UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB/A-2
(Mark One)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended December 31, 2005
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
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Commission file number 000-21914
HEALTHRENU MEDICAL, INC.
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(Exact name of small business issuer as specified in its charter)
NEVADA 25-1907744
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
12777 Jones Road, Suite 481, Houston, Texas 77070
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(Address of principal executive offices)
(281) 890-2561
-------------------------------
(Issuer's telephone number, including area code)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE
PAST FIVE YEARS
Check whether the registrant filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court. Yes |_| No |_|
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: As of December 31, 2005 the issuer
had 26,082,089 shares of common stock, $0.001 par value per share, outstanding.
Transitional Small Business Disclosure Format: Yes |_| No |X|
1
Statement Regarding This Amendment
We are amending our Quarterly Report on Form 10QSB/A for the quarter ended
December 31, 2005 as previously filed on April 6, 2006. We have identified
certain accounting errors related to the recording of our debt arrangements. We
have performed an analysis of our existing debt agreements and have concluded
that we incorrectly recorded our debt obligations and associated warrants. Our
analysis determined that the warrants associated with our convertible notes
payable are derivatives as defined under SFAS No. 133 and EITF 00-19. We also
did not appropriately account for financing costs incurred as a direct result of
these debt arrangements. Accordingly, we are also amending our Form 10-KSB/A for
the year ending September 30, 2005; our Form 10-QSB/A for the six months ended
March 31, 2006; and our Form 10-QSB for the nine months ended June 30, 2006.
As a result of this analysis, warrants issued to consultants and the conversion
features of the convertible notes payable and associated warrants have been
accounted for as derivative instrument liabilities. Additionally, the embedded
conversion features of the notes payable have been bifurcated from the debt and
accounted for separately as derivative instrument liabilities. We have added
footnote 10 to disclose the derivative instrument liabilities and provide
information on subsequent changes.
We are required to record the fair value of the conversion features and the
warrants on our balance sheet at fair value with changes in the values of these
derivatives reflected in the statement of operations as "Gain (loss) on embedded
derivative liability." The effect of the (non-cash) changes related to
accounting separately for these derivative instruments on our statement of
operations for the three months ended December 31, 2005, was an increase in our
net loss attributable to common shareholders of $302,136. Basic earnings (loss)
attributable to common shareholders per share for the three months ended
December 31, 2005 increased $0.01 per share. The cumulative effect on our
balance sheet as of December 31, 2005 was an additional derivative liability of
$2,932,257.
During our analysis we noted that costs directly associated from our debt
arrangements were originally treated as a reduction in additional
paid-in-capital and as a result of this amendment are now recorded as deferred
loan costs net of applicable accumulated amortization. We have added footnote 5
to disclose the deferred loan costs and provided information on subsequent
changes. The effect of the (non-cash) changes related to accounting for these
deferred financing costs on our statement of operations for the three months
ended December 31, 2005 was an increase in our net loss attributable to common
shareholders of $11,434. The cumulative effect on our balance sheet as of
December 31, 2005 was an additional deferred financing cost net of accumulated
amortization of $124,873.
In all other material respects, this Amended Quarterly Report on Form 10-QSB/A-2
is unchanged from the Amended Quarterly Report on Form 10-QSB/A previously filed
by us on April 6, 2006. This Amended Quarterly Report on Form 10-QSB/A-2 does
not attempt to modify or update any other disclosures set forth in the Form
10-QSB and Form 10-QSB/A previously filed or discuss any other developments
after the respective dates of those filings except to reflect the effects of the
restatements described above, certain risk factor disclosure and except as
otherwise specifically identified herein. This amendment should also be read in
conjunction with our amended Annual Report on from 10-KSB/A-2 for the year ended
September 30, 2005 and our amended Quarterly Report on Form 10-QSB/A-2 for the
quarter ended March 31, 2006 and Form 10-QSB/A for the quarter ended June 30,
2006, together with any subsequent amendments thereof.
2
HEALTHRENU MEDICAL, INC.
FORM 10-QSB/A-2
FOR THE QUARTER ENDED DECEMBER 31, 2005
INDEX
PART 1-FINANCIAL INFORMATION PAGE
----
ITEM 1. FINANCIAL STATEMENTS
Unaudited Balance Sheets as of December 31,
2005 and September 30, 2005 4
Unaudited Statement of Operations for the
three months ended December 31, 2005 and 2004 5
Unaudited Statement of Stockholders' Equity
for the three months ended December 31, 2005 6
Unaudited Statement of Cash Flows for the
three months ended December 31, 2005 and 2004 7
Notes to Unaudited Financial Statements 8-18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS 19-36
ITEM 3. CONTROLS AND PROCEDURES 37-38
PART II-OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 39
ITEM 2. UNREGISTERED SALES OF SECURITIES AND USE OF PROCEEDS 39
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 39
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 39
ITEM 5. OTHER INFORMATION 39
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 40
3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HEALTHRENU MEDICAL, INC.
BALANCE SHEETS
December 31, 2005 and September 30, 2005
(Unaudited)
December 31, September 30,
2005 2005
ASSETS
------ ------------- -------------
(Restated) (Restated)
Current assets:
Cash and cash equivalents $ 226 $ 163,095
Accounts receivable 1,689 716
Inventories 22,042 18,188
Prepaid expense 2,146 2,146
------------- -------------
Total current assets 26,103 184,145
Property and equipment, net 13,545 9,592
Deferred loan costs, net 124,873 136,307
------------- -------------
Total assets $ 164,521 $ 330,044
============= =============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 218,810 $ 117,863
Accounts payable-stockholder -- 2,329
Accrued liabilities 44,070 30,327
Note payable 188,843 188,843
Derivative liability 2,932,257 2,630,121
------------- -------------
Total current liabilities 3,383,980 2,969,483
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Convertible notes payable, net 46,362 9,324
Total liabilities 3,430,342 2,978,807
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Stockholders' deficit:
Convertible preferred stock, Series 2000A, $0.001 par
value; 1,500,000 shares authorized, 1,763 shares issued and
outstanding at December 31, 2005 and September 30, 2005 2 2
Common stock, $0.001 par value; 150,000,000 shares authorized,
26,082,089 and 25,619,589 shares issued and outstanding at
December 31, 2005 and September 30, 2005, respectively 26,082 25,620
Additional paid-in capital 3,749,390 3,748,602
Accumulated deficit (7,041,295) (6,422,987)
------------- -------------
Total stockholders' deficit (3,265,821) (2,648,763)
------------- -------------
Total liabilities and stockholders' deficit $ 164,521 $ 330,044
============= =============
See accompanying notes to financial statements.
4
HEALTHRENU MEDICAL, INC.
STATEMENTS OF OPERATIONS
for the three months ended December 31, 2005 and 2004
(Unaudited)
Three Months Ended
December 31,
2005
(Restated) 2004
------------ ------------
Sales $ 5,364 $ 3,753
Cost of sales 1,083 948
------------ ------------
Gross profit (loss) 4,281 2,805
General and administrative expenses 255,266 349,278
------------ ------------
Loss from operations (250,985) (346,473)
Interest and financing expense (65,187) (11)
Loss on embedded derivative liability 302,136 --
------------ ------------
Net loss $ (618,308) $ (346,484)
============ ============
Weighted average shares outstanding 25,629,589 26,073,972
============ ============
Basic and diluted net loss per common share $ (0.02) $ (0.01)
============ ============
See accompanying notes to financial statements.
5
HEALTHRENU MEDICAL, INC.
STATEMENT OF STOCKHOLDERS' DEFCIT
for the three months ended December 31, 2005
(Unaudited)
- ------------------------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
Preferred Common Common Additional
Stock Amount Stock Stock Paid In Accumulated Total
Shares Shares Amount Capital Deficit
- ------------------------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
Balance at September 30, 2005 1,763 $ 2 25,619,589 $ 25,620 $ 3,748,602 $ (6,422,987) $ (2,648,763)
- ------------------------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
Common stock issued for -- -- 12,500 12 1,238 -- 1,250
consulting services
- ------------------------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
Rescinding the previous _ _ 450,000 450 (450) _ _
cancellation common stock
- ------------------------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
Net loss -- -- -- -- -- (618,308) (618,308)
- ------------------------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 2005 1,763 $ 2 26,082,089 $ 26,082 $ 3,749,390 $ (7,041,295) $ (3,265,821)
(Restated)
- ------------------------------ ------------ ------------ ------------ ------------ ------------ ------------ ------------
See accompanying notes to financial statements.
6
HEALTHRENU MEDICAL, INC.
STATEMENT OF CASH FLOWS
for the three months ended December 31, 2005 and 2004
(Unaudited)
Three Months Ended
December 31,
--------------------------
(Restated)
----------- -----------
2005 2004
----------- -----------
Cash flows from operating activities:
Net loss $ (618,308) $ (346,484)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation 190 359
Common stock issued as compensation -- 750
Amortization of debt issuance costs 11,434 --
Amortization of debt discount 37,037 --
Loss on embedded derivative liability 302,136 --
Common stock issued for services 1,250 300,000
Changes in operating assets and liabilities:
Accounts receivable (973) (1,389)
Other current assets -- (2,086)
Inventories (3,854) 665
Accounts payable 100,947 (18,266)
Accrued liabilities 13,744 9,106
----------- -----------
Net cash used in operating activities (156,397) (57,345)
----------- -----------
Cash flows from investing activities:
Purchase of fixed assets (4,143) --
----------- -----------
Net cash used in investing activities (4,143) --
----------- -----------
Cash flows from financing activities:
Common stock issued for cash -- 30,450
Change in accounts payable - stockholder (2,329) --
Issuance of convertible promissory notes -- 25,600
Payment received on stock subscription receivable -- 2,500
----------- -----------
Net cash (used) provided by financing activities (2,329) 58,550
----------- -----------
(Decrease)/Increase in cash and cash equivalents (162,869) 1,205
Cash and cash equivalents, beginning of period 163,095 7,560
----------- -----------
Cash and cash equivalents, end of period 226 8,765
=========== ===========
Supplemental disclosure of cash flow information:
Cash paid for interest -- --
=========== ===========
Cash paid for income taxes -- --
=========== ===========
Non-cash investing and financing activities:
Issuance of common stock as payment of liability -- 52,512
=========== ===========
See accompanying notes to financial statements
7
HEALTHRENU MEDICAL, INC.
NOTES TO UNAUDITED FINANCIAL STATEMENTS
1. Basis of Presentation
The accompanying unaudited interim financial statements have been prepared
without audit pursuant to the rules and regulations of the U.S. Securities and
Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America have been
condensed or omitted, pursuant to such rules and regulations. These unaudited
financial statements should be read in conjunction with the audited financial
statements and notes thereto of HealthRenu Medical, Inc. included in the
Company's Annual Report on Form 10-KSB/A-2 for the year ended September 30,
2005. In the opinion of management, all adjustments (consisting of normal
recurring adjustments) considered necessary for a fair presentation of financial
position, results of operations and cash flows for the interim periods presented
have been included. Operating results for the interim periods are not
necessarily indicative of the results that may be expected for the full year.
Restatements
Restatements of 2005 information previously reported were made. See Note 11 for
details.
2. Organization
HealthRenu Medical, Inc. (the "Company" or "HealthRenu"), a Nevada corporation,
is headquartered in Houston, Texas. The Company provides raw materials to a
third party manufacturing company who produces various skin care products that
are purchased and distributed by the Company primarily to the home health care
and other medical markets throughout the United States.
The Company was originally incorporated in Delaware as Health Renu, Inc. in
1997. In September 2003, upon completion of a recapitalization through
acquisition of a non-operating public shell, the name was changed to HealthRenu
Medical, Inc. The public shell had no significant assets or operations at the
date of acquisition. The Company assumed all liabilities of the public shell on
the date of the acquisition. The historical financial statements presented
herein are those of HealthRenu Medical, Inc., and its predecessor, Health Renu,
Inc.
3. Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect reported amounts and related disclosures.
Actual results could differ from those estimates.
Revenue Recognition
Revenue is recognized when products are shipped and when all of the following
have occurred: a firm sales agreement is in place, pricing is fixed or
determinable and collection is reasonably assured. Sales are reported net of
estimated returns, consumer and trade promotions, rebates and freight allowed.
8
Concentrations of Credit Risk
Financial instruments which subject the Company to concentrations of credit risk
include cash and cash equivalents and accounts receivable.
The Company maintains its cash in well-known banks selected based upon
management's assessment of the banks' financial stability. Balances may
periodically exceed the $100,000 federal depository insurance limit; however,
the Company has not experienced any losses on deposits.
Accounts receivable generally arise from sales of various skin care products to
the home health care and other medical markets throughout the United States.
Collateral is generally not required for credit granted.
The Company establishes an allowance for doubtful accounts based upon the aging
of customers balances and the likelihood of collection. As of December 31, 2005
the Company has determined that no allowance for doubtful accounts is necessary.
Cash Equivalents
For purposes of reporting cash flows, the Company considers all short-term
investments with an original maturity of three months or less to be cash
equivalents.
Property and Equipment
Property and equipment are recorded at cost. Depreciation is provided using the
straight-line method over the estimated useful lives of the assets, which range
from three to twenty-five years. Expenditures for major renewals and betterments
that extend the original estimated economic useful lives of the applicable
assets are capitalized. Expenditures for normal repairs and maintenance are
charged to expense as incurred. The cost and related accumulated depreciation of
assets sold or otherwise disposed of are removed from the accounts, and any gain
or loss is included in operations.
Inventories
Inventories consist solely of finished goods and are stated at the lower of cost
or market. Cost is computed using actual costs on a first-in, first-out basis.
Since the inventory typically has a very long shelf life, management reviews the
inventory on an annual basis and records a reserve for obsolescence when
considered necessary. As of December 31, 2005, the Company has determined that
no reserve for inventory obsolescence is necessary.
Shipping and Delivery Costs
The cost of shipping and delivery are charged directly to cost of sales at the
time of shipment.
Research and Development
Research and development activities are expensed as incurred, including costs
relating to patents or rights, which may result from such expenditures.
9
Income Taxes
The Company uses the liability method of accounting for income taxes. Under this
method, deferred income taxes are recorded to reflect the tax consequences on
future years of temporary differences between the tax basis of assets and
liabilities and their financial amounts at year-end. The Company provides a
valuation allowance to reduce deferred tax assets to their net realizable value.
Loss Per Share
Basic and diluted loss per share is computed on the basis of the weighted
average number of shares of common stock outstanding during each period. Common
equivalent shares from convertible preferred stock and common stock options and
warrants are excluded from the computation as their effect would dilute the loss
per share for all periods presented. If the Company had reported net income for
the three months ended December 31, 2005 or 2004, the calculation of diluted net
income per share would have included 367,919 and -0-, respectively, and 1,763
and 1,763, respectively, of additional common equivalent shares for the
Company's stock warrants and convertible preferred stock, respectively.
Impairment of Long-Lived Assets
In the event that facts and circumstances indicate that the carrying value of a
long-lived asset, including associated intangibles, may be impaired, an
evaluation of recoverability is performed by comparing the estimated future
undiscounted cash flows associated with the asset or the asset's estimated fair
value to the asset's carrying amount to determine if a write-down to market
value or discounted cash flow is required.
Fair Value of Financial Instruments
The Company includes fair value information in the notes to financial statements
when the fair value of its financial instruments is different from the book
value. When the book value approximates fair value, no additional disclosure is
made.
Comprehensive Income
Comprehensive income includes such items as unrealized gains or losses on
certain investment securities and certain foreign currency translation
adjustments. The Company's financial statements include none of the additional
elements that affect comprehensive income. Accordingly, comprehensive income
(loss) and net income (loss) are identical.
Stock-Based Compensation
Stock-based compensation is accounted for using the intrinsic value method
prescribed in Accounting Principles Board Opinion ("APB") No. 25, "Accounting
for Stock Issued to Employees", rather than applying the fair value method
prescribed in SFAS No. 123, "Accounting for Stock-Based Compensation", as
amended by SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and
Disclosure".
Debt Issuance Costs
Debt issuance costs are deferred and recognized, using the effective interest
method, over the expected term of the related debt.
10
Derivative Financial Instruments
The Company does not use derivative instruments to hedge exposures to cash flow,
market, or foreign currency risks.
Derivative financial instruments are initially measured at their fair value. For
derivative financial instruments that are accounted for as liabilities, the
derivative instrument is initially recorded at it fair value and is then
re-valued at each reporting date, with changes in the fair value reported as
charges or credits to income. For option-based derivative financial instruments,
the Company uses the Black-Scholes model to value the derivative instruments.
The classification of derivative instruments, including whether such instruments
should be recorded as liabilities or as equity, is reassessed at the end of each
reporting period. Derivative instrument liabilities are classified in the
balance sheet as current or non-current based on whether or not net-cash
settlement of the derivative instrument could be required within 12 months of
the balance sheet date.
Reclassifications
Certain items in the prior period financial statements have been reclassified to
conform to the current period financial statement presentation. Such
reclassifications had no effect on stockholders' equity (deficit) or net loss.
4. Going Concern
During the three months ended December 31, 2005, the Company has continued to
accumulate payables to its vendors and has experienced negative financial
results as follows:
Net loss $ (618,308)
Negative cash flows from operations $ (158,726)
Negative working capital $(3,357,877)
Accumulated deficit $(7,041,295)
Stockholders' deficit $(3,265,821)
Management has developed specific current and long-term plans to address its
viability as a going concern as follows:
o Effective September 2003, the Company entered into a
recapitalization transaction with a public shell to gain access to
public capital markets, to increase attractiveness of its equity and
to create liquidity for stockholders.
o The Company is also attempting to raise funds through debt and/or
equity offerings. If successful, these additional funds will be used
to pay down liabilities and to provide working capital.
o In the long-term, the Company believes that cash flows from growth
in its operations will provide the resources for continued
operations.
11
o In May 2005 the Company entered into a Standby Equity Distribution
Agreement with Cornell Capital Partners, L.P., where the Company may
periodically sell shares of common stock for a purchase price up to
a maximum of $10 million subject to the completion of the
registration of the Company's common stock under the Securities Act
of 1933.
There can be no assurance that the Company will have the ability to implement
its business plan and ultimately attain profitability. The Company's long-term
viability as a going concern is dependent upon three key factors, as follows:
o The Company's ability to obtain adequate sources of debt or equity
funding to meet current commitments and fund the continuation of its
business operations in the near term.
o The ability of the Company to control costs and expand revenues.
o The ability of the Company to ultimately achieve adequate
profitability and cash flows from operations to sustain its
operations.
5. Deferred Loan Costs
In connection with the Convertible Notes Payable described in Note 7 below the
Company incurred certain direct expenses as a result of these debt agreements.
As of December 31, 2005 the total costs capitalized by the Company were
$137,200. These deferred loan costs are being amortized using the effective
interest method over the three-year estimated life of the related debt
agreements. The Company recorded $11,434 of amortization expense during the
three month period ending December 31, 2005 related to these deferred loan costs
which are included in the statement of operations as additional interest and
financing expense. The accumulated amortization of deferred loan costs was
$12,327 at December 31, 2005.
6. Litigation
The Company is party to certain litigation arising in the normal course of
business from time to time. Management believes that such litigation will not
have a material impact on the Company's financial position or results of
operations. In addition, the Company is a party to the below described
litigation.
12
In October 2005, a stockholder filed a lawsuit against the Company, its chief
executive officer and a former chief executive officer, in the District Court
for the City and County of Denver, State of Colorado. The stockholder claims he
was issued 44,000 shares of common stock of AGTSports, Inc., a Colorado
corporation and the Company's predecessor, prior to 1997 which shares were
intended to be "non-dilutive" and that he purchased 44,000 additional shares in
May 1997. He further claims that he was not given notice of or an opportunity to
vote with the respect to the reincorporation and exchange transaction in
September 2003 whereby the Company became HealthRenu Medical, Inc. and that he
was prevented from liquidating his shares at $8.50 per share. The stockholder
alleges various claims for relief based upon negligent and fraudulent
misrepresentation and concealment, civil conspiracy, civil theft, breach of
fiduciary duty, breach of contract, failure to provide notice of dissenter
rights, violation of the Colorado Securities Act, and intentional infliction of
emotional distress. The stockholder seeks relief including compensation for his
stock, forfeited opportunities to liquidate his stock, actual, compensatory and
punitive damages, costs and attorney fees and treble damages with respect to his
civil theft claim. The Company believes this complaint is without merit and has
filed an answer to defend against such complaint.
7. Convertible Notes Payable
In August and September 2005, the Company entered into agreements to issue
convertible promissory notes and received proceeds of $410,800, net of $137,200
offering costs. The notes are for a term of three years and bear interest at 8%
per annum, which is payable annually in shares of the Company's common stock.
The holders of the notes have the option to convert the note at any time on or
after the issuance date of the note. The notes are convertible at 85% of the
average of the trading prices of the common stock for the ten days ending one
day prior to the Company's receipt of the conversion notice. The note holders
were also granted two warrants to purchase the Company's common stock to become
exercisable for each share of common stock to be issued upon conversion of the
notes with each warrant to purchase one share of common stock at an exercise
price of 125% and 150%, respectively, of the conversion price of the notes then
in effect. These warrants will expire on October 31, 2009.
In February 2006, HealthRenu issued convertible promissory notes for $600,000
and received proceeds of $494,964, after $105,036 offering costs. The notes are
for a term of five years and bear interest at 8% per annum, which is payable
annually in shares of HealthRenu's common stock. The holders of the notes have
the option to convert the notes at any time on or after the issuance date. The
notes are convertible at 80% of the average of the trading prices of the common
stock for the ten days ending one day prior to HealthRenu's receipt of the
conversion notice. The note holders were also granted eight warrants to purchase
HealthRenu's common stock to become exercisable for each share of common stock
to be issued upon conversion of the notes with two warrants to purchase one
share of common stock at an exercise price of 100% of the conversion price of
the notes then in effect, three warrants to purchase one share of common stock
at an exercise price of 125% of the conversion price of the notes then in effect
and three warrants to purchase one share of common stock at an exercise price of
150% of the conversion price of the notes then in effect. The warrants will
expire on March 31, 2011.
Since the number of warrants to become exercisable in connection with both
convertible note issuances are indeterminable, they have been classified as a
derivative instrument based on the guidance of SFAS No. 133 and EITF 00-19 (see
Note 10 below for further discussion).
13
8. Related Party Transaction
During the three months ended December 31, 2004, the Company issued 2,000,000
shares of its common stock as payment of accrued compensation of $40,000 owed to
an officer of the Company. However, based on the quoted market price of $0.17
per share, the Company recorded additional compensation expense of $300,000 in
the statement of operations for the three months ended December 31, 2004. No
other material related party transactions have taken place subsequent to those
disclosed above.
9. Common Stock
In May 2005, the Company entered into a Standby Equity Distribution Agreement
with Cornell Capital Partners, L.P., where the Company may periodically sell
shares of common stock for a purchase price up to a maximum of $10 million
subject to the completion of the registration of the Company's common stock
under the Securities Act of 1933.
10. Derivatives
The Company evaluated the application of SFAS No. 133 and EITF 00-19 for all of
its financial instruments and identified the following financial instruments as
derivatives:
1. Convertible notes payable ("Notes Payable")
2. Warrants to purchase common stock associated with the notes
payables ("Note Warrants")
3. Warrants to purchase common stock issued to placement agent
("Placement Warrants")
4. Warrants to purchase common stock issued to consultants
("Consulting Warrants")
Based on the guidance in SFAS No. 133 and EITF 00-19, the Company concluded that
these instruments were required to be accounted for as derivatives. SFAS 133 and
EITF 00-19 require the Company to bifurcate and separately account for the
conversion features of the Notes Payable and warrants issued as embedded
derivatives.
Pursuant to SFAS No. 133, the Company bifurcated the conversion feature from the
Notes Payable because the conversion price is not fixed and the Notes Payable
are not convertible into a fixed number of shares. Accordingly, the embedded
derivative must be bifurcated and accounted for separately.
14
Furthermore, the Company concluded that the exercise price and the number of
shares to be issued under the Placement Warrants and the Consulting Warrants are
fixed. However, since the Notes Payable were issued prior to these warrants and
these debentures might result in issuing an indeterminate number of shares, it
cannot be concluded that the Company has a sufficient number of authorized
shares to settle these warrants. As such, the warrants were accounted for as
derivative instrument liabilities. The Company is required to record the fair
value of the conversion features and the warrants on its balance sheet at fair
value with changes in the values of these derivatives reflected in the statement
of operations as "Gain (loss) on embedded derivative liability." The derivative
liabilities were not previously classified as such in the Company's historical
financial statements. In order to reflect these changes, HealthRenu is
concurrently restating its financial statements for the year ended September 30,
2005, and each of the quarters ended December 31, 2005, March 31, 2006, and June
30, 2006.
The impact of the application of SFAS No. 133 and EITF 00-19 on the balance
sheet as of December 31, 2005 is as follows:
Embedded derivative
liability balance
December 31, 2005
-------------------
Notes Payable $ 2,569,872
Placement Warrants 111,323
Consulting Warrants 251,062
-------------------
Total: $ 2,932,257
The impact on statements of operations as of the three months ended December 31,
2005 is as follows:
Gain (loss) on embedded
------------------------
Derivative liabilities: three months ended
------------------------ ------------------
December 31, 2005
------------------
Notes Payable $ (636,144)
Placement Warrants 102,512
Consulting Warrants 231,496
------------------
Total gain (loss) on
embedded derivative
liabilities: $ (302,136)
------------------
11. Restatement of Financial Statements
The Company has restated its quarterly financial statements from amounts
previously reported December 31, 2005. The Company has determined that certain
financial instruments issued by the Company contain features that require the
Company to account for these features as derivative instruments. Accordingly,
warrants issued to consultants, the conversion features of the Notes Payable and
associated warrants have been accounted for as derivative instrument liabilities
rather than as equity. Additionally, the embedded conversion features of the
Notes Payable and warrants related to the debt, have been bifurcated from the
debt and accounted for separately as derivative instrument liabilities. Note 10
was added to disclose the derivative instrument liabilities and provide
information on subsequent changes.
15
The Company is required to record the fair value of the conversion features and
the warrants on each balance sheet date at fair value with changes in the values
of these derivatives reflected in the statement of operations as "Gain (loss) on
derivative instrument liabilities." The effect of the (non-cash) changes related
to accounting separately for these derivative instrument liabilities and
modifying the estimated volatility, on the statement of operations for the three
months ended December 31, 2005, was an increase in the net loss attributable to
common shareholders of $302,136. Basic earnings (loss) attributable to common
shareholders per share for the three months ended December 31, 2005 increased
$0.01 per share.
The Company has also determined that costs related to certain debt agreements
were directly related to these debt agreements and therefore are now accounted
for as deferred loan costs net of accumulated amortization rather than as
equity. Additionally the Company has added Note 5 to provide information related
to these assets.
The effect of the (non-cash) changes related to accounting for these deferred
loan costs on the statement of operations for the three months ended December
31, 2005 was an increase in the Company's net loss attributable to common
shareholders of $11,434. The cumulative effect on the balance sheet as of
December 31, 2005 was an additional deferred financing cost net of accumulated
amortization of $124,873. Basic earnings (loss) attributable to common
shareholders per share for the three month period ended December 31, 2005
increased $0.01 per share.
16
In all other material respects, the financial statements are unchanged.
Following is a summary of the restatement adjustments:
As of December 31, 2005
As Reported Adjustments As Restated
SUMMARY BALANCE SHEET
- ------------------------------------------
ASSETS
------
Current assets:
Cash and cash equivalents $ 226 $ -- $ 226
Accounts receivable 1,689 -- 1,689
Inventories 22,042 -- 22,042
Prepaid expense 2,146 -- 2,146
-------------- -------------- --------------
Total current assets 26,103 -- 26,103
Property and equipment, net 13,545 -- 13,545
Deferred financing costs -- 124,873 (a) 124,873
-------------- -------------- --------------
Total assets $ 39,648 $ 124,873 $ 164,521
============== ============== ==============
LIABILITIES AND
- ---------------
STOCKHOLDERS' DEFICIT
- ---------------------
Current liabilities:
Accounts payable $ 218,810 $ -- $ 218,810
Accounts payable-stockholder -- -- --
Accrued liabilities 41,057 3,013 (b) 44,070
Note payable 188,843 -- 188,843
Derivative liability -- 2,932,257 (c) 2,932,257
-------------- -------------- --------------
Total current liabilities 448,710 2,935,270 3,383,980
Convertible notes payable 56,001 (9,639) (d) 46,362
Total liabilities 504,711 2,925,631 3,430,342
-------------- -------------- --------------
Stockholders' deficit:
Convertible preferred stock, Series 2000A 2 -- 2
Common stock 26,082 -- 26,082
Additional paid-in capital 4,617,460 (868,070) (e) 3,749,390
Accumulated deficit (5,108,607) (1,932,688) (f) (7,041,295)
-------------- -------------- --------------
Total stockholders' deficit (465,063) (2,800,758) (3,265,821)
-------------- -------------- --------------
Total Liabilities and Stockholders' Deficit 39,648 124,873 164,521
-------------- -------------- --------------
(a) To record net deferred loan costs associated with the 2005
convertible notes payable.
(b) To adjust accrued interest to actual based upon previous errors.
(c) To record the estimated fair value of warrants and embedded
derivatives.
(d) To adjust debt discount to actual resulting from errors in the
initial establishment of debt discounts resulting from accounting
for embedded derivatives and warrants.
(e) To adjust additional paid-in capital for derivative instruments
previously considered having beneficial conversion features.
Included in this adjustment is the effect of the prior consideration
of convertible notes payable previously considered having beneficial
conversion features ($410,800) and warrants that are now included in
the Company's estimated embedded derivative liability that were
previously recorded as additional paid-in capital. ($457,270).
(f) To adjust accumulated deficit for the correction of prior period
errors including those mentioned above and to close out the
adjustments to the statement of operation to accumulated deficit.
See the Company's September 30, 2005 form10KSB/A-2 or subsequent
amendments thereof.
17
For the three months ended December 31, 2005
As Reported Adjustments As Restated
SUMMARY STATEMENT OF
--------------------
OPERATIONS
----------
Sales $ 5,364 $ -- $ 5,364
Cost of sales 1,083 -- 1,083
--------------- --------------- ---------------
Gross profit (loss) 4,281 -- 4,281
General and administrative expenses 255,266 -- 255,266
--------------- --------------- ---------------
Loss from operations (250,985) -- (250,985)
Interest and financing expense (61,667) (3,520) (a) (65,187)
Other income/(expense)
Loss on embedded derivative liability -- (302,136) (b) (302,136)
Net loss $ (312,652) $ 305,656) $ (618,308)
=============== =============== ===============
Weighted average shares outstanding 25,629,589 -- 25,629,589
Basic and diluted net loss per common
share $ (0.01) $ (0.01) $ (0.02)
(a) To adjust interest expense to actual based upon amortization errors, to
record current period deferred loan cost amortization, and to adjust
the accretion of debt discounts.
(b) To record changes in the estimated fair value of warrants and embedded
derivatives.
18
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
This report contains forward looking statements that are subject to certain
risks and uncertainties that could cause actual results to differ materially
from historical results or anticipated results, including those set forth under
"Risk Factors" in this "Management's Discussion and Analysis" and elsewhere in
this report. The following discussion and analysis should be read in conjunction
with our financial statements and notes thereto included elsewhere in this
report and appearing in our annual report filed on Form 10-KSB/A-2 for the year
ended September 30, 2005.
OVERVIEW
On September 26, 2003, we acquired 100% of the outstanding shares of Health
Renu, Inc., a Delaware corporation to whose business we succeeded ("Health
Renu-DE"), pursuant to an exchange agreement. Since its inception, Health
Renu-DE had been in the medical research and development stage, with a focus on
improving its skin care and developing wound care products. During this period,
Health Renu-DE had nominal production or revenue. As a result of the exchange
agreement, the business of Health Renu-DE became our business, our control
shifted to the former Health Renu-DE stockholders and we subsequently changed
our name to HealthRenu Medical, Inc.
CRITICAL ACCOUNTING POLICIES
The following discussion and analysis of our financial condition and results of
operations is based upon our financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires us to make estimates and
judgments 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 these estimates, including those related to revenue
recognition, inventories and stock-based compensation. We base our estimates on
historical experience and on various other assumptions that we believe 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.
Of the significant accounting policies used in the preparation of our financial
statements, the following are critical accounting policies, which may involve a
higher degree of judgment, complexity and estimates.
Revenue Recognition
Revenue is recognized when products are shipped and when all of the following
have occurred: a firm sales agreement is in place, pricing is fixed or
determinable and collection is reasonably assured. Sales are reported net of
estimated returns, consumer and trade promotions, rebates and freight allowed.
Inventories
Inventories consist solely of finished goods and are stated at the lower of cost
or market. Cost is computed using actual costs on a first-in, first-out basis.
Since the inventory typically has a very long shelf life, management reviews the
inventory on an annual basis and records a reserve for obsolescence when
considered necessary. As of December 31, 2005, we did not have a reserve for
obsolescence.
19
Derivative Financial Instruments
We do not use derivative instruments to hedge exposures to cash flow, market, or
foreign currency risks.
Derivative financial instruments are initially measured at their fair value. For
derivative financial instruments that are accounted for as liabilities, the
derivative instrument is initially recorded at it fair value and is then
re-valued at each reporting date, with changes in the fair value reported as
charges or credits to income. For option-based derivative financial instruments,
we use the Black-Scholes model to value the derivative instruments.
The classification of derivative instruments, including whether such instruments
should be recorded as liabilities or as equity, is reassessed at the end of each
reporting period. Derivative instrument liabilities are classified in the
balance sheet as current or non-current based on whether or not net-cash
settlement of the derivative instrument could be required within 12 months of
the balance sheet date.
Stock-Based Compensation
We account for employee stock options using the intrinsic value method
prescribed in Accounting Principles Board Opinion ("APB") No. 25, "Accounting
for Stock Issued to Employees", and have adopted the disclosure-only alternative
of SFAS No. 123, "Accounting for Stock-Based Compensation", as amended by SFAS
No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure".
COMPARISON OF OPERATING RESULTS
Three Months Ended December 31, 2005 Compared to Three Months Ended December 31,
2004
Revenues increased from $3,753 for the three months ended December 31, 2004 to
$5,364 for the three months ended December 31, 2005. The increase in revenues is
due to increased sales volume related to increased marketing activity.
Cost of sales increased from $948 for the three months ended December 31, 2004
to $1,083 for the three months ended December 31, 2005. The increase in cost of
sales is due to increased sales volume.
Gross profit increased from $2,805 for the three months ended December 31, 2004
to $4,281 for the three months ended December 31, 2005. The increase in gross
profit is due to increased sales volume.
General and administrative expenses decreased from $349,278 for the three months
ended December 31, 2004 to $255,266 for the three months ended December 31,
2005. The decrease in general and administrative expenses was due to stock based
compensation of $300,000 recorded in 2004 offset by higher costs in 2005 related
to our expansion efforts, increased compensation to our chief executive officer,
and approximately $100,000 related to increased legal and financing expenses
related to seeking and obtaining outside financing.
20
Gain (loss) on derivative instruments liabilities. We recognized a loss on
derivative instruments of $302,136 during the three months ended December 31,
2005 compared to no activity during the quarter ended December 31, 2004, an
increase of $302,136. The increase is a result of the net unrealized (non-cash)
change in the fair value of our derivative instrument liabilities related to
certain warrants and embedded derivatives in our debt instruments that have been
bifurcated and accounted for separately. These warrants and debt instruments
were issued during August and September of 2005.
Interest and financing expense increased from $11 for three months ended
December 31, 2004 to $65,187 for the three months ended December 31, 2005. The
increase is attributable to the additional interest related to the note payable
and the convertible note payable and $53,754 of amortized debt issuance costs
recorded in the three months ended December 31, 2005.
We recorded a loss from operations of $346,473 for the three months ended
December 31, 2004 compared to a loss from operations of $250,985 for the three
months ended December 31, 2005. The decrease in loss from operations is
principally due to the decrease in general and administrative expenses.
We reported a net loss of $346,484 for the three months ended December 31, 2004
compared to a net loss of $618,308 for the three months ended December 31, 2005.
The increase in net loss is principally due to the increase in general and
administrative expense, an increase in interest financing expenses related to
new issuances of debt, and a loss on derivative instrument liabilities.
Basic and diluted net loss per common share was $0.01 for the three months ended
December 31, 2004 compared to $0.02 for the three months ended December 31,
2005.
LIQUIDITY AND CAPITAL RESOURCES
For the three months ended December 31, 2005 we have not generated positive cash
flow from our own operations due to the preliminary nature of our operations and
our ongoing investment in our expansion. Consequently, we have been dependent on
external financing to fund our cash requirements.
As of December 31, 2005, our cash totaled $226 and total current assets were
$26,103. Inventory at December 31, 2005 was $22,042.
As of December 31, 2005, our accounts payable totaled $218,810. Total current
liabilities were $3,383,980.
We operate with minimal overhead costs by outsourcing our shipping, receiving,
purchasing and production functions. We also contract with consultants to assist
in numerous areas of our operations and development in order to minimize
expenses. We intend to hire additional employees only as needed.
Our immediate financing needs are currently expected to be provided by a private
placement of our convertible debt securities of $600,000 as described below. We
require such financing in order to pay professional fees associated with our
securities and corporate compliance requirements, for registration of our shares
to be issued in connection with the standby equity distribution agreement
("SEDA") described below and to fund our inventory and working capital needs
until the SEDA is available for us to draw upon. Such private placement
financing may not be available on favorable terms, in sufficient amounts or at
all.
21
Our near term financing needs are currently expected to be provided in large
part from the SEDA described below. Financing under the SEDA may not be
available on favorable terms, in sufficient amounts or at all when needed. We
may not be able to satisfy the conditions precedent to enable us to draw down
upon the SEDA, including the registration of the shares to be issued thereunder.
Furthermore, the amount of financing available will fluctuate with the price of
our common stock. As the price declines, the number of shares we must issue in
order to receive such financing will increase.
If we are unable to obtain financing on a timely basis, upon terms that we deem
sufficiently favorable, or at all, it would have a materially adverse impact
upon our ability to maintain our current operations or pursue our marketing
strategy. Without capital funding, we cannot continue to operate in 2006 and
cannot expand or meet our business objectives. Failure by us to obtain adequate
financing may require us to delay, curtail or scale back some or all of our
operations, sales, marketing efforts and research and development programs. If
we do not receive external financing, our revenue stream cannot expand, would
likely decrease and significant opportunities would be lost which would be a
limiting factor on our growth.
In May 2005, we entered into the SEDA with Cornell Capital Partners, LP
("Cornell Capital"). Pursuant to this agreement, we may, at our discretion for
up to two years, periodically issue and sell to Cornell Capital shares of common
stock for a total purchase price of $10.0 million. If we request an advance
under the SEDA, Cornell Capital will purchase shares of common stock for 97% of
the lowest volume weighted average price on the principal market on which our
common stock is traded as quoted by Bloomberg, L.P. for the five trading days
immediately following the notice date. In addition, Cornell Capital will retain
a cash fee of 5% from the proceeds received by us for each advance under the
SEDA for a total effective discount to the market price of our common stock of
8%. Cornell Capital intends to sell any shares purchased under the SEDA at the
market price. The sale of the shares under the SEDA is conditioned upon us
registering the shares of common stock under the Securities Act and maintaining
such registration. Upon the execution of the SEDA, we issued as compensation to
Cornell Capital 1,465,065 shares of our common stock with a value of $161,157,
including 293,013 shares held by its transferee, and a 12% interest bearing
promissory note in the principal amount of $188,843 from us. We issued to
Monitor Capital, Inc., as a placement fee pursuant to the placement agent
agreement between us and Monitor, 90,909 shares with an aggregate value of
$10,000 in connection with the SEDA.
We issued convertible debt securities in respect of loans in the aggregate
amount of $103,000 made to us by members of our Board of Directors and a
consultant to us in May and June 2005. The debt was convertible into shares of
our common stock at the option of the holders at the rate of $0.03 per share.
The loans accrued interest at the rate of 8% per annum. The convertible debt has
been converted or repaid in full. The convertible debt and related accrued
interest was converted into 2,560,807 shares of common stock and repaid by
approximately $32,000 in cash, including accrued interest.
22
In August and September 2005, we closed on $548,000 of equity units (the "2005
Units") in a private placement. Each Unit consists of an unsecured convertible
promissory note in the principal amount of $1,000 (the "2005 Notes") and two
warrants for each share of common stock to be issued upon conversion of the 2005
Notes, with each warrant exercisable to purchase one share of our common stock.
The purchase price per Unit was $1,000. The 2005 Notes are convertible at the
election of the holder thereof, at any time commencing from and after their date
of issuance and for a period of three years thereafter at a price equal to 85%
of the average closing price of our common stock for the 10 trading days
immediately preceding the day upon which we receive a conversion notice from the
noteholder. The 2005 Notes are entitled to receive an 8% annual interest payment
payable in shares of our common stock. The per share exercise price of the
warrants is 125% and 150%, respectively, of the conversion price of the 2005
Notes. The warrants are exercisable for shares of our common stock at any time
beginning on the date of conversion of the 2005 Notes and ending on October 31,
2009 and are subject to adjustment for anti-dilution purposes.
In February 2006, we closed on $600,000 of equity units (the "2006 Units") in a
private placement. Each Unit consists of a secured convertible promissory note
in the principal amount of $1,000 (the "2006 Notes") and eight warrants for each
share of common stock to be issued upon conversion of the 2006 Notes, with each
warrant exercisable to purchase one share of our common stock. The purchase
price per Unit was $1,000. The 2006 Notes are convertible at the election of the
holder thereof, at any time commencing from and after their date of issuance and
for a period of five years thereafter at a price equal to 80% of the average
closing price of our common stock for the 10 trading days immediately preceding
the day upon which we receive a conversion notice from the noteholder. The 2006
Notes are entitled to receive an 8% annual interest payment payable in shares of
our common stock. The per share exercise price of the warrants is 100% for two
warrants, 125% for three warrants and 150% for three warrants, respectively, of
the conversion price of the 2006 Notes. The warrants are exercisable for shares
of our common stock at any time beginning on the date of conversion of the 2006
Notes and ending on March 31, 2011 and are subject to adjustment for
anti-dilution purposes.
GOING CONCERN
Our accompanying financial statements have been prepared on a going concern
basis, which contemplates our continuation of operations, realization of assets
and liquidation of liabilities in the ordinary course of business. Since
inception, we have incurred substantial operating losses and expect to incur
additional operating losses over the next several years. As of December 31,
2005, we had an accumulated deficit of approximately $7.0 million and a working
capital deficit of $3,357,877. These factors raise substantial doubt regarding
our ability to continue as a going concern. Our accompanying financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
We have financed our operations since inception primarily through equity and
debt financings and loans from our officers, directors and stockholders. We have
recently entered into the SEDA. The additional capital necessary to meet our
working capital needs or to sustain or expand our operations may not be
available in sufficient amounts or at all under the SEDA or otherwise.
Continuing our operations is dependent upon obtaining such further financing.
These conditions raise substantial doubt about our ability to continue as a
going concern.
23
RISK FACTORS
FINANCIAL CONDITION RISKS
o We have had limited product sales, a history of operating losses and
may not become profitable in the near future or at all.
We have had limited sales of our products to date. We incurred net losses of
approximately ($7.0 million) from inception in 1997 to December 31, 2005,
including approximately ($3.6 million) of net loss during the year ended
September 30, 2005 and ($618,000) of net losses during the three months ended
December 31, 2005. We expect to incur substantial additional operating losses in
the future. During the year ended September 30, 2005 and the three months ended
December 31, 2005, we only generated revenues from product sales in the amounts
of approximately $9,785 and $5,364, respectively. We may not continue to
generate revenues from operations or achieve profitability in the near future or
at all.
o We may not be able to obtain the significant financing that we need
to continue to operate.
We may not be able to obtain sufficient funds to continue to operate or
implement our business plan. We estimate that we will need approximately
$1,000,000 to continue to operate over the next 12 months and an additional
$500,000 in each of the two following years to continue to operate. We will need
approximately $2,000,000 over the next two years in order to commence
implementing our business plan, including increased marketing and product
production. We are dependent on external financing to fund our operations. Our
immediate financing needs are expected to be provided from a private placement
of our debt securities of $600,000 and our long-term financing needs are
expected to be provided from the standby equity distribution agreement, in large
part. Such financing may not be available on favorable terms, in sufficient
amounts or at all when needed. We may not be able to satisfy the conditions
precedent to enable us to draw down upon the standby equity credit agreement,
including registration of the shares to be issued thereunder. Furthermore, the
amount of financing available under the standby equity distribution agreement
will fluctuate with the price of our common stock. As the price declines, the
number of shares the investor under the standby equity distribution agreement
must purchase to satisfy an advance request from us will increase, resulting in
additional dilution to existing stockholders and potentially causing the
investor to hold more than 9.9% of our outstanding stock which is prohibited
under the agreement. Other financing may not be available to us on favorable
terms or at all.
o The report of our independent auditors expresses doubt about our
ability to continue as a going concern.
In its report dated January 25, 2006 our auditors, Ham, Langston & Brezina,
L.L.P., expressed an opinion that there is substantial doubt about our ability
to continue as a going concern. Our accompanying financial statements have been
prepared on a going concern basis, which contemplates our continuation of
operations, realization of assets and liquidation of liabilities in the ordinary
course of business. Since inception, we have incurred substantial operating
losses and expect to incur additional operating losses over the next several
years. As of December 31, 2005, we had an accumulated deficit of approximately
$7.0 million. Our accompanying financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
24
We have financed our operations since inception primarily through equity and
debt financings and loans from our officers, directors and stockholders. We have
recently entered into a standby equity distribution agreement. The additional
capital necessary to meet our working capital needs or to sustain or expand our
operations may not be available on favorable terms, in sufficient amounts or at
all under the standby equity distribution agreement or otherwise. Continuing our
operations in 2006 is dependent upon obtaining such further financing. These
conditions raise substantial doubt about our ability to continue as a going
concern.
As is disclosed in the notes to our financial statements, our long-term
viability as a going concern is dependent upon our ability to:
> obtain adequate sources of debt or equity funding to meet
current commitments and fund the continuation of our business
operations in the near term;
> control costs and expand revenues; and
> ultimately achieve adequate profitability and cash flows from
operations to sustain our operations.
o We have a working capital loss, which means that our current assets
on December 31, 2005 were not sufficient to satisfy our current
liabilities.
We had a working capital deficit of $3,357,877 at December 31, 2005. Current
assets are assets that are expected to be converted to cash or otherwise
utilized within one year and, therefore, may be used to pay current liabilities
as they become due. Our working capital deficit means that our current assets on
December 31, 2005 were not sufficient to satisfy all of our current liabilities
on that date.
o We face risks related to our accounting restatements.
On July 11, 2006 we publicly announced that we had discovered accounting errors
in previously reported financial statements. Following consultation with our
independent accountants, we concluded it was necessary to restate our financial
statements for each of the quarters ended June 30, 2006, March 31, 2006 and
December 31, 2005 and the year ended September 30, 2005. The restatements relate
to the accounting for certain debt financings we conducted in August 2005 and
February 2006 as well as certain warrants issued by us. Further information
about these restatements is contained in our Current Report on Form 8-K filed
July 11, 2006 and this Amended Quarterly Report on Form 10-QSB/A-2 for the
quarter ended December 31, 2005. We are concurrently filing restated financial
statements for the year ended September 30, 2005; the quarter ended March 31,
2006 and the quarter ended June 30, 2006.
25
The restatement of these financial statements may lead to litigation claims
and/or regulatory proceedings against us. The defense of any such claims or
proceedings may cause the diversion of our management's attention and resources,
and we may be required to pay damages if any such claims or proceedings are not
resolved in our favor. Any litigation or regulatory proceeding, even if resolved
in our favor, could cause us to incur significant legal and other expenses. We
also may have difficulty raising equity capital or obtaining other financing. We
may not be able to effectuate our current business strategy. Moreover, we may be
the subject of negative publicity focusing on the financial statement errors and
resulting restatements and negative reactions from our stockholders, creditors
or others with whom we do business. The occurrence of any of the foregoing could
harm our business and reputation and cause the price of our securities to
decline.
o If we fail to maintain an effective system of internal and
disclosure controls, we may not be able to accurately report our
financial results or prevent fraud. As a result, current and
potential stockholders could lose confidence in our financial
reporting which would harm our business and the trading price of our
securities.
Effective internal and disclosure controls are necessary for us to provide
reliable financial reports and effectively prevent fraud and to operate
successfully as a public company. If we cannot provide reliable financial
reports or prevent fraud, our reputation and operating results would be harmed.
We have in the past discovered, and may in the future discover, areas of our
disclosure and internal controls that need improvement. As a result after a
review of our June 30, 2006, March 31, 2006, December 31, 2005 and September 30,
2005 operating results, we identified certain deficiencies in certain disclosure
controls and procedures which we have addressed as stated below.
We have undertaken improvements to our internal controls in an effort to
remediate these deficiencies through the following: (1) implementing a review of
all convertible securities to identify any securities that are not conventional
convertible securities, (2) engaging the consulting services of an outside
accountant to review our financial statements each month, and (3) improving
supervision and training of our accounting staff to understand and implement
applicable accounting requirements, policies and interpretations. We cannot be
certain that our efforts to improve our internal and disclosure controls will be
successful or that we will be able to maintain adequate controls over our
financial processes and reporting in the future. Any failure to develop or
maintain effective controls or difficulties encountered in their implementation
or other effective improvement of our internal and disclosure controls could
harm our operating results or cause us to fail to meet our reporting
obligations. Ineffective internal and disclosure controls could cause investors
to lose confidence in our reported financial information, which would likely
have a negative effect on the trading price of our securities.
o We may be unable to implement our business plan if the investor
under the standby equity distribution agreement does not fulfill its
obligations under the agreement.
We will be reliant upon the ability of Cornell Capital Partners, L.P. to provide
a significant amount of funding pursuant to the standby equity distribution
agreement, which it has agreed to do in accordance with the terms of the
agreement. In the event that the investor is unwilling or unable to fulfill its
commitment under the standby equity distribution agreement for whatever reason,
our ability to implement our business plan will suffer.
26
o Sales made under our standby equity distribution agreement may
adversely affect our stock price and our ability to raise funds in
new stock offerings.
Even if we are able to obtain the financing we require to implement our business
plan pursuant to the standby equity distribution agreement, sales made under our
standby equity distribution agreement may result in one or more of the following
consequences:
> Sales made under our standby equity distribution agreement may
adversely affect our stock price.
> The sales of our stock under our standby equity distribution
agreement could encourage short sales by third parties, which
could contribute to the further decline of our stock price.
> The investor under the standby equity distribution agreement
may sell shares of our common stock acquired under the standby
equity distribution agreement during an applicable pricing
period for determination of stock price, which could further
contribute to the decline of our stock price.
> Existing stockholders will experience significant dilution
from our sale of shares under the standby equity distribution
agreement.
> The standby equity distribution agreement prohibits us from
raising capital at less than the market price which may
severely limit our ability to raise capital from the sale of
equity.
> We may not be able to access funds under the standby equity
distribution agreement sufficient to meet our operating needs.
o We may be required to amend our standby equity distribution
agreement.
As a result of the number of shares that could be acquired by Cornell Capital
upon full utilization of our standby equity distribution agreement, Cornell
Capital could become an affiliate of us and own a majority of our outstanding
common shares. Accordingly, we may be required to amend our standby equity
distribution agreement to substantially reduce the dollar amount available
thereunder. To the extent that we must substantially reduce the amount of
financing available under the standby equity distribution agreement, our
financing plans may be materially adversely affected. Additionally, further
delays could occur with respect to the review and approval of the registration
statement covering the standby equity distribution agreement shares.
o Since Health Renu-DE became a public reporting company under the
Securities Exchange Act of 1934 by acquiring us when we were a
publicly-traded shell corporation, we remain subject to the shell
corporation's unknown liabilities, if any. If any significant
unknown liabilities arise, they could materially and adversely
affect our ability to continue in business.
27
On September 26, 2003, we entered into an exchange agreement with Health
Renu-DE, a Delaware corporation, and the former Health Renu-DE stockholders
whereby our control shifted to the former Health Renu-DE stockholders. We were
then a non-operating, publicly-traded corporation. The exchange agreement
represented a recapitalization of Health Renu-DE with accounting treatment
similar to that used in a reverse acquisition. Health Renu-DE emerged as the
surviving financial reporting entity but we remained as the legal reporting
entity. We then changed our business focus to skin care and wound care products
and our name to HealthRenu Medical, Inc.
This process is commonly referred to as a "public shell merger" because we
already had achieved public-trading status and were a reporting company with the
U.S. Securities and Exchange Commission and had previously ceased our day-to-day
business. The advantages that we hope to achieve in effecting this acquisition
include gaining access to sources of capital that are generally limited to
publicly-traded entities on an expedited basis since the public shell merger
process can typically be completed in less time than a traditional registered
initial public offering.
The risks and uncertainties involved in this strategy include that we are
subject to the shell corporation's then existing liabilities, including any
undisclosed liabilities of the shell corporation arising out of the shell
corporation's prior business operations, financial activities or equity
dealings. There is a risk of litigation by third parties or governmental
investigations or proceedings. For example, we have been sued by a stockholder
based on alleged equity dealings between the stockholder and management of the
shell corporation. There is also a risk of sales of undisclosed stock into the
public market by stockholders of the shell corporation as we improve our
business and financial condition and stock price, which would result in dilution
to our stockholders and could negatively impact our stock price. In addition,
within certain segments of the financial and legal communities there may be a
negative perception of corporations that have achieved public-trading status by
means of a public shell merger. This negative perception could adversely affect
us in the future including in our efforts to raise capital in certain markets.
RISKS RELATED TO OUR OPERATIONS
o If we are unable to successfully compete in the skin and wound care
industry on the basis of our products prices, effectiveness and
other factors, our business and financial condition will be
significantly negatively impacted.
The personal skin care industry and wound care industry is extremely competitive
and consists of major domestic and international medical, pharmaceutical,
cosmetic, consumer products, and other companies, many of which have financial,
technical, manufacturing, distribution, marketing, sales and other resources
substantially greater than ours. We compete against companies producing and
selling medical as well as consumer skin care products. We compete based upon
our product quality and price. Our competitors may introduce more effective or
less expensive products or products with greater market recognition and
acceptance which could compete with our products and have a significant negative
impact on our business and financial condition.
o We are dependent upon a third party pharmaceutical laboratory for
manufacture of our products and would likely experience production
delays and interruptions in sales if the laboratory discontinued
production of our products.
28
Our products are manufactured by Rosel & Adys Inc., a Texas-based pharmaceutical
laboratory which has been approved by the U.S. Food and Drug Administration. We
do not have a contract with this laboratory for manufacture of our products.
This laboratory may not continue to maintain its Food and Drug Administration
certification or continue to be willing or able to produce our products for us
at reasonable prices or at all. If for any reason this laboratory discontinues
production of our products, it would likely result in significant delays in
production of our products and interruption of our product sales as we seek to
establish a relationship and commence production with a new laboratory. We may
be unable to make satisfactory production arrangements with another laboratory
on a timely basis or at all.
Our production laboratory is responsible for supplying our formulas' ingredients
other than the essential fatty acids which we supply for quality control
purposes. We currently have on hand sufficient essential fatty acid supplies to
meet our short terms needs and we have developed sources for their supply for
the long-term future. If however any of these ingredients is not available to us
on favorable pricing terms or at all when they are needed, we may experience
production delays and interruption of sales.
o We do not own our products' formulas and if the owner of the
formulas does not honor its contractual commitment to sell the
formulas to us if and when requested by us, we could lose use of our
proprietary products.
We do not own our product formulas. Our production laboratory owns our product
formulas subject to an agreement of indefinite term which provides for our
exclusive use and right to purchase them. It is possible that the production
laboratory may not honor its contractual commitments and may disclose our
proprietary formulas to a third party or refuse to sell the formulas to us in
the event the laboratory ceases to produce products for us, either of which
would materially and adversely affect our business.
o We may be unable to protect our proprietary products or prevent the
development of similar products by our competitors, which could
materially and adversely affect our ability to successfully compete.
We claim proprietary rights in various unpatented technologies, know-how and
trade secrets relating to our products and their manufacturing processes. The
protection that these claims afford may prove to be inadequate. We protect our
proprietary rights in our products and operations through contractual
obligations, including nondisclosure agreements, with our production laboratory,
employees and consultants. These contractual measures may not provide adequate
protection. Further, our competitors may independently develop or patent
products that are substantially equivalent or superior to our products.
o Our founder and former president has competed with us by selling
similar products and soliciting our customers.
29
Darrell Good, the founder and principal of Health Renu-DE, has competed against
us by posting products similar to ours with the same product numbers on his
website for sale. Mr. Good has also attempted to solicit sales from our
customers. We have various other claims against Mr. Good including for fraud,
breach of contract and breach of fiduciary duty based on Mr. Good's
misrepresentation to us that we owned our products' formulas when in fact they
are owned by the production laboratory. We filed a lawsuit against Mr. Good in
the U.S. District Court for the Southern District of Texas seeking recovery for
these claims. Among other recovery sought, we sought to recover approximately
8.1 million shares of our common stock from Mr. Good and requested that Mr. Good
cease competing with us and soliciting our customers. A final non-appealable
default judgment against Mr. Good was entered in this case on July 29, 2005 and
the court ordered that the shares be cancelled and returned to us and that Mr.
Good is enjoined from competing with us for one year. The time for appeal of the
order expired on August 28, 2005. We plan to pursue enforcement of the judgment.
The shares have been cancelled on the books and records of our transfer agent.
We may not be able to prevent Mr. Good from continuing to compete with us or
soliciting our customers. If Mr. Good continues to compete with us or to solicit
our customers, it could have a material adverse effect on our business.
o We may not achieve the market acceptance of our products necessary
to generate revenues.
Products we produce may not achieve market acceptance. Market acceptance will
depend on a number of factors, including:
> the effectiveness of our products.
> our ability to keep production costs low.
> our ability to successfully market our products. We must
create an advertising campaign to create product recognition
and demand for our products.
> timely introductions of new products. Our introduction of new
products will be subject to the inherent risks of unforeseen
problems and delays. Delays in product availability may
negatively affect their market acceptance.
o We may not be able to generate increased demand for our products or
successfully meet any increased product demands.
We have had limited sales of our products to date. Rapid growth of our business
may significantly strain our management, operations and technical resources. If
we are successful in obtaining large orders for our products, we will be
required to deliver large volumes of quality products to our customers on a
timely basis and at a reasonable cost. We outsource production of our products.
We may not obtain large scale orders for our products or if we do, we may not be
able to satisfy large scale production requirements on a timely and cost
effective basis. As our business grows, we will also be required to continue to
improve our operations, management and financial systems and controls. Our
failure to manage our growth effectively could have an adverse effect on our
ability to produce products and meet the demands of our customers.
We may face liability if our products cause injury or fail to perform properly.
30
We maintain liability insurance coverage that we believe is sufficient to
protect us against potential claims. Our liability insurance may not continue to
be available to us on reasonable terms or at all. Further, such liability
insurance may not be sufficient to cover any claims that may be brought against
us.
o Our business and growth will suffer if we are unable to hire and
retain key personnel.
Our success depends in large part upon the services of our Chief Executive
Officer. Our Chief Executive Officer is our only full-time employee. We contract
with consultants and outsource key functions to control costs. If we lose the
services of our Chief Executive Officer or key consultants or are unable to hire
and retain key employees or senior management as needed in the future, it could
have a significant negative impact on our business.
o If we do not comply with regulations imposed on us by the U.S. Food
and Drug Administration, we may be unable to sell one or more of our
products or otherwise face liability.
Our sales of products are subject to regulation by the U.S. Food and Drug
Administration, or FDA. The two most important laws pertaining to cosmetics
marketed in the United States are the Federal Food, Drug, and Cosmetic Act, or
FD&C Act, and the Fair Packaging and Labeling Act, or FPLA. The FD&C Act
prohibits the marketing of adulterated or misbranded cosmetics. Violations of
the Act involving product composition--whether they result from ingredients,
contaminants, processing, packaging, or shipping and handling--cause cosmetics
to be adulterated and are subject to regulatory action. Improperly labeled or
deceptively packaged products are considered misbranded and are subject to
regulatory action. In addition, under the authority of the FPLA, the FDA
requires an ingredient declaration to enable consumers to make informed
purchasing decisions. Cosmetic products and ingredients are not generally
subject to FDA premarket approval authority, however, the FDA may pursue
enforcement action against violative products or companies who violate the law.
We are responsible for substantiating the safety of our products and ingredients
before marketing them.
Over-the-counter (OTC) drugs, however, are subject to FDA approval. Generally,
OTC drugs must either receive premarket approval by FDA or conform to final
regulations specifying conditions whereby they are generally recognized as safe
and effective, and not misbranded. OTC drugs must also be labeled according to
OTC drug regulations, including the "Drug Facts" labeling. Currently, certain
OTC drugs that were marketed before the beginning of the OTC Drug Review (May
11, 1972) may be marketed without specific approval pending publication of final
regulations under the ongoing OTC Drug Review. Once a regulation covering a
specific class of OTC drugs is final, those drugs must either:
o be the subject of an approved New Drug Application (NDA), or
o comply with the appropriate monograph, or rule, for an OTC drug.
An NDA is the vehicle through which drug sponsors formally propose that the FDA
approve a new pharmaceutical for sale and marketing in the U.S. The FDA only
approves an NDA after determining that the data are adequate to show the drug's
safety and effectiveness for its proposed use and that its benefits outweigh the
risks. The NDA process can be expensive and time consuming for a drug sponsor.
31
The FDA has published monographs, or rules, for a number of OTC drug categories.
These monographs state requirements for categories of non-prescription drugs,
such as what ingredients may be used and for what intended use. Among the many
non-prescription drug categories covered by OTC monographs are acne medications,
treatments for dandruff, seborrheic dermatitis, and psoriasis and sunscreens.
Our management, with the help of a FDA consultant, has determined that our
currently marketed products are either cosmetics or OTC drugs that may be
marketed without specific FDA approval as they are covered by OTC monographs.
The FDA, however, may disagree with our management's classification of our
products.
The FDA has broad regulatory and enforcement powers. If the FDA determines that
we have failed to comply with applicable regulatory requirements, it can impose
a variety of enforcement actions from public warning letters, fines,
injunctions, consent decrees and civil penalties to suspension or delayed
issuance of approvals, seizure or recall of our products, total or partial
shutdown of production, withdrawal of approvals or clearances already granted,
and criminal prosecution. The FDA can also require us to replace or refund the
cost of products that we distributed. If any of these events were to occur, it
could materially adversely affect our ability to market our products and our
business and financial condition.
The FDA recently required us to change certain of our product classifications,
certain of our package labeling and sales literature, and refrain from making
certain claims about our product uses. We complied and now believe that we are
in material compliance with the FDA's requirements. It is possible that the FDA
will determine that we do not so comply or that its policies, regulations or
interpretations thereof will change such that we no longer so comply, that our
products are no longer considered OTC or cosmetic products, or such that we may
not be able to obtain favorable product classification for any future products
that we may develop. Any of the foregoing could materially adversely impact our
ability to market our products and our business and financial condition.
RISKS ASSOCIATED WITH OUR COMMON STOCK
o We do not intend to pay dividends on our common stock so
stockholders must sell their shares at a profit to recover their
investment.
We have never declared or paid any cash dividends on our common stock. We intend
to retain any future earnings for use in our business and do not anticipate
paying cash dividends on our common stock in the foreseeable future. Because we
may not pay dividends, our stockholders' return on investment in our common
stock will depend on their ability to sell our shares at a profit.
o The market price of our common stock may be volatile, which could
cause the value of an investment in our stock to decline.
The market price of shares of our common stock has been and is likely to
continue to be highly volatile. Factors that may have a significant effect on
the market price of our common stock include the following:
> sales of large numbers of shares of our common stock in the
open market, including shares issuable at a fluctuating
conversion price or at a discount to the market price of our
common stock;
> our operating results;
32
> quarterly fluctuations in our financial results;
> our need for additional financing;
> announcements of product innovations or new products by us or
our competitors;
> developments in our proprietary rights or our competitors'
developments;
> our relationships with current or future suppliers,
manufacturers, distributors or other strategic partners;
> governmental regulation; and
> other factors and events beyond our control, such as changes
in the overall economy or condition of the financial markets.
In addition, our common stock has been relatively thinly traded. Thinly traded
common stock can be more volatile than common stock trading in an active public
market. We cannot predict the extent to which an active public market for our
common stock will develop.
In addition, the stock market in general has experienced extreme volatility that
often has been unrelated to the operating performance of particular companies.
These broad market and industry fluctuations may adversely affect the trading
price of our common stock, regardless of our actual operating performance.
As a result of potential stock price volatility, investors may be unable to
resell their shares of our common stock at or above the cost of their purchase
prices. In addition, companies that have experienced volatility in the market
price of their stock have been the subject of securities class action
litigation. If we were to become the subject of securities class action
litigation, this could result in substantial costs, a diversion of our
management's attention and resources and harm to our business and financial
condition.
o Future sales of currently outstanding shares of our common stock
could adversely affect our stock price.
As of February 1, 2006, we had 26,082,089 shares of common stock outstanding. Of
these shares, as of February 1, 2006, approximately 22 million shares of our
common stock are subject to restrictions on resale pursuant to Rule 144 and
approximately 4 million outstanding shares of our common stock are eligible for
sale in the public market without restriction or registration.
In addition, we intend to register under the Securities Act of 1933 the sale by
selling security holders of 1,465,065 shares of common stock issued as a
commitment fee, 90,909 shares of common stock issued as a placement agent fee
and up to $10,000,000 of common stock issuable pursuant to the standby equity
distribution agreement, shares of common stock issuable upon conversion or
exercise of securities issued in our 2005 and 2006 private placements of units
and up to 1,587,237 shares of common stock underlying compensation warrants.
o The OTC Bulletin Board has temporarily ceased quoting our common
stock and although our stock is again eligible for quotation on the
OTC-BB, it is uncertain as to if or when the reinclusion of our
share quotation on the OTC-BB will be achieved.
33
On July 12, 2006, the OTC-BB temporarily ceased quoting our shares because our
Quarterly Report on Form 10-QSB for the quarter ended March 31, 2006 had not
been timely filed. We filed our 10-QSB for the quarter ended March 31, 2006 on
July 12, 2006 and we believe that our stock is again eligible for quotation on
the OTC-BB. We intend to pursue reinclusion of our share quotation on the OTC-BB
in the future. It is uncertain as to if or when the reinclusion of our share
quotation on the OTC-BB will be achieved.
o Our common stock is deemed to be "penny stock," which may make it
more difficult for investors to sell their shares due to suitability
requirements.
Our common stock is deemed to be "penny stock" as that term is defined in Rule
3a51-1 promulgated under the Securities Exchange Act of 1934. These requirements
may reduce the potential market for our common stock by reducing the number of
potential investors. This may make it more difficult for investors in our common
stock to sell shares to third parties or to otherwise dispose of them. This
could cause our stock price to decline. Penny stocks are stocks:
o with a price of less than $5.00 per share;
o that are not traded on a "recognized" national exchange;
o whose prices are not quoted on the Nasdaq stock market; or
o of issuers with net tangible assets less than $2.0 million (if the
issuer has been in continuous operation for at least three years) or
$5.0 million (if in continuous operation for less than three years),
or with average revenues of less than $6.0 million for the last
three years.
Broker/dealers dealing in penny stocks are required to provide potential
investors with a document disclosing the risks of penny stocks. Moreover,
broker/dealers are required to determine whether an investment in a penny stock
is a suitable investment for a prospective investor.
o Our common stock has been relatively thinly traded and we cannot
predict the extent to which a trading market will develop.
There has been a limited public market for our common stock and an active
trading market for our stock may not develop. Absence of an active trading
market could adversely affect our stockholders' ability to sell our common stock
in short time periods, or possibly at all. Our common stock is thinly traded
compared to larger more widely known companies in our industry. Thinly traded
common stock can be more volatile than common stock trading in an active public
market. Our common stock has experienced, and is likely to experience in the
future, significant price and volume fluctuations that could adversely affect
the market price of our common stock without regard to our operating results.
o Our 8% convertible notes have a fluctuating conversion rate which
could cause substantial dilution to stockholders and adversely
affect our stock price.
34
Conversion of a material amount of the 8% convertible notes included in our 2005
and 2006 private placements of units could materially affect a stockholder's
investment in us. As of February 1, 2006, $548,000 of notes issued in our 2005
private placement and $600,000 of notes issued in our 2006 private placement
were issued and outstanding. The notes are convertible into a number of shares
of common stock determined by dividing the principal amount of the notes
converted by their respective conversion prices in effect.
The 2005 private placement notes are convertible by the holders into shares of
our common stock at any time at a conversion price equal to 85% of the average
of the trading prices of our common stock for the ten trading days ending one
day prior to the date we receive a conversion notice from a 2005 noteholder. In
addition, two warrants to purchase shares of common stock have been issued to
each purchaser of the 2005 notes. The warrants are exercisable for one share of
common stock for each share to be acquired upon conversion of the 2005 notes and
are exercisable until October 31, 2009 at fluctuating prices equal to 125% and
150%, respectively, of the conversion price of the 2005 notes.
The 2006 private placement notes are convertible by the holders into shares of
our common stock at any time at a conversion price equal to 80% of the average
of the trading prices of our common stock for the ten trading days ending one
day prior to the date we receive a conversion notice from a 2006 noteholder. In
addition, eight warrants to purchase shares of common stock have been issued to
each purchaser of the 2006 notes. The warrants are exercisable for one share of
common stock for each share to be acquired upon conversion of the 2006 notes and
are exercisable until March 31, 2011 at fluctuating prices equal to 100%, 125%
and 150%, respectively, of the conversion price of the 2006 notes.
Conversion of a material amount of our notes could significantly dilute the
value of a stockholder's investment in us. Also, in the absence of a
proportionate increase in our earnings and book value, an increase in the
aggregate number of our outstanding shares of common stock caused by a
conversion of the 8% notes or exercise of the warrants would dilute the earnings
per share and book value of all of our outstanding shares of common stock. If
these factors were reflected in the trading price of our common stock, the
potential realizable value of a stockholder's investment in us could also be
adversely affected.
Assuming a conversion price of $0.17 (85% of the average of the trading prices
of our common stock on the OTC Bulletin Board for the ten trading days ending on
February 1, 2006 of $0.20), the 2005 notes would convert into 3,223,529 shares
of our common stock (excluding interest) and the related warrants would be
exercisable to purchase 6,447,059 shares. Assuming a conversion price of $0.16
(80% of the average of the trading prices of our common stock on the OTC
Bulletin Board for the ten trading days ending on February 1, 2006 of $0.20),
the 2006 notes would convert into 3,750,000 shares of our common stock
(excluding interest) and the related warrants would be exercisable to purchase
30,000,000 shares. These numbers of shares, however, could be significantly
greater in the event of a decrease in the trading price of our stock.
35
Set forth in the table below is the potential dilution to the stockholders and
ownership interest of the holders of our 2005 notes which could occur upon
conversion of $548,000 in principal amount of our 2005 notes. The calculations
in the table are based upon the 26,082,089 shares of our common stock which were
outstanding on February 1, 2006 and shares issuable upon conversion of the 2005
notes at the following prices:
Conversion At Conversion At Conversion At Conversion At
Assumed Assumed Assumed Assumed
Average Trading Average Trading Average Trading Average Trading
Price of $0.20 Price of $0.15 Price of $0.10 Price of $0.05
--------------- --------------- --------------- ---------------
Conversion Price $ 0.17 $ 0.127 $ 0.085 $ 0.0425
Shares Issuable on Conversion 3,223,529 4,298,039 6,477,059 12,894,118
of 2005 Notes
Shares Issuable on Exercise 6,447,059 8,596,078 12,894,118 25,788,235
of Warrants
Percentage of Outstanding
Common Stock 27.0% 33.1% 42.6% 59.7%
Set forth in the table below is the potential dilution to the stockholders and
ownership interest of the holders of our 2006 notes which could occur upon
conversion of $600,000 in principal amount of our 2006 notes. The calculations
in the table are based upon the 26,082,089 shares of our common stock which were
outstanding on February 1, 2006 and shares issuable upon conversion of the 2006
notes at the following prices:
Conversion At Conversion At Conversion At Conversion At
Assumed Assumed Assumed Assumed
Average Trading Average Trading Average Trading Average Trading
Price of $0.20 Price of $0.15 Price of $0.10 Price of $0.05
--------------- --------------- --------------- ---------------
Conversion Price $ 0.16 $ 0.12 $ 0.08 $ 0.04
Shares Issuable on Conversion 3,750,000 5,000,000 7,500,000 15,000,000
of 2006 Notes
Shares Issuable on Exercise 30,000,000 40,000,000 60,000,000 120,000,000
of Warrants
Percentage of Outstanding
Common Stock 56.4% 63.3% 72.1% 83.8%
36
ITEM 3. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Our management, including
our Chief Executive Officer, has determined that the effectiveness of
disclosures controls and procedures under Rule 13a-15(e) and Rule 15d-15(e) of
the Securities Exchange Act of 1934 are inadequate as of December 31, 2005.
Our auditors, Ham, Langston & Brezina, LLP have advised us that, under standards
established by the Public Company Oversight Accounting Board (United States),
reportable conditions involve matters that come to the attention of auditors
that relate to significant deficiencies in the design or operation of internal
controls of an organization that, in the auditors' judgment, could adversely
affect the organization's ability to record, process, summarize and report
financial data consistent with the assertions of management in the financial
statements.
Ham, Langston & Brezina, LLP has advised our management that, in Ham, Langston &
Brezina, LLP's opinion, there were reportable conditions during the three months
ended December 31, 2005 which constituted "material weaknesses" in internal
controls. The weakness concerned the interpretation and implementation of
various complex accounting principles in the area of our financing transactions,
and resulted from the fact that we needed additional personnel and outside
consulting expertise with respect to the application of some of these more
complex accounting principles to our financial statements. While all of these
transactions were recorded, Ham, Langston & Brezina in their review work noted
instances where Generally Accepted Accounting Principles were not correctly
applied and adjustments to our financial statements were required. The
adjustments relate solely to the accounting treatment of these financing
transactions and do not affect our historical cash flow.
As a result of the material weaknesses described above, our management,
including our Chief Executive Officer, has determined that our disclosure
controls and procedures were not effective as of December 31, 2005. We are
attempting to remediate the material weakness in internal control over financial
reporting and the ineffectiveness of our disclosure controls and procedure by
conducting a review of our accounting treatment of our financing transactions
and correcting our method of accounting for such transactions. Additionally, we
are considering engaging outside expertise to enable us to properly apply
complex accounting principles to our financial statements, when necessary.
(b) Changes in internal control over financial reporting. There were no
significant changes in our internal control over financial reporting during the
first fiscal quarter that materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting. Subsequent to
our second fiscal quarter, we have adopted and implemented disclosure controls
and procedures designed to provide reasonable assurance that all reportable
information will be recorded, processed, summarized and reported within the time
period specified in the SEC's rules and forms. Under the supervision and with
the participation of our management, including our President and Chief Executive
Officer, we have evaluated the effectiveness of design and operation of our
disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(e) as of
the end of the fiscal quarter covered by this report. Based on that evaluation,
the President and Chief Executive Officer (Principal Financial and Accounting
Officer) has identified weaknesses in the accounting for convertible instruments
and disclosure of embedded derivatives.
37
Specifically, we identified deficiencies in our internal controls and disclosure
controls related to the accounting for convertible debt with conversion features
contingent upon future prices of our stock and convertible debt with detachable
warrants, primarily with respect to accounting for derivative liabilities in
accordance with EITF 00-19 and SFAS No. 133. We are concurrently restating our
financial statements for the year ended September 30, 2005 and for the interim
periods ending March 31, 2006 and June 30, 2006, in order to correct the
accounting in such financial statements with respect to derivative liabilities
in accordance with EITF 00-19 and SFAS No. 133. Since March 2006, we have
undertaken improvements to our internal controls in an effort to remediate these
deficiencies through the following efforts: 1) implementing a review of all
convertible securities to identify any securities that are not conventional
convertible securities 2) engaging the consulting services of an outside
accountant to review our financial statements each month and; 3)improving
supervision and training of our accounting staff to understand and implement the
requirements of EITF 00-19 and SFAS 133.
38
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There are no material legal proceedings pending against us except as described
below.
In October 2005, a stockholder, filed a lawsuit against us, our chief executive
officer and a former chief executive officer, in the District Court for the City
and County of Denver, State of Colorado. The stockholder claims he was issued
44,000 shares of common stock of AGTSports, Inc., a Colorado corporation and our
predecessor, prior to 1997 which shares were intended to be "non-dilutive" and
that he purchased 44,000 additional shares in May 1997. He further claims that
he was not given notice of or an opportunity to vote with the respect to the
reincorporation and exchange transaction in September 2003 whereby we became
HealthRenu Medical, Inc. and that he was prevented from liquidating his shares
at $8.50 per share. The stockholder alleges various claims for relief based upon
negligent and fraudulent misrepresentation and concealment, civil conspiracy,
civil theft, breach of fiduciary duty, breach of contract, failure to provide
notice of dissenter rights, violation of the Colorado Securities Act, and
intentional infliction of emotional distress. The stockholder seeks relief
including compensation for his stock, forfeited opportunities to liquidate his
stock, actual, compensatory and punitive damages, costs and attorney fees and
treble damages with respect to his civil theft claim. We believe this complaint
is without merit and has filed an answer to defend against such complaint.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECUIRTY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
39
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit No. Description
4.1 Amended and Restated Standby Equity Distribution Agreement
dated as of February 3, 2006 between the issuer and Cornell
Capital Partners, LP*
10.1 Letter Agreement dated as of February 3, 2006 between the
issuer and Cornell Capital Partners, LP (exhibits omitted)*
10.2 Termination Agreement dated as of February 3, 2006 between the
issuer, David Gonzalez, Esq. and Cornell Capital Partners, LP*
31 Certificate of the Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.+
32 Certificate of the Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.+
* Filed as Exhibits 4.1, 10.1 and 10.2 to our Form 10-QSB/A filed with the
Securities and Exchange Commission on April 5, 2006 and incorporated herein
by reference
+ Filed herewith as an exhibit.
(b) Reports on Form 8K. During the quarter ended December 31, 2005, the issuer
filed the following Reports on Form 8-K:
None
40
SIGNATURES
In accordance the requirements of the Exchange Act, the registrant caused this
report to be signed on its behalf by the undersigned, thereunto duly authorized.
HEALTHRENU MEDICAL, INC.
DATED: October 20, 2006 By: /s/ Robert W. Prokos
-------------------------------
Robert W. Prokos
Chief Executive Officer and
President
(Principal Executive, Financial
and Accounting Officer)
41