UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
 
x Quarterly Report Under Section 13 Or 15(d) Of The Securities Exchange Act Of 1934
 
For quarterly period ended June 30, 2008
 
¨ Transition Report Under Section 13 Or 15(d) Of The Securities Exchange Act Of 1934
 
For the transition period from _____ to _____
 
COMMISSION FILE NUMBER 033-24138-D
 
IMAGENETIX, INC.
(Exact name of registrant as specified in its charter)
 
NEVADA
87-0463772
(State or other jurisdiction of incorporation or
organization) 
(I.R.S. Employer Identification No.)

10845 Rancho Bernardo Road, Suite 105
San Diego, California 92127
(Address of principal executive offices)
 
Registrant’s telephone number (including area code) (858) 674-8455
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x    No ¨  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.

Large accelerated filer o  
 
Accelerated filer o  
 
Non-accelerated filer o  
 
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 ¨       No x
 
 
State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date:
 
Common Stock, $.001 par value
 
10,960,788
 
(Class)
 
 
Outstanding at August 13, 2008
 

 
Imagenetix, Inc.
 
INDEX
   
     
Page
       
PART I. FINANCIAL INFORMATION
 
       
 
Item 1.
Financial Statements:
 
       
   
Condensed Consolidated Balance Sheets as of June 30, 2008 (unaudited) and March 31, 2008
3  
       
   
Condensed Consolidated Statements of Operations for the three months ended June 30, 2008 and 2007 (unaudited)
4  
       
   
Condensed Consolidated Statements of Cash Flows for the three months ended June 30, 2008 and 2007 (unaudited)
5  
       
   
Notes to Unaudited Condensed Consolidated Financial Statements
6  
       
 
Item 2.
Management’s Discussion and Analysis or Plan of Operation
11  
       
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
*  
       
 
Item 4T.
Controls and Procedures
18  
       
PART II. OTHER INFORMATION
 
       
 
Item 1.
Legal Proceedings
*  
 
Item 1A.
Risk Factors
*  
    
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
*  
 
Item 3.
Defaults Upon Senior Securities
*  
 
Item 4.
Submission of Matters to a Vote of Security Holders
*  
 
Item 5.
Other Information
*  
 
Item 6.
Exhibits
19  
       
SIGNATURES
 

  No information provided due to inapplicability of the item.

2

 
PART I - FINANCIAL INFORMATION
 
Item 1. Financial Statements
 
Imagenetix, Inc.
Condensed Consolidated Balance Sheets
 
   
June 30, 
 
  March 31, 
 
 
 
2008 
 
2008 
 
   
(Unaudited)
 
   
 
ASSETS
             
Current assets:
             
Cash and cash equivalents
 
$
2,065,256
 
$
1,022,555
 
Accounts receivable, net
   
1,249,603
   
765,492
 
Inventories, net
   
1,246,851
   
1,109,845
 
Prepaid expenses and other current assets
   
170,121
   
252,138
 
Deferred tax asset
   
390,097
   
862,497
 
Total current assets
   
5,121,928
   
4,012,527
 
               
Property and equipment, net
   
104,652
   
112,190
 
Long-term prepaid expenses
   
39,000
   
42,000
 
Other assets
   
231,705
   
218,155
 
Total Assets
 
$
5,497,285
 
$
4,384,872
 
               
LIABILITIES AND STOCKHOLDERS' EQUITY
             
Current liabilities:
             
Accounts payable
 
$
974,378
 
$
713,324
 
Accrued liabilities
   
91,878
   
72,301
 
Customer deposits
   
262,666
   
63,216
 
Contract payable
   
23,100
   
46,200
 
Short term license payable
   
28,929
   
34,259
 
Total current liabilities
   
1,380,951
   
929,300
 
Long term license payable
   
-
   
2,980
 
Total Liabilities
   
1,380,951
   
932,280
 
               
Stockholders' equity
             
Preferred stock, $.001 par value; 5,000,000 shares
             
authorized: none outstanding
   
-
   
-
 
Common stock, $.001par value; 50,000,000 shares
             
authorized: 10,960,788 issued and outstanding at
             
June 30 and March 31, 2008
   
10,960
   
10,960
 
Capital in excess of par value
   
12,558,073
   
12,481,407
 
Accumulated deficit
   
(8,452,699
)
 
(9,039,775
)
Total stockholders' equity
   
4,116,334
   
3,452,592
 
Total Liabilities and Stockholders' Equity
 
$
5,497,285
 
$
4,384,872
 
See accompanying notes to unaudited condensed consolidated financial statements.      

3

 
Imagenetix, Inc.
Condensed Consolidated Statements of Operations
(Unaudited)

   
Three Months Ended
 
   
  June 30, 
 
  June 30, 
 
 
 
2008
 
2007
 
             
Net sales
 
$
1,394,358
 
$
1,126,991
 
               
Cost of sales
   
819,711
   
536,604
 
               
Gross profit
   
574,647
   
590,387
 
               
Operating expenses:
             
General and administrative
   
605,472
   
646,509
 
Payroll expense
   
372,190
   
356,497
 
Consulting expense
   
345,761
   
251,524
 
Operating expenses
   
1,323,423
   
1,254,530
 
Operating income (loss)
   
(748,776
)
 
(664,143
)
Other income (expense):
             
Other income
   
7,742
   
6,944
 
Settlement income
   
1,785,000
   
-
 
Interest expense
   
(690
)
 
(1,327
)
Other income
   
1,792,052
   
5,617
 
Income (loss) before income taxes
   
1,043,276
   
(658,526
)
               
Income tax expense (benefit)
   
456,200
   
(223,000
)
               
Income (loss)
 
$
587,076
 
$
(435,526
)
               
Basic income (loss) per share
 
$
0.05
 
$
(0.04
)
               
Diluted income (loss) per share
 
$
0.05
 
$
(0.04
)
               
Basic weighted average common shares outstanding
   
10,960,788
   
10,871,400
 
               
Diluted weighted average common shares outstanding
   
11,021,173
   
10,871,400
 

See accompanying notes to unaudited condensed consolidated financial statements.

4


Imagenetix, Inc.
Consolidated Statements of Cash Flows
(Unaudited)

   
Three Months Ended
 
 
 
June 30, 2008
 
June 30, 2007
 
Operating activities:
             
Net income (loss)
 
$
587,076
 
$
(435,526
)
Adjustments to reconcile net income (loss)
             
to cash provided by (used in) operating activities:
             
Amortization and depreciation
   
10,188
   
12,176
 
Provision for doubtful accounts
   
-
   
15,000
 
Provision for inventory obsolescence
   
(12,003
)
 
22,105
 
Non cash expense related to issuance of warrants
             
and granting of stock options
   
76,666
   
304,607
 
Changes in assets and liabilities:
             
(Increase) decrease in accounts receivable
   
(484,111
)
 
656,053
 
(Increase) decrease in employee receivable
   
845
   
764
 
(Increase) decrease in inventories
   
(125,003
)
 
(152,389
)
(Increase) decrease in other assets
   
84,171
   
(11,434
)
(Increase) decrease in deferred taxes
   
456,200
   
(223,000
)  
Increase (decrease) in accounts payable
   
261,055
   
57,410
 
Increase (decrease) in accrued liabilities
   
19,577
   
11,319
 
Increase (decrease) in customer deposits
   
199,450
   
375,000
 
Net cash provided by operating activities
   
1,074,111
   
632,085
 
Investing activities:
             
Purchases of property and equipment
   
-
   
(12,840
)
Net cash used in investing activities
   
-
   
(12,840
)
Financing activities:
             
Payments on contracts payable
   
(23,100
)
 
(24,985
)
Payments on patent license financed
   
(8,310
)
 
(7,673
)
Net cash used in financing activities
   
(31,410
)
 
(32,658
)
Net increase in cash and cash equivalents
   
1,042,701
   
586,587
 
Cash and cash equivalents , beginning of period
   
1,022,555
   
958,896
 
Cash and cash equivalents, end of period
 
$
2,065,256
 
$
1,545,483
 
               
Supplemental Disclosure of Cash Flow Information:
             
Cash paid during the period for:
             
Interest
 
$
690
 
$
1,327
 
Income taxes
 
$
-
 
$
-
 

See accompanying notes to unaudited condensed consolidated financial statements.

5

 
IMAGENETIX, INC.
Notes to the Unaudited Condensed Consolidated Financial Statements

1.
BASIS OF PRESENTATION  

The consolidated financial statements of Imagenetix, Inc. ("Imagenetix") presented herein have been prepared pursuant to the rules of the Securities and Exchange Commission for quarterly reports on Form 10-Q and do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America. These statements should be read in conjunction with our audited consolidated financial statements and notes thereto included in Form 10-KSB for the year ended March 31, 2008.

In the opinion of management, the interim consolidated financial statements reflect all adjustments of a normal recurring nature necessary for a fair statement of the results for interim periods. Operating results for the three month period is not necessarily indicative of the results that may be expected for the year.

Earnings Per Share  

We follow Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share." Under SFAS No. 128, basic earnings per share is calculated as earnings available to common stockholders divided by the weighted average number of common shares outstanding. Diluted earnings per share is calculated as net income divided by the diluted weighted average number of common shares. The diluted weighted average number of common shares is calculated using the treasury stock method for common stock issuable pursuant to outstanding stock options and common stock warrants. See Note 6 for discussion of commitments to issue additional shares of common stock and warrants.

Stock Based Compensation  

Effective January 1, 2006, we adopted FASB Statement No. 123R, “Accounting for Stock-Based Compensation” (“SFAS 123R”). SFAS 123R requires all share-based payments to employees, including grants of employee stock options and restricted stock, to be recognized in the financial statements based on their fair values.

We have selected the Black-Scholes method of valuation for share-based compensation. The charge is recognized in non cash compensation, which is included in stock-based compensation expense, on a straight-line basis over the remaining service period based on the options’ original estimate of fair value.

We apply SFAS No. 123 in valuing options granted to consultants and estimate the fair value of such options using the Black-Scholes option-pricing model. The fair value is recorded as consulting expense as services are provided. Options granted to consultants for which vesting is contingent based on future performance are measured at their then current fair value at each period end, until vested.

2.   RECENT ACCOUNTING PRONOUNCEMENTS

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (SFAS No. 161”). SFAS No. 161 amends and expands the disclosure requirement for FASB Statement No. 133, “Derivative Instruments and Hedging Activities” (“SFAS No. 133”). It requires enhanced disclosure about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedge items are accounted for under SFAS No. 133 and its related interpretations, and (iii) how derivative instruments and related hedge items affect an entity’s financial position, financial performance, and cash flows. SFAS No. 161 is effective for the Company as of April 1, 2009. The Company is currently assessing the impact of SFAS 161 on its consolidated financial position and results of operations.

6


IMAGENETIX, INC.
Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” SFAS No. 162 identifies the sources of accounting principles and provides entities with a framework for selecting the principles used in preparation of financial statements that are presented in conformity with GAAP. The current GAAP hierarchy has been criticized because it is directed to the auditor rather than the entity, it is complex, and it ranks FASB Statements of Financial Accounting Concepts, which are subject to the same level of due process as FASB Statements of Financial Accounting Standards, below industry practices that are widely recognized as generally accepted but that are not subject to due process. The Board believes the GAAP hierarchy should be directed to entities because it is the entity (not its auditors) that is responsible for selecting accounting principles for financial statements that are presented in conformity with GAAP. The adoption of FASB 162 is not expected to have a material impact on the Company’s consolidated financial position and results of operations.

In April 2008, the FASB issued FSP 142-3, “Determination of the Useful Life of Intangible Assets”, (FSP 142-3). FSP 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets”. FSP 142-3 is effective for fiscal years beginning after December 15, 2008. The Company is currently assessing the impact of FSP 142-3 on its consolidated financial position and results of operations.

3.   ACCOUNTS RECEIVABLE

Accounts receivable are carried at the expected realizable value. Accounts receivable consisted of the following:
 
   
June 30, 
2008 
 
March 31, 
2008 
 
   
 
 
 
 
           
Accounts receivable - trade
 
$
1,354,603
 
$
870,492
 
Allowance for doubtful accounts
   
(105,000
)
 
(105,000
)
               
Accounts receivable, net
 
$
1,249,603
 
$
765,492
 
 
At June 30, 2008, we had two customers which accounted for 46% and 19% of our accounts receivable balances.   At March 31, 2008, we had two customers which accounted for 16% and 12% of our accounts receivable balances.

For the three months ended June 30, 2008, we had two significant customers which accounted for 48%, and 26% of sales. For the three months ended June 30, 2007, we had three significant customers which accounted for 28%, 11% and 11% of sales.

7


IMAGENETIX, INC.
Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)
 
4.   INVENTORIES

Inventories consist of the following:

   
  June 30,
 
  March 31, 
 
 
 
2008
 
2008
 
             
Raw materials
 
$
940,746
 
$
824,807
 
Finished products
   
236,242
   
295,615
 
Boxes, labels, tubes & bottles
   
208,402
   
139,965
 
     
1,385,390
   
1,260,387
 
Reserve for obsolescence
   
(138,539
)
 
(150,542
)
 
 
$
1,246,851
 
$
1,109,845
 


5.
OTHER ASSETS

The following is a summary of intangible assets which are included in “Other Assets” on the face of the balance sheet:

   
  June 30,
 
  March 31, 
 
 
 
2008
 
2008
 
             
Trademarks
 
$
13,032
 
$
13,032
 
Patent
   
172,965
   
172,965
 
Deferred tax asset
   
103,900
   
87,700
 
     
289,897
   
273,697
 
               
Less accumulated amortization
   
58,192
   
55,542
 
               
 
 
$
231,705
 
$
218,155
 

6.   EQUITY TRANSACTIONS

We recorded non-cash compensation expense for stock options and warrants issued to employees and consultants of $76,666 for the three months ended June 30, 2008 and $164,019 for the three months ended June 30, 2007. Also, we recorded non-cash general and administrative expense for warrants granted to individuals of $140,588 for the three months ended June 30, 2007.

The significant assumptions used in the Black-Scholes model to estimate the compensation and general and administrative expense for the issuance of stock options and warrants are as follows:
 
   
Three months ended June 30,
 
 
 
2008
 
2007
 
           
Expected term of options and warrants
   
5 years
   
5 years
 
Expected volatility
   
61
%
 
71
%
Expected dividends
   
None
   
None
 
Risk-free interest rate
   
3.36 to 3.54
%
 
4.55
%
Forfeitures
   
0
%
 
0
%

8


IMAGENETIX, INC.
Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

A summary of the options outstanding follows:

   
  For the Three Months Ended   
 
   
  June 30, 2008
 
       
  Weighted
 
       
  Average
 
       
  Exercise
 
Options
   
Shares
   
Price
 
Outstanding at beginning of year
   
944,000
 
$
1.00
 
Granted
   
305,000
   
0.65
 
Cancelled
   
-
   
-
 
Exercised
   
-
   
-
 
Outstanding at end of the period
   
1,249,000
   
0.92
 
                 
Exercisable at end of the the period
   
1,096,500
 
$
0.95
 
               
Weighted average fair value of options granted during the period
   
305,000
 
$
0.36
 
 
As of June 30, 2008, the unamortized portion of stock compensation expense on all existing stock options was $54,562.

A summary of warrants outstanding follows:

   
For the Three Months Ended   
 
   
  June 30, 2008   
 
       
  Weighted
 
       
  Average
 
       
  Exercise
 
Warrants
   
Shares
   
Price
 
Outstanding at beginning of year
   
3,902,957
 
$
1.18
 
Granted
   
25,000
   
1.20
 
Cancelled
   
-
   
-
 
Exercised
   
-
   
-
 
Outstanding at end of the period
   
3,927,957
   
1.18
 
                 
Exercisable at end of the the period
   
3,927,957
 
$
1.18
 
               
Weighted average fair value of warrants granted during the period
   
25,000
 
$
0.42
 

7.   INCOME TAXES

We file income tax returns in the U.S. federal jurisdiction and the state of California. With few exceptions, we are no longer subject to U.S. federal, state and local or non-U.S. income tax examinations by tax authorities for years before 2004.

We adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, on April 1, 2007. As a result of the implementation of Interpretation 48, we did not recognize an increase
in the liability for unrecognized tax benefits. No unrecognized tax benefits are being reported for the three months ended June 30, 2008.

9


IMAGENETIX, INC.
Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

Included in the balance at April 1, 2007, were no tax positions for which the ultimate deductibility is highly certain but for which there is uncertainty about the timing of such deductibility. Because of the impact of deferred tax accounting, other than interest and penalties, the disallowance of the shorter deductibility period would not affect the annual effective tax rate but would accelerate the payment of cash to the taxing authority to an earlier period.

Our policy is to recognize interest accrued related to unrecognized tax benefits in interest expense and penalties in operating expenses.
 
10


ITEM 2.     MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION. 

THE FOLLOWING DISCUSSION INCLUDES FORWARD-LOOKING STATEMENTS WITH RESPECT TO OUR FUTURE FINANCIAL PERFORMANCE. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE CURRENTLY ANTICIPATED AND FROM HISTORICAL RESULTS DEPENDING UPON A VARIETY OF FACTORS, INCLUDING THOSE DESCRIBED BELOW UNDER THE SUB-HEADING, "RISK FACTORS." SEE ALSO OUR ANNUAL REPORT ON FORM 10-KSB FOR THE YEAR ENDED MARCH 31, 2008.
 
Overview
 
We develop, formulate and market over-the-counter, natural-based nutritional supplements and skin care products. Our products are proprietary, often supported by scientific studies which we request and are offered through multiple channels of distribution, including direct marketing companies, also known as network marketing or multi-level marketing companies, and chain store retailers. Our primary product is Celadrin® a product formulation which we sell to the mass market through retailers and on a private label basis to wholesale customers.

A key part of our marketing strategy is to provide to our wholesale customers a "turnkey" approach to the marketing and distribution of our products. This turnkey approach provides these customers with all the services necessary to market our products, including developing specific product formulations, providing supporting scientific studies regarding the effectiveness of the product and arranging for the manufacture and marketing of the product.

We sell directly to the mass markets through retailers InflameAway, our own Celadrin® branded product. We also develop and sell products and formulations to businesses and organizations that market these products through multiple channels of distribution, including direct marketing companies, mass marketing companies, medical, health and nutritional professionals, medical newsletters and direct response radio and television. We also offer Celadrin® products through wholesale customers that in turn offer their products containing Celadrin® to mass market retailers.

Management's discussion and analysis or plan of operation is based upon the Company's financial statements. These statements have been prepared in accordance with accounting principles generally accepted in the United States of America. These principles require management to make certain estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates based on historical experience and 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 under different assumptions or conditions .

  Critical Accounting Policies and Estimates

We have identified four accounting principles that we believe are key to an understanding of our financial statements. These important accounting policies require management's most difficult, subjective judgments .

1.   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 collectibility of specific customer accounts and the aging of the accounts receivable. If there were a deterioration of a major customer’s creditworthiness, or actual defaults 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.

2. Inventory
Inventory is carried at the lower of cost or market. Cost is determined by the first-in first-out method. At each period end, management adjusts the inventory allowance based on estimates. These estimates take into account
spoilage, yields, obsolescence and overstocked inventory amounts.

11


3. Revenue Recognition
 
We recognize revenue in accordance with the SEC’s Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial Statements” (SAB104), Statement of Financial Accounting Standards No. 48, “Revenue Recognition When Right of Return Exists” (SFAS 48), and Emerging Issues Task Force Abstract (EITF) No. 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products.” SAB 104 requires that four basic criteria be met before revenue can be recognized: 1) there is evidence that an arrangement exists; 2) delivery has occurred; 3) the fee is fixed or determinable; and 4) collectibility is reasonably assured. SFAS 48 states that revenue from sales transactions where the buyer has the right to return the product shall be recognized at the time of sale only if (1) the seller’s price to the buyer is substantially fixed or determinable at the date of sale; (2) the buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product; (3) the buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product; (4) the buyer acquiring the product for resale has economic substance apart from that provided by the seller; (5) the seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer; and (6) the amount of future returns can be reasonably estimated. We recognize revenue upon determination that all criteria for revenue recognition have been met. The criteria are usually met at the time title passes to the customer, which usually occurs upon shipment. Revenue from shipments where title passes upon delivery is deferred until the shipment has been delivered.
 
We account for payments made to customers in accordance with EITF 01-09, 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. We have 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 EITF 01-09 are recorded as sales and marketing expense.
 
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 periodically assess the adequacy of this policy and will record a liability as necessary. For the three months ended June 30, 2008, there were no returns that would suggest a liability needed to be recorded.
 
We review gross revenue for estimated returns of private label contract manufacturing products and direct-to-consumer products. The estimated returns are based upon the trailing six months of private label contract manufacturing gross sales and our historical experience for both private label contract manufacturing and direct-to-consumer product returns. 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. For the three months ended June 30, 2008, there were no returns that would suggest a liability needed to be recorded.
 
As part of the services we provide to our private label contract manufacturing customers, we may perform, but are not required to perform, certain research and development activities related to the development or improvement of their products. While our customers typically do not pay directly for this service, the cost of this service is included as a component of the price we charge to manufacture and deliver their products.

4. Income Taxes
Deferred income taxes are provided using the liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of the changes in tax laws and rates of the date of enactment.

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other portions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with the tax positions taken that exceed the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

12

 
Selected Financial Information
 
Results of Operations
 
Three Months Ended June 30, 2008 Compared to Three Months Ended June 30, 2007
 
   
Three Months Ended
         
            
Increase
     
   
6/30/08
 
 6/30/07
 
(Decrease)
 
%
 
                    
Statements of Operations:
                         
Net sales
 
$
1,394,358
 
$
1,126,991
 
$
267,367
   
23.7
%
Cost of goods sold
   
819,711
   
536,604
   
283,107
   
52.8
%
% of net sales
   
59
%
 
48
%
 
11
%
 
23.5
%
Gross profit
   
574,647
   
590,387
   
(15,740
)
 
-2.7
%
% of net sales
   
41
%
 
52
%
 
-11
%
 
-21.3
%
Operating expenses
                         
General and administrative
   
605,472
   
646,509
   
(41,037
)
 
-6.3
%
Payroll expense
   
372,190
   
356,497
   
15,693
   
4.4
%
Consulting expense
   
345,761
   
251,524
   
94,237
   
37.5
%
Total operating expenses
   
1,323,423
   
1,254,530
   
68,893
   
5.5
%
Interest expense
   
(690
)
 
(1,327
)
 
(637
)
 
-48.0
%
Settlement income
   
1,785,000
   
-
   
1,785,000
   
NM
 
Other income
   
7,742
   
6,944
   
798
   
11.5
%
Provision for (benefit from) taxes
   
456,200
   
(223,000
)
 
(679,200
)
 
NM
 
Net income (loss)
   
587,076
   
(435,526
)
 
1,022,602
   
NM
 
Net income (loss) per share basic
   
0.05
   
(0.04
)
 
0.09
   
NM
 
 
Net Sales
 
Net sales for the quarter ended June 30, 2008 increased $267,367, a 23.7% increase, to $1,394,358 compared to $1,126,991 for the quarter ended June 30, 2007. The primary reason for the sales increase was attributed to increased sales to a distributor of our raw material. Sales of our own branded product, Inflame Away, that identifies Celadrin â as its marquee ingredient, continued to increase but was offset by product rebates and giveaways in support of marketing InflameAway through retail distribution channels. In addition, sales of our weight loss product increased during the first fiscal quarter. We anticipate, the new marketing program coupled with additional distribution agreements to wholesale and multi-level marketing customers to result in improved sales during the balance of our current fiscal year.
 
Cost of Goods Sold
 
Cost of goods sold as a percentage of net sales increased from 48% for the quarter ended June 30, 2007 to 59% for the quarter ended June 30, 2008. This increase was primarily due to the rebate and giveaway marketing strategy discussed above which resulted in InflameAway product being provided at no cost to the eventual customer. Rebate and giveaway programs are customary in the mass market distribution channel. We anticipate levels of promotional activities used to launch the awareness of InflameAway will be reduced in the future.

13

 
General and Administrative
 
General and administrative expenses decreased by $41,037, a 6.3% decrease, to $605,472 for the quarter ended June 30, 2008 from $646,509 for the quarter ended June 30, 2007. The primary reasons for the decrease were an approximate $73,000 decrease in advertising expenses related to the launch of InflameAway offset by an increase in expenses related to clinical research studies and travel expenses. We anticipate continued increases in general and administrative expenses as a result of increasing our advertising campaign for our Inflame Away product and an increase in clinical research studies.
 
Payroll Expense
 
Payroll expense increased to $372,190 for the quarter ended June 30, 2008, an increase of 4.4% or $15,693, compared to $356,497 for the quarter ended June 30, 2007. This increase was a result of normal salary increases.
 
Consulting Expenses
 
Consulting expenses increased to $345,761 for the quarter ended June 30, 2008, an increase of 37.5% or $94,237 compared to $251,524 for the quarter ended June 30, 2007. This increase was a result of increased litigation expenses related to the settlement of a potential trademark infringement case coupled with increased audit fees related to requirements to include management’s assessment of internal controls in financial statements. We anticipate consulting fees to decrease since litigation has been successfully concluded.
 
Settlement Income
 
During the quarter ended June 30, 2008, we received $2,100,000 ($1,785,000 after costs) as a result of entering into a settlement agreement with a company we alleged was infringing on the Celadrin trademark. In addition, we entered into a supply agreement with the same company whereby we will provide Celadrin for use in their products.
 
Provision for Income Taxes
 
As a result of income for the quarter ended June 30, 2008, an income tax expense of $456,200 was recognized during the current quarter compared to $223,000 of income tax benefit being recognized during the quarter ended June 30, 2007.

14


 
Capital Resources
 
Working Capital
               
            
  Increase
 
   
6/30/08
 
  3/31/08
 
  (Decrease)
 
                 
Current assets
 
$
5,121,928
 
$
4,012,527
 
$
1,109,401
 
Current liabilities
   
1,380,951
   
929,300
   
451,651
 
Working capital
 
$
3,740,977
 
$
3,083,227
 
$
657,750
 
                     
Long-term debt
 
$
-
 
$
2,980
 
$
(2,980
)
                     
Stockholders' equity
 
$
4,116,334
 
$
3,452,592
 
$
663,742
 

Statements of Cash Flows Select Information
 
   
Thre e Months Ended
 
Increase
 
 
 
6/30/08
 
6/30/07
 
(Decrease)
 
Net cash provided by (used in):
                   
Operating activities
 
$
1,074,111
 
$
632,085
 
$
442,026
 
Investing activities
 
$
-
 
$
(12,840
)
$
12,840
 
Financing activities
 
$
(31,410
)
$
(32,658
)
$
1,248
 
 
Balance Sheet Select Information

            
  Increase
 
   
6/30/08
 
  3/31/08
 
  (Decrease)
 
                 
Cash and cash equivalients
 
$
2,065,256
 
$
1,022,555
 
$
1,042,701
 
                     
Accounts receivable, net
 
$
1,249,603
 
$
765,492
 
$
484,111
 
 
                   
Inventories, net
 
$
1,246,851
 
$
1,109,845
 
$
137,006
 
                     
Accounts payable and accrued expenses
 
$
1,089,388
 
$
785,625
 
$
303,763
 
 
Liquidity
 
We have historically financed our operations internally and through debt and equity financings. At June 30, 2008, we had cash holdings of $2,065,256, an increase of $1,042,701 compared to March 31, 2008. Our net working capital position at June 30, 2008, was $3,740,977 compared to $3,083,227 as of March 31, 2008. We have initiated a direct mass market strategy with our own product, Inflame Away. Although, a significant portion of our working capital may be needed to implement this strategy, we believe that our cash position is sufficient to fund our operating activities for at least the next 12 months.

New Accounting Pronouncements

See Note 2- Recent Accounting Pronouncements- to our condensed consolidated financial statements included in Item 1 of this Form 10-Q for discussion of recent accounting pronouncements.

15

 
Risk Factors
 
You should consider the following discussion of risks as well as other information regarding our common stock. The risks and uncertainties described below are not the only ones. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risks actually occur, our business could be harmed.
 
There Is Only One Supplier for Celadrin®. If We Are Unable to Purchase Celadrin® from This Supplier, Our Business Would Be Harmed.

There is only one supplier for Celadrin®, which we use in approximately 58% of our products and which represented approximately 74% of our sales for the year ended March 31, 2008. We will rely upon Celadrin® to expand our product lines and revenue in the future. If our Celadrin® supplier goes out of business or elects for any reason not to supply us with Celadrin®, we would have to find another Celadrin® supplier or suffer a significant reduction in our revenue.
 
We Rely upon a Limited Number of Customers the Loss of Which Would Reduce Our Revenue and Any Earnings.

Our two largest customers accounted for 29% and 16% of our net sales for the year ended March 31, 2008 and 48% and 26% of our net sales for the three months ended June 30, 2008. The loss of these customers could significantly reduce our revenue and adversely affect our cash flow and earnings, if any.

We Rely upon Other Outside Suppliers to Produce Our Products Which Could Delay Our Product Deliveries.

All of our products are produced by outside manufacturers who process ingredients provided to them by our suppliers and with whom we have contracts. Our profit margins and our ability to deliver products on a timely basis are dependent upon these manufacturers and suppliers. Should any of these manufacturers or suppliers fail to provide us with product, we would be required to obtain new manufacturers and suppliers, which would be costly and time consuming and could delay our product deliveries.

Product Liability Claims Against Us Could Be Costly.

Some of our nutritional supplements contain newly-introduced ingredients or combinations of ingredients, and we have little long-term health information about individuals consuming those ingredients. If any of these products were thought or proved to be harmful, we could be subject to litigation. Although we carry product liability insurance in the face amount of $1,000,000 per occurrence and $2,000,000 in the aggregate and require our suppliers and manufacturers to include us as insured parties on their product liability insurance policies, our coverage may not be adequate to protect us from potential product liability claims and costs of defense.

We Are Subject to Intense Competition from Other Nutritional Supplement Marketers Which Could Reduce Our Revenue and Profit Margins.

Competition in the nutritional supplement market is intense. We compete with numerous companies that have longer operating histories, more products and greater name recognition and financial resources than we do. In order to compete, we could be forced to lower our product prices, which would reduce our revenue and profit margins.

We Are Highly Regulated, Which Increases Our Costs of Doing Business.

We are subject to laws and regulations which cover:

the formulation, manufacturing, packaging, labeling, distribution, importation, sale and storage of our products;

the health and safety of food and drugs;

trade practice and direct selling laws; and

16


product claims and advertising by us; or for which we may be held responsible.  

Compliance with these laws and regulations is time consuming and expensive. Moreover, new regulations could be adopted that would severely restrict the products we sell or our ability to continue our business. We are unable to predict the nature of any future laws, regulations, interpretations or applications, nor can we predict what effect additional governmental regulations or administrative orders, when and if promulgated, would have on our business in the future. These future changes could, however, require the reformulation or elimination of certain products; imposition of additional record keeping and documentation requirements; imposition of new federal reporting and application requirements; modified methods of importing, manufacturing, storing or distributing certain products; and expanded or different labeling and substantiation requirements for certain products and ingredients. Any or all of these requirements could harm our business.

There Are Limitations on the Liability of Our Officers and Directors Which May Restrict Our Stockholders from Bringing Claims.

Our Bylaws substantially limit the liability of our officers and directors to us and our stockholders for negligence and breach of fiduciary or other duties to us. This limitation may prevent stockholders from bringing claims against our officers and directors in the future.

Shares of Our Common Stock Which Are Eligible for Sale by Our Stockholders May Decrease the Price of Our Common Stock.

We have 10,960,788 common shares outstanding which are freely tradeable or saleable under Rule 144. We also have outstanding common stock warrants and stock options exercisable into up to 5,176,957 shares of common stock which could become free trading if exercised. If our stockholders sell substantial amounts of our common stock, the market price of our common stock could decrease.

There is a Limited but Potentially Volatile Trading Market in Our Common Stock, Which May Adversely Affect Our Stock Price.

Our common stock trades on the Electronic Bulletin Board. The Bulletin Board tends to be highly illiquid, in part because there is no national quotation system by which potential investors can track the market price of shares except through information received or generated by a limited number of broker-dealers that make a market in particular stocks. There is a greater chance of market volatility for securities that trade on the Bulletin Board as opposed to a national exchange or quotation system. This volatility may be caused by a variety of factors, including:

•  The lack of readily available price quotations;

•  The absence of consistent administrative supervision of "bid" and "ask" quotations;

•  Lower trading volume; and

•  Market conditions.

There could be wide fluctuations in the market price of our common stock. These fluctuations may have an extremely negative effect on the market price of our securities and may prevent you from obtaining a market price equal to your purchase price when you attempt to sell our securities in the open market. In these situations, you may be required to either sell our securities at a market price which is lower than your purchase price, or to hold our securities for a longer period of time than you planned.

17


Because Our Common Stock May Be Classified as "Penny Stock," Trading in it Could Be Limited, and Our Stock Price Could Decline.

In the future, our common stock may fall under the definition of "penny stock" if our net tangible assets decline below $2,500,000. In such event, trading in our common stock would be limited because broker-dealers will be required to provide their customers with disclosure documents prior to allowing them to participate in transactions involving our common stock. These disclosure requirements are burdensome to broker-dealers and may discourage them from allowing their customers to participate in transactions involving our common stock.

"Penny stocks" are equity securities with a market price below $5.00 per share, other than a security that is registered on a national exchange or included for quotation on the Nasdaq system, unless, as in our case, the issuer has net tangible assets of more than $2,000,000 and has been in continuous operation for greater than three years. Issuers who have been in operation for less than three years must have net tangible assets of at least $5,000,000.

Rules promulgated by the Securities and Exchange Commission under Section 15(g) of the Exchange Act require broker-dealers engaging in transactions in penny stocks, to first provide to their customers a series of disclosures and documents, including:

A standardized risk disclosure document identifying the risks inherent in investment in penny  stocks;

All compensation received by the broker-dealer in connection with the transaction;

Current quotation prices and other relevant market data; and

Monthly account statements reflecting the fair market value of the securities. In addition, these  rules require that a broker-dealer obtain financial and other information from a customer, determine  that transactions in penny stocks are suitable for such customer and deliver a written statement to  such customer setting forth the basis for this determination.
 
ITEM 4T.     CONTROLS AND PROCEDURES.  
 
Disclosure Controls and Procedures  
The Company maintains disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed in reports filed under the Securities Exchange Act of 1934 (“Exchange Act”) is recorded, processed, summarized, and reported within the specified time periods and accumulated and communicated to the Company’s management, including its Principal Executive Officer and Principal Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

The Company’s management, under the supervision and with the participation of its Principal Executive Officer and its Principal Financial Officer, evaluated the effectiveness of its disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) promulgated under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, the Company’s Principal Executive Officer and Principal Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2008 to provide reasonable assurance in the Company’s financial reporting.
 
Remediation of Certain Weaknesses and Changes in Internal Controls  

As discussed in the Company’s Annual Report on Form 10-KSB for the year ended March 31, 2008, filed with the SEC on June 25, 2008, during the financial reporting process for the fiscal year end March 31, 2008, the following weaknesses in the Company’s internal control over financial reporting were identified:

(1) Deficiencies in Segregation of Duties. The Chief Executive Officer and the Chief Financial Officer are actively involved in the preparation of the financial statements, and therefore cannot provide an independent review and quality assurance function within the accounting and financial reporting group. The limited number of qualified accounting personnel discussed above results in an inability to have independent review and approval of financial accounting entries. Furthermore, management and financial accounting personnel have wide-spread access to create and post entries in the Company’s financial accounting system. There is a risk that a material misstatement of the financial statements could be caused, or at least not be detected in a timely manner, due to insufficient segregation of duties, and

18


(2) Our financial statement closing process did not identify all the journal entries that needed to be recorded as part of the closing process for certain complex and non-routine transactions. As part of the audit, our independent registered public accounting firm proposed certain entries that should have been recorded as part of the normal closing process. Our internal control over financial reporting did not detect such matters and, therefore, was not effective in detecting misstatements in the financial statements.

To address the material weakness, during the quarter ended June 30, 2008, we performed additional analysis and other post-closing procedures in an effort to ensure our consolidated financial statements included in this quarterly report have been prepared in accordance with generally accepted accounting principles. We continue to implement a plan whereby during fiscal year 2009 sufficient testing to satisfy COSO requirements will be performed. The absence of the ability to conclude as to the sufficiency of internal controls, is a material weakness.

Management believes that there are no material inaccuracies or omissions of material fact and, to the best of its knowledge, believes that the condensed consolidated financial statements for the quarter ended June 30, 2008, fairly present in all material respects the financial condition and results of operations for the Company in conformity with accounting principles generally accepted in the United States of America.

Other than as described above, there have not been any other changes in the Company’s internal control over financial reporting during the quarter ended June 30, 2008, which have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Limitations on the Effectiveness of Controls  

A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The Company’s management, including its Principal Executive Officer and its Principal Financial Officer, do not expect that the Company’s disclosure controls will prevent or detect all errors and all fraud. 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. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with associated policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
 
PART II.   OTHER INFORMATION
 
ITEM 6.       EXHIBITS.
 
Exhibit No.
 
Title  
 
31.1
 
 
302 Certification of William P. Spencer, Chief Executive Officer
 
31.2
 
 
302 Certification of Lowell W. Giffhorn, Chief Financial Officer
 
32.1
 
 
906 Certification of William P. Spencer, Chief Executive Officer
 
32.2
 
 
906 Certification of Lowell W. Giffhorn, Chief Financial Officer

19

 
SIGNATURES
 
In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 
IMAGENETIX, INC.
 
a Nevada corporation
       
Date: August 13 , 2008
 
By:
/s/ WILLIAM P. SPENCER
 
   
William P. Spencer
 
   
Chief Executive Officer
       
     
(Principal Executive Officer and duly authorized
     
to sign on behalf of the Registrant)

20

 
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