ITEM
2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF
OPERATION
THIS
REPORT CONTAINS FORWARD LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A
OF
THE SECURITIES ACT OF 1933, AS AMENDED AND SECTION 21E OF THE SECURITIES
EXCHANGE ACT OF 1934, AS AMENDED. THE COMPANY'S ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE SET FORTH ON THE FORWARD LOOKING STATEMENTS AS A RESULT
OF
THE RISKS SET FORTH IN THE COMPANY'S FILINGS WITH THE SECURITIES AND EXCHANGE
COMMISSION, GENERAL ECONOMIC CONDITIONS, AND CHANGES IN THE ASSUMPTIONS USED
IN
MAKING SUCH FORWARD LOOKING STATEMENTS.
Pediatric
Prosthetics, Inc. (the "Company," "we," and "us") is engaged in the custom
fitting and fabrication of custom made prosthetic limbs for both upper and
lower
extremities to infants and children throughout the United States. We also
provide our services to families from the international community when the
parents can bring the child to the United States for fitting. We buy
manufactured components from a number of manufacturers and combine those
components to fabricate custom measured, fitted and designed prosthetic limbs
for our patients. We also create "anatomically form-fitted suspension sockets"
that allow the prosthetic limbs to fit comfortably and securely with each
patient's unique residual limb. These suspension sockets must be hand crafted
to
mirror the surface contours of a patient's residual limb, and must be
dynamically compatible with the underlying bone, tendon, ligament, and muscle
structures in the residual limb.
We
are
accredited by the Texas Department of Health as a fully accredited prosthetics
provider. We began operations as a fully accredited prosthetic facility on
March
18, 2004.
We
have a
website at www.kidscanplay.com, which contains information which we do not
desire to be incorporated by reference into this filing.
We
generate an average of approximately $8,000 of gross profit per fitting of
the
prosthetics devices, however, the exact amount of gross profit we will receive
for each fitting will depend on the exact mix of arms versus legs fitted and
the
number of re-fittings versus new fittings. From July 1, 2005 until
December 31, 2005, we made twenty-seven fittings; from January 1, 2006
until June 30, 2006, we made thirty-six fittings; from July 1, 2006 to June
30,
2007, we made fifty-nine fittings, and from July 1, 2007 until November 15,
2007, we made twenty-two fittings, two of which were pro bono. We currently
average 4 fittings per month.
HISTORY
OF THE COMPANY
Pediatric
Prosthetics, Inc. (“we,” “us,” and the “Company”) was formed as an Idaho
corporation on January 29, 1954, under the name Uranium Mines, Inc. From
January 1954 onward, we experienced various restructurings and name changes,
including a name change effective March 9, 2001, to Grant Douglas Acquisition
Corp. From approximately February 6, 2001, until the date of the Exchange
(defined below) we had been a non-operating, non-reporting, corporate shell,
without assets or operations, but had traded our common stock on the Pinksheets
under the symbol "GDRG."
On
October 10, 2003, a separate Texas corporation Pediatric Prosthetics, Inc.
("Pediatric Texas"), entered into an acquisition agreement with us, whereby
Pediatric Texas agreed to exchange 100% of its outstanding stock for 8,011,390
shares of our common stock and 1,000,000 shares of our Series A Convertible
Preferred Stock (the "Exchange"). Prior to the Exchange, Pediatric Texas had
limited operations, consisting solely of hiring Dan Morgan, our current Vice
President and Chief Prosthetist, and seeking a merger and/or acquisition
candidate, which was eventually affected in connection with the
Exchange.
In
connection with the Exchange, the shareholders of Pediatric Texas (who became
our shareholders subsequent to and in connection with the Exchange) agreed
to
assume $443,632 in liabilities related to the assumption of a $350,000
convertible note and $93,632 of accrued interest on such note that was held
by
us prior to the Exchange. From November 2003 through June of 2005 we repaid
$148,955 of note principal through the issuance of common stock with a fair
market value of $2,688,734 and recognized a $2,539,779 loss on extinguishment
of
debt. During the year ended June 30, 2006, we negotiated the extinguishment
of
the remaining convertible note of $201,045 and accrued interest of $139,754
for
a onetime cash payment of $30,000 and recognized a gain on extinguishment of
debt of $310,799.
Following
the Exchange, we remained as the surviving accounting entity and adopted a
name
change from Grant Douglas Acquisition Corp. to Pediatric Prosthetics, Inc.
on
October 31, 2003. We entered into the Exchange to acquire an operating business
in the form of Pediatric Texas, and the shareholders of Pediatric Texas entered
into the Exchange to obtain a shell company in which to place the operations
of
Pediatric Texas, and to trade such resulting company’s common stock on the
Pinksheets. Since May 25, 2007, our common stock has been quoted on
the OTCBB under the symbol “PDPR.”.
On
March
15, 2007, we filed an amendment to our Articles of Incorporation with the
Secretary of State of Idaho to increase our authorized shares of common stock
to
950,000,000 shares of Common Stock, $0.001 par value per share, and to
re-authorize 10,000,000 shares of preferred stock, $0.001 par value per share
(the “Amendment”).
Additionally,
the Amendment provided that shares of our preferred stock may be issued from
time to time in one or more series, with distinctive designation or title as
shall be determined by our Board of Directors prior to the issuance of any
shares thereof. The preferred stock shall have such voting powers, full or
limited, or no voting powers, and such preferences and relative, participating,
optional or other special rights and such qualifications, limitations or
restrictions thereof, as shall be stated in such resolution or resolutions
providing for the issue of such class or series of preferred stock as may be
adopted from time to time by our Board of Directors prior to the issuance of
any
shares thereof. The number of authorized shares of preferred stock may be
increased or decreased (but not below the number of shares thereof then
outstanding) by the affirmative vote of the holders of a majority of the voting
power of all the then outstanding shares of the capital stock of the corporation
entitled to vote generally in the election of directors, voting together as
a
single class, without a separate vote of the holders of the preferred stock,
or
any series thereof, unless a vote of any such holders is required pursuant
to
any preferred stock designation.
The
effect of the Amendment is reflected throughout this report.
Warranties
We
provide an unlimited one-year warranty on each of our prostheses, which covers
both materials and workmanship. Our sub-component suppliers also provide us
a
one-year warranty on all components, whether electrical or structural, as a
result, we are in effect only responsible for the cost of the re-installation
of
failed sub-components. Warranty repair costs borne by us have been
limited and totaled approximately $6,379 during the fiscal year ended June
30, 2007. Warranty costs for the three months ended September 30,
2007 totaled $21.
Convertible
Loan Agreements
On
March
1, 2006, and March 21, 2006, we entered into two separate loans for $17,500,
with two shareholders, Robert Castignetti and John Swartz, to provide us with
an
aggregate of $35,000 in funding. The loans bear interest at the rate of 12%
per
annum until paid. Both loans became due in May 2006, but were subsequently
verbally extended to May 2007, but were not further extended. Both
loans were repaid with all accrued and unpaid interest in August
2007.
In
April
2006, we borrowed $50,000 from a shareholder of the Company and issued a
promissory note and warrants in connection with such loan. The promissory note
bears interest at the rate of 12% per annum, and was due and payable on
September 29, 2006, which date was subsequently extended until May 29, 2007,
but
which was not further extended. The outstanding balance of the loan,
plus accrued and unpaid interest was repaid by us in August 2007.
May
2006 Securities Purchase Agreement
On
May
30, 2006 (the "Closing"), we entered into a Securities Purchase Agreement
("Purchase Agreement") with AJW Partners, LLC; AJW Offshore, Ltd.; AJW Qualified
Partners, LLC; and New Millennium Capital Partners II, LLC (each a "Purchaser"
and collectively the "Purchasers"), pursuant to which the Purchasers agreed
to
purchase $1,500,000 in convertible debt financing from us. Pursuant to the
Securities Purchase Agreement, we agreed to sell the investors $1,500,000 in
Callable Secured Convertible Notes (the "Debentures," the “Notes” or the
“Convertible Notes”), which are to be payable in three tranches, $600,000 of
which was received by the Company on or around May 31, 2006, in connection
with
the
entry into the Securities Purchase Agreement; $400,000 which was received in
February 2007, upon the filing of our registration statement to register shares
of common stock which the Debentures are convertible into as well as the shares
of common stock issuable in connection with the exercise of the Warrants
(defined below); and $500,000 which was received in August 2007, shortly after
the effectiveness of our registration statement on July 27,
2007.
The
Debentures are convertible into our common stock at a 40% discount to the
average of the three lowest intraday trading prices over the most recent twenty
(20) day trading period in which our common stock trades on the market or
exchange , ending one day prior to the date a conversion notice is received
(the
“Conversion Price”). Additionally, in connection with the Securities Purchase
Agreement, we agreed to issue the Purchasers warrants to purchase an aggregate
of 50,000,000 shares of our common stock at an exercise price of $0.10 per
share
(the "Warrants"). We originally agreed to register all of the shares of common
stock which the Debentures are convertible into and the shares of common stock
which the Warrants are exercisable for; however, pursuant to the Second Waiver
of Rights Agreement, described below, the Purchasers agreed to amend the terms
of the Registration Rights Agreement such that we were only required to register
9,356,392 shares underlying the Debentures on our Form SB-2 registration
statement, which was declared effective on July 20, 2007. We secured the
Debentures pursuant to the Security Agreement and Intellectual Property Security
Agreement, described below.
We
also
agreed in the Purchase Agreement to use our best efforts to increase our key
man
life insurance on our President and Director, Linda Putback-Bean and our Vice
President and Director Kenneth W. Bean, which we have been able to increase
to
$3,000,000 and $2,000,000, respectively.
The
$600,000 we received from the Purchasers at the Closing, in connection with
the
sales of the Debentures was used and distributed as follows:
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$100,000
to Lionheart Associates, LLC doing business as Fairhills Capital
("Lionheart" or "Fairhills"), as a finder's fee in connection with
the
funding (we also have agreed to pay Lionheart an additional $50,000
upon
the payment of the next tranche of the funding by the
Purchasers);
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$18,000
to OTC Financial Network, as a finder's fee in connection with the
funding
(we also have agreed to pay OTC Financial Network an additional $27,000
upon the payment of additional tranches of funding by the
Purchasers);
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$75,000
in legal fees and closing payments to our counsel, the Purchaser's
counsel
and certain companies working on the Purchaser's
behalf;
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$10,000
to be held in escrow for the payment of additional key man life insurance
on Linda Putback-Bean and Kenneth W. Bean which policy has been obtained
and for which the Company will receive such funds as policy beneficiary;
and
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$370,000
to us, which we spent on legal and accounting fees in connection
with the
filing of our amended Form 10-SB, outstanding reports on Form 10-QSB,
and
Form SB-2 registration statement, as well as marketing and promotional
fees and inventory costs, as well as other general working capital
purposes.
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Pursuant
to the Purchase Agreement, we agreed to sell the Purchasers an aggregate of
$1,500,000 in Debentures, which Debentures have a three year term and bear
interest at the rate of six percent (6%) per annum, payable quarterly in
arrears, provided that no interest shall be due and payable for any month in
which the trading value of our common stock is greater than $0.10375 for each
day that our common stock trades. Any amounts not paid under the Debentures
when
due bear interest at the rate of fifteen percent (15%) per annum until paid.
The
conversion price of the Debentures is equal to 60% of the average of the three
lowest intraday trading prices over the most recent twenty (20) day trading
period in which our common stock trades on the market or exchange , ending
one
day prior to the date a conversion notice is received (the "Conversion
Price").
Furthermore,
the Purchasers have agreed to limit their conversions of the Debentures to
no
more than the greater of (1) $80,000 per calendar month; or (2) the average
daily volume calculated during the ten business days prior to a conversion,
per
conversion.
Pursuant
to the Debentures, the Conversion Price is automatically adjusted if, while
the
Debentures are outstanding, we issue or sell, any shares of common stock for
no
consideration or for a consideration per share (before deduction of reasonable
expenses or commissions or underwriting discounts or allowances in connection
therewith) less than the Conversion Price then in effect, with the consideration
paid per share, if any being equal to the new Conversion Price; provided
however, that each Purchaser has agreed to not convert any amount of principal
or interest into shares of common stock, if, as a result of such conversion,
such Purchaser and affiliates of such Purchaser will hold more than 4.99% of
our
outstanding common stock.
"Events
of Default" under the Debentures include:
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1.
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Our
failure to pay any principal or interest when
due;
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2.
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Our
failure to issue shares of common stock to the Purchasers in connection
with any conversion as provided in the
Debentures;
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3.
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Our
failure to file a Registration Statement covering the shares of common
stock which the Debentures are convertible into within sixty (60)
days of
the Closing (July 31, 2006), or obtain effectiveness of such Registration
Statement within one hundred and forty-five (145) days of the Closing
(October 22, 2006), which dates were later amended to February 15,
2007,
and August 13, 2007, respectively in connection with the Waiver of
Rights
Agreement and the Second Waiver of Rights Agreement, described in
greater
detail below, and which amended dates were both met by us, or if
such
Registration Statement once effective, ceases to be effective for
more
than ten (10) consecutive days or more than twenty (20) days in any
twelve
(12) month period;
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4.
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Our
entry into bankruptcy or the appointment of a receiver or
trustee;
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5.
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Our
breach of any covenants in the Debentures or Purchase Agreement,
if such
breach continues for a period of ten (10) days after written notice
thereof by the Purchasers, or our breach of any representations or
warranties included in any of the other agreements entered into in
connection with the Closing; or
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6.
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If
any judgment is entered against us or our property for more than
$100,000,
and such judgment is unvacated, unbonded or unstayed for a period
of
twenty (20) days, unless otherwise consented to by the Purchasers,
which
consent will not be unreasonably
withheld.
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Upon
the
occurrence of and during the continuance of an Event of Default, the Purchasers
can make the Debentures immediately due and payable, and can make us pay the
greater of (a) 130% of the total remaining outstanding principal amount of
the
Debentures, plus accrued and unpaid interest thereunder, or (b) the total dollar
value of the number of shares of common stock which the funds referenced in
section (a) would be convertible into (as calculated in the Debentures),
multiplied by the highest closing price for our common stock during the period
we are in default. If we fail to pay the Purchasers such amount within five
(5)
days of the date such amount is due, the Purchasers can require us to pay them
in shares of common stock at the greater of the amount of shares of common
stock
which (a) or (b) is convertible into, at the Conversion Rate then in
effect.
Pursuant
to the Debentures, we have the right, assuming (a) no Event of Default has
occurred or is continuing, (b) that we have a sufficient number of authorized
but unissued shares of common stock, (c) that our common stock is trading at
or
below $0.20 per share, and (d) that we are then able to prepay the Debentures
as
provided in the Debentures, to make an optional prepayment of the outstanding
amount of the Debentures equal to 120% of the amount outstanding under the
Debentures (plus any accrued and unpaid interest thereunder) during the first
180 days after the Closing, 130% of the outstanding amount of the Debentures
(plus any accrued and unpaid interest thereunder) between 181 and 360 days
after
the Closing, and 140% thereafter, after giving ten (10) days written notice
to
the Purchasers.
Additionally,
pursuant to the Debentures, we have the right, in the event the average daily
price of our common stock for each day of any month the Debentures are
outstanding is below $0.20 per share, to prepay a portion of the outstanding
principal amount of the Debentures equal to 101% of the principal amount of
the
Debentures divided by thirty-six (36) plus one month's interest. Additionally,
the Purchasers
have
agreed in the Debentures to not convert any principal or interest into shares
of
common stock in the event we exercise such prepayment right.
At
the
Closing, we entered into a Security Agreement and an Intellectual Property
Security Agreement (collectively, the "Security Agreements"), with the
Purchasers, whereby we granted the Purchasers a security interest in, among
other things, all of our goods, equipment, machinery, inventory, computers,
furniture, contract rights, receivables, software, copyrights, licenses,
warranties, service contracts and intellectual property to secure the repayment
of the Debentures.
Stock
Purchase Warrants
In
connection with the Closing, we sold Warrants for the purchase of 50,000,000
shares of our common stock to the Purchasers, which warrants are exercisable
for
shares of our common stock at an exercise price of $0.10 per share (the
"Exercise Price"). Each Purchaser, however, has agreed not to exercise any
of
the Warrants into shares of common stock, if, as a result of such exercise,
such
Purchaser and affiliates of such Purchaser will hold more than 4.99% of our
outstanding common stock.
The
Warrants expire, if unexercised at 6:00 p.m., Eastern Standard Time on May
30,
2013. The Warrants also include reset rights, which provide for the Exercise
Price of the Warrants to be reset to a lower price if we (a) issue any warrants
or options (other than in connection with our Stock Option Plans), which have
an
exercise price of less than the then market price of the common stock, as
calculated in the Warrants, at which time the Exercise Price of the Warrants
will be equal to the exercise price of the warrants or options granted, as
calculated in the Warrants; or (b) issue any convertible securities, which
have
a conversion price of less than the then market price of the common stock,
as
calculated in the Warrants, at which time the Exercise Price of the Warrants
will be equal to the conversion price of the convertible securities, as
calculated in the Warrants.
Pursuant
to the Warrants, until we register the shares of common stock which the Warrants
are exercisable for, the Warrants have a cashless exercise feature, where the
Purchasers can exercise the Warrants and pay for such exercise in shares of
common stock, in lieu of paying the exercise price of such Warrants in
cash.
Registration
Rights Agreement
Pursuant
to the Registration Rights Agreement entered into at the Closing, we agreed
to
file a registration statement on Form SB-2, to register two (2) times the number
of shares of common stock which the Debentures are convertible into (to account
for changes in the Conversion Rate and the conversion of interest on the
Debentures) as well as the shares of common stock issuable in connection with
the exercise of the Warrants, within sixty (60) days of the Closing which we
were not able to accomplish, but which date was amended from sixty (60) days
from the Closing until January 15, 2007, in connection with the Waiver of Rights
Agreement, and until February 15, 2007, in connection with the Second Waiver
of
Rights Agreement (both described below), which filing date was met by us.
Additionally, the number of shares of common stock we were required to register
on the Registration Statement has been amended to include only 9,356,392 shares
of common stock underlying the Debentures, due to amendments to the Registration
Rights Agreement affected by the Second Waiver of Rights
Agreement. We gained effectiveness of the Registration
Statement on July 20, 2007.
Waiver
of Rights Agreement
On
October 25, 2006, with an effective date of July 31, 2006, we entered into
a
Waiver of Rights Agreement with the Purchasers, whereby the Purchasers agreed
to
waive our prior defaults under the Securities Purchase Agreement and
Registration Rights Agreement. In connection with the Waiver of Rights
Agreement, the Purchasers agreed to amend the Securities Purchase Agreement
to
state that we are required to use our best efforts to timely file our periodic
reports with the Commission, which amendment waived the previous default caused
by our failure to timely file our annual report on Form 10-KSB with the
Commission. The Waiver of Rights Agreement also amended the Securities Purchase
Agreement to provide for us to use our best efforts to obtain shareholder
approval to increase our authorized shares of common stock as was required
by
the Securities Purchase Agreement, which amendment waived our failure to obtain
shareholder approval to increase our authorized shares of common stock by August
15, 2006. Finally, the Waiver of Rights Agreement amended the dates we were
required to file our registration statement from July 31, 2006 to January 15,
2007, which filing date was not met, and the date our
registration
statement was required to be effective with the Commission from October 22,
2006
to April 16, 2007. The amendments affected by the Waiver of Rights Agreement
were later modified pursuant to the Second Waiver of Rights Agreement, described
below.
Closing
of Second Funding Tranche
On
or
about February 16, 2007 (the "Second Closing”) we sold an aggregate of $400,000
in Callable Secured Convertible Notes (“Debentures," the “Notes” or the
“Convertible Notes”), to the Purchasers. The sale of the Debentures represented
the second tranche of funding in connection with our Securities Purchase
Agreement ("Purchase Agreement") entered into with the Purchasers on May 30,
2006.
The
Debentures are convertible into our common stock at a 40% discount to the
average of the three lowest intraday trading prices over the most recent twenty
(20) day trading period in which our common stock trades on the market or
exchange , ending one day prior to the date a conversion notice is received
(the
“Trading Price”), and bear interest at the rate of six percent (6%) per annum,
payable quarterly in arrears, provided that no interest shall be due and payable
for any month in which the trading price of our common stock is greater than
$0.10375 for each day that our common stock trades. Any amounts not paid under
the Debentures when due bear interest at the rate of fifteen percent (15%)
per
annum until paid.
The
$400,000 we received from the Purchasers at the Second Closing, in connection
with the sales of the second tranche of Debentures was distributed as follows
(all amounts listed are approximate):
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$50,000
to Lionheart Associates, LLC doing business as Fairhills Capital
("Lionheart"), as a finder's fee in connection with the
funding;
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$50,000
in legal fees owed to our corporate counsel in connection with the
preparation of our Form 10-SB and Form SB-2 registration statements
and
various other of our public filings;
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$60,000
in accounting/auditing fees in connection with the audit of and review
of
our financial statements contained in our Form 10-SB and Form SB-2
registration statements and our other quarterly and annual report
filings;
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$18,000
to OTC Financial Network, as a finder's fee in connection with the
funding
(we also have agreed to pay OTC Financial Network an additional $9,000
upon the payment of the final tranche of funding by the
Purchasers);
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$5,000
in closing costs associated with the
funding;
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$40,000
to be used by us in connection with the purchase of additional equipment
and machinery in connection with the fitting of
prosthesises;
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$100,000
to be used by us in connection with our continuing marketing and
advertising plans (as described in greater detail under “Plan of
Operations” in our latest periodic filing); and
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$77,000
to be used by us as needed for general working capital and the purchase
of
inventory for our prosthesises on an ongoing
basis.
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Second
Waiver of Rights Agreement
On
April
17, 2007, with an effective date of January 15, 2007, we entered into a Second
Waiver of Rights Agreement (the “Second Waiver”) with the Purchasers. Pursuant
to the previous Waiver of Rights Agreement we entered into with the Purchasers
in October 2006 (the “First Waiver”), we agreed to use our best efforts to
obtain shareholder approval to increase our authorized shares by December 15,
2006; to file a registration statement with the SEC covering the Underlying
Shares no later than January 15, 2007, and to obtain effectiveness of such
registration statement with the SEC by April 16, 2007.
Pursuant
to the Second Waiver, the Purchasers agreed to waive our failure to file a
registration statement by the prior January 15, 2007, deadline (we filed the
registration statement on February 9, 2007), agreed we are not in default of
the
Rights Agreement; agreed to waive our inability to maintain effective controls
and
procedures
as was required pursuant to the Purchase Agreement, that we are required to
use
our “best efforts” to maintain effective controls and procedures moving forward;
to waive the requirement pursuant to the Purchase Agreement that we keep solvent
at all times (defined as having more assets than liabilities); to waive the
requirement pursuant to the Purchase Agreement that we obtain authorization
to
obtain listing of our common stock on the Over-the-Counter Bulletin Board
(“OTCBB”), and to allow for us to use our “best efforts” to obtain listing of
our common stock on the OTCBB, which listing we obtained effective May 25,
2007.
We
also
agreed along with the Purchasers, pursuant to the Second Waiver, to amend the
Rights Agreement to reduce the number of shares we are required to register
pursuant to the Rights Agreement, from all of the Underlying Shares, to only
9,356,392 of the shares issuable upon conversion of the Notes and to amend
the
date we are required to obtain effectiveness of our registration statement
by
from April 16, 2007, to August 13, 2007, which registration statement was
declared effective on July 20, 2007. The 9,356,392 shares of common
stock we are required to register pursuant to the Second Waiver is equal to
the
amount remaining after calculating approximately 30% of our then public float
(17,909,961 shares, with our public float equal to approximately 58,866,538
shares as of the date of the Second Waiver), and subtracting the 8,553,569
shares of common stock held by other shareholders, which were being registered
in our Registration Statement, which gave us a total of 9,356,392 shares
available to be registered for the Purchasers. Because we believe that the
registration of shares totaling only approximately 30% of our public float
clearly does not represent a primary offering of our securities, we and the
Purchasers believe that the registration of only 9,356,392 shares underlying
the
Notes would expedite the review and effectiveness of our Registration
Statement.
It
is
anticipated that the Purchasers will rely on Rule 144 under the Securities
Act
of 1933, as amended in the future for any sales of shares issuable in connection
with the conversion of the Notes and/or exercise of the Warrants which are
no
longer required to be registered on a registration statement by us pursuant
to
the amendments above.
In
consideration for their entry into the Second Waiver, we granted the Purchasers
additional warrants to purchase 1,000,000 shares of our common stock at an
exercise price of $0.10 per share, which warrants shall expire if unexercised
on
the same date as the original Warrants expire if unexercised, May 30, 2013,
which warrants were granted to the Purchasers as follows:
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AJW
Partners, LLC
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102,000
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AJW
Offshore, Ltd.
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606,000
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AJW
Qualified Partners, LLC
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279,000
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New
Millennium Capital Partners II, LLC
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13,000
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Total
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1,000,000
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Third
Funding Tranche
On
or
about July 27, 2007 (the "Third Closing"), we sold an aggregate of $500,000
in
Callable Secured Convertible Notes (“Debentures”), to the Purchasers, which
funds were received by us on or about July 31, 2007. The sale of the Debentures
represented the third and final tranche of funding in connection with our
Securities Purchase Agreement ("Purchase Agreement") entered into with the
Purchasers on May 30, 2006.
The
$500,000 we received from the Purchasers at the Third Closing, in connection
with the sales of the Debentures will be used as follows (all amounts listed
are
approximate):
|
Outstanding
legal expenses in connection with
|
|
|
our
Form SB-2 Registration Statement and periodic filings:
|
$40,000
|
|
|
|
|
Accounting
fees and expenses
|
$40,000
|
|
|
|
|
Repayment
of shareholder notes
|
$75,000
|
|
|
|
|
Supplier
expenses
|
$40,000
|
|
|
|
|
Closing
costs and finders fees
|
$20,000
|
|
|
|
|
Equipment
purchases and capital improvements
|
$40,000
|
|
|
|
|
Marketing
expenses and general working capital
|
$245,000
|
|
|
|
|
Total
|
$500,000
|
The
Market Place
According
to the Limb Loss Research and Statistics Program ("LLR&SP"), a multi-year
statistical study done by the American Amputee Coalition in 2001, in concert
with the Johns Hopkins Medical School, and the United States Center of Disease
Control, approximately 1,000 children are born each year with a limb loss in
the
United States. The LLR&SP can be found at www.amputee-coalition.org. During
their high growth years, ages 1 through age 12, these children will be
candidates for re-fitting once per year as they grow. We calculate that there
are presently approximately up to 12,000 pre-adolescent (younger than age 12)
children in the United States in need of prosthetic rehabilitation, based on
the
fact that there are approximately 1,000 children born each year with a limb-loss
in the United States.
Competition
Although
there are many prosthetic provider companies in the United States, to the best
of our knowledge, there is no other private sector prosthetics provider in
the
country specializing in fitting infants and children. The delivery of prosthetic
care in the United States is extremely fragmented and is based upon a local
practitioner "paradigm." Generally, a local practitioner obtains referrals
for
treatment from orthopedic physicians in their local hospitals based on
geographic considerations. Management believes the inherent limitation of this
model for pediatric fittings is that the local practitioner may never encounter
more than a very few small children with a limb loss, even during an entire
career. The result is that the local practice is a "general practice", and
in
prosthetics that is considered an "adult practice" because of the overwhelming
percentage of adult patients. In any given year, according to The American
Amputee Coalition, over 150,000 new amputations are performed, suggesting the
need for prosthetic rehabilitation. The overwhelming majority of those
amputations are performed upon adults. For children ages 1-14, there will be
approximately 1,200 limb losses per year due primarily to illness, vascular
problems, and congenital accidents. Children, especially small children, cannot
provide practitioners the critical verbal feedback they usually receive from
their adult patients.
Management
believes the challenge to effectively treat children with a limb-loss in the
United States is compounded by the time constraints of local practitioners
working primarily with their adult patients and a limited overall number of
board certified prosthetists. To engage in the intensive patient-family focus
required to fit the occasional infant or small child puts enormous time pressure
on local practitioners trying to care for their adult patients.
Though
not competitors in a business sense, the Shriner's Hospital system, a non-profit
organization with 22 orthopedic hospitals throughout North America, has
historically extended free prosthetic rehabilitation in addition to providing
medical and surgical services to children at no charge. The free care offered
by
Shriner's may put downward pressure on the prices we charge for our services
and/or lower the number of potential clients in the marketplace, which may
in
turn lower our revenues.
PLAN
OF OPERATIONS
We
have
established working relationships with fifteen (15) Host Affiliates operating
in
approximately 21 states. In establishing the relationships with the fifteen
Host
Affiliates, we also provided one-on-one pediatric training to fifteen
prosthetists who are employed by those Host Affiliates. We currently plan to
hire one more certified prosthetist and two additional support personnel during
the next twelve months, funding permitting, of which there can be no
assurance.
As
of
September 2007, we believe we can operate for at least the next twelve
months. We believe we will require recurring cash for overhead of
approximately $54,000 per month, and that we will receive monthly gross profits
of approximately $50,000 per month in connection with fittings of our prosthetic
limbs, of which there can be no assurance. If we are required to raise
additional funding, we will likely do so through the sale of debt or equity
securities.
We
received $600,000 on May 30, 2006 (less closing costs and structuring fees),
from the sale of certain Convertible Debentures described above, an additional
$400,000 through the sale of additional Convertible Debentures in connection
with our filing of our Registration Statement with the SEC, and a final $500,000
in connection with the sale of Debentures when our Registration Statement was
declared effective on or around July 20, 2007. Increases in our
advertising and marketing budget during the year ended June 30, 2007, have
allowed us to undertake the following advertising and marketing
activities:
|
o
|
The
composition of and distribution of certain feature newspaper articles;
and
|
|
o
|
Publicity
and marketing campaign, pursuant to which we previously issued 7,000,000
shares of common stock to certain
consultants.
|
Additionally,
we believe the increases in our advertising and marketing budget will allow
us
to undertake the following activities during the next twelve (12) months,
funding permitting, of which there can be no assurance:
|
o
|
The
production, filming, editing and narration of informational videos
on the
value of modern prosthetic options for children, which videos describe
the
success stories we have had in helping children overcome limb loss
by
fitting such children with artificial limbs, as well as the distribution
of such videos to fellow pediatric professionals such as nurses,
physical
therapists, doctors and hospital-based family counselors nationally,
at a
cost of approximately $10,000;
|
|
o
|
Costs
associated with a national internet marketing campaign utilizing
state of
the art S.E.O.P and pay per click
advertising at a cost of approximately
$50,000
|
|
o
|
Travel
and associated costs involved with appearances on television shows,
medical conventions and nursing schools at a cost of approximately
$20,000; and travel and components expenses related to pro-bono fittings
in various cities across the United States of approximately $100,000,
and
the establishment of a national internet chat-room for parents and
kids
with a limb-loss at a cost of approximately $10,000
|
|
|
|
|
o
|
Sponsorship
costs of non-profit organizations such as the "Amputee Coalition
of
American" and the Para-Olympics, at a cost of approximately
$10,000.
|
COMPARISON
OF OPERATING RESULTS
RESULTS
OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2007 COMPARED TO THE
THREE MONTHS ENDED SEPTEMBER 30, 2006
We
had
revenue of $99,920 for the three months ended September 30, 2007, compared
to
revenue of $195,230 for the three months ended September 30, 2006, a decrease
in
revenue of $95,310 or 48.8% from the prior period. The decrease in revenue
was
mainly due to an unusual number of delayed fittings caused by those clients’
insurance providers requesting additional information regarding the fitting
process. From time to time, prospective clients may have their
fittings delayed by their insurance providers (usually Medicaid and Medicare)
requesting additional information and/or clarification regarding the procedures
we perform prior to those insurance providers paying for the prospective
client’s procedures. During the three months ended September 30,
2007, an unusually large amount of our prospective clients had their procedures
delayed due to an increased number of such questions from their insurance
providers. While we believe that we had an unusually high number of
such delays during the three months ended September 30, 2007, and that such
delays will not be nearly as extreme or prevalent during the remainder of fiscal
2007, there can be no assurance that our future revenues will not be impacted
by
such delays in the future.
We
had
total operating expenses of $365,821 for the three months ended September 30,
2007, compared to total operating expenses of $625,199 for the three months
ended September 30, 2006, a decrease in total operating expenses of $259,378
or
41.5% from the previous year’s period. The decrease in total operating expenses
was mainly due to a $28,369 or 37.3% decrease in cost of sales to $47,632 for
the three months ended September 30, 2007, compared to $76,001 for the three
months ended September 30, 2006 and a $231,088 or 42.5% decrease in selling,
general and administrative expenses, to $312,151 for the three months ended
September 30, 2007, compared to $543,239 for the three months ended September
30, 2006, offset by a $79 or 1.3% increase in depreciation expense to $6,038
for
the three months ended September 30, 2007 compared to $5,959 for the three
months ended September 30, 2006.
The
37.3%
decrease in our cost of sales for the three months ended September 30, 2007,
compared to the three months ended September 30, 2006, was mainly attributable
to our decrease in revenue, in connection with a reduced number of fittings
over
the same period.
The
$231,088 or 42.5% decrease in selling, general and administrative expenses
for
the three months ended September 30, 2007 as compared to the three months ended
September 30, 2006, was mainly due to a $227,369 decrease in stock-based
compensation paid to consultants to $33,750 for the three months ended September
30, 2007, as compared to $261,119 for the three months ended September 30,
2006.
Our selling, general and administrative expenses will remain high as compared
to
revenue until we can generate enough revenues to sustain our operations, due
to
early stage startup costs associated with building our administrative
infrastructure and initial marketing and investor relations
activities.
We
had a
loss from operations of $265,901 for the three months ended September 30, 2007,
compared to $429,969 for the three months ended September 30, 2006, a decrease
in loss from operations of $164,068 or 38.2% from the prior period. The decrease
in loss from operations was primarily the result of the decrease in stock-based
compensation.
We
had
total other income, net of $1,076,947 for the three months ended September
30,
2007, compared to $1,112,049 for the three months ended September 30, 2006,
which represented a decrease in other income of $35,102 from the prior period.
The decrease in net other income was mainly due to an increase of $74,695 in
net
interest expense to $165,186 for the three months ended September 30, 2007,
as
compared to net interest expense of $90,492 for the three months ended September
30, 2006, which interest was mainly in connection with the amortization of
the
deferred financing cost and accretion of debt discount related to the
Convertible Notes and other notes which were previously outstanding, but which
have since been paid in full, as described in greater detail below, offset
by a
$39,593 increase in income from the change in value of the derivative financial
instruments for the three months ended September 30, 2007, as compared to the
same period in 2006, to $1,242,133 for the three months ended September 30,
2007, compared to $1,202,540 for the three months ended September 30, 2006,
.
We
had
net income of $811,046 for the three months ended September 30, 2007, compared
to $682,080 for the three months ended September 30, 2006, an increase of
$128,966 from the previous period. The
increase
in net income was mainly due to the decrease in cost of sales, selling, general
and administrative expenses and the increase in income from derivative financial
instruments, partially offset by the decrease in revenue and increase in
interest expense, as described above.
Investors
should keep in mind that our net income for the three months ended September
30,
2007 was the result of changes in the value of our derivative financial
instruments and not the result of our core operations. Without the
changes to net income due to the changes in the fair value of derivative
instruments, we would have had a significant net loss for the
period.
LIQUIDITY
AND CAPITAL RESOURCES
We
had
total assets of $629,741 as of September 30, 2007, which included current assets
of $482,039, furniture and equipment, net of accumulated depreciation, of
$40,841, and deferred financing cost, net of amortization, of $106,861. Current
assets included cash and cash equivalents of $126,103, trade and accounts
receivable, net of $186,721, prepaid expenses and other current assets of
$8,920, and current portion of deferred financing cost of $160,295.
We
had
total liabilities of $2,709,943 as of September 30, 2007, which included current
liabilities of $2,348,802, consisting of trade accounts payable of $134,679;
accrued liabilities of $129,009; which included deferred salary payable to
our
officers; amounts due to related party of $500, which amounts were owed to
our
Chief Executive Officer, Linda Putback-Bean, in connection with the initial
funding of our corporate bank account, which amounts have not been repaid to
date; derivative financial instruments of $2,084,614, in connection with our
Convertible Debentures and Warrants; and non-current liabilities consisting
of
deferred rent of $8,954 and long term portion of convertible debt, net of
discount of $352,187.
We
had a
working capital deficit of $1,866,763 and an accumulated deficit of $10,845,087
as of
September
30, 2007.
We
had
total net cash used by operating activities of $309,454 for the three months
ended September 30, 2007, which was mainly due to the change in value
of derivative instruments of $1,242,133, as well as the net decrease of $108,389
for various trade accounts payable which had accumulated prior to our most
recent funding related to the Convertible Debentures.
We
had
$410,000 in net cash provided by financing activities for the three months
ended
September 30, 2007, which included $500,000 raised through the third tranche
of
Convertible Debentures sold during the period offset by
$15,000 of debt issuance
costs associated with fees paid to finders in connection with the sale and
the
$75,000 repayment of outstanding convertible notes held by certain shareholders
of the Company.
Our
trade
accounts receivable are often for substantial amounts that can generate
challenges by insurance companies and, in certain cases, the need to pursue
collections directly from the patients. These challenges have continually
increased the collection period for our receivables. We believe that our trade
accounts receivable balances will increase at a greater rate than revenue growth
until such revenue growth subsides for a meaningful period of time. Management
constantly reviews receivables for collectability issues and has recognized
a
provision for bad debts of approximately 36% of revenue thus far for fiscal
2008.
These
collection challenges in trade accounts receivable are expected to present
liquidity issues in future periods if we do not substantially increase sales
and/or raise funds from other sources. Historically, our Host Affiliates,
which represent the majority of our recievables, have been slow to collect
receivables and/or answer billing appeals, whick in turn has led to our large
accounts receivable balances. During the three months ended September 30,
2007, we conducted approximately three, three day classes, which were attended
by six total Host Affiliates to help our Host Affiliates with their collection
issues. We believe that those classes, and any similar classes we may arrange
in
the future, will help us decrease our receivables moving
forward.
We
expect
our accounts payable to grow with the increase in our business over time and
they include a substantial amount of professional fees related to our SEC
filings. Accrued liabilities include accrued salaries and accrued stock based
compensation, and as with accounts payable, the balance of accrued liabilities
will increase based on the growth of our business. Timely payment of accounts
payable and accrued liabilities will require that we raise additional debt
or
equity funding in the near term.
In
April
2006, we borrowed $50,000 from a shareholder of the Company, and issued that
individual a promissory note and warrants in connection with such loan. The
promissory note bears interest at the rate
of
12%
per annum, and was due and payable on September 29, 2006, which date was
extended until May 29, 2007. The balance of the loan, plus accrued and unpaid
interest, was repaid in August 2007.
On
March
1, 2006, and March 21, 2006, we entered into two separate loans for $17,500,
with two separate shareholders to provide us with an aggregate of $35,000 in
funding. The loans bear interest at the rate of 12% per annum until paid. Both
loans became due in March 2007, but were verbally extended to May 2007, and
were
repaid with all accrued and unpaid interest in August 2007.
In
May
2006, we entered into a Securities Purchase Agreement with certain third parties
to provide us $1,500,000 in convertible debt financing (the "Purchase
Agreement"). Pursuant to the Purchase Agreement, we agreed to sell the investors
an aggregate of $1,500,000 in Convertible Debentures, which were paid in three
tranches, $600,000 upon signing the definitive agreements on May 30, 2006,
which
are due May 30, 2009, $400,000 upon the filing of our original Registration
Statement filing, which Registration Statement we filed on February 9, 2007,
and
which Convertible Debentures we sold shortly thereafter, and $500,000 upon
the
effectiveness of our Registration Statement. The Convertible Debentures are
to
be convertible into shares of our common stock at a discount to the then trading
value of our common stock. Additionally, in connection with the Securities
Purchase Agreement, we agreed to issue the third parties warrants to purchase
an
aggregate of 50,000,000 shares of our common stock at an exercise price of
$0.10
per share (the "Warrants").
The
fees
and costs associated with the $1,500,000 in funding we have received to date
are
disclosed in the table below:
|
First
Closing Fees and Costs (in connection with $600,000 received
through
the
sale of Notes in May 2006)
|
|
|
|
|
|
|
|
|
|
$100,000
|
|
Finder
|
|
Lionheart
Associates, LLC doing business as Fairhills Capital as a finder's
fee in
connection with the funding;
|
|
|
$18,000
|
|
Finder
|
|
OTC
Financial Network, as a finder's fee in connection with the
funding;
|
|
|
$75,000
|
|
Legal
Fees and Closing Payments
|
|
To
our counsel, the Purchasers' counsel and certain companies working
on the
Purchasers' behalf
|
|
|
$10,000
|
|
Held
in escrow
|
|
Held
in Escrow for the payment of additional Key Man life insurance on
Linda
Putback-Bean and Kenneth W. Bean
|
|
Total
|
$203,000
|
|
|
|
|
|
Second
Closing Fees and Costs (in connection with $400,000 received
through
the
sale of Notes in February 2007)
|
|
|
|
|
|
|
|
|
|
$50,000
|
|
Finder
|
|
Lionheart
Associates, LLC doing business as Fairhills Capital as a finder's
fee in
connection with the funding;
|
|
|
$18,000
|
|
Finder
|
|
OTC
Financial Network, as a finder's fee in connection with the
funding;
|
|
|
$5,000
|
|
Closing
costs
|
|
Escrow
fees
|
|
Total
|
$73,000*
|
|
|
|
|
|
|
|
|
|
|
|
|
*
Which amount includes funds paid by the Company to its legal counsel
and
independent auditor in connection with its reporting requirement
and the
drafting and review of our Registration Statement and the financial
statements contained therein.
|
Third
Closing Fees and Costs (in connection with $500,000 received
through
the
sale of Notes in July 2007)
|
·
|
$75,000
- Repayment of stockholder loans;
|
|
·
|
$10,000
- Inventory for our prosthetics operations;
|
|
·
|
$60,000
- Equipment and building improvements;
|
|
·
|
$200,000
- Promotional, marketing and travel costs associated with our increased
marketing campaign;
|
|
·
|
$15,000
- Closing costs and finders fees in connection with the funding;
and
|
|
·
|
$75,000-
General working capital, including certain amounts for officers and
directors salaries, rent and office expenses, of which a portion
may be
used to pay accrued interest on the Convertible Notes. We have not
paid
any of the accrued interest on the Convertible Notes to date, and
have not
been requested to pay such interest by the Purchasers to
date.
|
|
|
|
Total
Notes sold to the Purchasers
|
|
$1,500,000
|
|
Minus
fees described above
|
|
$291,000
|
|
Total
funds received by the Company
|
|
$1,209,000
|
As
of
November 2007, we believe we can operate for at least the next twelve months
with our current cash on hand and revenues we will receive from our fittings,
based on our current estimate of non-discretionary and recurring cash overhead
of approximately $64,000 per month and monthly gross profits of approximately
$50,000 per month. We currently anticipate that our operations will continue
to
grow as a result of our increased advertising and marketing expenditures, which
has allowed a greater number of potential clients to become aware of our
operations and services and that the increase in revenues and gross
profits associated with such growth will substantially fund future
operations
If
we are required to raise additional funding, we will likely do so through the
sale of debt or equity securities. Other than the funding transaction described
above, no additional financing has been secured and the Company has no
commitments from officers, directors or affiliates to provide
funding.
RISK
FACTORS
Any
investment in shares of our common stock involves a high degree of risk. You
should carefully consider the following information about these risks before
you
decide to buy our common stock. If any of the following risks actually occur,
our business would likely suffer. In such circumstances, the market price of
our
common stock could decline, and you may lose all or part of the money you paid
to buy our common stock.
WE
HAVE EXPERIENCED SUBSTANTIAL OPERATING LOSSES AND MAY INCUR ADDITIONAL OPERATING
LOSSES IN THE FUTURE.
During
the fiscal years ended June 30, 2007 and 2006, we incurred net income of
$843,103 and a net loss of $4,413,417, respectively, and experienced negative
cash flows from operations of $554,271 and $436,226, respectively. During the
three months ended September 30, 2007, we had net income of $811,046, which
net
income was mainly the result of changes in the value of our derivative financial
instruments and not the result of our core operations, and negative cash flows
from operations of $309,454. Additionally, we had negative working capital
of
$1,866,763 and a total accumulated deficit of 10,845,087 as of September 30,
2007. Our historical losses have been related to two primary factors as follows:
1) we are not currently generating sufficient revenue to cover our fixed costs
and we believe that the break-even point from a cash flow standpoint may require
that we fit as many as 100 clients, up from 59 fitted in fiscal 2007; and 2)
we
have issued a significant number of our shares of common stock to compensate
employees and consultants and those stock issuances have resulted in charges
to
income of $585,946 and $482,360 during the years ended June 30, 2007 and 2006,
costs that we believe will not be recurring in such large amounts in future
periods. In the event we are unable to increase our gross margins, reduce our
costs and/or generate sufficient additional revenues, we may continue to sustain
losses and our business plan and financial condition will be materially and
adversely affected.
THERE
IS DOUBT REGARDING OUR ABILITY TO CONTINUE AS A GOING
CONCERN.
Since
our
inception, we have suffered significant net losses. During the three months
ended September 30, 2007 we had a loss from operations of $265,901 and we had
a
working capital deficit of $1,866,763 as of September 30, 2007. Furthermore,
we
had an accumulated deficit of $10,845,087 at September 30, 2007. Due to our
negative financial results and our current financial position, there is
substantial doubt about our ability to continue as a going concern.
OUR
BUSINESS DEPENDS UPON OUR ABILITY TO MARKET OUR SERVICES TO AND SUCCESSFULLY
FIT
CHILDREN BORN WITH A LIMB-LOSS.
Our
growth prospects depend upon our ability to identify and subsequently fit the
small minority of children born with a limb-loss. The LLR&SP Report
(referred to in our "Description of Business" section herein) indicates that
approximately 26 out of every 100,000 live births in the United States result
in
a possible need for prosthetic rehabilitation. In addition, our business model
demands that we continue to successfully fit infants and children each year
as
they outgrow their prostheses. Because of the relatively small number of these
children born each year and the fact that each child is different, there can
be
no assurance that we will be able to identify and market our services to such
children (or the parents or doctors of such children) and/or that we will be
able to successfully fit such children with prosthetic’s devices if retained. If
we are unable to successfully market our services to the small number of
children born with a limb-loss each year and/or successfully fit such children
if marketed to, our results of operations and revenues could be adversely
affected and/or may not grow.
DUE
TO IMPROVED HEALTHCARE, THERE COULD BE FEWER AND FEWER CHILDREN EACH YEAR WITH
PRE-NATAL LIMB-LOSS.
Since
the
majority of our first-time prospective fittings are assumed to be with children
with a pre-natal limb-loss, breakthroughs in pre-natal safety regimens and
treatment could end the need for the vast majority of future fittings of
pediatric prosthetics. As such, there can be no assurance that the number of
children requiring our services will continue to grow in the future, and in
fact
the number of such children may decline as breakthroughs occur.
CHANGES
IN GOVERNMENT REIMBURSEMENT LEVELS COULD ADVERSELY AFFECT OUR NET SALES, CASH
FLOWS AND PROFITABILITY.
We
derived a significant percentage of our net sales for the years ended June
30,
2006 and 2007, from reimbursements for prosthetic services and products from
programs administered by Medicare, or Medicaid. Each of these programs sets
maximum reimbursement levels for prosthetic services and products. If these
agencies reduce reimbursement levels for prosthetic services and products in
the
future, our net sales could substantially decline. Additionally, reduced
government reimbursement levels could result in reduced private payor
reimbursement levels because fee schedules of certain third-party payors are
indexed to Medicare. Furthermore, the healthcare industry is experiencing a
trend towards cost containment as government and other third-party payors seek
to impose lower reimbursement rates and negotiate reduced contract rates with
service providers. This trend could adversely affect our net sales. Medicare
provides for reimbursement for prosthetic products and services based on prices
set forth in fee schedules for ten regional service areas. Additionally, if
the
U.S. Congress were to legislate modifications to the Medicare fee schedules,
our
net sales from Medicare and other payors could be adversely and materially
affected. We cannot predict whether any such modifications to the fee schedules
will be enacted or what the final form of any modifications might be. As such,
modifications to government reimbursement levels could reduce our revenues
and/or cause individuals who would have otherwise retained our services to
look
for cheaper alternatives.
IF
WE CANNOT COLLECT OUR ACCOUNTS RECEIVABLE OUR BUSINESS, RESULTS OF OPERATIONS,
AND FINANCIAL CONDITION COULD BE ADVERSELY AFFECTED.
As
of
September 30, 2007, our accounts receivable over 120 days old represented
approximately one-third of total accounts receivable outstanding. If we cannot
collect our accounts receivable, our business, results of operations, and
financial condition could be adversely affected.
IF
WE ARE UNABLE TO MAINTAIN GOOD RELATIONS WITH OUR SUPPLIERS, OUR EXISTING
PURCHASING COSTS MAY BE JEOPARDIZED, WHICH COULD ADVERSELY AFFECT OUR GROSS
MARGINS.
Our
gross
margins have been, and will continue to be, dependent, in part, on our ability
to continue to obtain favorable terms from our suppliers. These terms may be
subject to changes in suppliers' strategies from time to time, which could
adversely affect our gross margins over time. The profitability of our business
depends, in part, upon our ability to maintain good relations with these
suppliers, of which there can be no assurance.
WE
DEPEND ON THE CONTINUED EMPLOYMENT OF OUR TWO PROSTHETISTS WHO WORK AT OUR
HOUSTON PATIENT-CARE FACILITY AND THEIR RELATIONSHIPS WITH REFERRAL SOURCES
AND
PATIENTS. OUR ABILITY TO PROVIDE PEDIATRIC PROSTHETIC SERVICES AT OUR
PATIENT-CARE FACILITY WOULD BE IMPAIRED AND OUR NET SALES REDUCED IF WE WERE
UNABLE TO MAINTAIN THESE EMPLOYMENT AND REFERRAL
RELATIONSHIPS.
Our
net
sales would be reduced if either of our two (2) practitioners leaves us. In
addition, any failure of these practitioners to maintain the quality of care
provided or to otherwise adhere to certain general operating procedures at
our
facility, or among our Host Affiliates, or any damage to the reputation of
any
of our practitioners could damage our reputation, subject us to liability and/or
significantly reduce our net sales.
WE
FACE REVIEWS, AUDITS AND INVESTIGATIONS UNDER OUR CONTRACTS WITH FEDERAL AND
STATE GOVERNMENT AGENCIES, AND THESE AUDITS COULD HAVE ADVERSE FINDINGS THAT
MAY
NEGATIVELY IMPACT OUR BUSINESS.
We
contract with various federal and state governmental agencies to provide
prosthetic services. Pursuant to these contracts, we are subject to various
governmental reviews, audits and investigations to verify our compliance with
the contracts and applicable laws and regulations, including reviews from
Medicare and Texas Medicaid, in connection with rules and regulations we are
required to follow and comply with as a result of our position as a Medicare
and
Texas Medicaid approved provider. Any adverse review, audit or investigation
could result in:
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refunding
of amounts we have been paid pursuant to our government
contracts;
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imposition
of fines, penalties and other sanctions on us;
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loss
of our right to participate in various federal
programs;
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damage
to our reputation in various markets; or
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material
and/or adverse effects on the business, financial condition and results
of
operations.
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WE
HAVE NEVER PAID A CASH DIVIDEND AND IT IS LIKELY THAT THE ONLY WAY OUR
SHAREHOLDERS WILL REALIZE A RETURN ON THEIR INVESTMENT IS BY SELLING THEIR
SHARES.
We
have
never paid cash dividends on any of our securities. Our Board of Directors
does
not anticipate paying cash dividends in the foreseeable future. We currently
intend to retain future earnings to finance our growth. As a result, the ability
of our investors to generate a profit our common stock will likely depend on
their ability to sell our stock at a profit, of which there can be no
assurance.
WE
MAY ISSUE ADDITIONAL SHARES OF COMMON STOCK IN THE FUTURE, WHICH COULD CAUSE
DILUTION TO OUR THEN EXISTING SHAREHOLDERS.
We
may
seek to raise additional equity capital in the future. Any issuance of
additional shares of our common stock will dilute the percentage ownership
interest of all our then shareholders and may dilute the book value per share
of
our common stock, which would likely cause a decrease in value of our common
stock.
WE
MAY ISSUE ADDITIONAL SHARES OF PREFERRED STOCK WHICH PREFERRED STOCK MAY HAVE
RIGHTS AND PREFERENCES GREATER THAN OUR COMMON STOCK.
The
Board
of Directors has the authority to issue up to 10,000,000 shares of Preferred
Stock. As of November 7, 2007, 1,000,000 shares of the Series A Convertible
Preferred Shares have been issued. Additional shares of preferred stock, if
issued, could be entitled to preferences over our outstanding common stock.
The
shares of preferred stock, when and if issued, could adversely affect the rights
of the holders of common stock, and could prevent holders of common stock from
receiving a premium for their common stock. An issuance of preferred stock
could
result in a class of securities outstanding that could have preferences with
respect to voting rights and dividends and in liquidation over the common stock,
and could (upon conversion or otherwise) enjoy all of the rights of holders
of
common stock. Additionally, we may issue a series of preferred stock in the
future, which may convert into common stock, which conversion would cause
immediate dilution to our then shareholders. The Board of Directors’ authority
to issue preferred stock could discourage potential takeover attempts and could
delay or prevent a change in control through merger, tender offer, proxy contest
or otherwise by making such attempts more difficult to achieve or more costly
and/or otherwise cause the value of our common stock to decrease in
value.
OUR
MANAGEMENT CONTROLS A SIGNIFICANT PERCENTAGE OF OUR CURRENTLY OUTSTANDING COMMON
STOCK AND THEIR INTERESTS MAY CONFLICT WITH THOSE OF OUR
SHAREHOLDERS.
As
of
November 7, 2007, our President and Chief Executive Officer, Linda Putback-Bean
beneficially owned 30,210,251 shares of common stock or approximately 29% of
our
outstanding common stock. Additionally, Ms. Putback-Bean owns 900,000 shares
of
our Series A Convertible Preferred Stock which represents 90% of the issued
and
outstanding shares of preferred stock. Dan Morgan, our Vice President/Chief
Prosthetist owns 9,198,861 shares of our common stock as well as the remaining
100,000 shares of our Series A Convertible Preferred Stock which represents
10%
of the Series A Convertible Preferred Stock. Thus, management owns 100% of
our
Series A Convertible Preferred Stock. The Series A Convertible Preferred Stock
is convertible on a one-to-one basis for our common stock but has voting rights
of 20-to-1, giving our management the right to vote a total of 59,409,112 shares
of our voting shares, representing the 30,210,251 shares held by Ms.
Putback-Bean, the 900,000 shares of Series A Convertible Preferred Stock which
has the right to vote 18,000,000 shares of common stock, the 9,198,861 shares
of
common stock held by Mr. Morgan, and the 100,000 shares of Series A Convertible
Preferred Stock which has the right to vote 2,000,000 shares of common stock,
for a total of a total of approximately 48% of our
total
voting power based on 125,925,789 voting shares, which includes the 105,925,789
shares of common stock outstanding and the 20,000,000 shares which our Series
A
Convertible Preferred Stock are able to vote. This concentration of a
significant percentage of voting power provides our management substantial
influence over any matters that require a shareholder vote, including, without
limitation, the election of Directors and/or approving or preventing a merger
or
acquisition, even if their interests may conflict with those of other
shareholders. Such control could also have the effect of delaying or preventing
a change in control or otherwise discouraging a potential acquirer from
attempting to obtain control of the Company. Such control could have a material
adverse effect on the market price of our common stock or prevent our
shareholders from realizing a premium over the then prevailing market prices
for
their shares of common stock.
WE
MAY BE REQUIRED TO IMMEDIATELY PAY THE $1,500,000 IN OUTSTANDING DEBENTURES
AND/OR BE FORCED TO PAY SUBSTANTIAL PENALTIES TO THE DEBENTURE HOLDERS UPON
THE
OCCURRENCE OF AND DURING THE CONTINUANCE OF AN EVENT OF
DEFAULT.
Upon
the
occurrence of and during the continuance of any Event of Default under the
Debentures, which includes the following events:
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Our
failure to pay any principal or interest on the Debentures when
due;
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Our
failure to issue shares of common stock to the Purchasers in connection
with any conversion as provided in the
Debentures;
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Our
Registration Statement ceases to be effective for more than ten (10)
consecutive days or more than twenty (20) days in any twelve (12)
month
period;
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Our
entry into bankruptcy or the appointment of a receiver or
trustee;
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Our
breach of any covenants in the Debentures or Purchase Agreement,
or our
breach of any representations or warranties included in any of the
other
agreements entered into in connection with the Closing;
or
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If
any judgment is entered against us or our property for more than
$100,000,
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the
Purchasers can make the Debentures immediately due and payable, and can make
us
pay the greater of (a) 130% of the total remaining outstanding principal amount
of the Debentures, plus accrued and unpaid interest thereunder, or (b) the
total
dollar value of the number of shares of common stock which the funds referenced
in section (a) would be convertible into (as calculated in the Debentures),
multiplied by the highest closing price for our common stock during the period
we are in default. As we do not currently have sufficient cash on hand to repay
the debentures, if an Event of Default occurs under the Debentures, we could
be
forced to curtail or abandon our operations and/or sell substantially all of
our
assets in order to repay all or a part of the Debentures.
THE
DEBENTURES ARE CONVERTIBLE INTO SHARES OF OUR COMMON STOCK AT A DISCOUNT TO
MARKET.
The
conversion price of the Debentures is equal to 60% of the trading price of
our
common stock, which will likely cause the value of our common stock, if any,
to
decline in value as subsequent conversions are made, as described in greater
detail under the Risk Factors below.
THE
ISSUANCE AND SALE OF COMMON STOCK UPON CONVERSION OF THE CONVERTIBLE NOTES
AND
EXERCISE OF THE WARRANTS MAY DEPRESS THE MARKET PRICE OF OUR COMMON
STOCK.
As
sequential conversions of the Debentures and sales of such converted shares
take
place, the price of our common stock may decline, and as a result, the holders
of the Debentures will be entitled to receive an increasing number of shares
in
connection with their conversions, which shares could then be sold in the
market, triggering further price declines and conversions for even larger
numbers of shares, to the detriment of our investors. Upon the successful
registration of the shares of common stock which the Debentures are convertible
into and the Warrants are exercisable for, all of the shares issuable upon
conversion of the Debentures and upon exercise of the Warrants, may be sold
without restriction. The sale of these shares may adversely affect the market
price, if any, of our common stock.
In
addition, the common stock issuable upon conversion of the Debentures and
exercise of the Warrants may represent overhang that may also adversely affect
the market price of our common stock. Overhang occurs when there is a greater
supply of a company's stock in the market than there is demand for that stock.
When this happens the price of the company's stock will decrease, and any
additional shares which shareholders attempt to sell in the market will only
further decrease the share price. The Debentures may be converted into common
stock at a discount to the market price of our common stock of 40% of the
average of the three lowest intraday trading prices which our common stock
trades on the market or exchange which it then trades over the most recent
twenty (20) day trading period, ending one day prior to the date a conversion
notice is received, and such discount to market, provides the holders with
the
ability to sell their common stock at or below market and still make a profit.
In the event of such overhang, holders will have an incentive to sell their
common stock as quickly as possible. If the share volume of our common stock
cannot absorb the discounted shares, then the value of our common stock will
likely decrease.
THE
ISSUANCE OF COMMON STOCK UPON CONVERSION OF THE DEBENTURES AND UPON EXERCISE
OF
THE WARRANTS WILL CAUSE IMMEDIATE AND SUBSTANTIAL
DILUTION.
The
issuance of common stock upon conversion of the Debentures and exercise of
the
Warrants will result in immediate and substantial dilution to the interests
of
other stockholders since the Debenture holders may ultimately receive and sell
the full amount issuable on conversion or exercise. Although the Debenture
holders may not convert the Debentures and/or exercise their Warrants if such
conversion or exercise would cause them to own more than 4.99% of our
outstanding common stock, this restriction does not prevent the Debenture
holders from converting and/or exercising some of their holdings, selling those
shares, and then converting the rest of their holdings, while still staying
below the 4.99% limit. In this way, the Debenture holders could sell more than
this limit while never actually holding more shares than this limit allows.
If
the Debenture holders choose to do this it will cause substantial dilution
to
the then holders of our common stock.
THE
CONTINUOUSLY ADJUSTABLE CONVERSION PRICE FEATURE OF OUR DEBENTURES COULD REQUIRE
US TO ISSUE A SUBSTANTIALLY GREATER NUMBER OF SHARES, WHICH MAY ADVERSELY AFFECT
THE MARKET PRICE OF OUR COMMON STOCK AND CAUSE DILUTION TO OUR EXISTING
STOCKHOLDERS.
Our
existing stockholders will
experience substantial dilution of their investment upon conversion of the
Debentures and exercise of the Warrants. The Debentures will be convertible
into
shares of our common stock at a discount to market of 40% of the trading value
of our common stock. As a result, the number of shares issuable could prove
to
be significantly greater in the event of a decrease in the trading price of
our
common stock, which decrease would cause substantial dilution to our existing
stockholders. As sequential conversions and sales take place, the price of
our
common stock may decline and if so, the holders of the Debentures would be
entitled to receive an increasing number of shares, which could then be sold,
triggering further price declines and conversions for even larger numbers of
shares, which would cause additional dilution to our existing stockholders
and
would likely cause the value of our common stock to decline.
THE
CONTINUOUSLY ADJUSTABLE CONVERSION PRICE FEATURE OF OUR DEBENTURES MAY ENCOURAGE
INVESTORS TO SELL SHORT OUR COMMON STOCK, WHICH COULD HAVE A DEPRESSIVE EFFECT
ON THE PRICE OF OUR COMMON STOCK.
The
Debentures will be convertible into shares of our common stock at a discount
to
market of 40% of the average of the three lowest intraday trading prices which
our common stock trades on the market or exchange which it then trades over
the
most recent twenty (20) day trading period, ending one day prior to the date
a
conversion notice is received (the “Conversion Price”). The significant downward
pressure on the price of our common stock as the Debenture holders convert
and
sell material amounts of our common stock could encourage investors to short
sell our common stock. This could place further downward pressure on the price
of our common stock. In addition, not only the sale of shares issued upon
conversion of the Debentures or exercise of the Warrants, but also the mere
perception that these sales could occur, may adversely affect the market price
of our common stock.
THE
TRADING PRICE OF OUR COMMON STOCK ENTAILS ADDITIONAL REGULATORY REQUIREMENTS,
WHICH MAY NEGATIVELY AFFECT SUCH TRADING PRICE.
Our
common stock is currently listed on the Pink Sheets, an over-the-counter
electronic quotation service, which stock currently trades below $4.00 per
share. We anticipate the trading price of our common stock will continue to
be
below $4.00 per share. As a result of this price level, trading in our common
stock would be subject to the requirements of certain rules promulgated under
the Securities Exchange Act of 1934, as amended (the "Exchange Act"). These
rules require additional disclosure by broker-dealers in connection with any
trades generally involving any non-NASDAQ equity security that has a market
price of less than $4.00 per share, subject to certain exceptions. Such rules
require the delivery, before any penny stock transaction, of a disclosure
schedule explaining the penny stock market and the risks associated therewith,
and impose various sales practice requirements on broker-dealers who sell penny
stocks to persons other than established customers and accredited investors
(generally institutions). For these types of transactions, the broker-dealer
must determine the suitability of the penny stock for the purchaser and receive
the purchaser's written consent to the transaction before sale. The additional
burdens imposed upon broker-dealers by such requirements may discourage
broker-dealers from effecting transactions in our common stock. As a
consequence, the market liquidity of our common stock could be severely affected
or limited by these regulatory requirements.
IN
THE FUTURE, WE WILL INCUR SIGNIFICANT INCREASED COSTS AS A RESULT OF OPERATING
AS A FULLY REPORTING COMPANY UNDER THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED, AND OUR MANAGEMENT WILL BE REQUIRED TO DEVOTE SUBSTANTIAL TIME TO
NEW
COMPLIANCE INITIATIVES.
Moving
forward, we anticipate incurring significant legal, accounting and other
expenses in connection with our status as a fully reporting public company.
The
Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act") and new rules subsequently
implemented by the SEC have imposed various new requirements on public
companies, including requiring changes in corporate governance practices. As
such, and as a result of the filing of our Form 10-SB to become a publicly
reporting company, our management and other personnel will need to devote a
substantial amount of time to these new compliance initiatives. Moreover, these
rules and regulations will increase our legal and financial compliance costs
and
will make some activities more time-consuming and costly. For example, we expect
these new rules and regulations to make it more difficult and more expensive
for
us to obtain director and officer liability insurance, and we may be required
to
incur substantial costs to maintain the same or similar coverage. In addition,
the Sarbanes-Oxley Act requires, among other things, that we maintain effective
internal controls for financial reporting and disclosure of controls and
procedures. In particular, commencing in fiscal 2008, we must perform system
and
process evaluation and testing of our internal controls over financial reporting
to allow management and our independent registered public accounting firm to
report on the effectiveness of our internal controls over financial reporting,
as required by Section 404 of the Sarbanes-Oxley Act. Our testing, or the
subsequent testing by our independent registered public accounting firm, may
reveal deficiencies in our internal controls over financial reporting that
are
deemed to be material weaknesses. Our compliance with Section 404 will require
that we incur substantial accounting expense and expend significant management
efforts. We currently do not have an internal audit group, and we will need
to
hire additional accounting and financial staff with appropriate public company
experience and technical accounting knowledge. Moreover, if we are not able
to
comply with the requirements of Section 404 in a timely manner, or if we or
our
independent registered public accounting firm identifies deficiencies in our
internal controls over financial reporting that are deemed to be material
weaknesses, the market price of our
stock
could decline, and we could be subject to sanctions or investigations by the
SEC
or other regulatory authorities, which would require additional financial and
management resources.
Government
Regulation
We
are
subject to a variety of federal, state and local governmental regulations.
We
make every effort to comply with all applicable regulations through compliance
programs, manuals and personnel training. Despite these efforts, we cannot
guarantee that we will be in absolute compliance with all regulations at all
times. Failure to comply with applicable governmental regulations may result
in
significant penalties, including exclusion from the Medicare and Medicaid
programs, which could have a material adverse effect on our business. In
November 2003, Congress initiated a three-year freeze on reimbursement
levels for all orthotic and prosthetic services starting January 1, 2004.
The effect of this legislation has been a downward pressure on our gross profit;
however, we have initiated certain purchasing and efficiency programs which
we
believe will minimize such effects. The most important efficiency program we
have instituted to date was entering into contracts with our Host affiliates.
By
acquiring laboratory access from such Host Affiliates, and acquiring the Host
Affiliates help in billing and collections from third party payers such as
insurance companies and their respective state-centered Medicaid programs,
we
have also cut down our travel costs, and our costs of added staff to invoice
and
collect receivables. Additionally, in an attempt to maximize our efficiency,
we
modified our "just in time" inventorying of components for prosthetic devices
to
allow sufficient time for us to send such components via less expensive ground
freight instead of higher priced overnight delivery. Finally, we have instituted
a ten day lead-time policy on our airline reservations to achieve lower
air-fares to our patients, when we are required to travel across the country,
except in cases of emergencies.
HIPAA
Violations. The Health Insurance Portability and Accountability Act ("HIPAA")
provides for criminal penalties for, among other offenses, healthcare fraud,
theft or embezzlement in connection with healthcare, false statements related
to
healthcare matters, and obstruction of criminal investigation of healthcare
offenses. Unlike the federal anti-kickback laws, these offenses are not limited
to federal healthcare programs. In addition, HIPAA authorizes the imposition
of
civil monetary penalties where a person offers or pays remuneration to any
individual eligible for benefits under a federal healthcare program that such
person knows or should know is likely to influence the individual to order
or
receive covered items or services from a particular provider, practitioner
or
supplier. Excluded from the definition of "remuneration" are incentives given
to
individuals to promote the delivery of preventive care (excluding cash or cash
equivalents), incentives of nominal value and certain differentials in or
waivers of coinsurance and deductible amounts. These laws may apply to certain
of our operations. Our billing practices could be subject to scrutiny and
challenge under HIPAA.
Physician
Self-Referral Laws. We are also subject to federal and state physician
self-referral laws. With certain exceptions, the federal Medicare/Medicaid
physician self-referral law (the "Stark II" law) (Section 1877 of the Social
Security Act) prohibits a physician from referring Medicare and Medicaid
beneficiaries to an entity for "designated health services" - including
prosthetic and orthotic devices and supplies - if the physician or the
physician's immediate family member has a financial relationship with the
entity. A financial relationship includes both ownership or investment interests
and compensation arrangements. A violation occurs when any person presents
or
causes to be presented to the Medicare or Medicaid program a claim for payment
in violation of Stark II. With respect to ownership/investment interests, there
is an exception under Stark II for referrals made to a publicly traded entity
in
which the physician has an investment interest if the entity's shares are traded
on certain exchanges, including the New York Stock Exchange, and had
shareholders' equity exceeding $75.0 million for its most recent fiscal year,
or
an average of $75.0 million during the three previous fiscal years.
With
respect to compensation arrangements, there are exceptions under Stark II that
permit physicians to maintain certain business arrangements, such as personal
service contracts and equipment or space leases, with healthcare entities to
which they refer. We believe that our compensation arrangements comply with
Stark II, either because the physician's relationship fits within a regulatory
exception or does not generate prohibited referrals. Because we have financial
arrangements with physicians and possibly their immediate family members, and
because we may not be aware of all those financial arrangements, we must rely
on
physicians and their immediate family members to avoid making referrals to
us in
violation of Stark II or similar state laws. If, however, we receive a
prohibited referral without knowing that the referral was prohibited, our
submission of a bill for services rendered pursuant to a referral could subject
us to sanctions under Stark II and applicable state laws.
Certification
and Licensure. Most states do not require separate licensure for practitioners.
However, several states currently require practitioners to be certified by
an
organization such as the American Board for Certification ("ABC"). Our
Prosthetists are certified by the State of Texas and by the ABC. When we fit
children in other States which have state licensure laws, we work, under the
supervision of licensed Prosthetists in those states.
The
American Board for Certification Orthotics and Prosthetics conducts a
certification program for practitioners and an accreditation program for
patient-care centers. The minimum requirements for a certified practitioner
are
a college degree, completion of an accredited academic program, one to four
years of residency at a patient-care center under the supervision of a certified
practitioner and successful completion of certain examinations. Minimum
requirements for an accredited patient-care center include the presence of
a
certified practitioner and specific plant and equipment requirements. While
we
endeavor to comply with all state licensure requirements, we cannot assure
that
we will be in compliance at all times with these requirements. Failure to comply
with state licensure requirements could result in civil penalties, termination
of our Medicare agreements, and repayment of amounts received from Medicare
for
services and supplies furnished by an unlicensed individual or
entity.
Confidentiality
and Privacy Laws. The Administrative Simplification Provisions of HIPAA, and
their implementing regulations, set forth privacy standards and implementation
specifications concerning the use and disclosure of individually identifiable
health information (referred to as "protected health information") by health
plans, healthcare clearinghouses and healthcare providers that transmit health
information electronically in connection with certain standard transactions
("Covered Entities"). HIPAA further requires Covered Entities to protect the
confidentiality of health information by meeting certain security standards
and
implementation specifications. In addition, under HIPAA, Covered Entities that
electronically transmit certain administrative and financial transactions must
utilize standardized formats and data elements ("the transactions/code sets
standards"). HIPAA imposes civil monetary penalties for non-compliance, and,
with respect to knowing violations of the privacy standards, or violations
of
such standards committed under false pretenses or with the intent to sell,
transfer or use individually identifiable health information for commercial
advantage, criminal penalties. The privacy standards and transactions/code
sets standards went into effect on April 16, 2003 and required compliance by
April 21, 2005. We believe that we are subject to the Administrative
Simplification Provisions of HIPAA and have taken steps necessary to meet
applicable standards and implementation specifications; however, these
requirements have had a significant effect on the manner in which we handle
health data and communicate with payors. Our added costs of complying with
the
HIPPA requirements relate primarily to attaining the on-going educational
credits needed for our Prosthetists to remain current with the professional
standards of practice. These credits are achieved by attending work-shops and
seminars in various locations throughout North America. During fiscal year
ended
June 30, 2006 we spent approximately $5,000 complying with these on-going
educational needs. However, since our original formation, we have been aware
of
impending HIPPA regulations, and have set up our systems and procedures to
comply with HIPPA requirements in view of such regulations. As a result, added
costs due to compliance with HIPPA guidelines have been minimal and
immaterial.
In
addition, state confidentiality and privacy laws may impose civil and/or
criminal penalties for certain unauthorized or other uses or disclosures of
individually identifiable health information. We are also subject to these
laws.
While we endeavor to assure that our operations comply with applicable laws
governing the confidentiality and privacy of health information, we could face
liability in the event of a use or disclosure of health information in violation
of one or more of these laws.