 shares of common stock
pursuant to a Subscription Agreement dated October 26, 1994.
The Company is contingently liable to issue up to an additional 360,000 shares
of restricted common stock in connection with a settlement agreement. The
Company has claims which partially offset this obligation.
(b) Warrants -- The public warrants outstanding were issued as part of a 250,000
unit offering in August 1987. Each unit was offered at $0.75 and consisted of
one share of common stock, four "A" warrants, four "B" warrants, and four "C"
warrants.
F-14
<PAGE> 15
SEQUESTER HOLDINGS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1997 AND JANUARY 31, 1997
In May 1997, the Company extended the date within which the outstanding warrants
of the Company could be exercised to June 30, 1998 and reduced the exercise
price. Exercise of the extended warrants is subject to an effective registration
statement with the Securities and Exchange Commission. The outstanding warrants
of the Company at October 31, 1997 are as follows:
<TABLE>
<CAPTION>
Warrant Class Amount Outstanding Exercise Price
------------- ------------------ --------------
<S> <C> <C>
A 398,850 $ 0.25
B 488,600 0.38
C 488,600 0.50
---------
1,376,050
=========
</TABLE>
No warrants were exercised during the nine months ended October 31, 1997 or the
twelve months ended January 31, 1997.
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.
(c) Preferred Stock -- In January 1997, the Company authorized issuance of a
series of 5,000 shares of Convertible Preferred Stock and designated an initial
issuance of 750 shares of Series A Convertible Preferred Stock with a par value
of $1,000 per share. Upon any liquidation, dissolution or winding up of the
Company, whether voluntary or involuntary, the holders of Series A Shares shall
be entitled, before any distribution or payment is made upon any shares of
common stock or any preferred stock junior in rank to the Series A Shares, to be
paid an amount per share equal to the liquidation value (the "Liquidation
Value"). The per share Liquidation Value of the Series A Shares on any date is
equal to the sum of the following: (i) $1,000, plus (ii) an amount equal to any
accrued and unpaid dividends from the issuance date. In January 1997, the
Company sold 375 shares and in February 1997 sold an additional 375 shares to
two accredited investors receiving gross proceeds of $750,000. The Company paid
placement and finder's fees aggregating 15% of the gross proceeds in connection
with this financing.
The Series A Shares are convertible into the Company's common stock, in phases
following the date of issuance (the "Closing Date"). The Series A Shares are
entitled to a 6% cumulative dividend payable in common stock at the time of
conversion and all of the Series A Shares are subject to a mandatory twelve
month conversion feature. One-third of the Series A Shares are convertible into
common stock at any time forty-five days after the Closing Date; an additional
one-third (two-thirds cumulatively) are convertible into common stock at any
time sixty days after the Closing Date; and an additional one-third (the entire
amount cumulatively) are convertible into common stock at any time seventy-five
days after the Closing Date. The number of common shares issuable upon
conversion of the Series A Shares equals the par value of the Series A Shares
plus accrued dividends through the date of conversion divided by the lesser of
(i) 70% of the "Market Price" (the five day average closing bid for the common
stock for the five business days immediately preceding the conversion date); or
F-15
<PAGE> 16
SEQUESTER HOLDINGS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1997 AND JANUARY 31, 1997
(ii) 100% of the five day average closing bid for the common stock for the five
business days immediately preceding the Closing Date. Provided, that, for any
conversions of the Series A Shares occurring after the eighty-nineth day
following the Closing Date the conversion rate will be the lesser of (i) 65% of
the Market Price; or (ii) 100% of the five day average closing bid for the
common stock for the five business days immediately preceding the Closing Date.
During April 1997, an aggregate of 190 shares of outstanding preferred stock
were converted into 914,438 shares of Company common stock. During May 1997, an
aggregate of 100 shares of outstanding preferred stock were converted into
712,006 shares of Company common stock. During December 1997, an aggregate of
thirty shares of outstanding preferred stock were converted into 452,194 shares
of Company common stock.
In August 1997, the Company entered into an agreement with the convertible
preferred stockholders to (i) delay conversion of the remaining 460 outstanding
series A preferred shares through November 30, 1997 and (ii) offer to sell to
the Company the remaining 460 outstanding series A preferred shares at par value
at any time through November 30, 1997. As consideration for this agreement, the
Company issued an aggregate of 300,000 shares of restricted common stock to such
preferred stockholders.
(d) Financial Advisory Agreement -- In August 1997, the Company entered into a
financial advisory agreement with Nova Bancorp USA wherein the Company sought to
raise additional capital in the approximate amount of $5,000,000 through an
anticipated institutional private placement. The financial advisory agreement
was terminated in October 1997 and no assurance can be given that the Company
will be successful in obtaining additional capital on satisfactory terms or at
all.
12. FEDERAL TRADE COMMISSION
The advertising and promotion of the Company's products is subject to regulation
by the Federal Trade Commission ("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. The Company's advertising claims for its SeQuester(R)
1 product were recently the subject of inquiry by the Seattle Regional Office of
the FTC which alleged that previous claims for the SeQuester(R) 1 product were
false and/or unsubstantiated in violation of the FTCA. On December 18, 1996, the
Company's Board of Directors approved a proposed administrative consent order
which, was given final approval by the FTC on June 16, 1997, and requires the
Company to pay $150,000 to the FTC over a twelve-month period and maintain
adequate substantiation for future advertising claims. The consent order also
requires Clark M. Holcomb, a former officer and director of the Company and
Bonnie L. Richards, a former officer and director of the Company, to maintain
adequate substantiation for the future advertising claims and imposes joint and
several liability for the $150,000 payment to the FTC between the Company and
Ms. Richards. The Company has pledged and transferred to an escrow account
$125,000 in cash and has issued a security agreement which covers $25,000 of
inventory to secure the payment of the indebtedness to the FTC. The balance due
to the FTC was $72,920 at October 31, 1997. The Company, Mr. Holcomb and Ms.
Richards will be subject to substantial
F-16
<PAGE> 17
SEQUESTER HOLDINGS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1997 AND JANUARY 31, 1997
monetary penalties in the event of non-compliance with the consent order. Such
penalties, if imposed, could have a material adverse effect on the Company.
13. LITIGATION
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 December 1996, the Company approved a proposed
administrative consent order with the FTC regarding alleged unsubstantiated
advertising claims which requires the Company to pay an aggregate of $150,000 to
the FTC. As of October 31, 1997, the remaining balance due to the FTC was
$72,920. In February 1997, the Company settled certain other disputed and
doubtful claims for the sum of $24,000 to avoid further litigation costs
inherent in defending the action. In September 1997, the Company completed
settlement of certain litigation resulting from a management consulting
agreement and related matters for the aggregate cash sum of $230,000. The
balance of prepaid consulting fees of $241,150 remaining after the settlement
was recorded as a loss.
The Company is currently involved in the following legal actions. In the opinion
of the management, the Company has adequate legal defenses with respect to these
actions, as noted below:
David J. Krizman vs. KCD Incorporated, et. al.
In April 1997, David Krizman, individually and as attorney in fact, sued the
Company and the Company's former President, Clark M. Holcomb, in the United
States Bankruptcy Court for the Central District of California. The Complaint
alleges that the Company breached a written contract by failing to transfer
shares of the Company's common stock owned by Mr. Holcomb to the plaintiff. It
is the Company's position that it has no obligation or liability to plaintiff in
connection with this matter other than to facilitate the transfer of the shares
in the ordinary course of business in compliance with applicable securities laws
and orders applicable to Mr. Holcomb. The Company is currently negotiating a
settlement of this action.
Geotermica, Ltd. vs. SeQuester Holdings Incorporated, et. al.
In September 1997, Geotermica, Ltd. filed an action against the Company and its
current and former directors, as individuals, in the Superior Court of
California for the County of Los Angeles. The Complaint alleges causes of action
for breach of contract; interference with contract and contractual relations;
and misrepresentation. The Complaint is based upon a purported interest
Geotermica, Ltd. held in a license agreement by and between the Company and
Effective Health, Inc. and the Company's alleged failure to recognize
Geotermica's purported interest therein. The Company had previously settled its
action against Effective Health, Inc. and its parent company, Interactive
Medical
F-17
<PAGE> 18
SEQUESTER HOLDINGS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1997 AND JANUARY 31, 1997
Technologies, Ltd., concerning the Company's obligations under the license
agreement, which were deemed satisfied in full per the terms of the settlement.
In response to Geotermica's complaint, the Company filed a demurrer as to all
causes of action, and as to the current and former directors. The demurrer was
heard on October 30, 1997. The court issued its ruling on November 10, 1997,
sustaining the Company's demurrer as to the causes of action for breach of
contract and interference with contract and contractual relations in its
entirety without leave to amend. The court sustained the Company's demurrer as
to the cause of action for misrepresentation as to all parties except one former
director and the Company with fifteen days leave to amend. On December 2, 1997,
Geotermica served a motion for reconsideration which is scheduled to be heard on
December 18, 1997. No amended complaint was filed pursuant to the court's order.
The Company views the motion to reconsider as frivolous. Further, the Company
continues to believe that the remaining allegations contained in the complaint
are without merit and intends to vigorously defend the remaining cause of
action.
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, 1997.
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.
14. SUBSEQUENT EVENTS
In November 1997, the Company entered into an agreement with Chadwick Financial
Corporation and certain vendors to exchange inventory for a reduction in
accounts payable of $491,157 and barter credits of $235,900. In addition, in
November 1997, the Company reached an agreement with certain suppliers for the
return of inventory in exchange for a reduction in accounts payable of up to
approximately $368,000.
In December 1997, the stockholders of the Company approved amendments to the
Company's Articles of Incorporation to provide for a reverse stock split of the
Company's common stock in the ratio up to one share for ten shares as the Board
of Directors, in its discretion, may determine.
F-18
<PAGE> 19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS
General
SeQuester Holdings, Incorporated ("the Company"), formerly KCD Holdings
Incorporated, was incorporated in the state of Nevada on February 13, 1986. 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 only nominal net assets and no operational activities
from the fiscal years 1986 through 1993 and all expenses incurred were solely
related to maintaining the entity and reviewing potential business
opportunities.
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 technologically advanced health products. The
Company currently markets dietary aid products under the names SeQuester(R),
ChromaQuest(TM) and PhytoQuest(TM). These products are sold to national drug and
food chain retailers, wholesalers and mass merchandisers throughout the United
States using several of the nation's largest food brokerage firms.
In October 1994, the Company acquired 100% of the ownership of SeQuester
in a reverse merger by issuing 14,100,000 shares of its common stock, $0.002 par
value, which consisted of 100,000 shares to the stockholders of the Company for
cancellation of indebtedness then outstanding and 14,000,000 shares to the
stockholders of SeQuester when unrestricted shares were trading at approximately
$1.00 per share. The stock exchange was recorded as a recapitalization of
SeQuester using the Company's historical cost. SeQuester, which is engaged in
the business of marketing and distributing dietary aids, commenced its
operations in February 1994.
The Company's activities through 1995 consisted primarily of the
development and marketing of its dietary supplement product, SeQuester(R) 1. In
December 1995, the Company introduced an appetite suppressant (SeQuester(R) 2)
and a chromium based dietary supplement (ChromaQuest(TM)) in addition to
SeQuester(R) 1. 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. The preceding products are collectively known as the SeQuester(R)
brand products. To date, the Company has developed access to major domestic
retail, pharmacy, food and mass merchandiser chains in the United States.
The weight loss industry represents an estimated one billion dollars in
revenues. Millions of Americans begin diets every year and buy diet supplements.
The primary target for the Company's SeQuester(R) brand products 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 fat. They
understand that reduced caloric intake is part of any effective weight loss plan
and they are inclined to use the product as directed.
F-19
<PAGE> 20
Market leaders in the weight reduction industry include Dexatrim(TM) and
Accutrim(TM), along with several additional smaller product marketers.
Market research indicates that there is a substantial market for dietary
supplements that are natural, drug-free products. SeQuester(R) 1 and
ChromaQuest(TM) 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.
PhytoQuest(TM) contains plant sterols. All of the ingredients comprising the
SeQuester(R) 1 product are included in published Food and Drug Administration
guidelines for ingredients generally recognized as safe ("GRAS").
ChromaQuest(TM), consists of a synergistic combination of five 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
its SeQuester(R) products in the first calendar months of 1994. Certain costs
and necessary expenditures have been incurred that have delayed results on
sales, such as sales travel calls and visits to wholesalers, brokers and
retailers across the nation, as well as a national media advertising campaign.
The results of these efforts have brought the Company's SeQuester(R) products to
national attention.
For the three month period ended October 31, 1997 compared to the three month
period ended October 31, 1996:
Revenues are derived from sales of the dietary fat sequestrant product,
an appetite suppressant, a chromium based dietary supplement and a phytosterol
based dietary supplement all under the name SeQuester(R). Gross Revenues for the
three months ended October 31, 1997 decreased to $344,675 from $1,410,685 for
the three months ended October 31, 1996 or a 76% decrease. Gross Revenues have
been reduced for a variety of discounts to provide Net Revenues of $156,725 for
the three months ended October 31, 1997 and $953,511 for the three months ended
October 31, 1996 or an 84% decrease. The decrease is attributed to a decrease in
sales and an increase in the percentage of returns. The decrease in sales is due
to a lack of adequate financing to continue the Company's advertising campaign.
The increase in the refunds and returns resulted primarily from (i) return of
dated products which had remained unsold by retailers and which could not be
resold, (ii) disposal by retailers of unsaleable products and (iii) a reserve
recorded for estimated sales returns.
F-20
<PAGE> 21
<TABLE>
<CAPTION>
Three Months Ended
------------------
October 31, 1997 October 31, 1996
---------------------- ----------------------
$ % $ %
------- --- ------- ---
<S> <C> <C> <C> <C>
Gross Revenues 344,675 100 1,410,685 100
Discounts:
Refunds and Returns 167,167 49 309,730 22
Introductory and Promotional 6,871 2 52,042 3
Co-op Advertising 10,000 3 66,168 5
Other 3,912 1 29,234 2
------- --- ------- ---
Total Discounts 187,950 55 457,174 32
------- --- ------- ---
Net Revenues 156,725 45 953,511 68
======= === ======= ===
</TABLE>
Gross Profits are comprised of Net Revenues less direct costs of
products, packaging and services. The Cost of Goods Sold of the dietary products
for the three month period ended October 31, 1997 was $421,703 or 269% of Net
Revenues which provided a Gross Profit of ($264,978) or (169%) of Net Revenues.
For the three month period ended October 31, 1996, the Cost of Goods Sold was
$362,094 or 38% of Net Revenues, which provided a Gross Profit for the first
three month period of the previous year of $591,417 or 62% of Net Revenues. The
decrease in Gross Profit percent resulted from an increase in returns and an
increase in the allowance for obsolescence. The increase in refunds and returns
resulted primarily from (i) return of dated products which had remained unsold
by retailers and which could not be resold and (ii) disposal by retailers of
unsaleable products. In addition, the Company recorded an additional allowance
for obsolescence of $289,732 which was charged to cost of goods sold during the
three months ended October 31, 1997. The allowance for obsolescence is
maintained at an amount management deems adequate to cover unsaleable inventory.
In determining the allowance to be maintained, management evaluates many factors
including alternate uses and a specific review for items no longer saleable.
<TABLE>
<CAPTION>
Three Months Ended
------------------
October 31, 1997 October 31, 1996
---------------------- ----------------------
$ % $ %
------- --- ------- ---
<S> <C> <C> <C> <C>
Net Revenues 156,725 100 953,511 100
Cost of Goods Sold 421,703 269 362,094 38
-------- --- ------- ---
Gross Profit (264,978) (169) 591,417 62
======== ==== ======== ===
</TABLE>
Advertising expenses consist of a multi-media advertising campaign which
includes TV and radio, print, 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
F-21
<PAGE> 22
other professionals, rent and occupancy costs, bad debt expense, travel expenses
and other administrative costs.
There was no advertising expense for the three months ended October 31,
1997 compared with $605,952 for the same three months of 1996 due to lack of
adequate financing to continue the Company's advertising campaign. The Company
is currently evaluating all of its marketing and distribution programs.
Selling and Marketing expenses decreased to $174,541 for the three
months ended October 31, 1997 from $284,855 for the same three months of 1996.
The Company experienced decreases in sales commissions and freight due to a
reduction in sales and decreases in design, warehouse expense, payroll and
travel expenses for the 1997 period which were partially offset by increases in
consulting expenses.
General and Administrative expenses decreased to $323,921 for the three
months ended October 31, 1997 from $395,198 for the same three months of 1996.
The Company experienced decreases in legal and accounting fees, salaries and
office expenses, which were partially offset by increases in bad debt expense,
shareholder expense and consulting fees.
There was no interest expense for the three months ended October 31,
1997 compared to $12,089 for the same three months of 1996. Interest expense for
the 1997 period reflects no principal balances on short term loans from
stockholders which were converted to equity as of March 31, 1997.
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 December 1996, the Company approved a
proposed administrative consent order with the FTC regarding alleged
unsubstantiated advertising claims which requires the Company to pay an
aggregate of $150,000 to the FTC. In February 1997, the Company settled certain
other disputed and doubtful claims for the sum of $24,000 to avoid further
litigation costs inherent in defending the action. In September 1997, the
Company completed settlement of certain litigation resulting from a management
consulting agreement and related matters for the aggregate cash sum of $230,000.
The balance of prepaid consulting fees of $241,150 remaining after the
settlement was recorded as a loss.
The net loss for the three month period ended October 31, 1997 of
$1,004,590 was incurred principally as a result of (i) a decrease in sales and
an increase in returns, (ii) an increase in the allowance for inventory
obsolescence and (iii) the write-off of the balance of prepaid consulting fees
subsequent to a litigation settlement. The net loss for the three month period
ended October 31, 1996 of $555,432 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.
F-22
<PAGE> 23
Net loss per common share was $0.05 for the three months ended October
31, 1997 and $0.04 for the three months ended October 31, 1996 based on the
weighted average shares of common stock outstanding.
For the nine month period ended October 31, 1997 compared to the nine month
period ended October 31, 1996:
Revenues are derived from sales of the dietary fat sequestrant product,
an appetite suppressant, a chromium based dietary supplement product and a
phytosterol-based dietary supplement all under the name SeQuester(R). Gross
revenues for the first nine months ended October 31, 1997 were $1,423,358 vs.
$3,477,124 for the nine months ended October 31, 1996 or a 59% decrease. Gross
Revenues have been reduced for a variety of discounts to provide Net Revenues of
$708,741 for the nine months ended October 31, 1997 and $2,525,872 for the nine
months ended October 31, 1996 or a 72% decrease. The decrease is attributed to a
decrease in sales and an increase in returns. The decrease in sales is due to a
lack of adequate financing to continue the Company's advertising campaign. The
increase in refunds and returns resulted primarily from (i) return of dated
products which had remained unsold by retailers and which could not be resold,
(ii) disposal by retailers of unsaleable products and (iii) a reserve recorded
for estimated sales returns.
<TABLE>
<CAPTION>
Nine Months Ended
-----------------
October 31, 1997 October 31, 1996
-------------------------- --------------------------
$ % $ %
---------- --- ---------- ---
<S> <C> <C> <C> <C>
Gross Revenues $1,423,358 100 $3,477,124 100
---------- --- ---------- ---
Discounts:
Refunds and Returns $ 627,092 44 $ 441,509 12
Introductory and Promotional 34,697 2 172,675 5
Co-op Advertising 35,607 3 268,305 8
Other 17,221 1 68,763 2
---------- --- ---------- ---
Total Discounts $ 714,617 50 $ 951,252 27
---------- --- ---------- ---
Net Revenues $ 708,741 50 $2,525,872 73
========== == ========== ==
</TABLE>
Gross profits are comprised of Net Revenues less direct costs of
products, packaging and services. The Cost of Goods Sold of the dietary products
for the nine month period ended October 31, 1997 was $645,485 or 91% of Net
Revenues which provided a Gross Profit of $63,256 or 9% of Net Revenues. For the
nine month period ended October 31, 1996, the Cost of Goods Sold was $1,055,591
or 42% of Net Revenues, which provided a Gross Profit for the first nine month
period of the previous year of $1,470,281 or 58% of Net Revenues. The decrease
in Gross Profit percent resulted from an increase in returns and an increase in
the allowance for obsolescence. The increase in refunds and returns resulted
primarily from (i) return of dated products which had remained unsold by
retailers and which could not be resold and (ii) disposal by retailers of
unsaleable products. In addition, the Company recorded an additional allowance
for obsolescence of $228,465 which was
F-23
<PAGE> 24
charged to cost of goods sold during the nine months ended October 31, 1997. The
allowance for obsolescence is maintained at an amount management deems adequate
to cover unsaleable inventory. In determining the allowance to be maintained,
management evaluates many factors including alternate uses and a specific review
for items no longer saleable.
<TABLE>
<CAPTION>
Nine Months Ended
-----------------
October 31, 1997 October 31, 1996
---------------------- ----------------------
$ % $ %
------- --- ------- ---
<S> <C> <C> <C> <C>
Net Revenues 708,741 100 2,525,872 100
Cost of Goods Sold 645,485 91 1,055,591 42
--------- --- --------- ---
Gross Profit 63,256 9 1,470,281 58
========= === ========= ===
</TABLE>
Advertising expenses consist of a multi-media advertising campaign which
includes TV and radio, print, 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, bad debt expense,
travel expenses and other administrative costs.
Advertising expense decreased to $317,828 for the nine months ended
October 31, 1997 from $863,459 for the first nine months of 1996. Advertising
expenses for the first nine months ended October 31, 1997 included testing of TV
spot commercials in selected markets and utilization of prepaid radio barter
advertising. Lack of adequate financing curtailed continuance of the TV
scheduling during this period. The Company is currently evaluating all of its
marketing and distribution programs.
Selling and Marketing expenses decreased to $532,594 for the nine months
ended October 31, 1997 from $726,160 for the first nine months of 1996. The
Company experienced decreases in sales commissions and freight due to a
reduction in sales and decreases in design, salaries and travel expenses for the
1997 period. The decreases were partially offset by increases in coupon expense
and consulting fees. Selling and Marketing expenses are expected to continue to
decrease during the remainder of 1997.
General and Administrative expenses decreased to $937,324 for the nine
months ended October 31, 1997 from $1,374,115 for the same nine months of 1996.
The Company experienced decreases in legal fees, salaries, bad debt expense,
travel and office expenses, which were partially offset by increases in
shareholder expense and consulting fees. General and Administrative expenses are
expected to continue to decrease during the remainder of 1997.
Interest expense decreased to $5,142 for the nine months ended October
31, 1997 from $70,001 for the same nine months of 1996. Interest expense for the
1997 period reflects reduced
F-24
<PAGE> 25
principal balances on short term loans from stockholders which were converted to
equity as of March 31, 1997.
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 December 1996, the Company approved a
proposed administrative consent order with the FTC regarding alleged
unsubstantiated advertising claims which requires the Company to pay an
aggregate of $150,000 to the FTC. In February 1997, the Company settled certain
other disputed and doubtful claims for the sum of $24,000 to avoid further
litigation costs inherent in defending the action. In September 1997, the
Company completed settlement of certain litigation resulting from a management
consulting agreement and related matters for the aggregate cash sum of $230,000.
The balance of prepaid consulting fees of $241,150 remaining after the
settlement was recorded as a loss.
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 $2,223,707. 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 nine
months ended October 31, 1996.
Interest income of $5,055 for the nine months ended October 31, 1997 is
the result of interest earned on a certificate of deposit of $100,000 which the
Company had pledged as collateral and subsequently cashed and transferred to an
escrow account in accordance with the terms of a consent order with the Federal
Trade Commission.
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 net operating loss carryforwards.
The net loss for the nine month period ended October 31, 1997 of
$1,967,527 was incurred principally as a result of (i) a decrease in sales and
an increase in returns, (ii) an increase in the allowance for inventory
obsolescence and (iii) the write-off of the balance of prepaid consulting fees
subsequent to a litigation settlement. The net loss for the nine month period
ended October 31, 1996 of $718,470 was the result of a gain on settlement of
certain advertising litigation which was offset by a loss from operations.
Net loss per common share was $0.11 for the nine months ended October
31, 1997 and $0.05 for the nine months ended October 31, 1996 based on the
weighted average shares of common stock outstanding.
F-25
<PAGE> 26
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, 1997, revenues from operations
have been insufficient to satisfy operating expenses, product development and
legal costs. The Company, therefore has been dependent on the private placement
of securities and loans from private investors and stockholders.
The Company faces continuing significant business risks, including but
not limited to, its ability to maintain vendor and supplier relationships by
making timely payments when due. The accompanying financial statements have been
prepared assuming that the Company will continue as a going concern. The
financial statements do not include any adjustments relating to the
recoverability and classification of asset carrying amounts or the amount and
classification of liabilities that might result should the Company be unable to
continue as a going concern.
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 and distribution
methods 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, 1997 of $9,825,200 including a
net loss of $1,967,527 for the nine months ended October 31, 1997 and net losses
of $1,852,365 and $4,317,833 during the fiscal years ended January 31, 1997 and
1996, respectively.
Management devoted considerable effort during the nine months ended
October 31, 1997 and the fiscal year ended January 31, 1997 towards (i)
obtaining additional equity financing (ii) settlement of remaining litigation
matters (iii) reduction of salaries and general and administrative expenses (iv)
reduction of inventories (v) management of accounts payable and (vi) evaluation
of its distribution and marketing methods.
In November 1997, the Company entered into an agreement with Chadwick
Financial Corporation and certain vendors to exchange inventory for a reduction
in accounts payable of $491,157 and barter credits of $235,900. In addition, in
November 1997, the Company reached an agreement with certain suppliers for the
return of inventory in exchange for a reduction in accounts payable of up to
approximately $368,000.
Management has reduced its administrative expenses and anticipates
additional distribution methods for its SeQuester(R) products during the
remainder of 1997. The Company introduced an appetite suppressant and a chromium
based dietary supplement in December, 1995 and a phytosterol based dietary
supplement in October 1996.
F-26
<PAGE> 27
In January 1997, the Company authorized issuance of a series of 5,000
shares of Convertible Preferred Stock and designated an initial issuance of 750
shares of Series A Convertible Preferred Stock with a par value of $1,000 per
share. Upon any liquidation, dissolution or winding up of the Company, whether
voluntary or involuntary, the holders of Series A Shares shall be entitled,
before any distribution or payment is made upon any shares of common stock or
any preferred stock junior in rank to the Series A Shares, to be paid an amount
per share equal to the liquidation value (the "Liquidation Value"). The per
share Liquidation Value of the Series A Shares on any date is equal to the sum
of the following: (i) $1,000, plus (ii) an amount equal to any accrued and
unpaid dividends from the issuance date. In January 1997, the Company sold 375
shares and in February 1997 sold an additional 375 shares to two accredited
investors receiving gross proceeds of $750,000. The Company paid placement and
finder's fees aggregating 15% of the gross proceeds in connection with this
financing.
The Series A Shares are convertible into the Company's common stock, in
phases following the date of issuance (the "Closing Date"). The Series A Shares
are entitled to a 6% cumulative dividend payable in common stock at the time of
conversion and all of the Series A Shares are subject to a mandatory twelve
month conversion feature. One-third of the Series A Shares are convertible into
common stock at any time forty-five days after the Closing Date; an additional
one-third (two-thirds cumulatively) are convertible into common stock at any
time sixty days after the Closing Date; and an additional one-third (the entire
amount cumulatively) are convertible into common stock at any time seventy-five
days after the Closing Date. The number of common shares issuable upon
conversion of the Series A Shares equals the par value of the Series A Shares
plus accrued dividends through the date of conversion divided by the lesser of
(i) 70% of the "Market Price" (the five day average closing bid for the common
stock for the five business days immediately preceding the conversion date); or
(ii) 100% of the five day average closing bid for the common stock for the five
business days immediately preceding the Closing Date. Provided, that, for any
conversions of the Series A Shares occurring after the 89th day following the
Closing Date the conversion rate will be the lesser of (i) 65% of the Market
Price; or (ii) 100% of the five day average closing bid for the common stock for
the five business days immediately preceding the Closing Date.
During April 1997, an aggregate of 190 shares of outstanding preferred
stock were converted into 914,438 shares of Company common stock. During May
1997, an aggregate of 100 shares of outstanding preferred stock were converted
into 712,006 shares of Company common stock. During December 1997, an aggregate
of thirty shares of outstanding preferred stock were converted into 452,194
shares of Company common stock.
In August 1997, the Company entered into an agreement with the
convertible preferred stockholders to (i) delay conversion of the remaining 460
outstanding series A preferred shares through November 30, 1997 and (ii) offer
to sell to the Company the remaining 460 outstanding series A preferred shares
at par value at any time through November 30, 1997. As consideration for this
agreement, the Company issued an aggregate of 300,000 shares of restricted
common stock to such preferred stockholders.
In March 1997, the Company entered into an agreement with certain
stockholders to convert the outstanding principal balance of their loans as of
March 31, 1997, which was $343,600, to
F-27
<PAGE> 28
1,047,242 restricted common shares of Company stock. The principal balance of
such loans was converted at a price 25% below the closing bid price of the
Company's common stock as of March 31, 1997 (approximately $0.328). These
restricted shares were issued in May 1997 and contain certain registration
rights. In December 1997, the Company reached an agreement with these
stockholders to waive their registration rights and release a lien on accounts
receivable in exchange for an additional 523,621 shares of restricted common
shares of Company stock.
In August 1997, the Company restated its Consulting Agreement and Stock
Plan with a consultant, dated February 1, 1996 to extend the term of such
agreement for a three-year period commencing August 1, 1997 and issued 1,000,000
shares of registered Company common stock to such consultant.
In December 1997, the stockholders of the Company approved amendments to
the Company's Articles of Incorporation to provide for a reverse stock split of
the Company's common stock in the ratio up to one share for ten shares as the
Board of Directors, in its discretion, may determine.
As of October 31, 1997, the Company's working capital position decreased
to $369,737 from $639,789 at January 31, 1997. Increases in current assets
include increases in accounts receivable of $60,142 offset by decreases in cash
of $328,303, inventory of $575,101 and other assets of $6,000. Changes in
current liabilities include decreases in accounts payable of $61,475, accrued
expenses of $6,928, FTC payable of $52,080 and accrued advertising of $125,849
offset by an increase in commissions payable of $8,621. Notes payable and loans
from stockholders decreased $341,499. Current assets decreased a net of $849,262
and current liabilities decreased a net of $579,210 for the nine months ended
October 31, 1997. The net loss for the nine months ended October 31, 1997 of
$1,967,527 was reduced by non-cash charges for (i) depreciation and amortization
of $478,716, (ii) issuance of stock of $25,624 in connection with settlement of
litigation, (iii) issuance of stock of $60,375 for other expenses and (iv)
reduction of prepaid consulting fees of $471,150 subsequent to a litigation
settlement, to reconcile to net cash used in operating activities.
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 this Item 2. "Management's Discussion and Analysis of
Operations" 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, the effectiveness of advertising and revised
distribution and marketing methods) 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.
F-28
<PAGE> 29
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 nine months ended October 31, 1997
which are incorporated herein by reference.
Item 2. - Changes in Securities:
In August 1997, the Company entered into an agreement with the convertible
preferred stockholders to (i) delay conversion of the remaining 460 outstanding
series A preferred shares through November 30, 1997 and (ii) offer to sell to
the Company the remaining 460 outstanding series A preferred shares at par value
at any time through November 30, 1997. As consideration for this agreement, the
Company issued an aggregate of 300,000 shares of restricted common stock to such
preferred stockholders. The stockholders to whom the shares were issued are
"accredited investors" as defined in Regulation D promulgated under the 1933
Act. The Company relied upon the exemption from registration contained in
Section 5 of the 1933 Act. All of the foregoing shares were issued with the
appropriate restrictive legend.
In October 1997, the Company issued 180,000 shares of common stock to a
stockholder pursuant to a Subscription Agreement dated October 26, 1994. The
Company relied upon the exemptions from registration contained in Sections 4(1)
and 5 of the 1933 Act and Rule 144.
Item 6. - Exhibits and Reports on Form 8-K:
(b) On October 28, 1997, the Company filed a report on Form 8-K, which
reported under Items 6 and 7 of such form.
On October 31, 1997, the Company filed a report on Form 8-K, which
reported under Items 6 and 7 of such form.
(27) Financial Data Schedule (included only in EDGAR filing).
F-29
<PAGE> 30
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.
SEQUESTER HOLDINGS, INCORPORATED
(Registrant)
Dated December 10, 1997 By: /s/ Steven K. Karsh
---------------------------------
Steven K. Karsh
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/ Steven K. Karsh President, Principal Accounting Officer, December 10, 1997
- ---------------------------- and Director
Steven K. Karsh
/s/ Stephen R. Miller, M.D. Director December 10, 1997
- ----------------------------
Stephen R. Miller, M.D.
</TABLE>
F-30
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE
SHEETS AND STATEMENTS OF OPERATIONS AND IS QUALIFIED IN ITS ENTIRETY TO SUCH
10-QSB FOR THE NINE MONTHS ENDED OCTOBER 31, 1997.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-31-1997
<PERIOD-START> FEB-01-1997
<PERIOD-END> OCT-31-1997
<CASH> 80,814
<SECURITIES> 0
<RECEIVABLES> 340,390
<ALLOWANCES> 73,144
<INVENTORY> 1,573,289
<CURRENT-ASSETS> 1,922,522
<PP&E> 214,900
<DEPRECIATION> 155,217
<TOTAL-ASSETS> 1,989,412
<CURRENT-LIABILITIES> 1,552,785
<BONDS> 0
0
460,000
<COMMON> 39,295
<OTHER-SE> (62,668)
<TOTAL-LIABILITY-AND-EQUITY> 1,989,412
<SALES> 708,741
<TOTAL-REVENUES> 708,741
<CGS> 645,485
<TOTAL-COSTS> 645,485
<OTHER-EXPENSES> 2,023,841
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 5,142
<INCOME-PRETAX> (1,965,727)
<INCOME-TAX> 1,800
<INCOME-CONTINUING> (1,967,527)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,967,527)
<EPS-PRIMARY> (0.11)
<EPS-DILUTED> (0.11)
</TABLE>
