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 March 31, 2006
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from to
----------- -------------
Commission file number 000-21914
HEALTHRENU MEDICAL, INC.
---------------------------------------------------------------
(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
-------------------------------------------------
(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 March 31, 2006 the issuer had
26,094,589 shares of common stock, $.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 10-QSB/A for the quarter ended
March 31, 2006 as previously filed on July 12, 2006. We have identified certain
accounting errors related to cost directly associated from our debt arrangements
that were originally treated as a reduction in additional paid-in-capital and as
a result of this amendment have been recorded as deferred loan costs net of
applicable accumulated amortization. We have also identified certain accounting
errors related to our debt arrangements which have been determined to contain
embedded derivatives. Our original accounting adjustments for these instruments
did not include fully reducing the associated net convertible notes payable
balance to zero and accreting these discounts throughout the life of the related
instruments. There were also other minor adjustments related to changes in the
estimated fair market value of our derivative instruments. Accordingly, we are
concurrently amending our Form 10-KSB/A for the year ended September 30, 2005;
our Form 10-QSB/A for the three months ended December 31, 2005; and our Form
10-QSB for the nine months ended June 30, 2006.
We have added footnote 5 to disclose the deferred loan costs and provide
information on subsequent changes. The effect of the (non-cash) changes related
to accounting for these deferred loan costs on our statement of operations for
the three months ended March 31, 2006 and six months ended March 31, 2006 was an
increase in our net loss attributable to common shareholders of $12,333 and
$23,767, respectively. Basic loss attributable to common shareholders per share
for the six months ended March 31, 2006 increased $0.00 per share. The
cumulative effect on our balance sheet as of March 31, 2006 was an additional
deferred loan cost net of accumulated amortization of $217,576.
We are required to record the fair value of the debt and other agreements deemed
to be embedded derivatives on our balance sheet with changes in the values of
these embedded derivatives reflected in the statement of operations as "loss on
embedded derivative liability." Although we did record the estimated fair value
of these derivatives on our balance sheet we did not fully reduce the associated
convertible notes payable through a note discount which resulted in an
overstatement of our liabilities and an overstatement of expenses reported in
our statement of operations. Also as a result of our re-evaluation of the
aforementioned instruments we have made slight adjustments to the estimated fair
market value of our derivative instruments. The effect of the (non-cash) changes
related to properly accounting for these derivative instrument liabilities and
convertible notes payable on our statement of operations for the three and six
months ended March 31, 2006, was a decrease in our net loss attributable to
common shareholders of $1,265, and $1,393, respectively. Basic loss attributable
to common shareholders per share for the six months ended March 31, 2006
decreased $0.00 per share. The cumulative effect on our balance sheet as of
March 31, 2006 was a decrease in our convertible notes payable of $38,991 and a
decrease in our derivative liability of $9,056. We have added footnote 12 to
disclose these changes and provide information on subsequent changes.
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 July 12, 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 Form 10-KSB/A-2 for the year ended
September 30, 2005, our amended Quarterly Report on Form 10-QSB/A-2 for the
quarter ended December 31, 2005, and our amended Quarterly Report on 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 MARCH 31, 2006
INDEX
PART 1-FINANCIAL INFORMATION PAGE
----
ITEM 1. FINANCIAL STATEMENTS
Unaudited Balance Sheets as of March 31, 2006...........................4
and September 30,2005
Unaudited Statement of Operations for the
three and six months ended March 31, 2006 and 2005....................5
Unaudited Statement of Cash Flows for the...............................6
six months ended March 31, 2006 and 2005
Notes to Unaudited Financial Statements..................................7-17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS..............................18-35
ITEM 3. CONTROLS AND PROCEDURES.............................................36
PART II-OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS...................................................37
ITEM 2. UNREGISTERED SALES OF SECURITIES AND USE OF PROCEEDS................37
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.....................................37
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................37
ITEM 5. OTHER INFORMATION...................................................37
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K..................................37-39
3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HEALTHRENU MEDICAL, INC.
BALANCE SHEETS
(Unaudited)
March 31, September 30,
2006 2005
ASSETS (Restated) (Restated)
------ ------------- -------------
Current assets:
Cash and cash equivalents $ 68,178 $ 163,095
Accounts receivable 1,383 716
Inventory 20,603 18,188
Prepaid expense 1,395 2,146
------------- -------------
Total current assets 91,559 184,145
Property and equipment, net 11,945 9,592
Deferred loan costs, net 217,576 136,307
------------- -------------
Total assets $ 321,080 $ 330,044
============= =============
LIABILITIES AND STOCKHOLDERS' DEFICIT
- -------------------------------------
Current liabilities:
Accounts payable $ 96,785 $ 117,863
Accounts payable-stockholder -- 2,329
Accrued interest 48,489 11,057
Accrued liabilities 18,580 19,270
Note payable 188,843 188,843
Derivative liability 9,874,375 2,630,121
------------- -------------
Total current liabilities 10,227,072 2,969,483
------------- -------------
Convertible notes payable, net 66,522 9,324
Total liabilities 10,293,594 2,978,807
------------- -------------
Stockholders' deficit:
Convertible preferred stock, Series 2000A,
$0.001 par value; 1,500,000 shares
authorized, 1,763 shares issued and
outstanding at March 31 2006
and September 30, 2005 2 2
Common stock, $.001 par value; 150,000,000
shares authorized, 26,094,589 and
25,019,589 shares issued and outstanding at
March 31 2006 and September 30, 2005, respectively 26,095 25,620
Additional paid-in capital 3,751,003 3,748,602
Accumulated deficit (13,749,614) (6,422,987)
------------- -------------
Total stockholders' deficit (9,972,514) (2,648,763)
------------- -------------
Total liabilities and stockholders' deficit $ 321,080 $ 330,044
============= =============
See accompanying notes to financial statements.
4
HEALTHRENU MEDICAL, INC.
STATEMENT OF OPERATIONS
for the three and six months ended March 31, 2006 and 2005
(Unaudited)
Three Months Ended Six Months Ended
March 31, March 31,
2006 2006
(Restated) 2005 (Restated) 2005
------------ ------------ ------------ ------------
Sales $ 4,470 $ 3,744 $ 9,834 $ 7,497
Cost of sales 5,571 1,353 6,654 2,301
------------ ------------ ------------ ------------
Gross profit (loss) (1,101) 2,391 3,180 5,196
General and administrative
expenses 311,805 44,482 567,071 93,760
------------ ------------ ------------ ------------
Loss from operations (312,906) (42,091) (563,891) (88,564)
Interest and financing expense (53,294) (7) (118,482) (18)
Loss on embedded derivative
liability (6,342,118) -- (6,644,253) --
------------ ------------ ------------ ------------
Net loss $ (6,708,318) $ (42,098) $ (7,326,626) $ (88,582)
============ ============ ============ ============
Weighted average shares
outstanding 26,094,033 28,099,325 25,859,287 26,362,745
============ ============ ============ ============
Basic and diluted net loss per
common share $ (0.26) $ (0.00) $ (0.28) $ (0.00)
============ ============ ============ ============
See accompanying notes to financial statements.
5
HEALTHRENU MEDICAL, INC.
UNAUDITED STATEMENT OF CASH FLOWS
for the six months ended March 31, 2006 and 2005
(Unaudited)
Six Months Ended
March 31,
--------------------------
2006 2005
(Restated)
----------- -----------
Cash flows from operating activities:
Net loss $(7,326,626) $ (88,582)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation 1,790 646
Common stock issued as settlement -- 750
Accretion of debt discount 57,198 --
Amortization of deferred financing
costs 23,767 --
Common stock issued for services 2,876 --
Embedded derivative liability 6,644,253 --
Changes in operating assets and
liabilities:
Accounts receivable (667) (1,957)
Other current assets 751 (2,086)
Inventory (2,415) (10,473)
Accounts payable & Other 13,335 91
----------- -----------
Net cash used in operating
activities (585,738) (101,611)
----------- -----------
Cash flows from investing activities:
Purchase of fixed assets (4,143) (506)
----------- -----------
Net cash used in investing
activities (4,143) (506)
----------- -----------
Cash flows from financing activities:
Common stock issued for cash -- 91,650
Increase in bank overdraft -- 407
Proceeds from convertible notes, net 494,964
Payment received on stock subscription
receivable -- 2,500
----------- -----------
Net cash provided by financing
activities 494,964 94,557
----------- -----------
Decrease in cash and cash equivalents (94,917) (7,560)
Cash and cash equivalents, beginning of
period 163,095 7,560
----------- -----------
Cash and cash equivalents, end of period 68,178 --
=========== ===========
Supplemental disclosure of cash flow information:
Cash paid for interest -- 18
=========== ===========
Non-cash investing and financing activities:
Debt discount related to derivatives 600,000 --
=========== ===========
Issuance of common stock as payment of
liability -- 52,512
=========== ===========
See accompanying notes to financial statements
6
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 respective full
year.
Restatements
Restatements of previously reported 2006 financial results were made. See
Note 12.
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.
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.
7
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 customer balances and the likelihood of collection. As of March
31, 2006 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 ten 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.
Inventory
Inventory consists solely of finished goods and is 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 March 31, 2006, 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.
8
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.
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 in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 123R, Share-Based Payment, as
interpreted by SEC Staff Accounting Bulletin No. 107. The Company adopted
SFAS 123R on January 1, 2006.
Prior to January 1, 2006, the Company accounted for stock options
according to the provisions of Accounting Principles Board ("APB") Opinion
No. 25, Accounting for Stock Issued to Employees, and related
interpretations, and therefore no related compensation expense was
recorded for awards granted with no intrinsic value.
Debt Issuance Costs
Debt issuance costs are deferred and recognized using the effective
interest method over the expected term of the related debt.
9
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 its 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'
deficit or net loss.
4. Going Concern
HealthRenu's financial statements have been presented on the basis that it
will continue as a going concern, which contemplates the realization of
assets and satisfaction of liabilities in the normal course of business.
HealthRenu has incurred net losses of $7,326,626 for the six months ended
March 31, 2006 and cumulative net losses of $13,749,614 since its
inception and has a working capital deficit of $10,135,513. These
conditions raise substantial doubt about HealthRenu's ability to continue
as a going concern. The financial statements do not include any
adjustments to reflect the possible future effects on the recoverability
and classification of assets or the amounts and classification of
liabilities that may result from the outcome of these uncertainties.
HealthRenu is working to secure additional financing to fund its operating
activities and to meet its obligations and working capital requirements
over the next twelve months.
There are no assurances that HealthRenu will be able to either (1) achieve
a level of revenues adequate to generate sufficient cash flow from
operations; or (2) obtain additional financing through either private
placement, public offerings or bank financing necessary to support
HealthRenu's working capital requirements. To the extent that funds
generated from operations and any private placements, public offerings or
bank financing are insufficient, Health Renu will have to raise additional
working capital. No assurance can be given that additional financing will
be available, or if available, will be on terms acceptable to Health Renu.
If adequate working capital is not available, Health Renu may be required
to curtail or cease its operations.
10
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 March 31, 2006 the total costs capitalized by the
Company were $242,236. These deferred financing costs are being amortized
using an effective interest method over the three-year and five-year
estimated lives of the related debt agreements. The Company recorded
$12,333 and $23,767, respectively, of amortization expense during the
three month and six month periods ending March 31, 2006 related to these
deferred financing costs which are included in the statement of operations
as additional interest and financing expense. The accumulated amortization
of deferred financing costs was $24,660 at March 31, 2006.
6. Litigation
The Company is a 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.
7. Convertible Notes Payable
In August and September 2005 the Company entered into agreements to issue
convertible promissory notes in the total amount of $548,000 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 notes at any time on or after the issuance
date. 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 granted
two warrants to purchase the Company's common stock 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.
The warrants expire on October 31, 2009.
In February 2006 the Company entered into agreements to issue convertible
promissory notes in the total amount of $600,000 and received proceeds of
$494,964 net of $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 the Company'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 the Company's
receipt of the conversion notice. The note holders were also granted eight
warrants to purchase the Company's common stock 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 be issued under both convertible note
agreements are indeterminable, they have been classified as derivative
instrument based on the guidance of SFAS No. 133 and EITF 00-19 (see Note
10 for further discussion).
11
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. The fair market value of the
shares issued of $0.02 per share was based on recent cash sales of the
Company's common stock. 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
HealthRenu 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 convertible
notes payables;
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 NO.133 and EITF 00-19 require the Company to bifurcate and separately
account for the conversion features of the convertible notes payables and
warrants issued to consultants 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.
12
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 will concurrently amend 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 March 31, 2006 is as follows:
Embedded derivative
Liability balance
Notes Payable $8,919,258
Placement Warrants 749,107
Consulting Warrants 206,010
----------
Total: $9,874,375
The impact on statements of operations as of the three and six months ended
March 31, 2006 is as follows:
Gain (loss) on embedded
derivative liabilities: three months ended six months ended
- ----------------------- ------------------------------------------------------------------
March 31, 2006 March 31, 2005 March 31, 2006 March 31, 2005
-------------- -------------- -------------- --------------
Notes Payable $ (6,367,276) $ -- $ (7,003,419) $ --
Placement Warrants (19,894) -- 82,618 --
Consulting Warrants 45,052 -- 276,548 --
-------------- -------------- -------------- --------------
Total gain (loss) on
embedded derivative
liabilities: $ (6,342,118) $ -- $ (6,644,253) --
-------------- -------------- -------------- --------------
11. Warrants
In September 2005 the Company granted warrants to certain consultants and
placement agents to purchase 1,587,237 shares of the Company's common
stock exercisable at $0.30 to $.50 per share, at which time the trading
price ranged from $0.31 to $0.44 per share. The warrants were fully
vested, exercisable at the date of grant and expire on October 31, 2009.
During the month of February 2006 the Company granted warrants to certain
consultants and placement agents to purchase a total of 3,469,125 shares
of the Company's common stock exercisable at $0.17 to $0.18 per share, at
which time the trading price ranged from $0.16 to $0.20 per share. The
warrants were fully vested, exercisable at the date of grant and expire
during March 2011.
13
As a result of the Company's determination that their convertible notes as
described in Note 7 result in an indeterminate number of shares to be
issued the warrant instruments described above and listed below are being
valued as embedded derivatives consistent with SFAS No. 133. The fair
value of these warrants are recorded in the Company's balance sheet as a
component of derivative liability with changes in the values of these
embedded derivatives reflected in the statement of operations as "Gain
(loss) on embedded derivative liability."
Outstanding options and warrants as of March 31, 2006 are as follows
Grant Expiration Exerc. Outstanding New Outstanding
Date Date Price 09/30/05 Grants Exercises 03/31/06
9/05 10/09 $0.50 1,100,000 - - 1,100,000
9/05 10/09 $0.48 119,318 - - 119,318
9/05 10/09 $0.35 106,875 - - 106,875
9/05 10/09 $0.36 121,818 - - 121,818
9/05 10/09 $0.30 139,226 - - 139,226
2/06 03/11 $0.18 1,181,250 1,181,250
2/06 03/11 $0.18 781,875 781,875
2/06 03/11 $0.17 1,506,000 1,506,000
------------------------------------------------
Totals 1,587,237 3,469,125 - 5,056,362
------------------------------------------------
12. Restatement
The Company has restated its quarterly financial statements from amounts
previously reported March 31, 2006. The Company has 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. Note 5 was added to
disclose the deferred loan costs and provide information on subsequent
changes.
The effect of the (non-cash) changes related to accounting for these
deferred financing costs on the statement of operations for the three and
six months ended March 31, 2006 was an increase in the Company's net loss
attributable to common shareholders of $12,333 and $23,767, respectively.
The cumulative effect on the balance sheet as of March 31, 2006 was an
additional deferred loan cost net of accumulated amortization of $217,576.
Basic earnings (loss) attributable to common shareholders per share for
the three and six month period ended March 31, 2006 increased $0.00 per
share.
The Company also has identified certain accounting errors related to its
debt arrangements and specifically instruments which have previously been
determined to contain embedded derivatives. The Company's original
accounting adjustments for these instruments did not include fully
reducing the associated net convertible notes payable balance to zero and
accreting these discounts throughout the life of the related instruments.
There were also other minor adjustments related to changes in the
estimated fair market value of its derivative instruments.
14
The Company is required to amortize these debt discounts over the life of
the related debt instrument. The Company's policy is to use the effective
interest method of amortization over the expected estimated life of the
underlying instruments. The effect of the (non-cash) changes related to
the increase in the basis of these discounts along with slight adjustments
in the fair market value of the Company's derivative liability, on the
statement of operations for the three and six months ended March 31, 2006,
was a decrease in the net loss attributable to common shareholders of
$1,265 and $1,393, respectively. Basic earnings (loss) attributable to
common shareholders per share for the six months ended March 31, 2006
decreased $0.00 per share as a result of the restatement.
15
HEALTHRENU MEDICAL, INC.
NOTES TO UNAUDITED FINANCIAL STATEMENTS
Restatement, continued
In all other material respects, the financial statements are unchanged.
Following is a summary of the restatement adjustments:
As of March 31, 2006
As Reported Adjustments As Restated
------------ ------------ ------------
SUMMARY BALANCE SHEET
- ---------------------
ASSETS
------
Current assets:
Cash and cash equivalents $ 68,178 $ -- $ 68,178
Accounts receivable 1,383 -- 1,383
Inventory 20,603 -- 20,603
Prepaid expense 1,395 -- 1,395
------------ ------------ ------------
Total current assets 91,559 -- 91,559
Property and equipment, net 11,945 -- 11,945
Deferred loan costs -- 217,576(a) 217,576
============ ============ ============
Total assets $ 103,504 $ 217,576 $ 321,080
============ ============ ============
LIABILITIES AND
STOCKHOLDERS' DEFICIT
------------
Current liabilities:
Accounts payable $ 96,785 $ -- $ 96,785
Accounts payable-stockholder -- -- --
Accrued liabilities 80,481 (13,412)(b) 67,069
Note payable 188,843 -- 188,843
Derivative liability 9,883,431 (9,056)(c) 9,874,375
------------ ------------ ------------
Total current liabilities 10,249,540 (22,468) 10,227,072
Convertible notes payable 105,513 (38,991)(d) 66,522
Total liabilities 10,355,053 (61,459) 10,293,594
------------ ------------ ------------
Stockholders' deficit:
Convertible preferred stock,
Series 2000A, 2 -- 2
Common stock 26,095 -- 26,095
Additional paid-in capital 2,307,783 1,443,220(e) 3,751,003
Accumulated deficit (12,585,429) (1,164,185)(f) (13,749,614)
------------ ------------ ------------
Total stockholders' deficit (10,251,549) 279,035 (9,972,514)
------------ ------------ ------------
Total liabilities and
stockholders' deficit $ 103,504 $ 217,576 $ 321,080
------------ ------------ ------------
(a) To record net deferred loan costs associated with the 2005 & 2006
convertible notes payable.
(b) To adjust accrued interest to actual based upon previous errors.
(c) To record changes in 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 and
other prior period adjustments. See the Company's September 30, 2005
form 10KSB/A-2 or subsequent amendments thereof for further
discussion.
(f) To adjust accumulated deficit for the correction of prior period
errors as discussed in the statement regarding this amendment in the
front of this filing along with closing net loss related to the
re-statement entires for the current period.
16
HEALTHRENU MEDICAL, INC.
NOTES TO UNAUDITED FINANCIAL STATEMENTS
Restatement, continued
For the three months ended March 31, 2005 For the six months ended March 31, 2006
As Reported Adjustments As Restated As Reported Adjustments As Restated
----------- ----------- ----------- ----------- ----------- -----------
SUMMARY STATEMENT
OF OPERATIONS
Sales 4,470 -- 4,470 9,834 -- 9,834
Cost of sales (5,571) -- (5,571) (6,654) -- (6,654)
----------- ----------- ----------- ----------- ----------- -----------
Gross profit (1,101) -- (1,101) 3,180 -- 3,180
(loss)
General and
administrative
expenses 311,805 -- 311,805 567,071 -- 567,071
----------- ----------- ----------- ----------- ----------- -----------
Loss from
operations (312,906) -- (312,906) (563,891) -- (563,891)
Interest and
financing expense (44,761) (8,533)(a) (53,294) (95,947) (22,535)(a) (118,482)
Loss on embedded
derivative
liability (6,339,583) (2,535)(b) (6,342,118) (6,644,414) 161(b) (6,644,253
Net loss (6,697,250) (11,068) (6,708,318) (7,304,252) (22,374) (7,326,626)
=========== =========== =========== ===========
Weighted average
shares outstanding 26,094,033 -- 26,094,033 25,859,287 -- 25,859,287
Basic and diluted
net loss per
common share (0.26) -- (0.26) (0.28) -- (0.28)
(a) To record changes in the amortization of debt discounts based upon
changes in the basis of the Company's debt discount, to record
current period amortization of deferred loan costs, and adjustments
to interest expense as a result of certain errors in the Company's
amortization schedules.
(b) To record the change in the estimated fair value of warrants and
embedded derivatives based upon revisions in the Company's estimated
fair market value.
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
This report contains forward looking statements. These forward looking
statements 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. 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.
Since its inception, Health Renu-DE had been in the research and development
stage, with a focus on improving its skin care and developing wound care
products. During this period, Health Renu-DE had very little production or
revenue.
We currently have six major products in our medical line, including:
o DERM-ALL GEL
o SKIN RENU PLUS
o SKIN RENU LOTION
o SKIN RENU SKIN THERAPY
o RENU CARE SKIN-CARE WASH CREAM
o HEALTH RENU DEEP RELIEF PAIN RELIEVER
Our BetterSkin consumer line consists of scented body lotions and body washes
that are designed for every day use by consumers. Our BetterSkin products come
in the most popular selling scents in the U.S. - vanilla, strawberry,
grapefruit, mango, cucumber melon, rose and peach - and contain seven essential
oils and vitamins. Unlike a majority of the consumer scented lotion lines on the
market today which can damage fat cells of the skin, we believe that BetterSkin
products offer a higher quality, healthier and less expensive lotion.
We have not yet commenced commercial distribution of our BetterSkin products. We
intend to place our BetterSkin 8 ounce lotion and body soaps in low end retail
markets, with the 13 ounce sizes in high end retail and drug stores. We expect
to commence initial distribution of the BetterSkin line during our fourth fiscal
quarter ending September 30, 2006.
We believe that our medical line products have a positive effect in caring for
aging skin, including skin care problems that often affect the elderly. We
believe that our products deliver nutrients deep within the skin's surface to
provide nourishment and hydration of the skin, reduce the appearance of fine
lines and wrinkles and relief from minor aches and pains in muscles and joints.
18
All of our products are made with a heavy concentration of omega-3, omega-6 and
omega-9 essential fatty acids. These fatty acids in our medical line products
are recognized by the body as natural substances and are readily absorbed by the
body. The body uses these ingredients to benefit the body and does not fight
them off as foreign. Essential fatty acids are currently being used in many
cosmetic products and therapeutic vehicles.
We believe that our medical line products provide a very simple, rapidly
working, effective and less expensive way to address skin problems, including
those associated with aging. We believe these factors will incentify the home
healthcare, long-term and assisted care industries to use our medical line
products. Our belief in the effectiveness of these products is based upon
responses in and positive feedback and reorders from customers and the personal
experiences of our management.
We provide essential fatty acid ingredients to a third party manufacturing
laboratory who provides all other raw materials needed and produces our skin
care products. We then purchase the products from the manufacturer and
distribute our products. The manufacturing laboratory owns our product formulas
subject to our exclusive use and right to purchase the formulas at prices that
we believe are reasonable.
Historically, most of our sales have been to nursing homes, hospices and
clinics.
Our current marketing efforts include use of regional medical supply
distribution companies, mailings and magazine advertising targeted to older
consumers in limited U.S. markets, and internet sales. We also intend to pursue
other business opportunities that compliment our products. We may also seek to
enter into joint ventures or other alliances with strategic partners. This plan
depends upon our receiving additional capital funding.
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, inventory 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.
19
Inventory
Inventory consists solely of finished goods and is 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 March 31, 2006, we did not have a reserve for
obsolescence.
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
Stock-based compensation is accounted for in accordance Statement of Financial
Accounting Standards ("SFAS") No. 123R, Share-Based Payment, as interpreted by
SEC Staff Accounting Bulletin No. 107. The Company adopted SFAS 123R on January
1, 2006.
Prior to January 1, 2006, the Company accounted for stock options according to
the provisions of Accounting Principles Board ("APB") Opinion No. 25, Accounting
for Stock Issued to Employees, and related interpretations, and therefore no
related compensation expense was recorded for awards granted with no intrinsic
value.
COMPARISON OF OPERATING RESULTS
Three Months Ended March 31, 2006 Compared to Three Months Ended March 31, 2005
Revenues increased to $4,470 for the three months ended March 31, 2006 from
$3,744 for the three months ended March 31, 2005. The increase in revenues is
due to increased sales volume related to increased marketing activity.
Cost of sales increased to $5,571 for the three months ended March 31, 2006 from
$1,353 for the three months ended March 31, 2005. The increase in cost of sales
is due to increased sales volume, as well as new product development.
Gross profit (loss) decreased to $(1,101) for the three months ended March 31,
2006 from $2,391 for the three months ended March 31, 2005. The decrease in
gross profit is due to increased cost of sales.
20
General and administrative expenses increased to $311,805 for the three months
ended March 31, 2006 to $44,482 for the three months ended March 31, 2005. The
increase in general and administrative expenses was due to higher costs related
to our expansion efforts and increased compensation to our chief executive
officer.
Loss on embedded derivative liability. We recognized a loss on derivative
instruments of $6,342,118 during the quarter ended March 31, 2006 compared to no
activity during the quarter ended March 31, 2005, an increase of $6,342,118. 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 in
August and September 2005 and February 2006.
Interest and financing expense increased to $53,294 for three months ended March
31, 2006 from $7 for the three months ended March 31, 2005. The increase is
attributable to the additional interest related to the note payable and the
convertible notes.
We recorded a loss from operations of $312,906 for the three months ended March
31, 2006 compared to a loss from operations of $42,091 for the three months
ended March 31, 2005. The increase in general and administrative expenses was
due to higher costs related to our expansion efforts and increased compensation
to our chief executive officer.
We reported a net loss of $6,708,318 for the three months ended March 31, 2006
compared to a net loss of $42,098 for the three months ended March 31, 2005. The
increase in loss is due to the loss on embedded derivatives.
Basic and diluted net loss per common share was ($0.26) for the three months
ended March 31, 2006 compared to $.00 for the three months ended March 31, 2005.
Six Months Ended March 31, 2006 Compared to Six Months Ended March 31, 2005
Revenues increased to $9,834 for the six months ended March 31, 2006 from $7,497
for the six months ended March 31, 2005. The increase in revenues is due to
increased sales volume related to increased marketing activity.
Cost of sales increased to $6,654 for the six months ended March 31, 2006 from
$2,301 for the six months ended March 31, 2005. The increase in cost of sales is
due to increased sales volume, as well as new product development.
Gross profit decreased to $3,180 for the six months ended March 31, 2006 from
$5,196 for the six months ended March 31, 2005. The decrease in gross profit is
due to increased cost of sales.
General and administrative expenses increased to $567,071 for the six months
ended March 31, 2006 from $93,760 for the six months ended March 31, 2005. The
increase in general and administrative expenses was due to higher costs related
to our expansion efforts and increased compensation to our chief executive
officer.
Loss on embedded derivative liability. We recognized a loss on derivative
instruments of $6,644,253 during the six months ended March 31, 2006 compared to
no activity during the six months ended March 31, 2005, an increase of
$6,644,253. 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 in August and September 2005 and February 2006.
21
Interest and financing expense increased to $118,482 for six months ended March
31, 2006 from $18 for the six months ended March 31, 2005. The increase is
attributable to the additional interest related to the note payable and the
convertible notes.
We recorded a loss from operations of $563,891 for the six months ended March
31, 2006 compared to a loss from operations of $88,564 for the six months ended
March 31, 2005. The increase in loss from operations is principally due to the
increase in general and administrative expenses.
We reported a net loss of $7,326,626 for the six months ended March 31, 2006
compared to a net loss of $88,582 for the six months ended March 31, 2005. The
increase in loss is due to the loss on embedded derivatives.
Basic and diluted net loss per common share was ($0.28) for the six months ended
March 31, 2006 compared to ($0.00) for the six months ended March 31, 2005.
LIQUIDITY AND CAPITAL RESOURCES
For the three and six months ended March 31, 2006 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 March 31, 2006, our cash totaled $68,178 and total current assets were
$91,559. Inventory at March 31, 2006 was $20,603.
As of March 31, 2006, our accounts payable totaled $96,785. Total current
liabilities were $10,227,072 primarily attributable to derivative liabilities.
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 from the
private placement of our convertible debt securities of $600,000 closed in
February 2006 as described below. Such financing was required 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 sufficient to meet our needs
until the SEDA is available for us to draw on.
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 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.
22
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 pursue our marketing strategy and maintain our current
operations. 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, subject to registration of
such shares. 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 shares under the SEDA at the market price. The sale of the
shares under the SEDA is conditioned upon us registering the sale of 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 the aggregate amount of $103,000 to
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 on August 31, 2006
into 2,560,807 shares of common stock and repaid by approximately $32,000 in
cash, including accrued interest.
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 the 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.
23
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 the 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 March 31, 2006,
we had an accumulated deficit of approximately $13.75 million and a working
capital deficit of $10,135,513. 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.
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 $13.75 million from inception in 1997 to March 31, 2006, including
approximately $7.3 million of net loss during the six months ended March 31,
2006. We expect to incur substantial additional operating losses in the future.
During the six months ended March 31, 2006, we only generated revenues from
product sales in the amounts of approximately $9,834. 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.
24
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 implement our
business plan. 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 convertible debt securities of $600,000 closed in February,
2006. Such private placement financing may not be sufficient to meet our needs
until the standby equity distribution agreement is available for us to draw on.
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 distribution 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, except for notes 15 and 16 which are dated
October 10, 2006, our former 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 March 31, 2006, we had an accumulated deficit of approximately
$13.75 million. 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 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.
o We have a working capital loss, which means that our current assets
on March 31, 2006 were not sufficient to satisfy our current
liabilities.
We had a working capital deficit of $10,135,513 at March 31, 2006, which means
that our current liabilities exceeded our current assets on March 31, 2006.
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
March 31, 2006 were not sufficient to satisfy all of our current liabilities on
that date.
25
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 that we were required to restate our
financial statements for 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 March 31, 2006. We are concurrently filing restated financial
statements for the quarters ended December 31, 2005, June 30, 2006, and the year
ended September 30, 2005 as soon as practicable.
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.
26
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.
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 sale 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.
27
>> 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.
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 products and wound care
development 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 upon 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.
28
RISKS RELATED TO OUR OPERATIONS
o If we are unable to successfully compete in the skin 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 is extremely competitive and consists of major
domestic and international medical, pharmaceutical, cosmetic, consumer products
and other companies, most 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 or 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 interruption in sales if the laboratory discontinued
production of our products.
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 are 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.
29
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.
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 filed a lawsuit against Mr. Good in the U.S. District Court for
the Southern District of Texas seeking recovery of 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 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.
30
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.
o We may face liability if our products cause injury or fail to
perform properly.
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. We have only three full-time employees, including our Chief Executive
Officer. We contract with consultants and outsource key functions to control
costs. If we lose the services of our Chief Executive Officer or any of our key
employees or 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.
31
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.
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.
o We may consider including in our business plan forming ventures or
alliances with certain users of our products which may divert the
time and attention of our management and ultimately prove to be not
feasible or unsuccessful.
32
We may consider forming joint ventures, strategic alliances or possibly
acquisitions of complementary businesses, such as existing and potential users
of our products including assisted living or long-term assisted care facilities
or wound care clinics. Management believes that such business strategy may
create additional distribution outlets for our products thus increasing our
product sales and revenues with minimal advertising and marketing costs. We may
ultimately decide not to pursue this strategy or if we choose to pursue it, find
that this strategy is not feasible, be unable to identify or structure
agreements with complementary businesses or be unsuccessful in any ventures or
alliances we form or acquisitions we make.
If we devote significant human or financial resources to this strategy and
ultimately abandon it or are not successful at it, such would materially
adversely affect our financial condition and business operations.
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;
>> 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.
33
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.
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 March 31, 2006, we had 26,094,589 shares of common stock outstanding. Of
these shares, as of March 31, 2006, approximately 22 million shares of our
common stock were subject to restrictions on resale pursuant to Rule 144 and
approximately 4 million outstanding shares of our common stock were 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.
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:
34
>> with a price of less than $5.00 per share;
>> that are not traded on a "recognized" national exchange;
>> whose prices are not quoted on the Nasdaq Stock Market; or
>> 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.
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 March 31, 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 the 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 acquired upon conversion of the 2005 notes and are
exercisable over the next four years at fluctuating prices equal to 125% and
150%, respectively, of the conversion price of the 2005 notes.
35
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 acquired upon conversion of the 2006 notes and are
exercisable over the next five years 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 or exercise of a material amount of
our warrants 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 $0.16 (85% of the closing price of our common
stock on the OTC Bulletin Board of $0.19 on March 31, 2006), the 2005 notes
would convert into 3,425,000 shares of our common stock and the related warrants
would be exercisable to purchase 6,850,000 shares. Assuming a conversion price
of $0.15 (80% of the closing price of our common stock on the OTC Bulletin Board
of $0.19 on March 31, 2006), the 2006 notes would convert into 4,000,000 shares
of our common stock and the related warrants would be exercisable to purchase
32,000,000 shares. These numbers of shares, however, could be significantly
greater in the event of a decrease in the trading price of our stock.
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 (excluding
interest). The calculations in the table are based upon the 26,094,589 shares of
our common stock which were outstanding on March 31, 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 $0.19 Price of $0.14 Price of $0.095 Price of $0.048
--------------- --------------- --------------- ---------------
Conversion Price $ 0.16 $ 0.12 $ 0.08 $ 0.04
Shares Issuable on Conversion 3,425,000 4,566,667 6,850,000 13,700,000
of 2005 Notes
Shares Issuable on Exercise 6,850,000 9,133,333 13,700,000 27,400,000
of Warrants
Percentage of Outstanding
Common Stock 28.5% 34.43% 44.06% 61.17%
36
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 (excluding
interest). The calculations in the table are based upon the 26,094,589 shares of
our common stock which were outstanding on March 31, 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 $0.19 Price of $0.14 Price of $0.095 Price of $0.048
--------------- --------------- --------------- ---------------
Conversion Price $ 0.15 $ 0.11 $ 0.08 $ 0.04
Shares Issuable on Conversion 4,000,000 5,454,545 7,500,000 15,000,000
of 2006 Notes
Shares Issuable on Exercise 32,000,000 43,636,364 60,000,000 120,000,000
of Warrants
Percentage of Outstanding
Common Stock 57.98% 65.29% 72.12% 83.80%
37
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 March 31, 2006.
Our management, including our Chief Executive Officer, has determined that our
disclosure controls and procedures were not effective as of March 31, 2006. 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 have engaged outside expertise to enable us to properly apply
complex accounting principles to our financial statements.
(b) Changes in internal control over financial reporting. There were no
significant changes in our internal control over financial reporting during the
second 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 the Company'sour 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.
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 will restate our financial
statements for the year ended September 30, 2005 and for the quarterly periods
ending December 31, 2005, 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 NO.133.
38
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not Applicable
ITEM 2. CHANGES IN SECURITIES
Not Applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECUIRTY HOLDERS
Not Applicable
ITEM 5. OTHER INFORMATION
Not Applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit No. Description
31 Certificate of the Chief Executive Officer and
Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.*
32 Certificate of the Chief Executive Officer and
Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.*
*Filed herewith as an exhibit.
(b) Reports on Form 8-K. During the quarter ended March 31, 2006, the issuer
filed the following Reports on Form 8-K:
Report on Form 8-K dated January 6, 2006 and filed with the Securities and
Exchange Commission on January 20, 2006.
Report on Form 8-K dated February 10, 2006 and filed with the Securities
and Exchange Commission on February 16, 2006.
Report on Form 8-K dated February 17, 2006 and filed with the Securities
and Exchange Commission of February 22, 2006.
Report on Form 8-K/A dated May 23, 2005 and filed with the Securities and
Exchange Commission on February 22, 2006.
39
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)
40