<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 July 31, 1998
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)
<TABLE>
<CAPTION>
<S> <C>
Nevada 95-4532103
- -------------------------------------- ----------------------
(State or other jurisdiction of (I.R.S. employer
incorporation or organization number) identification number)
31125 Via Colinas, Suite 904, Westlake Village, CA 91362
- -------------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
</TABLE>
Registrant's telephone number, including area code: (818) 707-0301
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 August 28, 1998
--------------------- ---------------
<S> <C>
$.002 par value 2,842,732
</TABLE>
Transitional Small Business Disclosure Format Yes___ No X
Number of sequentially numbered pages in the document: 28
<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>
Item 1. Financial Statements
Consolidated Balance Sheets at F-3
July 31, 1998 (unaudited) and January 31, 1998
Consolidated Statements of Operations for the three F-4
months and the six months ended July 31, 1998 (unaudited)
and 1997 (unaudited)
Consolidated Statement of Stockholders' Investment (Deficit) F-5
for the six months ended July 31, 1998 (unaudited)
Consolidated Statement of Cash Flows F-6
for the six months ended July 31, 1998 (unaudited)
and 1997 (unaudited)
Notes to Consolidated Financial Statements F-7
Item 2. Management's Discussion and Analysis of 18
Operations.
PART II. - OTHER INFORMATION
Item 1. Legal Proceedings 27
Item 2. Changes in Securities 27
Item 6. Exhibits and Reports on Form 8-K 27
Signatures 28
</TABLE>
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SEQUESTER HOLDINGS, INCORPORATED
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
JULY 31, 1998 JANUARY 31, 1998
------------- ----------------
(Unaudited)
<S> <C> <C>
CURRENT ASSETS:
Cash (including restricted cash of $32,559 as of January 31, 1998) $ 19,971 $ 75,020
Accounts receivable, net 83,950 169,862
Inventory 884,386 1,110,809
----------- -----------
Total current assets 988,307 1,355,691
----------- -----------
PROPERTY AND EQUIPMENT, net 40,193 50,370
----------- -----------
OTHER ASSETS:
Deposits 1,391 1,391
Intangibles, net 1,686 1,815
----------- -----------
Total other assets 3,077 3,206
----------- -----------
Total assets $ 1,031,577 $ 1,409,267
=========== ===========
LIABILITIES AND STOCKHOLDERS' INVESTMENT (DEFICIT)
CURRENT LIABILITIES:
Accounts payable $ 672,748 $ 626,998
Accrued expenses 275,276 385,010
Customer credit balances 272,546 207,912
Commissions payable 50,743 49,774
Loan from stockholder 24,631 -
FTC payable - 41,672
----------- -----------
Total current liabilities 1,295,944 1,311,366
----------- -----------
Commitments and contingencies (see Notes)
STOCKHOLDERS' INVESTMENT (DEFICIT):
Convertible Preferred stock, par value $1,000 per share; 5000 shares
authorized; issued and outstanding 220 shares of series A as of
July 31, 1998 and 350 shares of series A as of January 31, 1998 220,000 350,000
Common stock, par value $.002 per share; 25,000,000 shares
authorized; issued and outstanding 2,842,732 shares as of
July 31, 1998 and 22,846,109 shares as of January 31, 1998 5,685 45,692
Additional paid in capital 10,689,938 10,508,670
Accumulated deficit (10,946,680) (10,298,365)
Prepaid advertising and consulting fees (233,310) (508,096)
----------- -----------
Total stockholders' investment (deficit) (264,367) 97,901
----------- -----------
Total liabilities and stockholders' investment (deficit) $ 1,031,577 $ 1,409,267
=========== ===========
</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 SIX MONTHS ENDED JULY 31, 1998 AND 1997
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
--------------------------------- ----------------------------------
JULY 31, 1998 JULY 31, 1997 JULY 31, 1998 JULY 31, 1997
------------- --------------- ------------- -----------------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Net Revenues $36,584 $291,341 $190,464 $552,016
Cost of Goods Sold 20,331 127,353 226,564 223,782
------------- --------------- ------------- -------------
Gross (Loss) Profit 16,253 163,988 (36,100) 328,234
------------- --------------- ------------- -------------
Operating Expenses:
Advertising 72,200 - 73,594 317,828
Selling and marketing 11,262 164,088 93,293 358,053
General and administrative 232,176 263,707 443,734 613,403
------------- --------------- ------------- -------------
315,638 427,795 610,621 1,289,284
------------- --------------- ------------- -------------
Loss from Operations (299,385) (263,807) (646,721) (961,050)
------------- --------------- ------------- -------------
Non - Operating Income (Expense)
Interest expense (594) - (594) (5,142)
Interest income - 1,356 - 5,055
------------- --------------- ------------- -------------
(594) 1,356 (594) (87)
------------- --------------- ------------- -------------
Loss before Income Taxes (299,979) (262,451) (647,315) (961,137)
Provision for Income Taxes - - 1,000 1,800
------------- --------------- ------------- -------------
Net Loss ($299,979) ($262,451) ($648,315) ($962,937)
============= =============== ============= =============
Weighted average shares of
Common Stock Outstanding 2,842,732 1,765,475 2,424,902 1,646,175
============= =============== ============= =============
Basic Net Loss per Share* ($0.11) ($0.15) ($0.27) ($0.58)
============= =============== ============= =============
</TABLE>
* The basic net loss per share has been restated to retroactively effect a
reverse stock split in the ratio of one share for ten shares.
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE> 5
SEQUESTER HOLDINGS, INCORPORATED
CONSOLIDATED STATEMENT OF STOCKHOLDERS' INVESTMENT (DEFICIT)
FOR THE SIX MONTHS ENDED JULY 31, 1998
<TABLE>
<CAPTION>
Preferred Stock Common Stock
--------------------- ----------------------- Additional
Number of Number of Paid in Accumulated Equity Stockholders'
shares Par value shares Par value Capital Deficit Reductions Investment
--------- --------- ---------- ---------- ----------- ------------ ---------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance January 31, 1998 350 $350,000 22,846,109 $45,692 $10,508,670 ($10,298,365) ($508,096) $97,901
Reverse stock split (20,561,476) (41,123) 41,123 -
Conversion of preferred
stock (130) (130,000) 505,734 1,011 128,989 - - -
Conversion of debt to
common stock - - 52,365 105 11,156 - - 11,261
Amortization of prepaid
advertising and
consulting fees - - - - - - 274,786 274,786
Net loss for the six months
ended July 31, 1998 - - - - - ($648,315) - (648,315)
========= ======== ========== ========== =========== ============ ========== ============
Balance July 31, 1998 220 $220,000 2,842,732 $5,685 $10,689,938 ($10,946,680) ($233,310) ($264,367)
========= ======== ========== ========== =========== ============ ========== ============
</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 SIX MONTHS ENDED JULY 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
---------------- --------------
(Unaudited) (Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss ($648,315) ($962,937)
Adjustments to reconcile Net Loss to net cash used in operating
activities:
Depreciation and amortization 285,092 314,150
Stock issued for advertising and other expenses 11,261 -
Litigation settlements - 25,624
---------------- --------------
(351,962) (623,163)
---------------- --------------
(Increase) / decrease in current assets:
Accounts receivable, net 85,912 (216,986)
Inventory 226,423 192,574
Other current assets - 6,000
Increase / (decrease) in current liabilities:
Accounts payable 45,750 68,292
Accrued expenses (109,734) 128,063
Accrued advertising - (115,849)
Customer credit balances 64,634
Commissions payable 969 5,968
FTC payable (41,672) (20,832)
---------------- --------------
272,282 47,230
---------------- --------------
Net cash used in operating activities (79,680) (575,933)
---------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Retirement of common stock - (300)
Proceeds from sale of preferred stock - 318,750
Loans from stockholders, net 24,631 (13,400)
---------------- --------------
Net cash provided by financing activities 24,631 305,050
NET (DECREASE) IN CASH (55,049) (289,823)
CASH, BEGINNING BALANCE 75,020 409,117
---------------- --------------
CASH, ENDING BALANCE $19,971 $119,294
================ ==============
</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
JULY 31, 1998 AND JANUARY 31, 1998
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 1989 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 technically advanced health products. The Company
currently markets dietary aid products under the names SeQuester(R) 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. The Company
introduced an appetite suppressant, SeQuester(R) 2 and a chromium based dietary
supplement, SeQuester(R) 3 in addition to 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. The
preceding products are collectively known as the SeQuester(R) brand products. To
date, the Company has developed access to major domestic retail, pharmacy and
mass merchandiser chains in the United States. The Company is currently
evaluating all of its marketing and distribution programs and commenced
advertising for its mail order program in the second quarter of the current
fiscal year.
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.
F-7
<PAGE> 8
SEQUESTER HOLDINGS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 1998 AND JANUARY 31, 1998
Certain reclassifications were made to the 1997 consolidated financial statement
presentation to conform with the 1998 consolidated financial statement
presentation.
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 six months
ended July 31, 1998 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, 1998 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 $260,000 at
July 31, 1998 and $375,000 at January 31, 1998.
Significant customers accounting for 53% of revenues for the six months ended
July 31, 1998 include American Drug Stores 23%, Albertsons 10% and Bergen
Brunswig Corporation 6%. In addition, approximately 14% of revenues were mail
order sales.
The Company also had a one-time sale of $54,000 to Pan Chiao Hsin Hospital which
has been deemed to be of doubtful collection and has not been included in the
above percentages.
Significant customers accounting for 57% of revenues for the six months ended
July 31, 1997 include Walgreens 15%, Wal-Mart Stores 14%, Rite Aid Corp. 11%,
Target Stores 9%, and Eckerd Drug 8%.
(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
F-8
<PAGE> 9
SEQUESTER HOLDINGS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 1998 AND JANUARY 31, 1998
losses. The allowance for doubtful accounts was $325,000 at July 31, 1998 and
$225,000 at January 31, 1998.
(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:
<TABLE>
<CAPTION>
July 31, 1998 January 31, 1998
------------- ----------------
<S> <C> <C>
Product Units $ 1,001,103 $ 1,047,824
Packaging and Product Displays 195,277 195,277
Shipping Supplies 10,699 10,719
----------- -----------
1,207,079 1,253,820
Less Allowance for Obsolescence ( 322,693) ( 143,011)
----------- -----------
$ 884,386 $ 1,110,809
=========== ===========
</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:
<TABLE>
<S> <C>
Product Tooling 2 years
Machinery and Equipment 5-10 years
Furniture and Fixtures 5 years
Computer Equipment 5 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.
(h) Loss Per Common Share -- Loss per common share is based on the weighted
average number of common shares outstanding. Potentially dilutive securities
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. The net loss per common share has been
restated to retroactively effect a reverse stock split in the ratio of one share
for ten shares.
F-9
<PAGE> 10
SEQUESTER HOLDINGS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 1998 AND JANUARY 31, 1998
(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 accumulated deficit and has incurred
substantial losses from operations for the period from inception through July
31, 1998.
- 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) 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's revenues have declined
substantially and the Company has incurred net losses from inception to July 31,
1998 of $10,946,680 including a net loss of $648,315 for the six months ended
July 31, 1998 and net losses of $2,440,692 and $1,852,365 during the fiscal
years ended January 31, 1998 and 1997, 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.
F-10
<PAGE> 11
SEQUESTER HOLDINGS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 1998 AND JANUARY 31, 1998
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 fiscal years ended January 31, 1998 and 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, during the fiscal year
ended January 31, 1998, the Company sold additional shares of preferred stock
and exchanged debt and services for equity; however, there are no assurances
that private capital will continue to be available.
The Company has embarked on new marketing methods including general nutrition
outlets and a mail order program. In addition, the Company is actively pursuing
potential merger or acquisition candidates and strategic partners which would
enhance stockholders' investment. Management believes that the above actions
will allow the Company to continue operations through the next fiscal year.
4. REVENUES
In the normal course of business during the six month periods ended July 31,
1998 and 1997, the Company granted its customers a variety of discounts. The
discounts granted were as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Gross Revenues $247,272 $ 1,078,683
-------- -----------
Discounts:
Refunds and Returns $ 42,429 $ 459,925
Introductory and Promotional 6,360 27,826
Co-op Advertising 5,095 25,607
Other 2,924 13,309
-------- -----------
Total Discounts $ 56,808 $ 526,667
-------- -----------
Net Revenues $190,464 $ 552,016
======== ===========
</TABLE>
5. CUSTOMER CREDIT BALANCES
Customer credit balances consist of pending customer claims for co-op
advertising, refunds and returns and other discounts.
F-11
<PAGE> 12
SEQUESTER HOLDINGS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 1998 AND JANUARY 31, 1998
6. PROPERTY AND EQUIPMENT
<TABLE>
<CAPTION>
July 31, 1998 January 31, 1998
------------- ----------------
<S> <C> <C>
Product Tooling $ 43,900 $ 43,900
Machinery and Equipment 79,280 79,280
Computer Equipment 31,198 31,198
--------- ----------
154,378 154,378
Less Accumulated Depreciation ( 114,185) ( 104,008)
--------- ----------
$ 40,193 $ 50,370
========= ==========
</TABLE>
7. LOANS PAYABLE TO STOCKHOLDERS AND COLLATERALIZED PROMISSORY NOTE
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 which were issued in April 1998
(reduced to 52,365 shares to effect a reverse stock split).
In May 1998, the Company entered into a loan agreement with a stockholder for a
loan of $25,000 with interest at the rate of 9.5% per annum. Full payment of the
principal and interest on this loan is due on July 1, 1998 or that loan is
convertible to common stock at $0.01 per share. This loan is collateralized by
substantially all of the assets of the Company.
8. INCOME TAXES
No provision was made for Federal income tax since the Company has significant
net operating loss carryforwards. Through January 31, 1998, the Company incurred
net operating losses for tax purposes of approximately $8,866,000. 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 2012. Net
operating loss carryforwards for the State of California are approximately
$5,160,000 and are generally available to reduce taxable income through the year
2002. Net operating loss carryforwards for the State of New Jersey are
approximately $621,000 and are generally available to reduce taxable income
through 2004. 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
F-12
<PAGE> 13
SEQUESTER HOLDINGS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 1998 AND JANUARY 31, 1998
taxable years ended January 31, 1998, 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.
The gross deferred tax asset balance as of January 31, 1998 was approximately
$3,644,000. A 100% valuation allowance has been established against the deferred
tax assets, as the utilization of the loss carryforwards can not reasonably be
assured.
9. 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 July 31, 1998, $24,054 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 January 31, 1998. During October 1997, 500,000 previously issued options
terminated, leaving a balance of 1,000,000 options outstanding at July 31, 1998.
(d) 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
JULY 31, 1998 AND JANUARY 31, 1998
(e) Leases -- The Company leases its office and business facilities in Westlake
Village, California on a month-to-month basis. 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 $5,500 per month.
10. STOCKHOLDERS' INVESTMENT
(a) Common Stock -- 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. Such reverse
split became effective in the ratio of one share for ten shares during February
1998. The net loss per common share has been restated to retroactively effect a
reverse stock split in the ratio of one share for ten shares.
In October 1997, the Company issued an additional 180,000 shares of common stock
pursuant to a Subscription Agreement dated October 26, 1994. In February 1998,
the Company agreed to issue an additional 36,000 restricted shares of common
stock to settle certain disagreements with respect to such agreement.
The Company is also contingently liable to issue up to an additional 36,000
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 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.
In May 1996, the Company extended the date within which the outstanding warrants
of the Company could be exercised to June 30, 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
June 30, 1998 after giving effect to a reverse stock split in the ratio of one
share for ten shares in February 1998 are as follows:
<TABLE>
<CAPTION>
Warrant Class Amount Outstanding Exercise Price
------------- ------------------ --------------
<S> <C> <C>
A 39,885 $ 2.50
B 48,860 3.80
C 48,860 5.00
-------
137,605
=======
</TABLE>
F-14
<PAGE> 15
SEQUESTER HOLDINGS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 1998 AND JANUARY 31, 1998
No warrants were exercised during the six months ended July 31, 1998 or the
twelve months ended January 31, 1998. All such warrants expired on June 30,
1998.
The Company has an additional 300,000 warrants outstanding to purchase common
stock at $25.00 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. 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 12 month
conversion feature. One-third of the Series A Shares are convertible into common
stock at any time 45 days after the Closing Date; an additional one-third
(two-thirds cumulatively) are convertible into common stock at any time 60 days
after the Closing Date; and an additional one-third (the entire amount
cumulatively) are convertible into common stock at any time 75 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 lessor of (i) 70% of the "Market
Price" (the 5 day average closing bid for the common stock for the 5 business
days immediately preceding the conversion date); or (ii) 100% of the 5 day
average closing bid for the common stock for the 5 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 lessor of (i) 65% of the Market Price; or (ii) 100% of the 5
day average closing bid for the common stock for the 5 business days immediately
preceding the Closing Date.
In August 1997, the Company entered into an agreement with the convertible
preferred stockholders to (i) delay conversion of the then remaining 460
outstanding series A preferred shares through November 30, 1997 and (ii) offer
to sell to the Company the then 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.
Through July 31, 1998, an aggregate of 530 shares of outstanding preferred stock
were converted into 988,248 shares of Company common stock.
F-15
<PAGE> 16
SEQUESTER HOLDINGS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 1998 AND JANUARY 31, 1998
11. 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 required 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 the Company to maintain adequate substantiation for the future
advertising claims. The balance due to the FTC was satisfied in full as of July
31, 1998. The Company will be subject to substantial 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.
12. LITIGATION
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 Technologies, Ltd., concerning the Company's obligations under the
license agreement, which were deemed satisfied in full per the terms of the
settlement.
F-16
<PAGE> 17
SEQUESTER HOLDINGS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JULY 31, 1998 AND JANUARY 31, 1998
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. On December 2, 1997, Geotermica served a motion for
reconsideration. On February 18, 1998, the court granted the motion as to the
first cause of action for breach of contract and denied it as to the second
cause of action for interference with contract and contractual relations. In
March 1998, Geotermica amended the first cause of action for breach of contract
and misrepresentation. The Company continues to believe that the remaining
allegations contained in the amended complaint are without merit. The Company
intends to pursue a reasonable settlement in order to avoid the costs inherent
in continued litigation.
SeQuester Incorporated vs. Prudential Insurance Company of America
In January 1998, SeQuester Incorporated filed a lawsuit in Los Angeles Superior
Court against the Prudential Insurance Company of America, Pruco Securities
Corporation, and Patrick C. Welch. The lawsuit alleges various damages including
but not limited to alleged damages in the amount of $4 million for defendants'
unauthorized disclosure of confidential information concerning Clark M. Holcomb
which interfered with the economic relationships and prospective economic
advantage of SeQuester. Management of the Company believes that the lawsuit is
meritorious but is unable to determine the outcome at this time.
McKesson Corporation vs. SeQuester Incorporated, et. al.
In July 1998, McKesson Corporation filed an action against the Company in the
Superior Court of California for the County of Ventura. The Complaint alleges
causes of action for breach of contract, account stated and open book account.
The Complaint is based on the alleged failure of the Company to issue credits
for unsaleable product which has either been returned or destroyed. Plaintiff
has alleged damages in the amount of $304,404 plus interest and attorneys' fees.
The Company intends to pursue a settlement of this action.
Except as otherwise 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 July 31, 1998.
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-17
<PAGE> 18
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 1989 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 technically advanced health products. The Company
currently markets dietary aid products under the names SeQuester(R) 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. The
Company introduced an appetite suppressant (SeQuester(R) 2) and a chromium based
dietary supplement (SeQuester(R) 3) in addition to 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. To date,
the Company has developed access to major domestic retail, pharmacy and mass
merchandiser chains in the United States. The Company is currently evaluating
all of its marketing and distribution programs and commenced advertising for its
mail order program in the second quarter of the current fiscal year.
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) 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.
18
<PAGE> 19
Market leaders in the weight reduction industry include Dexatrim(TM)
and Accutrim(TM), 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
SeQuester(R) 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.
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"). SeQuester(R)
3, consists of Chromium with L-Carnitine. Chromium is an essential trace mineral
which is necessary for proper carbohydrate metabolism.
Results of Operations
For the three month period ended July 31, 1998 compared to the three month
period ended July 31, 1997:
Revenues are derived from sales of the dietary fat sequestrant product
and an appetite suppressant under the name SeQuester(R), a chromium based
dietary supplement product sold under the name SeQuester(R) 3 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
July 31, 1998 were $85,000 compared to $506,542 for the three months ended July
31, 1997, or an 83% decrease. Gross Revenues have been reduced for a variety of
discounts to provide Net Revenues of $36,584 for the three months ended July 31,
1998 and $291,341 for the three months ended July 31, 1997 or an 87% decrease.
The decrease is attributed to a decrease in sales volume and continued returns.
The significant decrease in Gross Revenues is attributed to a decrease
in sales to national drug and food chain retailers as the Company redirects its
efforts towards mail order revenues and a lack of adequate financing to continue
the Company's advertising campaign.
19
<PAGE> 20
<TABLE>
<CAPTION>
Three Months Ended
------------------
July 31, 1998 July 31, 1997
------------- -------------
$ % $ %
--- --- --- ---
<S> <C> <C> <C> <C>
Gross Revenues 85,000 100 506,542 100
------ --- ------- ---
Discounts:
Refunds and Returns 40,752 48 199,033 39
Introductory and Promotional 875 1 8,717 2
Co-op Advertising 5,095 6 2,018 --
Other 1,694 2 5,433 1
------ --- ------- ---
Total Discounts 48,416 57 215,201 42
------ --- ------- ---
Net Revenues 36,584 43 291,341 58
====== === ======= ===
</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 July 31, 1998 was $20,331 or 56% of Net Revenues
which provided a Gross Profit of $16,253 or 44% of Net Revenues. For the three
month period ended July 31, 1997, the Cost of Sales was $127,353 or 44% of Net
Revenues, which provided a Gross Profit of $163,988 or 56% of Net Revenues. The
decrease in the Gross Profit resulted from reduced sales volume and continued
returns.
<TABLE>
<CAPTION>
Three Months Ended
------------------
July 31, 1998 July 31, 1997
------------- -------------
$ % $ %
--- --- --- ---
<S> <C> <C> <C> <C>
Net Revenues 36,584 100 291,341 100
Cost of Goods Sold 20,331 56 127,353 44
-------- ---- ------- ----
Gross Profit 16,253 44 163,988 56
======== ==== ======= ====
</TABLE>
Advertising expenses consist of a multi-media advertising campaign
which included magazines, TV 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, bad debt expense,
travel expenses and other administrative costs.
Advertising expense was $72,200 for the three months ended July 31,
1998 vs. no advertising for the three months ended July 31, 1997. Advertising
expenses for the three months ended July 31, 1998 included testing of radio spot
commercials in selected markets via 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 and commenced advertising for its mail order
program in the second quarter of the current fiscal year.
20
<PAGE> 21
Selling and Marketing expenses decreased significantly to $11,262 for
the three months ended July 31, 1998 from $164,088 for the three months ended
July 31, 1997. The Company experienced decreases in sales commissions and
freight due to a reduction in sales and decreases in office expense, salaries
and consulting fees during the three months ended July 31, 1998.
General and Administrative expenses decreased to $232,176 for the three
months ended July 31, 1998 from $263,707 for the three months ended July 31,
1997. The Company experienced decreases in legal and accounting fees, salaries,
insurance, shareholder expense and office expenses, which were partially offset
by increases in bad debt expense and consulting fees during the three months
ended July 31, 1998.
Interest expense of $594 for the three months ended July 31, 1998
resulted from a short-term loan from a stockholder. There was no interest
expense for the three months ended July 31, 1997.
There was no interest income for the three months ended July 31, 1998.
Interest income of $1,356 for the three months ended July 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 net loss for the three month period ended July 31, 1998 of $299,979
was incurred principally as a result of a decrease in sales, continued returns
and an increase in the allowance for doubtful accounts. The net loss for the
three month period ended July 31, 1997 of $262,451 was the result of a decrease
in net sales and an increase in returns.
The basic net loss per common share was $0.11 for the three months
ended July 31, 1998 and $0.15 for the three months ended July 31, 1997 based on
the weighted average shares of common stock outstanding. The basic net loss per
common share has been restated to retroactively effect a reverse stock split in
the ratio of one share for ten shares.
For the six month period ended July 31, 1998 compared to the six month period
ended July 31, 1997:
Revenues are derived from sales of the dietary fat sequestrant product
and an appetite suppressant under the name SeQuester(R), a chromium based
dietary supplement product sold under the name SeQuester(R) 3 and, commencing in
October 1996, from PhytoQuest(TM), a dietary supplement designed to reduce
cholesterol from the food you eat. Gross revenues for the first six months ended
July 31, 1998 were $247,272 vs. $1,078,683 for the six months ended July 31,
1997 or a 77% decrease.
Gross Revenues have been reduced for a variety of discounts to provide
Net Revenues of $190,464 for the six months ended July 31, 1998 and $552,016 for
the six months ended July 31, 1997 or a 65% decrease. The decrease is attributed
to a decrease in sales volume and continued returns.
21
<PAGE> 22
The significant decrease in Gross Revenues is attributed to a decrease
in sales to national drug and food chain retailers as the Company redirects its
efforts towards mail order revenues and a lack of adequate financing to continue
the Company's advertising campaign.
<TABLE>
<CAPTION>
Six Months Ended
----------------
July 31, 1998 July 31, 1997
------------- -------------
% %
<S> <C> <C> <C> <C>
Gross Revenues $247,272 100 $1,078,683 100
-------- --- ---------- ---
Discounts:
Refunds and Returns $ 42,429 17 $ 459,925 43
Introductory and Promotional 6,360 3 27,826 3
Co-op Advertising 5,095 2 25,607 2
Other 2,924 1 13,309 1
-------- --- ---------- ---
Total Discounts $ 56,808 23 $ 526,667 49
-------- --- ---------- ---
Net Revenues $190,464 77 $ 552,016 51
======== === ========== ===
</TABLE>
Gross profits are comprised of Net Revenues less direct costs of
products, packaging and services. The Cost of Goods Sold of the dietary product
for the six month period ended July 31, 1998 was $226,564 or 119% of Net
Revenues which provided a Gross Loss of ($36,100) or (19%) of Net Revenues. For
the six month period ended July 31, 1997, the Cost of Goods Sold was $223,782 or
41% of Net Revenues, which provided a Gross Profit for the first six month
period of the previous year of $328,234 or 59% of Net Revenues. The decrease in
the Gross Profit resulted from an increase in the allowance for inventory
obsolescence. 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>
Six Months Ended
----------------
July 31, 1998 July 31, 1997
------------- -------------
$ % $ %
--- --- --- ---
<S> <C> <C> <C> <C>
Net Revenues 190,464 100 552,016 100
Cost of Goods Sold 226,564 119 223,782 41
------- ---- ---------- ---
Gross (Loss) Profit ( 36,100) (19) 328,234 59
======== ==== ========== ===
</TABLE>
Advertising expenses consist of a multi-media advertising campaign
which includes TV 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, bad debt expense,
travel expenses and other administrative costs.
22
<PAGE> 23
Advertising expense decreased significantly to $73,594 for the six
months ended July 31, 1998 from $317,828 for the first six months of 1997.
Advertising expenses for the six months ended July 31, 1997 included testing of
TV spot commercials in selected markets and utilization of prepaid radio barter
advertising. Advertising expenses for the six months ended July 31, 1998
included testing of radio spot commercials in selected markets via 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 and commenced
advertising for its mail order program in the second quarter of the current
fiscal year.
Selling and Marketing expenses decreased significantly to $93,293 for
the six months ended July 31, 1998 from $358,053 for the first six months of
1997. The Company experienced decreases in sales commissions, coupon expense,
marketing expense and freight due to a reduction in sales and decreases in
office expense, salaries and consulting fees, travel and entertainment expenses
during the six months ended July 31, 1998.
General and Administrative expenses decreased significantly to $443,734
for the six months ended July 31, 1998 from $613,403 for the same six months of
1997. The Company experienced decreases in legal and accounting fees, salaries,
insurance, shareholder expense and office expenses, which were partially offset
by increases in bad debt expense and consulting fees during the six months ended
July 31, 1998.
Interest expense of $594 for the six months ended July 31, 1998
resulted from a short-term loan from a stockholder. Interest expense for the six
months ended July 31, 1997 was $5,142. Interest expense for the 1997 period
reflects remaining principal balances on short term loans from stockholders
which were converted to equity as of March 31, 1997.
There was no interest income for the six months ended July 31, 1998.
Interest income of $5,055 for the six months ended July 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 six month period ended July 31, 1998 of $648,315
was incurred principally as a result of a decrease in sales, continued returns
and an increase in the allowance for doubtful accounts. The net loss for the six
month period ended July 31, 1997 of $962,937 was the result of a decrease in net
sales and an increase in returns.
The basic net loss per common share was $0.27 for the six months ended
July 31, 1998 and $0.58 for the six months ended July 31, 1997 based on the
weighted average shares of common stock outstanding. The basic net loss per
common share has been restated to retroactively effect a reverse stock split in
the ratio of one share for ten shares.
23
<PAGE> 24
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 July 31, 1998, 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 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 July 31, 1998 of $10,946,680 including net
losses of $648,315 for the six months ended July 31, 1998 and net losses of
$2,440,692 and $1,852,365 during the fiscal years ended January 31, 1998 and
1997, respectively.
Management devoted considerable effort during the six months ended July
31, 1998 and the twelve months ended January 31, 1998 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.
The Company has embarked on new marketing methods including general
nutrition outlets and a mail order program. In addition, the Company is actively
pursuing potential merger or acquisition candidates and strategic partners which
would enhance stockholders' investment. Management believes that the above
actions will allow the Company to continue operations through the current fiscal
year.
Management has reduced its administrative expenses and anticipates
additional distribution methods for its SeQuester(R) products. The Company
introduced an appetite suppressant and a chromium based dietary supplement in
December, 1995 and a phytosterol based dietary supplement in October 1996.
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
24
<PAGE> 25
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 12 month
conversion feature. One-third of the Series A Shares are convertible into common
stock at any time 45 days after the Closing Date; an additional one-third
(two-thirds cumulatively) are convertible into common stock at any time 60 days
after the Closing Date; and an additional one-third (the entire amount
cumulatively) are convertible into common stock at any time 75 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 lessor of (i) 70% of the "Market
Price" (the 5 day average closing bid for the common stock for the 5 business
days immediately preceding the conversion date); or (ii) 100% of the 5 day
average closing bid for the common stock for the 5 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 lessor of (i) 65% of the Market Price; or (ii) 100% of the 5
day average closing bid for the common stock for the 5 business days immediately
preceding the Closing Date.
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.
Through July 31, 1998, an aggregate of 530 shares of outstanding
preferred stock were converted into 988,248 shares of Company common stock.
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
25
<PAGE> 26
for an additional 523,621 shares of restricted common shares of Company stock
which were issued in April 1998 (reduced to 52,365 shares to effect a reverse
stock split).
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. Such reverse split became
effective in the ratio of one share for ten shares during February 1998.
As of July 31, 1998, the Company's working capital position decreased
to ($307,637) from $44,325 at January 31, 1998. Decreases in current assets
include decreases in cash of $55,049, inventory, net of $226,423 and accounts
receivable, net of $85,912. Changes in current liabilities include decreases in
accrued expenses, net of $109,734 and FTC payable of $41,672 offset by increases
in accounts payable of $45,750, loan payable to a stockholder of $24,631,
commissions payable of $969 and customer credit balances of $64,634. Current
assets decreased a net of $367,384 and current liabilities decreased a net of
$15,422 for the six months ended July 31, 1998. The net loss for the six months
ended July 31, 1998 of $648,315 was reduced by non-cash charges for (i)
depreciation and amortization of $285,092 and (ii) issuance of stock of $11,261
for other expenses 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.
26
<PAGE> 27
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 six months ended July 31, 1998
which are incorporated herein by reference.
Item 2. - Changes in Securities:
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 which were issued in April 1998
(reduced to 52,365 shares to effect a reverse stock split). 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 exemptions from
registration contained in Sections 4(2) and 4(6) of the 1933 Act, on the basis
that the offer and sale of the shares did not involve any public offering. All
of the foregoing shares were issued with the appropriate restrictive legend.
Item 6. - Exhibits
(a) Exhibits
Exhibit 27 - Financial Data Schedule (included only in EDGAR
filing).
27
<PAGE> 28
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 August 28, 1998 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, August 28, 1998
- ---------------------------
Steven K. Karsh and Director
/s/ Stephen R. Miller, M.D. Director August 28, 1998
- ---------------------------
Stephen R. Miller, M.D.
</TABLE>
28
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE
SHEETS AND STATEMENT OF OPERATIONS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH 10-QSB FOR THE SIX MONTHS ENDED JULY 31, 1998.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JAN-31-1999
<PERIOD-START> FEB-01-1998
<PERIOD-END> JUL-31-1998
<CASH> 19,971
<SECURITIES> 0
<RECEIVABLES> 408,950
<ALLOWANCES> 325,000
<INVENTORY> 884,386
<CURRENT-ASSETS> 988,307
<PP&E> 154,378
<DEPRECIATION> 114,185
<TOTAL-ASSETS> 1,031,577
<CURRENT-LIABILITIES> 1,295,944
<BONDS> 0
0
220,000
<COMMON> 5,685
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 1,031,577
<SALES> 190,464
<TOTAL-REVENUES> 190,464
<CGS> 226,564
<TOTAL-COSTS> 226,564
<OTHER-EXPENSES> 610,621
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 594
<INCOME-PRETAX> (647,315)
<INCOME-TAX> 1,000
<INCOME-CONTINUING> (648,315)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (648,315)
<EPS-PRIMARY> (.27)<F1>
<EPS-DILUTED> (.27)
<FN>
<F1>THE NET LOSS PER SHARE HAS BEEN RESTATED TO RETROACTIVELY EFFECT A REVERSE
STOCK SPLIT IN THE RATIO OF ONE SHARE FOR TEN SHARES.
</FN>
</TABLE>
