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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

x     Quarterly Report Pursuant to Section 13 or 15(d) Securities
Exchange Act of 1934 for Quarterly Period Ended September 30, 2011

-OR-

¨     Transition Report Pursuant to Section 13 or 15(d) of the
Securities And Exchange Act of 1934 for the transaction period from
_________ to________

Commission File Number:  333-162469

LTS Nutraceuticals, Inc.
(Exact name of registrant as specified in its charter)

Nevada
27-0374885
(State or other jurisdiction
(I.R.S. Employer
of incorporation or organization
Identification Number)

450 East Las Olas Blvd.
Suite 830
Ft. Lauderdale, Florida 33301
(Address of principal executive offices) (zip code)

(954) 462-8895
(Registrant's telephone number, including area code)

Indicate by check mark whether the issuer (1) 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¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the   preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x No¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerate filer, or a small reporting company as defined by Rule 12b-2 of the Exchange Act):

Large accelerated filer ¨
Non-accelerated filer ¨
Accelerated filer ¨
Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨      Nox

The number of outstanding shares of the registrant's common stock, as of November 14, 2011:  42,100,000

 
 

 

LTS Nutraceuticals, Inc.
FORM 10-Q
September 30, 2011

INDEX

   
Page
     
PART I - FINANCIAL INFORMATION
3
Item 1.
Financial Statements
3
 
Condensed Consolidated Balance Sheets as of September 30, 2011 (unaudited) and December 31, 2010
3
 
Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2011 and 2010 (unaudited)
4
 
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and 2010 (unaudited)
5
 
Notes to Unaudited Condensed Consolidated Financial Statements
6
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
21
Item 4.
Controls and Procedures
28
     
PART II - OTHER INFORMATION
29
Item 1.
Legal Proceedings
29
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
29
Item 6.
Exhibits
30
     
SIGNATURES
30
 
2

 

PART I
Item I - FINANCIAL STATEMENTS
 
LTS Nutraceuticals, Inc.
Condensed Consolidated Balance Sheets

   
As of September
30, 2011
(unaudited)
   
As of
December 31,
2010
 
Assets
           
Current Assets:
           
Cash and cash equivalents
  $ 387,002     $ 53,855  
Restricted cash
    873,747        
Accounts receivable
    720,377       8,312  
Inventories
    229,277       67,168  
Prepaid expenses and other current assets
    383,084       136,589  
Deferred loan costs
    33,346       64,476  
Total Current Assets
    2,626,833       330,400  
                 
Property and equipment – net
    73,142       13,982  
Intangible asset – net
    784,444        
Total Assets
  $ 3,484,419     $ 344,382  
                 
Liabilities and Stockholders’ Deficiency
               
Current Liabilities:
               
Accounts payable
  $ 457,133     $ 303,134  
Accrued expenses
    548,944       205,612  
Accrued interest
    273,808       52,374  
Accrued rebate liability
    672,265        
Deferred revenue
    35,039       3,544  
Derivative liabilities
    286,136        
Current portion of convertible debentures
    70,000        
Total Current Liabilities
    2,343,325       564,664  
                 
Convertible debentures
    200,000       270,000  
Accrued licensing fee
    800,000       -  
Convertible notes payable, net of debt discount of $0 and $159,569, respectively
    4,690,376       1,047,129  
Total Liabilities
    8,033,701       1,881,793  
Stockholders' Deficiency:
               
Preferred Stock, $0.00001 par value, 20,000,000 shares authorized:
               
Convertible Series C preferred stock, ($0.001 par value, 157,835 shares authorized,  0 and 157,835 issued and outstanding, respectively)
          158  
Common stock, ($0.00001 par value, 250,000,000 shares authorized, 42,100,000 and 24,159,200 shares issued and outstanding, respectively)
    421       242  
Additional paid in capital
    276,639       329,066  
Accumulated deficit
    (4,826,342 )     (1,866,877 )
Total Stockholders' Deficiency
    (4,549,282 )     (1,537,411 )
Total Liabilities and Stockholders' Deficiency
  $ 3,484,419     $ 344,382  

The accompanying notes are an integral part of these condensed consolidated financial statements.

 
3

 

LTS Nutraceuticals, Inc.
Condensed Consolidated Statements of Operations
(unaudited)
 
   
For the Three
Months Ended September 30,
   
For the Nine
Months Ended September 30,
 
   
2011
   
2010
   
2011
   
2010
 
Gross sales
  $ 1,642,651     $ 249,761     $ 2,586,515     $ 997,657  
Reserve for rebates and promotional allowances
    446,051             828,125        
Net Sales
    1,196,600       249,761       1,758,390       997,657  
Cost of sales
    718,005       76,673       1,090,273       525,079  
Gross Profit
    478,595       173,088       668,117       472,578  
Operating expenses:
                               
Entrepreneur incentives
    274,398       35,854       578,553       305,192  
Selling, general and administrative expenses
    908,504       217,085       2,232,356       530,823  
Total operating expenses
    1,182,902       252,939       2,810,909       836,015  
Loss from Operations
    (704,307 )     (79,851 )     (2,142,792 )     (363,437 )
                                 
Other Expense:
                               
Change in fair value of derivative liability
    (281,230 )           (286,136 )      
Interest expense
    (130,213 )     (46,482 )     (530,537 )     (107,798 )
Total Other Expense
    (411,443 )     (46,482 )     (816,673 )     (107,798 )
Net Loss
  $ (1,115,750 )   $ (126,333 )     (2,959,465 )   $ (471,235 )
                                 
Net loss per common share - basic and diluted
  $ (0.03 )   $ (0.01 )   $ (0.08 )   $ (0.02 )
Weighted average number of common shares outstanding during the period - basic and diluted
    42,100,000       21,708,099       36,171,496       21,427,981  

The accompanying notes are an integral part of these condensed consolidated financial statements.

 
4

 

LTS Nutraceuticals, Inc.
Condensed Consolidated Statements of Cash Flows
(unaudited)

   
For the Nine
Months Ended
September 30,
2011
   
For the Nine
Months Ended
September
30, 2010
 
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net loss
  $ (2,959,465 )   $ (471,235 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Amortization of debt discount
    159,569       20,891  
Amortization of debt issuance costs
    87,130       8,473  
Depreciation and amortization
    28,973       4,786  
Change in fair value of derivative liability
    286,136        
Stock based compensation
    12,594        
Changes in operating assets and liabilities:
               
Decrease (increase) in:
               
Accounts receivable
    (712,065 )      
Inventories
    (162,109 )     (13,452 )
Prepaid expenses and other current assets
    (246,495 )     (67,404 )
Increase (decrease) in:
               
Accounts payable
    153,999       136,502  
Accrued expenses
    343,332       21,449  
Accrued interest
    284,587       78,435  
Accrued rebate liability
    672,265        
Deferred revenue
    31,495       (29,680 )
Net Cash Used In Operating Activities
    (2,020,054 )     (311,235 )
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Net increase in restricted cash
    (873,747 )      
Cash paid to purchase property and equipment
    (72,577 )      
Net Cash Used in Investing Activities
    (946,324 )      
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Proceeds from notes payable
    3,420,525       320,000  
Payment of debt issuance costs
    (56,000 )     (15,000 )
Purchase and retirement of treasury stock
    (65,000 )      
Net Cash Provided By Financing Activities
    3,299,525       305,000  
                 
Net Increase (Decrease) in Cash and Cash Equivalents
    333,147       (6,235 )
Cash and Cash Equivalents - Beginning of Period
    53,855       31,460  
                 
Cash and Cash Equivalents - End of Period
  $ 387,002     $ 25,225  
                 
SUPPLEMENTARY CASH FLOW INFORMATION:
               
Cash Paid During the Period for:
               
Interest
  $     $  
Taxes
  $     $  
                 
SUPPLIMENTARY DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
               
Conversion of Series C Preferred Stock in connection with reverse merger
  $ 158     $  
Issuance of common stock in connection with reverse merger
  $ 176     $  
Accrued licensing fee
  $ 800,000     $  
Effect of recapitalization
  $ 39,818     $  
Conversion of accrued interest into convertible notes payable
  $ 63,153     $  
Conversion of notes payable into convertible notes payable
  $ 1,606,128     $  
Issuance of common stock and stock options in connection with notes payable extension
  $     $ 253,293  
Common stock subscription applied against accrued interest
  $     $ 4,752  
Application of accrued interest to note payable principle balances
  $     $ 66,698  
Cancellation of Series A convertible preferred stock in connection with note payable extension
  $     $ 534  

The accompanying notes are an integral part of these condensed consolidated financial statements.

 
5

 

LTS Nutraceuticals, Inc.
Notes to Unaudited Condensed Consolidated Financial Statements

Note 1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and the rules and regulations of the United States Securities and Exchange Commission for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by GAAP. It is management's opinion, however, that all material adjustments (consisting of normal recurring adjustments) have been made which are necessary for a fair financial statement presentation. LTS Nutraceuticals, Inc. (the “Company”) evaluated subsequent events through the issuance date of this Form 10-Q.  The results for the interim period are not necessarily indicative of the results to be expected for the full year. The unaudited condensed consolidated financial statements should be read in conjunction with the Company's audited year end financials for the year ended December 31, 2010, as filed with the SEC as an exhibit to the Company’s Current Report on Form 8-K filed on April 6, 2011.

Note 2 – Organization and Business

Stone Harbor Investments, Inc. (“Stone Harbor”) was incorporated in Nevada on May 14, 2009, and changed its name to LTS Nutraceuticals, Inc. on April 21, 2011.  The Company has three direct subsidiaries and one indirect subsidiary.

The Source Vitamin Company, Inc. (“Source Vitamin”) was incorporated in Delaware on February 26, 2009.  As the result of a share exchange transaction which occurred on March 31, 2011, Source Vitamin is now a wholly owned subsidiary of the Company, and the Company, Source Vitamin, LTSC (defined below), LTS Brands (defined below) and Livethesource (defined below), are collectively hereinafter referred to as the “Company”.)
Source Vitamin has a wholly owned subsidiary, Live The Source “Canada” Ltd (“LTSC”), a Canadian corporation, which was incorporated on September 1, 2010. LTSC is currently inactive.
LTS Brands, Inc.(“LTS Brands”) and Livethesource, Inc.(“Livethesource”) were incorporated in Nevada on June 17, 2011 and became operating companies as of July 1, 2011.  The Company runs its business on a consolidated basis and separates out products in the LTS Brands and Livethesource subsidiaries in order to maximize product liability coverage due to the dollar limits available on its policies.

The Company is based in Florida and develops and sells high-quality nutritional products (“nutraceuticals”) that are distributed throughout North America through a network marketing system, and also sells products through its retail marketing channel.

The customer base for products sold by the network marketing system comprises two types of customer: “Entrepreneurs”, which are independent distributors, who also purchase the Company’s products for their own personal use, and "Retail Customers" which are direct consumers who purchase the Company’s products strictly for their personal use.
The customer base for products sold through the retail channel is primarily comprised of national drug store and warehouse store chains with the indirect end customer being the retail product consumer.

Reverse Merger and Recapitalization

On March 31, 2011, Stone Harbor,  (which was then a shell corporation), merged with Source Vitamin and Source Vitamin became the surviving corporation (the “Merger”). This transaction was accounted for as a reverse merger. Stone Harbor did not have any operations and majority-voting control was transferred to the shareholders of Source Vitamin.   Since Source Vitamin acquired a controlling voting interest, it was deemed the accounting acquirer, while Stone Harbor was deemed the legal acquirer. The historical financial statements of the Company are those of Source Vitamin.

 
6

 

Pursuant to the Merger, the Company acquired 77,924,000 shares of common stock from Stone Harbor’s majority shareholders for $65,000, which it then cancelled, and concurrently issued 24,300,000 shares of common stock to Source Vitamin stockholders.  Of the 24,300,000 shares issued to Source Vitamin shareholders, 172,600 shares were placed in escrow for conversion of convertible debentures in the principal amount of $270,000.  If the debentures are not converted into common stock by their maturity dates, the shares will revert back to the original shareholders of record on the date of merger on a pro rata basis.  Upon the closing of the Merger, former Source Vitamin stockholders held 58% of the issued and outstanding shares of common stock of the Company.

In connection with the reverse merger and recapitalization, all share and per share amounts have been retroactively restated.

Note 3 – Going Concern, Liquidity and Management's Plan

The Company incurred a $2,959,465 net loss and used $2,020,054 of cash in operations for the nine month period ended September 30, 2011. As of September 30, 2011, the Company has a $4,826,342 accumulated deficit and working capital of $283,508.

The Company does not yet have a sustained history of financial stability. Historically its principal source of liquidity has been the cash proceeds from various debt financing transactions. 

On November 10, 2011, the Company had $37,633 in cash.   The current operating plan indicates that losses from operations will be incurred for all of fiscal year 2011. Consequently the Company may not have sufficient liquidity necessary to sustain operations for the next twelve months and this raises substantial doubt that the Company will be able to continue as a going concern.

Management continues to execute its plan to improve the operating performance and the financial position of the Company. This plan includes obtaining cash from additional equity or debt financings, securing financing to purchase inventory, and increasing its product offering mix to the customers in its multi level marketing and retail networks.  In addition, the Company continues to develop other initiatives intended to either increase sales, reduce costs or improve liquidity. There can be no assurance that management's plan to improve the operating performance and the financial position of the Company will be successful.

The accompanying condensed consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability of assets or the amounts of liabilities that may result should the Company be unable to continue as a going concern.

Note 4 - Significant Accounting Policies

Use of Estimates

The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Such estimates and assumptions impact the following: the estimated useful lives for amortizable software, debt issue costs, licensing costs, accrued expenses, derivative liabilities, vendor rebate liability, sales returns and the fair value of equity instruments granted in connection with various transactions.  Making estimates requires management to exercise significant judgment. It is at least reasonably possible that the estimate of the effect of a condition, situation or set of circumstances that existed at the date of the financial statements, which management considered in formulating its estimate, could change in the near term due to one or more future confirming events. Accordingly, the actual results could differ significantly from its estimates.  The Company intends to re-evaluate all of its accounting estimates at least quarterly and record adjustments, when necessary.

Cash and Cash Equivalents

All highly liquid investments with an original maturity of 90 days or less when purchased are considered to be cash equivalents. Cash equivalents are stated at cost, which approximates market value. The Company minimizes credit risk associated with cash and cash equivalents by periodically evaluating the credit quality of its primary financial institutions. At times, its cash and cash equivalents may be uninsured or in deposit accounts that exceed the Federal Deposit Insurance Corporation insurance limit. The Company had no uninsured balances at September 30, 2011.

 
7

 

Restricted Cash

           Restricted cash is restricted for use for investment and public relation expenditures only in accordance with the terms of the issuance of the convertible notes payable (See Note 9).

Accounts Receivable

Accounts receivable are carried at the expected net realizable value. The allowance for doubtful accounts is based on management’s assessment of the collectability of specific customer accounts and the aging of the accounts receivable.  In addition, based on historical information, management estimates the amount of returned or damaged product and customers’ advertising allowances that may be deducted from outstanding accounts receivable.  If there were a deterioration of a major customer’s creditworthiness, or actual defaults or allowances were higher than historical experience, our estimates of the recoverability of amounts due to us could be overstated, which could have a negative impact on operations.

Inventories

Inventories consist of vitamins and related health and nutritional products and are carried at the lower of cost or net realizable value. Cost is based solely on the amount paid by the Company to third parties.

Property and Equipment

Property and equipment are stated at cost. Depreciation and amortization is calculated on a straight-line basis over the estimated useful lives of the related assets, which ranges from two to five years.  The costs of leasehold improvements are amortized over the lesser of the estimated useful lives of the assets or the length of the related lease.  Maintenance and repairs are charged to expense as incurred, costs of major additions and betterments are capitalized.  When property and equipment is sold or otherwise disposed of, the cost and related accumulated depreciation and amortization is eliminated from the accounts and any resulting gain or loss is reflected in income.

Convertible Instruments

The Company accounts for hybrid contracts such as notes that feature conversion option in accordance with Accounting Standards Codification 815 “Derivatives and Hedging Activities,” (“ASC 815”).  ASC 815 requires companies to bifurcate conversion options from their host instruments and account for them as free standing derivative financial instruments according to certain criteria. The criteria includes circumstances in which (a) the economic characteristics and risks of the embedded derivative instrument are not clearly and closely related to the economic characteristics and risks of the host contract, (b) the hybrid instrument that embodies both the embedded derivative instrument and the host contract is not re-measured at fair value under otherwise applicable generally accepted accounting principles with changes in fair value reported in earnings as they occur and (c) a separate instrument with the same terms as the embedded derivative instrument would be considered a derivative instrument.  Conversion options that contain variable settlement features such as provisions to adjust the conversion price upon subsequent issuance of equity or equity linked securities at exercise prices more favorable than that featured in the hybrid contract, generally result in their bifurcation from the host instrument.

The Company accounts for convertible instruments (when the Company has determined that the embedded conversion options should not be bifurcated from their host instruments) in accordance with ASC 470-20 “Debt with Conversion and Other “ (“ASC470-40”). Under ASC 470-20 discounts to convertible notes, when necessary, are recognized for the intrinsic value of conversion options embedded in debt instruments based upon the differences between the fair value of the underlying common stock at the commitment date of the note transaction and the effective conversion price embedded in the note. The Company accounts for convertible instruments (when it has determined that the embedded conversion options should be bifurcated from their host instruments) in accordance with ASC 815. Under ASC 815, a portion of the proceeds received upon the issuance of the hybrid contract are allocated to the fair value of the derivative. The derivative is subsequently marked to market at each reporting date based on current fair value, with the changes in fair value reporting in results of operations.

 
8

 

Note Payable Conversion Feature and Other Derivative Instruments

The Company’s free standing derivatives include conversion option embedded in its convertible notes issued in April 2011.  The Company evaluated the conversion option  in accordance with the provisions of ASC 815 and determined that the conversion option has all of the characteristics of a derivative in its entirety that does not qualify for an exception to the derivative accounting rules. Specifically, the exercise price of the conversion option is not fixed at any time during the term of the note based on the occurrence or non-occurrence of certain events and also entitles the counterparty to an adjustment of the exercise price in the event that the Company subsequently issues equity securities or equity linked securities at prices more favorable than the exercise price of the conversion option embedded in the notes. Accordingly, the conversion option is not indexed to the Company’s own stock. The Company classifies as equity any contracts that (i) require physical settlement or net-share settlement or (ii) provides a choice of net-cash settlement or settlement in the Company’s own shares (physical settlement or net-share settlement) providing that such contracts are indexed to the Company’s own stock as defined in ASC 815-40 “Contract in Entity’s Own Equity”.  The Company classifies as liabilities any contracts that (i) require net-cash settlement (including a requirement to net cash settle the contract if an event occurs and if that event is outside the Company’s control) or (ii) gives the counter party a choice of net-settlement or settlement in shares (physical or net-share settlement).  The Company assesses classification of common stock purchase warrants and other free standing derivatives at each reporting date to determine whether a change in classification between assets and liabilities is required.

The Company’s free standing derivatives include warrants to purchase common stock that were issued with the Convertible Notes Payable described in Note 9.  The Company evaluated the common stock purchase warrants to assess their proper classification in the balance sheet as of September 30, 2011 using the applicable classification criteria enumerated under GAAP.  The potential of a dilutive adjustment to the Warrants’ exercise price and number of underlying shares of Common Stock may result in a settlement amount that does not equal the difference between the fair value of a fixed number of the Common Stock and at a fixed exercise price.  Accordingly, the Warrants are not considered indexed to the Company’s own stock and, therefore, are accounted for as a derivative liability in the accompanying condensed consolidated balance sheet as of September 30, 2011.

Revenue Recognition

The Company generates revenue from the sales of its vitamin and related health and nutritional products directly to consumers through its Entrepreneurs and retail marketing network. Revenue is recognized when all of the following conditions exist: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred, (3) the sales price is fixed or determinable, and (4) collectability is reasonably assured.

The Company accounts for payments made to customers in accordance with ASC 605 “Revenue Recognition” (“ASC 605”), which states that cash consideration (including a sales incentive) given by a vendor to a customer is presumed to be a reduction of the selling prices of the vendor’s products or services and, therefore, should be characterized as a reduction of revenue when recognized in the vendor’s income statement, rather than a sales and marketing expense. The Company has various agreements with customers that provide for discounts and rebates. These agreements are classified as a reduction of revenue. Certain other costs associated with customers that meet the requirements of ASC 605 are recorded as sales and marketing expense. Vendor considerations recorded as a reduction of sales were $436,416 and $0 for the three months ended September 30, 2011 and 2010, and $818,490 and $0 for the nine months ended September 30, 2011 and 2010 respectively.

Revenue is recognized at the time products are shipped.  The Company generally requires cash or credit card payment at the point of sale certain products.  The compensation plan for the Company’s Entrepreneurs generally does not provide rebates or selling discounts to Entrepreneurs who purchase its products and services.

 
9

 

Product Return Policy

Refunds are allowed only to entrepreneurs who have given voluntary termination notices, or for incorrect or defective items.  In these circumstances only, the Company provides a 30-day return policy.  For the products sold through the retail network, returns are allowed only for incorrect or defective items.

For products sold to customer through the retail marketing network, we guarantee customer satisfaction. Our policy requires the customer to return the unused product to the retailer from whom they originally purchased it.  We pay the retailer for the returned product plus a handling cost. We review gross revenue for estimated returns. The estimated returns are based on historical and industry experience. However, the estimate for product returns does not reflect the impact of a large product recall resulting from product nonconformance or other factors as such events are not predictable nor is the related economic impact estimable.   We periodically assess the adequacy of this policy and record a liability as necessary.   We recorded reserves for returns of $9,635 and $0 for the three months ended September 30, 2011 and 2010, respectively, and $9,635  and $0, respectively, for the nine months ended September 30, 2011 and 2010, respectively.

Deferred Revenue

The Company requires cash or credit card payment at the time of sale for some of its products. Any payments that are received prior to shipment are recorded as deferred revenue until the specific product is shipped as described above, at which time, it is recorded as revenue.

Advertising

Advertising costs are expensed as they are incurred and are included in selling, general and administrative expenses. Advertising expense was $11,523 and $0 for the three months ended September 30, 2011 and 2010, respectively, and $12,715  and $0, respectively, for the nine months ended September 30, 2011 and 2010, respectively.

Shipping and Handling Costs

The Company’s shipping and handling costs are included in revenue, with the corresponding expense in cost of sales.

Entrepreneur Incentives

Entrepreneur incentives expenses include all forms of commissions, compensation, bonuses and other incentives paid to our founder and entrepreneurs.

Selling, General and Administrative


Selling, general and administrative expenses include wages and benefits, depreciation and amortization, rents and utilities, Entrepreneur event costs, professional fees and marketing.

Share-Based Payment Arrangements

Generally, all forms of share-based payments, including stock option grants, restricted stock grants and stock appreciation rights are measured at their fair value on the awards’ grant date, based on the estimated number of awards that are ultimately expected to vest.  Share-based compensation awards issued to non-employees for services rendered are recorded at either the fair value of the services rendered or the fair value of the share-based payment, whichever is more readily determinable. The expense resulting from share-based payments are recorded in cost of goods sold or general and administrative expense in the statement of operations, depending on the nature of the services provided.

 
10

 

Income Taxes

The Company accounts for income taxes in accordance with accounting guidance now codified as Financial Accounting Standards Board ASC Topic 740, “ Income Taxes ,” which requires that the Company recognize deferred tax liabilities and assets based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities, using enacted tax rates in effect in the years the differences are expected to reverse. Deferred income tax benefit (expense) results from the change in net deferred tax assets or deferred tax liabilities. A valuation allowance is recorded when it is more likely than not that some or all deferred tax assets will not be realized.

Accounting guidance clarifies the accounting for uncertainties in income taxes recognized by prescribing guidance for the recognition, de-recognition and measurement in financial statements of income tax positions taken in previously filed tax returns or tax positions expected to be taken in tax returns, including a decision whether to file or not to file in a particular jurisdiction. Accounting guidance requires that any liability created for unrecognized tax benefits be disclosed. The application of accounting for income taxes may also affect the tax bases of assets and liabilities and therefore may change or create deferred tax liabilities or assets. The Company would recognize interest and penalties related to unrecognized tax benefits in income tax expense. At September 30, 2011, the Company did not record any liabilities for uncertain tax positions.

Net Loss per Share

Basic earnings per share (“EPS”) is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding during the period, excluding the effects of any potentially dilutive securities. Diluted EPS gives effect to all dilutive potential of shares of common stock outstanding during the period including stock options or warrants, using the treasury stock method (by using the average stock price for the period to determine the number of shares assumed to be purchased from the exercise of stock options or warrants), and convertible debt or convertible preferred stock, using the if-converted method. Diluted EPS excludes all dilutive potential of shares of common stock if their effect is anti-dilutive.

The computation of basic and diluted loss per share for the year ended September 30, 2011 excludes the following potentially dilutive securities because their inclusion would be anti-dilutive:

   
For the
Period Ended
September 30,
2011
 
For the
Period Ended
September 30,
2010
Convertible Debentures
    172,600   172,600
Convertible Notes Payable
    9,380,753   -
Stock Warrants
    9,380,753    -
Stock Options
    3,000,000   45,350
Convertible Series C Preferred Stock     -   95,450
      21,934,106    313,400
 
Reclassification
 
Prior period amounts are reclassified, when necessary, to conform to the current period presentation.
 
New Accounting Pronouncements
 
In May 2011, the FASB issued Update No. 2011-04 related to fair value measurements and disclosures in the financial statements, which updates ASC Topic 820 “Fair Value Measurement”.  This guidance conforms the wording to describe many of the requirements in U.S. GAAP to International Financial Reporting Standards to ensure the related standards are consistently applied.  The guidance also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This new guidance is effective during interim and annual periods beginning after December 15, 2011 and is to be applied prospectively. The adoption of this standard will not materially expand the Company’s consolidated financial statement footnote disclosures.

 
11

 

Note 5 - Fair Value

Financial instruments, including cash and cash equivalents, restricted cash, accounts payable and accrued liabilities are carried at cost, which management believes approximates fair value due to the short-term nature of these instruments. The fair value of  convertible debentures and notes payable approximates their carrying amounts as a market rate of interest is attached to their repayment.

The Company measures the fair value of financial assets and liabilities based on the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. The Company uses three levels of inputs that may be used to measure fair value:

Level 1 — quoted prices in active markets for identical assets or liabilities

Level 2 — quoted prices for similar assets and liabilities in active markets or inputs that are observable

Level 3 — inputs that are unobservable (for example cash flow modeling inputs based on assumptions)

Financial liabilities measured at fair value on a recurring basis are summarized below:

Fair value measurements at September 30, 2011

   
September
30,
2011
   
Quoted prices in
active markets for
identical assets
(Level 1)
   
Significant
other
observable
inputs
(Level 2)
   
Significant
unobservable
inputs
(Level 3)
 
Derivative liabilities
  $ 286,136     $     $     $ 286,136  

The derivative liabilities are measured at fair value using the lattice pricing model, and are classified within Level 3 of the valuation hierarchy.

The following table sets forth a summary of the changes in the fair value of the Company’s Level 3 financial liabilities that are measured at fair value on a recurring basis:

   
September
30,
2011
 
Beginning Balance
  $  
Aggregate fair value of derivative issued
     
Change in fair value of derivative included in income
    286,136  
         
Ending Balance
  $ 286,136  

The significant assumptions and valuation methods that the Company used to determine fair value and the change in fair value of the derivative financial instrument at issue are discussed in Note 9.

In accordance with the provisions of ASC 815, the Company presented the conversion option and warrant liabilities at fair value on its condensed consolidated balance sheet, with the corresponding changes in fair value recorded in the Company’s condensed consolidated statement of operations for the applicable reporting periods. As disclosed in Note 9, the Company computed the fair value of the derivative liability at the date of issuance and the reporting date of September 30, 2011 using the lattice pricing model.

 
12

 

The Company developed the assumptions that were used as follows:
   
The fair value of the Company’s common stock was obtained from an independent third party valuation;
   
The term represents the remaining contractual term of the derivative;

   
The volatility rate was developed based on analysis of the historical volatility rates of several similarly situated companies (using a number of observations that was at least equal to or exceeded the number of observations in the life of the derivative financial instrument at issue);
   
The risk free interest rates were obtained from publicly available US Treasury yield curve rates; and
   
The dividend yield is zero because the Company has not paid dividends and does not expect to pay dividends in the foreseeable future.

Note 6 - Prepaid expenses and other current assets

   
September 30,
2011
   
December 31,
2010
 
Credit card reserves
  $ 40,000     $ 71,839  
Prepaid expenses
    10,586       21,377  
Prepaid consulting
    218,880        
Prepaid insurance
    31,286        
Prepaid inventory costs
    65,332       18,373  
Prepaid professional fees
    17,000       20,000  
Advances to consultant
          5,000  
Prepaid expenses and other current assets
  $ 383,084     $ 136,589  

Credit card reserves are cash collateral that is being held by the credit card processor to assure compliance with the individual processor’s policies, guidelines, and/or practices.

Note 7 – Property and Equipment

Property and equipment consist of the following:

   
September 30,
2011
   
December 31,
2010
 
Estimated
Useful Life
Equipment and software
  $ 77,279     $ 23,864  
2-5years
Leasehold Improvements
    13,800        
2 years
Less: Accumulated depreciation and amortization
    (17,937 )     (9,882 )  
Property and equipment, net
  $ 73,142     $ 13,982    

Depreciation and amortization was $5,355 and $1,595 for the three months ended September 30, 2011 and 2010, respectively and $13,417 and  $4,786  for the nine months ended September 30, 2011 and 2010, respectively.

Note 8 – Intangible Asset

On June 13, 2011, the Company entered into a Purchase and Exclusive Marketing Agreement (“Agreement”) with Imagenetix, Inc. (“Imagenetix”), Proprietary Nutritionals, Inc. (“Proprietary”) and Pharmachem Laboratories, Inc. (with Imagenetix and Proprietary, “PNI”) pursuant to which the Company was granted perpetual exclusive United States rights to purchase from PNI their Celadrin products and brand (“Celadrin”) as well as exclusive marketing and distribution and related rights in the U.S.  During the term of the Agreement, the Company has the right to purchase Celadrin from PNI for use in the U.S. at a purchase price equal to the then agreed upon wholesale prices at a 2% discount, with a net 60 days payment term.  Prices can be increased in any January for the next year by no more than the then consumer price index or 5% whichever is greater.  The Company agreed to issued $800,000 of its common stock in exchange for the marketing and distribution rights on February 1, 2012, which is six months after the date of execution of the Agreement.  The transaction was recorded as an intangible asset and is amortized over the estimated useful life of fifteen years.

 
13

 

Amortization was $13,333 and $0 for the three months ended September 30, 2011 and 2010, respectively and $15,556 and $0 for the nine months ended September 30, 2011 and 2010, respectively.

Note 9 - Debt Financing

Notes Payable

During June 2009, the Company entered into a $100,000 unsecured promissory note with a third party.  The note bore interest at fifteen percent per annum and was due on December 31, 2010.  In connection with the note, the Company agreed to issue 157,835 shares of Source Vitamin’s convertible preferred series C stock.  The preferred stock was valued at a fair value of $6,313 which was recorded as a debt discount to be amortized over the life of the note.  For the three months ended September 30, 2011 and 2010, $0 and $1,064 was amortized to interest expense and for the nine months ended September 30, 2011 and 2010, $0 and $3,192 was amortized to interest expense. The note and all accrued interest were subsequently satisfied as part of two $350,000 promissory notes the Company entered into during November 2010.

During June and July 2009, the Company entered into three unsecured promissory notes totaling $290,000 with a third party.  The notes bore interest at fifteen percent per annum and matured between June 22 and November 1, 2010.  In connection with these notes, the Company agreed to issue 533,904 shares of Source Vitamin’s convertible preferred series A stock.  The preferred stock was valued at a fair value of $21,356 which was recognized as a debt issue cost to be amortized over the life of the notes.  For the three months ended September 30, 2011 and 2010, $0 and $3,130, respectively, was amortized to interest expense and for the nine months ended September 30, 2011 and 2010, $0 and $12,113, respective was amortized to interest expense.  The Company used the net proceeds received from these notes to provide working capital.

In connection with these notes, on September 16, 2010, the Company entered into a new subscription agreement with the noteholder to purchase 2,646,850 shares of common stock at par and granted the holder a six month option to acquire an additional 45,350 shares of common stock at par. As a consideration of this agreement the notes holder agreed to (1) entered into a new debt arrangement (upon the maturity of the original notes) whereby the balance from the $290,000 notes and all unpaid accrued interest of $59,059 will be due on September, 30, 2011, (2) any accruing interest will be due September 30, 2011, (3) waive all rights, titles and interest in the 533,904 shares convertible preferred series A stock originally issued and (4) waive any loan defaults prior to the subscription agreement.  The option is exercisable upon certain conditions, including merging with a publicly traded company. 322,850 shares of the common stock issued were deemed to be for the conversion of convertible series A preferred stock that is cancelled as part of this agreement, and the remaining 2,324,000 shares were valued at fair value of $226,209 and was recognized as a debt discount and amortized over the remaining life of the notes.  The option was valued at fair value of $4,425 using the Black-Scholes-Merton valuation model and was also recognized as debt discount. These notes were subordinated to the two $350,000 promissory notes below and were refinanced along with accrued interest by the Convertible Notes Payable discussed below.  For the three months ended September 30, 2011 and 2010, $0 and $11,250, respectively, was amortized to interest expense and for the nine months ended September 30, 2011 and 2010, $145,452 and $11,250, respectively was amortized to interest expense.

During March 2010, the Company entered into an unsecured promissory note for $150,000.  The note bore interest at ten percent per annum and was due on February 28, 2011.  In accordance with this note, the Company paid $15,000 of debt issuance cost.  On September 22, 2010, the Company issued 226,750 shares of common stock to the note holder in exchange for an extension of the note maturity date to June 30, 2011, changes to repayment provisions so that accrued interest of $7,639 were added to the principle balance, and extend any accruing and unpaid interest until the extended maturity date. The modification of the terms of the note have been accounted for as an extinguishment of debt in accordance with ASC 470. The shares were valued at fair value of $22,500 and recognized as a debt discount and amortized over the remaining life of the note.  The note was subordinated to the two $350,000 promissory notes below and was refinanced along with accrued interest by the Convertible Notes Payable discussed below.  For the three months ended September 30, 2011 and 2010, $0 and $641, respectively, was amortized to interest expense and for the nine months ended September 30, 2011 and 2010, $14,117 and $641, respectively was amortized to interest expense.

 
14

 

During November 2010, the Company entered into two $350,000 promissory notes.  The notes refinanced two $50,000 notes issued in August 2010, bore interest at ten percent per annum, and were due on June 30, 2011.  The notes were collateralized by 17,303,300 of the founder’s shares and are guaranteed by the founder.  These notes and all accrued interest were refinanced by the Convertible Notes Payable discussed below.  In connection with these notes the Company incurred debt issue costs of $74,315 comprised of private placement and legal fees.

During March 2011, the Company entered into a $400,000 promissory note.  The note bore interest at ten percent per annum and was due on June 30, 2011.  The note was collateralized by 17,303,300 of the founder’s shares and is guaranteed by the founder.  The note and all accrued interest were refinanced by the Convertible Notes Payable discussed below.

Convertible Notes Payable

On April 6, 2011, in a private placement transaction, exempt from registration under Section 4(2) of the Securities Act of 1933, the Company issued $4,690,376 of Convertible Notes Payable, of which $1,670,376 went to refinancing of existing notes payable and related accrued interest. The refinancing of the existing notes have been accounted for as an extinguishment of debt in accordance with ASC 470.  The notes have a two year term maturing April 5, 2013, bear interest at ten percent per annum (payable semi-annually) and are secured by a first lien on all assets of the Company.  The Company did not make the first interest payment due in September 2011 and instead a majority in interest of the investors consented to a deferment of the payment of the interest due.  See Note 13 for further discussion concering the deferment.  The principal balances of the notes along with any unpaid interest may be converted anytime at the option of the holders to common stock at a price of $0.50 per share.  During the life of the notes, the conversion price will be adjusted any time the Company sells its stock for a price under $0.50 to the lowest price sold.  In connection with the notes, the Company issued 9,380,753 five year warrants to acquire the Company’s common stock at a price of $0.50 per share. During the life of the notes, the exercise price will be adjusted any time the Company sells its stock for a price under $0.50 to the lowest price sold.  The conversion option and warrants were accounted for as derivatives, with the fair value recorded as a debt discount to be amortized over the life of the notes. $1,500,000 of the proceeds were held in escrow after closing with Grushko & Mittman, PC to be utilized for payment of investor relations and public relations expenditures.

The fair value of the note conversion feature derivative liability at issuance was immaterial and therefore no debt discount was recorded.  The Company computed the fair value of the note conversion feature at the date of issuance and the reporting date of September 30, 2010 using the lattice pricing model with the following assumptions:

Input
 
April 6, 2011
(Issuance Date)
   
September 30, 2011
(Reporting Date)
 
             
Fair value of common stock
  $ 0.02     $ 0.20  
Exercise Price of Option
  $ 0.50     $ 0.50  
Term (years)
    2       1.5  
Volatility
    50.00 %     50.00 %
Risk Free Interest Rate
    .61 %     .19 %
Delta T
    1/12       1/12  
Up Ratio
    1.144       1.143  
Down Ratio
    0.857       0.857  
Up Transition Probability
    0.5001       0.5001  
Dividend Yield
    %     %
 
 
15

 

The fair value of the warrant exercise price derivative liability at issuance was immaterial and therefore no debt discount was recorded.  The Company computed the fair value of the derivative liability at the date of issuance and the reporting date of September 30, 2011 using the lattice pricing model with the following assumptions:

Input
 
April 6, 2011
(Issuance Date)
   
September 30, 2011
(Reporting Date)
 
             
Fair value of common stock
  $ 0.02     $ 0.20  
Exercise Price of Option
  $ 0.50     $ 0.50  
Term (years)
    5       4.5  
Volatility
    50.00 %     50.00 %
Risk Free Interest Rate
    1.96 %     .96 %
Delta T
    1/12       1/12  
Up Ratio
    1.144       1.143  
Down Ratio
    0.857       0.857  
Up Transition Probability
    0.5001       0.5001  
Dividend Yield
    %     %

Convertible Debentures

During October 2009, the Company issued a $200,000 Convertible debenture (the “Convertible debenture”).  The Convertible debenture has a three year term maturing October13, 2012, bears interest at an annual rate of ten percent per annum and is unsecured.  The Company used the net proceeds received from this Convertible debenture to provide working capital.

The Convertible debenture is convertible at the option of the holder, in whole or in part, into 81,700 shares of the Company’s common stock.  The conversion price may be adjustable for standard anti-dilution provisions such as stock splits, stock dividends and similar types of recapitalization events.

The Company evaluated the conversion feature embedded in the Convertible debenture to determine whether such conversion feature should be bifurcated from its host instrument and accounted for as a freestanding derivative and if a beneficial conversion feature exists. The Company has determined that no beneficial conversion feature exists and determined that since the exercise price of the convertible debt does not contain variable conversion features, such conversion feature should not be bifurcated from its host instrument and accounted for as a freestanding derivative.

During August and September 2010, the Company issued two Convertible debentures (the “September Convertible debentures”) totaling $70,000.  The September Convertible debentures have terms maturing in February 2012, bear interest at an annual rate of eight percent per annum and is unsecured.  The Company used the net proceeds received from these September Convertible debentures to provide working capital.

The September Convertible debentures are convertible at the option of the holders, in whole or in part, into 90,900 shares of its common stock.  The conversion price was adjustable for standard anti-dilution provisions such as stock splits, stock dividends and similar types of recapitalization events.    The Company evaluated the conversion feature embedded in the September Convertible debentures to determine whether such conversion feature should be bifurcated from its host instrument and accounted for as a freestanding derivative. The Company determined that since the exercise price of the convertible debt does not contain variable conversion features, such conversion feature should not be bifurcated from its host instrument and accounted for as a freestanding derivative.

 
16

 

Expected repayments of the convertible notes payable and convertible debentures are as follows:

   
For the Year Ended
December 31,
 
2011
  $  
2012
    270,000  
2013
    4,690,376  
    $ 4,960,376  

Note 10 - Stockholders’ Deficiency

Preferred Stock

The Company has authorized a total of 20,000,000 shares of $0.00001 par value blank check preferred stock.

Source Vitamin’s Convertible Series C Preferred Stock

Source Vitamin’s Convertible Series C Preferred Stock (“Series C PS”) has voting rights equivalent to one vote per share, no liquidation preference, and are entitled to receive dividends equal to three percent of the Source Vitamin’s net income to be paid quarterly. Each share of the Series C PS is convertible into one share of the Source Vitamin’s common stock at the election of the holder, however if all accrued dividends have been paid by July 1, 2012, all outstanding shares automatically convert to common shares. Source Vitamin authorized and issued 157,835 shares of the Series C PS in connection with one promissory notes totaling $100,000 to one individual (see Note 9).  These shares were converted into 95,450 common shares in connection with the reverse merger that occurred on March 31, 2011.

Common Stock

On March 2, 2009, the Company issued 21,285,600 founders shares of common stock for no consideration upon formation of Company.

On September 16, 2010, the Company entered into a subscription agreement with the note holder of the three promissory notes totaling $290,000 to purchase 2,646,850 shares of common stock at par and granted the holder a six month option to acquire an additional 45,350 shares of common stock at par (see Note 9).    The options were exercised in connection with the reverse merger that occurred in March 31, 2011 (Note 2).  Options issued in connection with the subscription agreement were recognized as a debt discount and amortized over the remaining life of the notes and valued at a fair value of $4,425 using the Black-Scholes-Merton valuation model utilizing the following assumptions:

Expected dividends
    0 %
Expected volatility
    27.32 %
Expected term – embedded conversion option
 
0.5 years
 
Risk free interest rate
    .20 %
Expected forfeitures
    100 %

On September 22, 2010, the Company issued 226,750 shares of common stock to the note holder of the unsecured $150,000 promissory note (see Note 9) in exchange for an extension of the notes maturity date to June 30, 2011, changes to repayment provisions so that all accrued interest is due on the maturity date and to remedy any defaults on the notes.  The shares were valued at fair value of $22,500 and recorded as a debt discount and amortized over the remaining life of the note.

On March 31, 2011, the Company issued 17,600,000 shares of common stock in connection with the Merger.

On April 21, 2011, the Company filed an amendment to its articles of incorporation in Nevada to change its name to LTS Nutraceuticals, Inc.  Its directors and shareholders also approved a stock dividend to its shareholders pursuant to which the shareholders shall receive 49 additional shares of Company’s common stock for each share of Company’s common stock owned.     All share and per share amounts have been retroactively restated.

 
17

 

On June 1, 2011, the Company issued 200,000 shares of common stock to a consultant for services valued at $8,000 ($0.04 per share).  The shares were fully vested and were recorded as stock compensation expense.

Stock Options

On March 30, 2011, the Company’s Board and shareholders approved its 2011 Stock Option Plan, which has 12,000,000 shares reserved for issuance to officers, directors, employees and consultants.

On March 31, 2011, the Company granted 3,000,000 options to its Chief Executive Officer (Note 11).  The options have an exercise price based on the fair market price or $0.02 per share and can be exercised over five years.  The exercise price was based on a valuation performed by an independent third party.  1,000,000 options to vest on each one year anniversary of the granted date, and all then unvested options to automatically vest on the date upon which the Company’s aggregate gross revenues reach $50,000,000.   These options had a fair value of $27,367 using the Black-Scholes-Merton option-pricing model using the following assumptions:
 
Risk-free interest rate
    2.24 %
Expected dividend yield
    0 %
Expected volatility
    50 %
Expected life
 
5 years
 
Expected forfeitures
    0 %

For the three months ended September 30, 2011 and 2010, $2,297 and $0, respectively, was recorded as stock compensation expense and for the nine months ended September 30, 2011 and 2010, $4,594 and $0, respectively was amortized stock compensation expense.

The following table summarizes our stock option activity for the period from December 31, 2010 through September 30, 2011:

   
Number of
Options
   
Weighted
Average
Exercise
Price
   
Weighted
Average
Remaining
Contractual
Life
(in Years)
   
Aggregate
Intrinsic
Value
 
Balance at December 31, 2010
                       
Granted
    3,000,000     $ 0.02       5.0        
Forfeited or Cancelled
                       
Balance at September 30, 2011
    3,000,000       0.02       4.5     $  
Exercisable at September  30, 2011
        $           $  

Total unamortized compensation expense related to stock options at September 30, 2011 amounted to $22,773 and is expected to be recognized over 2.5 years.

 
18

 

Stock Warrants

The following summarizes our warrant activity for the period from December 31, 2010 through September 30, 2011:

   
Warrants
   
Weighted
Average Exercise
Price
   
Weighted
Average
Remaining
Contractual
Life (in years)
 
Outstanding – December 31, 2011
        $        
Granted
    9,380,753       0.50       3.0  
Exercised
                 
Forfeited or Cancelled
                 
Outstanding – September 30, 2011
    9,380,753     $ 0.50       2.5  
Exercisable – September 30, 2011
    9,380,753     $ 0.50       2.5  

At September 30, 2011, the total intrinsic value of all warrants outstanding and exercisable was $-0-.

Note 11 - Related Party Transactions

The founder and Chairman of the Board of Directors had an agreement with the Company whereby he is to receive a bonus of five percent of eligible monthly sales.  As a result of this agreement, the Company recorded bonus expense of $0 and $2,764 to the founder for the three months ended September 30, 2011 and 2010, respectively, and $12,762 and $40,785 for the nine months ended September 30, 2011 and 2010, respectively.  This agreement ended effective May 1, 2011.

As of September 30, 2011, the Company owed the founder $29,138 in accounts payable.
 
On March 31, 2011, the Company entered into an employment agreement with its Chief Executive Officer (“CEO”) and a consulting agreement with its Chairman of the Board of Directors (“Chairman”). These agreements generally require each executive to devote substantially all of his business time to the Company’s affairs, establish standards of conduct, prohibit competition with the Company’s company during their term, affirm the Company’s rights respecting the ownership and disclosure of trade secrets and other confidential information, provide for the acts and events that would give rise to termination of such agreements and provide express remedies for a breach of the agreement. Each of the Company’s employees will participate in its standard employee benefit programs, including medical/hospitalization insurance as in effect from time to time. The provisions of the individual agreements are summarized below:

Under the terms of his employment agreement effective March 31, 2011, which has a term of three years and terminates on March 30, 2014 and which shall automatically renew for successive one year periods unless either the Company or the CEO gives written notice of termination at least three months in advance of the end of the initial period of the agreement or any renewal period thereof, the CEO receives an annual salary of $200,000 (with salary having commenced on May 1, 2011), a quarterly bonus of 1% of the Company’s gross revenue from direct sales of Company products for the just completed fiscal quarter due out of the Company’s net revenues for such quarter and due no later than 30 business days after the end of each fiscal quarter, and 5-year options to purchase our common stock with exercise prices equal to the market price per share of the Company’s common stock on the grant date as follows: (i) 3,000,000 options to be granted on March 31, 2011, with 1,000,000 options to vest on each one year anniversary of the granted date, and all then unvested options to automatically vest on the date upon which the Company’s aggregate gross revenues reach $50,000,000; and (ii) 1,000,000 options to be granted on the date on which the Company’s aggregate gross revenues reach $25,000,000, which options shall vest immediately on the grant date thereof. As a result of this agreement, the Company recorded bonus expense of $13,721 and $0 for the three months ended September 30, 2011 and 2010, respectively, and $16,975 and $0 for the nine months ended September 30, 2011 and 2010, respectively.

Under the terms of his consulting agreement March 31, 2011, which has a term of three years and terminates on March 30, 2014 and which shall automatically renew for successive one year periods unless the Company notifies the Chairman in writing prior to the end of the initial period of the agreement or any renewal period thereof, the Chairman receives an annual consulting fee of $150,000 (which fee commenced on May 1, 2011).

 
19

 

Note 12 – Commitments and Contingencies

Operating leases

The Company leases space for its corporate offices. The lease sets forth a rental payment of $4,000 per month and has a term through April 2012.

During May 2010, the Company entered into a three year lease for 1,562 square feet of warehouse space. The lease calls for rent of $1,571 per month through April 2013.

Expected payments on operating leases are as follows:

   
For the 12 months ended
September 30,
 
2012
  $ 46,852  
2013
    10,997  
    $ 57,849  

Economic Risks and Uncertainties

The recent global economic slowdown has caused a general tightening in the credit markets, lower levels of liquidity, increases in the rates of default and bankruptcy, and extreme volatility in credit, equity and fixed income markets. These conditions not only limit its access to capital, but also make it difficult for its customers, its vendors and us to accurately forecast and plan future business activities.

Legal Proceedings

From time to time, the Company is periodically a party to or otherwise involved in legal proceedings arising in the normal and ordinary course of business. As of the date of this Report, the Company is not aware of any proceeding, threatened or pending, against us which, if determined adversely, would have a material effect on its business, results of operations, cash flows or financial position.

Note 13 – Subsequent Events

Acquisition of Biocalth International

On October 20, 2011, the Company entered into an agreement with Jackson Wen, individually and as trustee for the shareholders of Biocalth International, Inc., Giantceuticals, Inc. and HerbSource Enterprises, Inc. (collectively, “Biocalth”), to purchase all of the issued and outstanding shares of stock of Biocalth (“Shares”). Biocalth’s business is the manufacturing, marketing and sales of nutraceutical products in Asia and Europe.

Closing is scheduled for November 23, 2011 with a deadline on closing of December 31, 2011. The purchase price, which was negotiated by the parties, is $5,000,000 to be paid in restricted shares of Company common stock. In addition, the Seller shall receive an “earn-out” based on the sales performance of products sold by Biocalth as follows (all to be paid in restricted shares of Company common stock):

Year:
 
Gross Revenue Target:
   
Earn-out Amount
 
1 (ending in 2012)
  $ 5,000,000     $ 5,000,000  
2 (ending in 2013)
  $ 10,000,000     $ 5,000,000  
3 (ending in 2014)
  $ 15,000,000     $ 2,500,000  

The Company’s obligation to close the purchase of the Shares is contingent upon completion of its due diligence on the Company, which will occur prior to closing.

 
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Leakout Agreements

During October 2011, the Company entered into leakout agreements whereby in exchange for limiting the manner in which 12,102,500 shares of stock being sold over a six month period, the Company granted 3,000,500 five year warrants to purchase the Company’s common stock for $1.00 per share.  The leakout agreements were executed by various shareholders in the Company to limit the amount of stock that could be sold into the market until February 2012 when the Company will have almost a full year of operation.

Interest Waiver

During October 2011, the Company obtained majority consent from the convertible note payable holders whereby all interest payments owed as of September 30, 2012 through March 31, 2012, will be deferred until March 31, 2012 in exchange for 925,225 five year warrants to purchase the Company’s common stock at $0.50 per shares the Company.  The warrants have the same rights and privileges as the warrants issued in connection with the April 6, 2011 Notes.

Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the accompanying condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q and with our Current Report on Form 8-K, which was filed with the United States Securities and Exchange Commission (the “SEC”) on April 6, 2011 and is available on the SEC’s website.

Unless the context requires otherwise, references in this Form 10-Q to the “Company,” The Source,” “we” “our” and “us” for the period prior to the closing of the reverse merger on March 31, 2011 discussed below, refer to The Source Vitamin Company, Inc., a privately held Delaware corporation that is now our wholly owned subsidiary, and references to the “Company,” Stone Harbor,” “we.” “our” and “us” for the period subsequent to the closing of the reverse merger on March 31, 2011, refer to LTS Nutraceuticals, Inc., a Delaware corporation that is a publicly traded company, and its subsidiary, The Source Vitamin Company, Inc, and its subsidiaries, Livethesource, Inc. and LTS Brands, Inc.

Management’s discussion and analysis of financial condition and results of operations is based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these unaudited condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates and assumptions, including, but not limited to, those related to estimated lives for amortizable software, debt issue costs and licensing costs, accrued expenses, derivative liabilities, vendor rebate liability, sales returns and the fair value of common stock granted in connection with various transactions.  We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates and assumptions.

Merger and Name Change
 
On March 31, 2011, Stone Harbor Investments, Inc. (“Stone Harbor”) a then shell corporation, merged with The Source Vitamin Company (“Source Vitamin”) and Source Vitamin became the surviving corporation (the “Merger”). This transaction was accounted for as a reverse merger. Stone Harbor did not have any operations and majority-voting control was transferred to the shareholders of Source Vitamin.   Since Source Vitamin acquired a controlling voting interest, it was deemed the accounting acquirer, while Stone Harbor was deemed the legal acquirer. The historical financial statements of the Company are those of Source Vitamin.

Pursuant to the Merger, the Company acquired 77,924,000 shares of common stock from Stone Harbor’s majority shareholders for $65,000, which it then cancelled, and concurrently issued 24,300,000 shares of common stock to Source Vitamin stockholders.  Of the 24,300,000 shares issued to Source Vitamin shareholders, 172,600 shares were placed in escrow for conversion of the convertible debentures.  If the debentures are not converted into common stock by their maturity dates, the shares will revert back to the original shareholders of record on the date of merger on a pro rata basis.  Upon the closing of the Merger, former Source Vitamin stockholders held 58% of the issued and outstanding shares of common stock of the Company.

 
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On April 21, 2011, the Company filed an amendment to its articles of incorporation in Nevada to change its name to LTS Nutraceuticals, Inc.  Its directors and shareholders also approved a stock dividend to its shareholders pursuant to which the shareholders shall received 49 additional shares of Company’s common stock for each share of Company’s common stock owned.     All share and per share amounts have been retroactively restated.

Company Overview

Our principal offices are located in Florida, and we develop and sell high-quality nutritional products (“nutraceuticals”) that are distributed throughout North America through a network marketing system, which is a form of direct selling. Our customer base comprises two types of customer: "Entrepreneurs" (formerly called “distributors”) and "Retail Customers." Entrepreneurs are independent distributors of our products who distribute them to retail users and who also purchase the products for their personal use. Retail Customers purchase our products strictly for their personal use.

On June 13, 2011, the Company entered into a Purchase and Exclusive Marketing Agreement with Imagenetix, Inc. (“Imagenetix”), Proprietary Nutritionals, Inc. (“Proprietary”) and Pharmachem Laboratories, Inc. (with Imagenetix and Proprietary, “PNI”) pursuant to which the Company was granted the exclusive United States rights to purchase from PNI their Celadrin® products and brand (“Celadrin”) as well as exclusive marketing and distribution and related rights in the U.S.  Celadrin is our first product formulation which we sell to the mass market through retail market channel of retailers, including Walgreens, Rite Aid, Costco and BJ’s Wholesale Club.  As further described below, we have had exceptional success with our retail sales, including unanticipated demand for our Celadrin product from Walgreens and other retailers.

We began shipping products to Entrepreneurs in the United States in June 2009 and in Canada in April 2010.  We also began selling to our retail market customers Celadrin in June 2011  and our Fit product in September 2011, and have orders to deliver Jointritis in January 2012.

As a developer and manufacturer of nutritional and personal care products, we utilize a direct selling model for the distribution of our products. The success and growth of our business is primarily based on our ability to attract new Entrepreneurs and retain existing Entrepreneurs to sell and consume our products. Additionally, it is important to attract and retain Retail Customers, many of whom are loyal consumers of our products. We believe that our ability to attract and retain Entrepreneurs and Retail Customers to sell and consume our products is influenced by a number of factors. Some of these factors include: the growing desire for a secondary source of income and small business ownership, the general public's heightened awareness and understanding of the connection between diet and long-term health, and the aging of the worldwide population, as older people generally tend to consume more nutritional supplements. Other keys to our success will be:

·
to increase the sales and product mix of Celadrin, Fit and add other  products
·
to implement our revised Entrepreneur compensation plan to provide our entrepreneurs an opportunity to earn compensation from the sales of Celadrin and other products through our retail network (called “inline marketing”)
·
to acquire new product lines and businesses which complement the Company’s existing businesses

We believe that our high-quality products and our anticipated financially rewarding entrepreneur compensation plan are the key components to attracting and retaining Entrepreneurs and the continued success and growth of our business. To support our Entrepreneurs in building their businesses, we will sponsor meetings and events throughout the year, which offer information about our products and our network marketing system. These meetings are designed to assist Entrepreneurs in their business development and to provide a forum for interaction with some of our Entrepreneurs with leaders and members of our management team. We will also provide low cost sales tools, which we believe are an integral part of building and maintaining a successful home-based business for our associates.

 
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Expansion Plans

Our international operations were initiated by launching in Canada in April 2010.  We are currently exploring additional future expansion plans that include entry into new foreign markets and potential acquisition targets.  We have identified several products and foreign markets in Europe, Asia and South America to be considered for future expansion.  Furthermore, we are considering mergers and acquisitions of network marketing or retail/wholesale nutraceutical companies that offer synergy with the Company’s operations in addition to identifying other products that we can offer through our retail marketing arm.

Our recently announced agreement to acquire the Biocalth business will provide both manufacturing and distribution capability domestically as well as sales opportunities throughout North Africa and Asia for our existing products, as well as providing a whole new line of products (Biocalth products) for our domestic and international retail and inline marketing customers.

We had previously anticipated opening a chain of Symbiotic Diet Centers.  During the third quarter of 2011, the Company determined that due to the response to its products and the proposed Biocalth acquisition that it would focus on the distribution of its products through its retail and multilevel distribution methodologies.

Critical Accounting Policies and Estimates

Accounts Receivable

Accounts receivable are carried at the expected net realizable value. The allowance for doubtful accounts is based on management’s assessment of the collectability of specific customer accounts and the aging of the accounts receivable.  In addition, based on historical information, management estimates the amount of returned or damaged product and customers’ advertising allowances that may be deducted from outstanding accounts receivable.  If there were a deterioration of a major customer’s creditworthiness, or actual defaults or allowances were higher than historical experience, our estimates of the recoverability of amounts due to us could be overstated, which could have a negative impact on operations.

Revenue Recognition

The Company generates revenue from the sales of its vitamin and related health and nutritional products directly to consumers through its Entrepreneurs and retail marketing network. Revenue is recognized when all of the following conditions exist: (1) persuasive evidence of an arrangement exists, (2) delivery has occurred, (3) the sales price is fixed or determinable, and (4) collectability is reasonably assured.

The Company accounts for payments made to customers in accordance with ASC 605 “Revenue Recognition” (“ASC 605”), which states that cash consideration (including a sales incentive) given by a vendor to a customer is presumed to be a reduction of the selling prices of the vendor’s products or services and, therefore, should be characterized as a reduction of revenue when recognized in the vendor’s income statement, rather than a sales and marketing expense. The Company has various agreements with customers that provide for discounts and rebates. These agreements are classified as a reduction of revenue. Certain other costs associated with customers that meet the requirements of ASC No. 605 are recorded as sales and marketing expense.

Revenue is recognized at the time products are shipped.  The Company generally requires cash or credit card payment at the point of sale for certain products.  The compensation plan for the Company’s Entrepreneurs generally does not provide rebates or selling discounts to Entrepreneurs who purchase its products and services.

 
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Product Return Policy

Refunds are allowed only to Entrepreneurs who have given voluntary termination notices, or for incorrect or defective items.  In these circumstances only, the Company provides a 30-day return policy.

For products sold to customer through the retail marketing network, we guarantee customer satisfaction. Our policy requires the customer to return the unused product to the retailer from whom they originally purchased it.  We pay the retailer for the returned product plus a handling cost. We review gross revenue for estimated returns. The estimated returns are based on historical and industry experience. However, the estimate for product returns does not reflect the impact of a large product recall resulting from product nonconformance or other factors as such events are not predictable nor is the related economic impact estimable.   We periodically assess the adequacy of this policy and record a liability as necessary.

Deferred Revenue

The Company requires cash or credit card payment at the time of sale for certain products. Any payments that are received prior to shipment are recorded as deferred revenue until the specific product is shipped as described above, at which time, it is recorded as revenue.

Results of Operations

Comparison of the three months ended September 30, 2011 and 2010

The following table sets forth, for the periods indicated, condensed consolidated statements of operations information:
 
   
Three Months
Ended
September
30, 2011
   
Three Months
Ended
September
30, 2010
   
Change
(Dollars)
   
Change
(Percentage)
 
Gross Sales
  $ 1,642,651     $ 249,761     $ 1,392,890       558 %
Reserve for rebates and promotional allowances
    446,051       -       446,051       100 %
Net Sales
    1,196,600       249,761       946,839       379 %
Cost of Sales
    718,005       76,673       641,332       836 %
Gross Profit
    478,595       173,088       305,507       177 %
Entrepreneur incentives
    274,398       35,854       238,544       665 %
Selling, General and Administrative
    908,504       217,085       691,419       319 %
Total Operating Expenses
    1,182,902       252,939       929,963       368 %
Loss from Operations
    (704,307 )     (79,851 )     (624,456 )     (782 )%
Derivative Expense
    281,230       -       281,230       100 %
Interest Expense
    130,213       46,482       83,731       180 %
Net Loss
  $ (1,115,750 )   $ (126,333 )   $ (989,417 )     (783 )%

Sales

Gross sales for the three months ended September 30, 2011 and 2010 were $1,642,651 and $249,761, respectively.  Gross sales increased $1,392,890 or 558%, in the third quarter of 2011 over the same period in 2010, primarily due to $1,141,742 in sales from our Celadrin product and $307,160 in sales from our Fit product, neither of which product was sold by us in 2010.  This trend demonstrates the success of the marketability of our new product lines upon which we anticipate to augment in future quarters as demand for our popular products increases and we acquire new product lines such as through our anticipated Biocalth acquisition.

 
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Reserve of rebates and promotional allowances for the three months ended September 30, 2011 and 2010 were $446,051 and $0 respectively.  The reserve for rebates which increased $446,051 or 100%, in 2011 over 2010, relates to the sales of the Celadrin and Fit products only that did not occur in 2010.   As of September 30, 2011, we had acquired some historical basis for evaluating our rebate and promotional allowance reserves for our products.  As a result, we believe our reserves as of September 30, 2011 are adequate.

Net sales for the three months ended September 30, 2011 and 2010 were $1,196,600 and $249,761, respectively.  Net sales increased $946,839 or 379%, in 2011 over 2010. $1,002,851 of the increase is attributed to the newly acquired Celadrin and Fit products.   Management expects this trend to continue as we obtain more product lines and perhaps increase distribution of products into the marketplace as we are able to obtain financing for purchase orders in order to be able to acquire raw materials for products to fuel demand at a strong rate.

Gross Profit

Gross profit for the three months ended September 30, 2011 and 2010 were $478,595 and $173,088 which represents 40% and 69% of the net sales respectively. The gross profit increased $305,507 or 177% in 2011 over 2010 due to the increase in sales incrementally due to our new Celadrin and Fit product sales.  The gross profit for 2011 of 40% decreased from 69% for 2010 largely due to the change in the sales mix as Celadrin and Fit have lower margins than our other products.   Cost of sales for the three months ended September 30, 2011 and 2010 were $718,005 and $76,673 which represents a 60% and 31% respectively of the net sales for the periods, this is an increase of $641,332 or 836% in 2011 over 2010.

Entrepreneur Incentives

Entrepreneur incentives increased to $274,398 for the three months ended September 30, 2011 compared to $35,854 for the three months ended September 30, 2010, an increase of $238,544 or 665%.  The increase in entrepreneur incentives was primarily due to (i) discretionary programs to motivate the entrepreneurs to increase sales in 2011 and (ii) initial incentives paid to entrepreneurs on sales of Celadrin and Fit (through the ability of Entrepreneurs to obtain incentives from our retail sales due to our “inline marketing” concept), both of which did not occur in 2010.

Selling, General and Administrative

Selling, general and administrative increased to $908,504 for the three months ended September 30, 2011 compared to $217,085 for three months ended September 30, 2010.  Selling, general and administrative expenses increased by $691,419 or 319% in 2011 over 2010.  The increase is primarily due to approximately $323,499 of consulting and professional fees pertaining to investor relations, public relations, accounting, auditing and legal fees relating which were not incurred in 2010 due to expenses relating to the Merger and public company expense, approximately $274,664 of salary expense attributable to the increase in workforce from approximately three employees as of September 30, 2010 to 17 employees as of September 30, 2011 and approximately $60,603 in additional travel expenses.

Interest Expense

Interest expense increased to $130,213 for the three months ended September 30, 2011 compared to $46,482 for the three months ended September 30, 2010.  Interest expense increased by $83,731 or  180%, largely due to increasing our outstanding debt of $806,698 at September 30, 2010 to $4,690,376 at September 30, 2011.   Also included in interest expense was accretion of note discounts and amortization of deferred loan costs.  $0 of note discount accretion and $0 of deferred loan cost amortization was recorded for the three months ended September 30, 2011 compared to $3,976 and $24,304, respectively, for the three months ended September 30, 2010. The decrease in accretion of note discount and amortization of deferred loan costs in 2011 over 2010 is largely due to writing off $74,737 of debt discount and $39,147 of deferred loan costs associated with the notes payable that were converted into convertible notes payable in conjunction with the April 6, 2011 financing.
 
 
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Comparison of the nine months ended September 30, 2011 and 2010

   
Nine
months Ended
September
30, 2011
   
Nine
months Ended
September
30, 2010
   
Change
(Dollars)
   
Change
(Percentage)
 
Gross Sales
  $ 2,586,515     $ 997,657     $ 1,588,858       159 %
Reserve for rebates
    828,125       -       828,125       100 %
Net Sales
    1,758,390       997,657       760,733       76 %
Cost of Sales
    1,090,273       525,079       565,194       108 %
Gross Profit
    668,117       472,578       195,539       41 %
Entrepreneur incentives
    578,553       305,192       273,361       90 %
Selling, General and Administrative
    2,232,356       530,823       1,701,533       321 %
Total Operating Expenses
    2,810,909       836,015       1,974,894       236 %
Loss from Operations
    (2,142,792 )     (363,437 )     (1,779,355 )     490 %
Derivative Expense
    286,136       -       286,136       100 %
Interest Expense
    530,537       107,798       422,739       392 %
Net Loss
  $ (2,959,465 )   $ (471,235 )   $ (2,488,230 )     528 %

Sales

Gross sales for the nine months ended September 30, 2011 and 2010 were $2,586,515 and $997,657 respectively.  Gross sales increased $1,588,858 or 159%, in 2011 over the same period 2010, primarily due to $1,665,178 in sales from our Celadrin product and $307,160 in sales from our Fit product, neither of which peoduct was sold by us in 2010.  This trend demonstrates the success of the marketability of our new product lines upon which we anticipate to augment in future quarters as demand for our popular products increases and we acquire new product lines such as through our anticipated Biocalth acquisition,

Reserve of rebates and promotional allowances for the nine months ended September 30, 2011 and 2010 were $828,125 and $0 respectively.  The reserve for rebates which increased $828,125 or 100%, in 2011 over 2010, relates to the sales of the Celadrin and Fit products only that did not occur in 2010. As of September 30, 2011 we had acquired some historical basis for evaluating the rebate and promotional allowance reserves for our products.  As a result we believe our reserves at September 30, 2011 are adequate.

Net sales for the nine months ended September 30, 2011 and 2010 were $1,758,390 and $997,657 respectively.  Net sales increased $760,733 or 76%, in 2011 over 2010. $1,144,213 of the increase is attributed the sales of our newly acquired Celadrin and Fit products in 2011. Management expects this trend to continue as we obtain more product lines and perhaps increase distribution of products into the marketplace as we are able to obtain financing for purchase orders in order to acquire raw materials for products to fuel demand at a strong rate.

Gross Profit

Gross profit for the nine months ended September 30, 2011 and 2010 were $668,117 and $472,578 which represents 38% and 47% of the net sales, respectively. The gross profit increased $195,539 or 41% in 2011 over 2010 due to increase in sales incrementally due to our new Celadrin and Fit product sales.  The gross profit for 2011 of 38% decreased from 47% for the full year 2010 largely due to the change in the sales mix as Celadrin has lower margins than our other products.   Cost of sales for the nine months ended September 30, 2011 and 2010 were $1,090,273 and $525,079 which represents a 62% and 53% respectively of the net sales for the periods, this is an increase of $565,194 or 108% in 2011 over 2010.

Entrepreneur Incentives

Entrepreneur incentives increased to $578,553 for the nine months ended September 30, 2011 compared to $305,192 for the nine months ended September 30, 2010, an increase of $273,361 or 90%.  The increase in entrepreneur incentives was primarily due to (i) discretionary programs to motivate the entrepreneurs to increase sales in the second quarter of 2011 and (ii) initial incentives paid to entrepreneurs on sales of Celadrin and Fit (through the ability of the Entrepreneurs to obtain incentives from our retail sales due to our “inline marketing” concept), both of which did not occur in 2010.

 
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Selling, General and Administrative

Selling, general and administrative increased to $2,232,356 for the nine months ended September 30, 2011 compared to $530,823 for nine months ended September 30, 2010.  Selling, general and administrative expenses increased by $1,701,533 or 321% in 2011 over 2010.  The increase is primarily due to approximately and additional $796,000 of consulting and professional fees pertaining to investor relations, public relations, accounting, auditing and legal fees relating which were not incurred in 2010 due to expenses relating to the Merger and public company expenses and approximately $638,000 of salary expense attributable to the increase in workforce from approximately three employees as of September 30, 2010 to 17 employees as of September 30, 2011 and $197,547 in additional travel expenses.

Interest Expense

Interest expense increased to $530,537 for the nine months ended September 30, 2011 compared to $107,798 for the nine months ended September 30, 2010.  Interest expense increased by $422,738 or 392%, largely due to increasing our outstanding debt of $806,698 at September 30, 2010 to $4,690,376 at September 30, 2011.   Also included in interest expense was accretion of note discounts and amortization of deferred loan costs.  $159,569 of note discount accretion and $81,592 of deferred loan cost amortization was recorded for the nine months ended September 30, 2011 compared to $18,472 and $35,415 respectively, for the nine months ended September 30, 2010. The increase in accretion of note discount and amortization of deferred loan costs in 2011 over 2010 is largely due to writing off $74,737 of debt discount and $39,147 of deferred loan costs associated with the notes payable that were converted into convertible notes payable in conjunction with the April 6, 2011 issuance of the convertible notes payable.

Going Concern, Liquidity and Management's Plan

During the nine months ended September 30, 2011, we incurred a net loss of $2,959,465 and used $2,020,054 in cash from our operations primarily as a result of our net loss offset by non cash expenses of $574,402, and increases in restricted cash, accounts receivable, prepaid expenses, accounts payable, accrued expenses and deferred revenues. In addition, at September 30, 2011, we had working capital of $283,508 and an accumulated deficit of $4,826,342.

During the nine months ended September 30, 2011, our investing activities used net cash of $946,324 to purchase fixed assets and a net increase in restricted cash and our financing activities generated $3,299,525 in net proceeds from the issuance of a $400,000 promissory note offset by $65,000 to purchase treasury stock in connection with the reverse merger, net proceeds of $3,020,525 from the April 6, 2011 capital raise and payment of $56,000 of debt issue costs.

We are also looking at different ways to obtain financing for production of products through a mix of purchase order and accounts receivable financing so that we can fund further production and bring larger quantities of product to market on a faster basis to meet demand.

We do not yet have a sustained history of financial stability. Historically our principal source of liquidity has been the issuances of debt securities, including notes payable and convertible debentures.

On November 10, 2011, the Company had $37,633 in cash. The current operating plan indicates that losses from operations may be incurred for all of fiscal 2011. Consequently the Company may not have sufficient liquidity necessary to sustain operations for the next twelve months and this raises substantial doubt that the Company will be able to continue as a going concern.

 
27

 

Management is in the process of executing a plan to improve the operating performance and the financial position of the Company. This plan includes optimizing obtaining additional equity or debt financings, securing financing to purchase inventory, and increasing our product offering mix to the customers in our retail network. In addition, the Company continues to develop other initiatives intended to either increase sales, reduce costs or improve liquidity. Although management's plan reflects improvements in these trends, there can be no assurance that management's plan to improve the operating performance and the financial position of the Company will be successful. The Company continues to evaluate other alternative sources of capital for ongoing cash needs, however, there can be no assurance the Company will be successful in those efforts.

The accompanying consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability of assets or the amounts of liabilities that may result should the Company be unable to continue as a going concern.

Related Party Transactions

The founder had an agreement with Source Vitamin whereby he was to receive a bonus of five percent of eligible monthly sales that ended May 1, 2011.  As a result of this agreement, the Company recorded bonus expense of $0 and $2,764 to the founder for the three months ended September 30, 2011 and 2010, respectively, and $12,762 and $40,785 for the nine months ended September 30, 2011 and 2010, respectively.

See “Related Party Transactions” in our footnotes to our condensed consolidated financial statements for a description of an employment agreement with our CEO and a consulting agreement with our founder.

Off-Balance Sheet Arrangements

With the exception of operating leases, the company is not a party to any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on the Company’s financial condition, results of operations or cash flows.  The Company enters into operating leases for property.

Cautionary Factors That May Affect Future Results

This Quarterly Report on Form 10-Q and other written reports and oral statements made from time to time by the Company may contain so-called “forward-looking statements,” all of which are subject to risks and uncertainties. You can identify these forward-looking statements by their use of words such as “expects,” “plans,” “will,” “estimates,” “forecasts,” “projects” and other words of similar meaning. You can identify them by the fact that they do not relate strictly to historical or current facts. These statements are likely to address the Company’s growth strategy, financial results and product and development programs. You must carefully consider any such statement and should understand that many factors could cause actual results to differ from the Company’s forward-looking statements. These factors include inaccurate assumptions and a broad variety of other risks and uncertainties, including some that are known and some that are not. No forward-looking statement can be guaranteed and actual future results may vary materially.

The Company does not assume the obligation to update any forward-looking statement. You should carefully evaluate such statements in light of factors described in this Form 10-Q. In various filings the Company has identified important factors that could cause actual results to differ from expected or historic results. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider any such list to be a complete list of all potential risks or uncertainties.

ITEM 4. CONTROLS AND PROCEDURES

Management’s Conclusions Regarding Effectiveness of Disclosure Controls and Procedures

Management, with the participation of our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this quarterly report on Form 10-Q (the “Evaluation Date”). Based upon that evaluation, our Chief Executive Officer/ Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures are not effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized, documented and reported, within the time periods specified in the SEC rules and forms and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 
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Notwithstanding the conclusion that our disclosure controls and procedures were not effective as of the end of the period covered by this Quarterly Report, the Chief Executive Officer/ the Chief Financial Officer believes that the condensed consolidated financial statements and other information contained in this Quarterly Report present fairly, in all material respects, our business, financial condition and results of operations.

Our management, including our Chief Executive Officer/ Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.

We have identified certain significant deficiencies that together constitute a material weakness in our disclosure controls and procedures. These significant deficiencies primarily relate to our lack of formalized written policies and procedures in the financial accounting area, our lack of appropriate resources to handle the accounting for complex equity and other transactions, and our lack of sophisticated financial reporting systems, due in part to the small size of our Company prior to the Merger. These significant deficiencies together constitute a material weakness in our disclosure controls and procedures.
 
We intend to continue taking steps in the fourth quarter to remedy these issues by implementing necessary written procedures and reports, as we still have additional work to do to bring our disclosure controls and procedures up to public-company standards. Because the Merger occurred on March 31, 2011 and because SourceVitamin was a small privately-held company, we were unable to upgrade our disclosure controls and procedures to the level required of a public company prior to the end of the period covered by this quarterly report. Nevertheless, we are initiating remediation steps to rectify the identified significant deficiencies thattogether constitute a material weakness in our disclosure controls and procedures. Because these remediation steps have not yet been completed, we have performed additional analyses and other post-closing procedures to ensure that our condensed consolidated financial statements contained in this Quarterly Report were prepared in accordance with U.S. GAAP and applicable SEC regulations. Our planned remediation includes formalizing written policies and procedures, determining the appropriate resources to handle complex transactions as they arise in the future, and upgrading our financial reporting systems.
 
Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting

PART II - OTHER INFORMATION

Item 1. Legal Proceedings.

We are not aware of any litigation pending or threatened by or against the Company.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

On March 31, 2011, Stone Harbor Investments, Inc. (“Stone Harbor” or the “Company”) entered into a Share Exchange Agreement (the “Exchange Agreement”), with The Source Vitamin Company, Inc. (“Source Vitamin”) and the shareholders of Source Vitamin. Pursuant to the Exchange Agreement, which closed on March 31, 2011, the Company issued 24,300,000 (486,000) shares of the Company’s common stock to the shareholders of Source Vitamin, representing approximately 58% of the Company’s aggregate issued and outstanding common stock following the closing of the Exchange Agreement, in exchange for all of the issued and outstanding common stock of Source Vitamin.

 
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On April 6, 2011, in a private placement transaction, exempt from registration under Section 4(2) of the Securities Act of 1933, the Company issued $4,690,376 of Convertible Notes Payable, of which $1,670,376 went to refinancing of existing notes payable and related accrued interest. The Convertible Notes have a two year term maturing April 5, 2013, bear interest at ten percent per annum (payable semi-annually) and are secured by a first lien on all assets of the Company. The principal balances of the notes along with any unpaid interest may be converted anytime at the option of the holders to common stock at a price of $0.50 per share. During the life of the notes, the conversion price will be adjusted any time the Company sells it stock for a price under $0.50 to the lowest price sold. In connection with the Notes, the Company issued 9,380,753 five year warrants to acquire the Company’s common stock at a price of $0.50 per share. During the life of the notes, the exercise price will be adjusted any time the Company sells it stock for a price under $0.50 to the lowest price sold.

In connection with the foregoing, the Company relied upon the exemption from securities registration afforded by Rule 506 of Regulation D as promulgated by the United States Securities and Exchange Commission under the Securities Act of 1933, as amended (the “Securities Act”) and/or Section 4(2) of the Securities Act. No advertising or general solicitation was employed in offering the securities. The offerings and sales were made to a limited number of persons, all of whom were accredited investors, and transfer was restricted by the Company in accordance with the requirements of the Securities Act of 1933.

Item 6. Exhibits

Exhibit 31 - Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32 - Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
The following materials from the Company’s Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2011, formatted in eXtensible Business Reporting Language (XBRL): (i) the Condensed Balance Sheets, (ii) the Condensed Statements of Operations, (iii) the Condensed Statements of Cash Flows and (v) the Notes to Condensed Financial Statements, as follows:
 
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema
101.CAL
XBRL Taxonomy Extension Calculation Linkbase
101.DEF
XBRL Taxonomy Extension Definition Linkbase
101.LAB
XBRL Taxonomy Extension Label Linkbase
101.PRE
XBRL Extension Presentation Linkbase
 
SIGNATURES

Pursuant to the requirements 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.

Dated: November 14, 2011

LTS Nutraceuticals, Inc.

By:
/s/Jerry Rayman
 
Jerry Rayman, Principal Executive Officer and
 
Principal Financial and Accounting Officer
 

 
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