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EX-32.1 - Skyline Medical Inc.v166985_ex32-1.htm
EX-31.1 - Skyline Medical Inc.v166985_ex31-1.htm
FORM 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended
                                  September 30, 2009
or
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                                                                            to ____________________________________ 
  
Commission File Number: Registration Statement No. 333-155299
 
BioDrain Medical, Inc.
 (Exact name of registrant as specified in its charter)

Minnesota
 
33-1007393
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)

2060 Centre Pointe Blvd., Suite 7,
 
Mendota Heights, MN 55120
(Address of principal executive offices)
 
(Zip Code)

651-389-4800
(Registrant’s telephone number, including area code)

 
 (Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                                                                        x  Yes ¨ No                    

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
¨ Yes x  No                   
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 1 2b-2 of the Exchange Act.

Large accelerated filer ¨                                                                                                         Accelerated filer ¨

Non-accelerated filer  ¨  (Do not check if a smaller reporting company)              Smaller reporting company  x

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

¨ Yes x No

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. As of October 31, 2009 the Company had 10,383,651 common shares, par value $.01 per share, outstanding.

 
 

 


BIODRAIN MEDICAL, INC.
TABLE OF CONTENTS
 
Page No.
PART I. FINANCIAL INFORMATION
 
   
Item 1.    Condensed Financial Statements
3
   
Condensed Balance Sheets September 30, 2009 and December 31, 2008
3
   
Condensed Statements of Operations for three- and nine-month periods ended
 
September 30, 2009 and September 30, 2008
4
   
Condensed Statements of Cash Flows for nine-month periods ended September 30, 2009
 
and September 30, 2008
6
   
 Notes to Condensed Financial Statements
7
   
Item  2.  Management’s Discussion and Analysis of Financial Condition and
16
Results of Operations
 
   
Item 3.  Quantitative and Qualitative Disclosures About Market Risk
23
   
Item 4T.  Controls and Procedures
23
   
PART II. OTHER INFORMATION
 
   
Item 1.  Legal Proceedings
23
   
Item 1A.  Risk Factors
23
   
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
23
   
Item 3.  Defaults Upon Senior Securities
24
   
Item 4.  Submission of Matters to a Vote of Security Holders
24
   
Item 5.  Other Information
24
   
Item 6.  Exhibits
24
   
Signatures
25
   
Exhibit Index
25
EX-31.1
 
EX-32.1
 

 
2

 

PART 1. FINANCIAL INFORMATION
Item 1. Condensed Financial Statements

BIODRAIN MEDICAL, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED BALANCE SHEETS

   
September 30,
   
December 31,
 
   
2009
   
2008
 
 
 
(Unaudited)
       
ASSETS
           
Current Assets:
           
Cash
  $ 68,197     $ 463,838  
Accounts receivable
    15,737       -  
Prepaid expense and other assets
    10,869       7,974  
Restricted cash in escrow (See Note 4)
    163,333       163,333  
Total Current Assets
    258,136       635,145  
                 
Fixed assets, net
    9,867       11,689  
Intangibles, net
    141,532       142,145  
                 
Total Assets
  $ 409,535     $ 788,979  
                 
LIABILITIES AND SHAREHOLDERS' DEFICIT
               
Current Liabilities:
               
Current portion of long term debt (See Note 8)
  $ 17,620     $ 17,620  
Current portion of convertible debt (See Note 8)
    170,000       170,000  
Accounts payable
    686,066       497,150  
Shares due investors under registration payment arrangement
    355,124       -  
Accrued expenses
    296,267       305,248  
Convertible debenture (See Note 7)
    10,000       10,000  
Total Current Liabilites
    1,535,077       1,000,018  
                 
Long term debt and convertible debt, net of discounts
               
of $19,619 and $26,157 (See Note 8)
    94,821       98,406  
                 
Liability for equity-linked financial instruments (See Note 10)
    1,059,980       -  
                 
Stockholders Deficit:
               
Common stock, $.01 par value, 40,000,000 authorized, 10,353,651 and 8,130,841 outstanding
    103,536       81,308  
Additional paid-in capital
    3,268,699       2,753,039  
Deficit accumulated during development stage
    (5,652,578 )     (3,143,792 )
Total Shareholder' Deficit
    (2,280,343 )     (309,445 )
                 
Total Liabilities and Shareholders' Deficit
  $ 409,535     $ 788,979  

See Notes to Condensed Financial Statements

 
3

 
 
BIODRAIN MEDICAL, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED STATEMENTS OF OPERATIONS

                           
Period From
 
                           
April 23, 2002
 
                           
(Inception)
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
   
To September 30,
 
   
2009
   
2008
   
2009
   
2008
   
2009
 
Revenue
  $ -     $ -     $ 15,737     $ -     $ 15,737  
                                         
Cost of goods sold
    -       -       7,450               7,450  
                                         
Gross margin
    -       -       8,287       -       8,287  
                                         
General and administrative expense
    521,532       435,941       1,393,072       845,100       3,823,213  
                                         
Operations expense
    156,523       -       351,449       91,449       805,323  
                                         
Sales and marketing expense
    136,220       7,460       344,723       7,670       393,798  
                                         
Interest expense
    24,689       4,134       64,009       11,135       274,711  
                                         
Loss (gain) on valuation of equity-linked
                                       
   financial instruments
    (65,949 )     -       370,474       -       363,820  
                                         
Total expense
    773,015       447,535       2,523,727       955,354       5,660,865  
                                         
Net loss available to common shareholders
  $ (773,015 )   $ (447,535 )   $ (2,515,440 )   $ (955,354 )   $ (5,652,578 )
                                         
Loss per  common share
                                       
   basic and diluted
  $ (0.08 )   $ (0.08 )   $ (0.28 )   $ (0.35 )   $ (2.77 )
                                         
Weighted average shares used in computation, basic and diluted
    9,634,828       5,582,437       8,903,119       2,758,557       2,041,540  

See Notes to Condensed Financial Statements

 
4

 
 
BIODRAIN MEDICAL, INC.
(A DEVELOPMENT STAGE COMPANY)
STATEMENT OF STOCKHOLDERS' DEFICIT
PERIOD FROM APRIL 23, 2002 (INCEPTION)
TO SEPTEMBER 30, 2009

   
Shares
   
Amount
   
Paid in Capital
   
Deficit
   
Total
 
Issuance of common stock 9/1/02, $.0167 (1)
    598,549     $ 5,985     $ 4,015     $ -     $ 10,000  
                                      -  
Issuance of common 10/23/02, $1.67/share
    2,993       30       4,970               5,000  
Net loss
                            (51,057 )     (51,057 )
Balance 12/31/02
    601,542     $ 6,015     $ 8,985     $ (51,057 )   $ (36,057 )
                                         
Issuance of common 2/12/03, $.0167 (2)
    23,942       239       161               400  
Issuance o common 6/11&12,$1.67 (3)
    21,548       216       34,784               35,000  
Net Loss
                            (90,461 )     (90,461 )
Balance 12/31/03
    647,032     $ 6,470     $ 43,930     $ (141,518 )   $ (91,118 )
                                         
Issuance of common 5/25/04, $.0167 (4)
    6,567       66       44               110  
Net Loss
                            (90,353 )     (90,353 )
Balance 12/31/04
    653,599     $ 6,536     $ 43,974     $ (231,871 )   $ (181,361 )
                                         
Issuance of common 12/14/05, $.0167 (5)
    14,964       150       100               250  
Vested stock options and warrants
                    2,793               2,793  
Net Loss
                            (123,852 )     (123,852 )
Balance 12/31/05
    668,563     $ 6,686     $ 46,867     $ (355,723 )   $ (302,170 )
                                         
Issuance of common 5/16 & 8/8, $.0167 (6)
    86,869       869       582               1,451  
Issuance of common 10/19 & 23, $.0167 (7)
    38,906       389       261               650  
Issuance of common 12/01, $1.67 (8)
    28,739       287       44,523               44,810  
Vested stock options and warrants
                    13,644               13,644  
Net Loss
                            (273,026 )     (273,026 )
Balance 12/31/06
    823,077     $ 8,231     $ 105,877     $ (628,749 )   $ (514,641 )
                                         
Issuance of common 1/30/07 @ 1.67 (9)
    599       6       994               1,000  
Value of equity instruments issued with debt
                    132,938               132,938  
Capital contributions resulting from waivers of debt
                    346,714               346,714  
Vested stock options and warrants
                    73,907               73,907  
Net loss
                            (752,415 )     (752,415 )
Balance 12/31/07
    823,676     $ 8,237     $ 660,430     $ (1,381,164 )   $ (712,497 )
                                         
Issuance of common 6/11 to 9/30, $.35 (10)
    4,552,862       45,528       1,547,974               1,593,502  
Shares issued to finders, agents
    2,012,690       20,127       (20,127 )             -  
Shares issued to pay direct legal fees
    285,714       2,857       (2,857 )                
Issuance of common due to antidilution provisions
    205,899       2,059       (2,059 )             -  
Shares issued to pay investor relations
                                       
  services  6/23/08, $.35
    250,000       2,500       85,000               87,500  
Vested stock options and warrants
                    354,994               354,994  
Capital contributions resulting from waivers of debt
                    129,684               129,684  
Net loss
                            (1,762,628 )     (1,762,628 )
Balance 12/31/08
    8,130,841     $ 81,308     $ 2,753,039     $ (3,143,792 )   $ (309,445 )
                                         
Cumulative effect of adoption of EITF 07-5
                    (486,564 )     6,654       (479,910 )
Vested stock options and warrants
                    100,545               100,545  
Shares issued 3/20/09 to pay for fund raising
    125,000       1,250       (1,250 )             -  
Shares issued under PMM in April 2009, $.50
    700,000       7,000       343,000               350,000  
Shares issued under PPM in May 2009, $.50
    220,000       2,200       107,800               110,000  
Shares issued under PPM in June 2009, $.50
    50,000       500       24,500               25,000  
Shares issued under PPM in August 2009, $.50
    80,000       800       39,200               40,000  
Shares issued under PPM in September 2009, $.50
    150,000       1,500       73,500               75,000  
Shares issued to directors, management and consultant
                                 
    in August 2009, $.50
    797,810       7,978       390,927               398,905  
Shares issued to finder in September 2009, $.50
    100,000       1,000       49,000               50,000  
Capital contributions resulting from waivers of debt
                    84,600               84,600  
Value of equity-linked financial instruments issued
                    (209,598 )             (209,598 )
   in connection with PPM
                                       
Net Loss (Unaudited)
                            (2,515,440 )     (2,515,440 )
Balance 9/30/09
    10,353,651     $ 103,536     $ 3,268,699     $ (5,652,578 )   $ (2,280,343 )

(1) Founders shares, 1,000,000 pre-split
(2) 23,492 (40,000 pre-split) shares valued at $.0167 per share as compensation for loan guarantees by management
(3) Investment including 670 shares issued as a 10% finders fee
(4) For payment of patent legal fees
(5) Compensation for loan guarantees by management
(6) For vendor contractual consideration
(7) Employment agreements
(8) Investment
(9) Conversion of convertible notes by management
(10) Investment, "October 2008 financing".
 
See Notes to Condensed Financial Statements

 
5

 
 
BIODRAIN MEDICAL, INC.
(A DEVELOPMENT STAGE COMPANY)
CONDENSED STATEMENTS OF CASH FLOWS

         
April 23,
 
         
2002
 
   
Nine Months
   
(Inception)
 
    
Ended September 30,
   
To September 30,
 
    
2009
   
2008
   
2009
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
Cash flow from operating activities:
                 
Net loss
  $ (2,515,440 )   $ (955,354 )   $ (5,652,578 )
Adjustments to reconcile net loss to
                       
net cash used in operating activities:
                       
Depreciation and amortization
    2,434       350       3,353  
Vested stock options and warrants
    150,544       264,178       595,872  
Stock issued for management and consulting services
    398,905               486,405  
Stock based registration payments
    355,124               355,124  
Conversion of accrued liabilites to capital
    84,600       -       560,998  
Amortization of debt discount
    6,538       -       113,319  
Loss on valuation of equity-linked instruments
    370,474       -       363,820  
Changes in assets and liabilities:
                       
Accounts receivable
    (15,737 )     -       (15,737 )
Prepaid expense and other
    (2,895 )     (32,715 )     (10,869 )
Notes payable to shareholders
    -       (8,500 )     (10,962 )
Accounts payable
    188,916       77,542       686,066  
Accrued expenses
    (8,981 )     50,832       296,267  
Net cash used in operating activities:
    (985,517 )     (603,667 )     (2,228,922 )
                         
Cash flow from investing activities:
                       
Purchase of fixed assets
    -       (8,699 )     (12,258 )
Purchase of intangibles
    -       (22,224 )     (142,495 )
Net cash used in investing activities
    -       (30,923 )     (154,753 )
                         
Cash flow from financing activities:
                       
Proceeds from long term debt
    -       -       421,505  
Principal payments on long term debt
    (10,124 )     (16,623 )     (98,473 )
Restricted cash in escrow
    -       (163,333 )     (163,333 )
Issuance of common stock
    600,000       1,555,296       2,292,173  
Net cash provided by (used in) financing activities
    589,876       1,375,340       2,451,872  
                         
Net increase (decrease) in cash
    (395,641 )     740,750       68,197  
Cash at beginning of period
    463,838       4,179       -  
Cash at end of period
  $ 68,197     $ 744,929     $ 68,197  

See Notes to Condensed Financial Statements

 
6

 
BIODRAIN MEDICAL, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO FINANCIAL STATEMENTS
(Amounts presented at and for the nine months ended September 30, 2008 and
September 30, 2009 are unaudited)

 
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations and Continuance of Operations

BioDrain Medical, Inc. was incorporated under the laws of the State of Minnesota in 2002. The Company is developing an environmentally safe system for the collection and disposal of infectious fluids that result from surgical procedures and post-operative care.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. The company has suffered recurring losses from operations and has a stockholders’ deficit. These factors raise substantial doubt about its ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Management hired Newbridge Securities Corporation, an investment banker, in February 2009, to raise an additional $3-$5 million in new equity with an interim closing of up to $500,000 expected by January 31, 2010.  Although our ability to raise this new capital is in substantial doubt we have received $600,000 in April through September 2009, and our April 1, 2009 510(k) clearance from the FDA to authorize us to market and sell our FMS products is being received very positively.  If the Company is successful in raising at least $3 million in new equity we will have sufficient capital to operate our business and execute our business plan for at least the next 12 months. If the Company raises the additional capital by issuing additional equity securities its shareholders could experience substantial dilution.

Recent Accounting Developments
 
In June 2009, the FASB issued SFAS No. 168, “ The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles,” which is incorporated in FASB Accounting Standards Codification (ASC). Topic 105, Generally Accepted Accounting Principles, identifies the ASC as the authoritative source of generally accepted accounting principles in the United States. Rules and interpretive releases of the SEC under federal securities laws are also sources of authoritative GAAP for SEC registrants. This standard is effective for financial statements issued for reporting periods that end after September 15, 2009. The Company adopted SFAS No. 168 in the current quarter and will include references to the ASC within our consolidated financial statements by December 31, 2009.

Effective June 30, 2009, the Company adopted Financial Accounting Standards Board Accounting Standards Codification (ASC) Topic 855,“Subsequent Events.” ASC Topic 855 addresses the types and timing of events that should be reported in the financial statements for events occurring between the balance sheet date and the date the financial statements are issued or available to be issued. The Company reviewed subsequent events for inclusion in the financial statements through November 6, 2009, the date that the accompanying financial statements were issued. The adoption of the ASC Topic did not affect the Company’s financial position or results of operations.
 
Accounting Estimates

The presentation 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 the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
 
 
7

 

Interim Financial Statements
 
The Company has prepared the unaudited interim financial statements and related unaudited financial information in the footnotes in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and the rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial statements. These interim financial statements reflect all adjustments consisting of normal recurring accruals, which, in the opinion of management, are necessary to present fairly the Company’s financial position, the results of its operations and its cash flows for the interim periods. These interim financial statements should be read in conjunction with the annual financial statements and the notes thereto contained in the Form S-1 filed with the SEC and declared effective October 19, 2009. The nature of the Company’s business is such that the results of any interim period may not be indicative of the results to be expected for the entire year.

Revenue Recognition We recognize revenue in accordance with the SEC’s Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, as amended by Staff Accounting Bulletin No. 104 (together, SAB 101), and Statement of Financial Accounting Standards No. 48, Revenue Recognition When Right of Return Exists (SFAS 48).

Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed and determinable and collectability is probable. Delivery is considered to have occurred upon either shipment of the product or arrival at its destination based on the shipping terms of the transaction. Our standard terms specify that shipment is FOB BioDrain and we will, therefore recognize revenue upon shipment in most cases. This revenue recognition policy applies to shipments of our FMS units as well as shipments of cleaning solution kits. When these conditions are satisfied, we recognize gross product revenue, which is the price we charge generally to our customers for a particular product.  Under our standard terms and conditions there is no provision for installation or acceptance of the product to take place prior to the obligation of the customer.  The Customer’s right of return is limited only to our standard warranty whereby we replace or repair, at our option, and it would be very rare that the unit or significant quantities of cleaning solution kits may be returned.  Additionally, since we buy both the FMS units and cleaning solution kits from “turnkey” suppliers we would have the right to replacements from the suppliers if this situation should occur.

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation of property and equipment is computed using the straight-line method over the estimated useful lives of the respective assets. Estimated useful asset life by classification is as follows:
 
   
Years
 
Computers and office equipment
   
3
 
Furniture and fixtures
   
5
 

Upon retirement or sale, the cost and related accumulated depreciation are removed from the balance sheet and the resulting gain or loss is reflected in operations. Maintenance and repairs are charged to operations as incurred.

Intangible Assets

Intangible assets consist of patent costs. These assets are not subject to amortization until the property patented is in production. The assets are reviewed for impairment annually, and impairment losses, if any, are charged to operations when identified. No impairment losses have been identified by management.

Income Taxes

The Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes (“SFAS No. 109”). Under SFAS No. 109, deferred tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities and net operating loss and credit carry forwards using enacted tax rates in effect for the year in which the differences are expected to impact taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. In June 2006, the FASB issued Interpretation 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), which became effective for the Company beginning January 1, 2007. FIN 48 addresses how tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FIN 48, the tax benefit from an uncertain tax position can be recognized only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. The adoption of FIN 48 had no impact on the Company’s financial condition, results of operations or cash flows.
 
 
8

 

Patents and Intellectual Property

The Company, in June 2008, completed and executed an agreement to secure exclusive ownership of the patent- from an inventor, Marshall Ryan. Mr. Ryan received a combination of cash and warrants, and he will receive a 4% royalty on FMS (the Product) sales for the life of the patent. At the signing of the agreement, Mr. Ryan received $75,000 in exchange for the exclusive assignment of the patent.  In addition, on June 30, 2009, Mr. Ryan, through his Mid-State Stainless, Inc. entity, was entitled to receive $100,000 as payment (currently recorded as an account payable with the Company) for past research and development activities.  Should Mr. Ryan be utilized in the future for additional product development activities, he will be compensated at a rate of ninety five dollars ($95.00) per hour.

Mr. Ryan also received a warrant, with immediate vesting, to purchase 150,000 shares of our common stock at a price of $.35 per share.  The warrant has a term of five years, ending on June 30, 2013 and is assigned a value of $28,060 using a Black-Scholes formula and this amount was expensed as consulting expense in 2008 using a 5 year expected life, a 3.73% risk free interest rate, an expected 59% volatility and a zero dividend rate. Should there be a change in control of the Company (defined as greater than 50% of the Company’s outstanding stock or substantially all of its assets being transferred to one independent person or entity), Mr. Ryan will be owed a total of $2 million to be paid out over the life of the patent if the change in control occurs within 12 months of the first sale of the Product; or $1 million to be paid out over the life of the patent if the change in control occurs between 12 and 24 months of the first sale of the Product; or $500,000 to be paid out over the life of the patent if the change in control occurs between 24 and 36 months of the first sale of the Product. There will be no additional payment if a change in control occurs more than 36 months after the first sale of the Product.

Subsequent Events

In May 2009, Financial Accounting Standards Board issued ASC 855 Subsequent Events .” This standard is intended to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. ASC 855 is effective for interim and annual periods ended after June 15, 2009. The Company adopted this standard effective June 15, 2009.

 The Company has evaluated any subsequent events through November 25, 2009.  The Company does not believe there are subsequent events that require disclosure.

NOTE 2 – DEVELOPMENT STAGE OPERATIONS

The Company was formed April 23, 2002. Since inception to September 30, 2009, 10,353,651 shares have been issued between par value and $1.67.  Operations since incorporation have been devoted to raising capital, obtaining financing, development of the Company’s product, and administrative services.

NOTE 3 – STOCKHOLDERS’ DEFICIT, STOCK OPTIONS AND WARRANTS

In connection with the financing completed in October 2008, the Company has effected two reverse stock splits, one on June 6, 2008 and another on October 20, 2008. In accordance with SAB Topic 4C, all stock options and warrants and their related exercise prices are stated at their post-reverse stock split values.

The Company has an equity incentive plan, which allows issuance of incentive and non-qualified stock options to employees, directors and consultants of the Company, where permitted under the plan. The exercise price for each stock option is determined by the board of directors. Vesting requirements are determined by the board of directors when granted and currently range from immediate to three years. Options under this plan have terms ranging from three to ten years.

Accounting for share-based payment
Effective January 1, 2006, we adopted SFAS No. 123 (revised 2004), Share-Based Payment (SFAS 123(R)) which replaced SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123) and superseded Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). Under SFAS 123(R), stock-based employee compensation cost is recognized using the fair value based method for all new awards granted after January 1, 2006 and unvested awards outstanding at January 1, 2006. Compensation costs for unvested stock options and non-vested awards that were outstanding at January 1, 2006, are being recognized over the requisite service period based on the grant-date fair value of those options and awards as previously calculated under SFAS 123 for pro forma disclosures, using a straight-line method. We elected the modified-prospective method in adopting SFAS 123(R), under which prior periods are not retroactively restated.
 
 
9

 

SFAS 123(R) requires companies to estimate the fair value of stock-based payment awards on the date of grant using an option-pricing model or other acceptable means. We use the Black-Scholes option valuation model which requires the input of significant assumptions including an estimate of the average period of time employees will retain vested stock options before exercising them, the estimated volatility of our common stock price over the expected term, the number of options that will ultimately be forfeited before completing vesting requirements, the expected dividend rate and the risk-free interest rate. Changes in the assumptions can materially affect the estimate of fair value of stock-based compensation and, consequently, the related expense recognized. The assumptions we use in calculating the fair value of stock-based payment awards represent our best estimates, which involve inherent uncertainties and the application of management's judgment. As a result, if factors change and we use different assumptions, our equity-based compensation expense could be materially different in the future.

Since our company stock has no public trading history, and we have experienced no option exercises in our history, we were required to take an alternative approach to estimating future volatility and estimated life and the future results could vary significantly from our estimates.  We compiled historical volatilities over a period of 2-7 years of 15 small-cap medical companies traded on major exchanges and 10 medical companies in the middle of the size range on the OTC Bulletin Board and combined the results using a weighted average approach.  In the case of ordinary options to employees we determined the expected life to be the midpoint between the vesting term and the legal term.  In the case of options or warrants granted to non-employees we estimated the life to be the legal term unless there was a compelling reason to make it shorter.

When an option or warrant is granted in place of cash compensation for services we deem the value of the service rendered to be the value of the option or warrant. In most cases, however, an option or warrant is granted in addition to other forms of compensation and its separate value is difficult to determine without utilizing an option pricing model. For that reason we also use the Black-Scholes-Merton option-pricing model to value options and warrants granted to non-employees, which requires the input of significant assumptions including an estimate of the average period the investors or consultants will retain vested stock options and warrants before exercising them, the estimated volatility of our common stock price over the expected term, the number of options and warrants  that will ultimately be forfeited before completing vesting requirements, the expected dividend rate and the risk-free interest rate. Changes in the assumptions can materially affect the estimate of fair value of stock-based consulting and/or compensation and, consequently, the related expense recognized.

Since we have no trading history in our stock and no first-hand experience with how these investors and consultants have acted in similar circumstances, the assumptions we use in calculating the fair value of stock-based payment awards represent our best estimates, which involve inherent uncertainties and the application of management's judgment. As a result, if factors change and we use different assumptions, our equity-based consulting and interest expense could be materially different in the future.

Valuation and accounting for options and warrants
The Company determines the grant date fair value of options and warrants using a Black-Scholes-Merton option valuation model based upon assumptions regarding risk-free interest rate, expected dividend rate, volatility and estimated term.  For grants during 2008 we used a 2.0 to 4.5% risk-free interest rate, 0% dividend rate, 53-66% volatility and estimated term of 2.5 to 7.5 years.  Values computed using these assumptions ranged from $.102 per share to $.336 per share.  Warrants or options awarded for services rendered are expensed over the period of service (normally the vesting period) as compensation expense for employees or an appropriate consulting expense category for awards to consultants and directors.  Warrants granted in connection with a common equity financing are included in stockholders’ equity, provided that there is no re-pricing provision that requires they be treated as a liability (See Note 11) and warrants granted in connections with a debt financing are treated as a debt discount and amortized using the interest method as interest expense over the term of the debt.  Warrants issued in connection with the $100,000 convertible debt, closed March 1, 2007, created a debt discount of $40,242 that is being amortized as additional interest over its 5 year term.  Warrants issued in connection with the $170,000 in convertible “bridge” debt, closed in July 2007, created a calculated debt discount of $92,700 that was fully expensed over its loan term that matured April 30, 2008.

The following summarizes transactions for stock options and warrants for the periods indicated:
 
 
 
Stock Options (1)
   
Warrants (1)
 
 
 
Number of
Shares
   
Average
Exercise
Price
   
Number of
Shares
   
Average
Exercise
Price
 
Outstanding at December 31, 2005
   
17,956
    $
1.67
     
20,950
    $
2.62
 
                                 
Issued
   
23,942
     
1.67
     
71,826
     
0.85
 
                                 
Outstanding at December 31, 2006
   
41,898
    $
1.67
     
92,776
    $
1.25
 
                                 
Issued
   
5,984
     
1.67
     
28,502
     
0.35
 
                                 
Outstanding at December 31, 2007
   
47,882
    $
1.67
     
121,278
    $
1.04
 
                                 
Issued
   
1,243,292
     
0.20
     
5,075,204
     
0.45
 
Expired
                   
(11,971)
     
3.76
 
Outstanding at December 31, 2008
   
1,291,174
    $
0.26
     
5,184,511
     
0.45
 
                                 
Issued
   
175,000
     
0.35
     
1,903,302
     
0.54
 
     
   
     
   
     
   
     
   
 
Outstanding at September 30, 2009
   
1,466,174
     
0.27
     
7,087,813
     
0.48
 

 
(1)
Adjusted for the reverse stock splits in total at June 6, 2008 and October 20, 2008.  There were no options or warrants exercised in the periods.
 
 
10

 

The weighted average grant date fair value of stock options granted through September 30, 2009 and the fair value of shares vesting in each year are as follows:
 
Year
 
Options
   
Fair Value
   
Fair value vested
 
2005
    17,956     $ 0.671     $ 1,673  
2006
    23,942     $ 0.682     $ 12,919  
2007
    5,984     $ 0.687     $ 71,038  
2008
    1,243,292     $ 0.232     $ 220,287  
2009
    175,000     $ 0.141     $ 48,956  
Total
    1,466,174     $ 0.236     $ 354,873  
 
At December 31, 2008, 651,174 stock options are fully vested and currently exercisable and 4,984,511 warrants are fully vested and exercisable. There are 640,000 unvested stock options at December 31, 2008 with a total unrecognized compensation expense of $15,698 to be amortized over a weighted average remaining term of 5.5 months.  There are 200,000 unvested warrants at December 31, 2008 with a total unrecognized consulting expense of $13,301 to be amortized over a weighted average remaining term of 18 months.

At September 30, 2009, 881,174 stock options are fully vested and currently exercisable with a weighted average exercise price of $.21 and a weighted average remaining term of 6.7 years. There are 7,087,813 warrants that are fully vested and exercisable. There are 585,000 unvested stock options at September 30, 2009 with no unrecognized compensation expense. Stock based compensation recognized in the year ended December 31, 2008 was $220,287 and nine months ended September 30, 2009 and 2008 were $31,160 and $220,287, respectively.

The following summarizes the status of options and warrants outstanding at December 31, 2008 and September 30, 2009:

December 31, 2008
Range of Exercise Prices
 
Shares
   
Weighted
Average
Remaining
Life
 
Options  
           
$0.01
 
$
543,292
   
$
9.43
 
$0.35
   
700,000
     
4.46
 
$1.67
   
47,882
     
2.50
 
Total
   
1,291,174
         
                 
Warrants  
               
$0.02
   
71,826
     
5.45
 
$0.35
   
178,502
     
4.29
 
$0.46
   
4,889,291
     
2.57
 
$1.67
   
44,892
     
2.69
 
Total
   
5,184,511
         
 
 
11

 
 
September 30, 2009
(Unaudited)
 
Range of Exercise Prices
 
Shares
   
Weighted
Average
Remaining
Life
 
Options
           
$0.01  
 
$
543,292
   
$
8.68
 
$0.35  
   
875,000
     
3.87
 
$1.67  
   
47,882
     
1.75
 
Total
   
1,466,174
         
                 
Warrants  
               
$0.02  
   
71,826
     
4.70
 
$0.35  
   
798,597
     
3.29
 
$0.46  
   
4,954,291
     
1.79
 
$0.65
   
1,200,000
     
2.65
 
$1.67
   
44,892
     
    1.94
 
Total
   
7,087,813
         

Stock options and warrants expire on various dates from August 2010 to June 2018.

Under terms of our agreement with investors in the October 2008 financing 1,920,000 shares of common stock were the maximum number of shares allocated to our existing shareholders at the time of the offering (also referred to as the original shareholders or the Founders). Since the total of our fully-diluted shares of common stock was greater than 1,920,000, in order for us to proceed with the offering, our board of directors approved a reverse stock split of 1-for-1.2545. After this split was approved, additional options and warrants were identified, requiring a second reverse stock split in order to reach the 1,920,000. The second reverse stock split on the reduced 1-for-1.2545 balance was determined to be 1-for-1.33176963. Taken together, if only one reverse stock were performed, the number would have been a reverse stock split of 1-for 1.670705.

On June 6, 2008, the Board of Directors approved the first reverse stock split. The authorized number of common stock of 20,000,000 was proportionately divided by 1.2545 to 15,942,607.

On October 20, 2008, the Board of Directors (i) approved the second reverse stock split pursuant to which the authorized number of shares of common stock of 15,942,607 was proportionately divided by 1.33177 to 11,970,994 and (ii) approved a resolution to increase the number of authorized shares of our common stock from 11,970,994 to 40,000,000, which was approved by the Company’s shareholders holding a majority of the shares entitled to vote thereon at a special meeting of shareholders held on December 3, 2008.

Stock, Stock Options and Warrants Granted by the Company

The following table is the listing of stock options and warrants as of December 31, 2008 and September 30, 2009 by year of grant:

December 31, 2008
Stock Options:
     
Year
 
Shares
   
Price
 
2005
   
17,956
   
$
1.67
 
2006
   
23,942
     
1.67
 
2007
   
5,984
     
.35-1.67
 
2008
   
1,243,292
     
.01-.35
 
Total
   
1,291,174
   
$
.01-$1.67
 
 
 
12

 
Warrants:
               
Year
 
Shares
   
Price
 
2005
   
8,979
   
$
1.67
 
2006
   
71,826
     
.02-1.67
 
2007
   
28,502
     
.35
 
2008
   
5,075,204
     
.02-.46
 
Total
   
5,184,511
   
$
.02-$1.67
 
 
 
 
September 30, 2009
(Unaudited)
 
Stock Options:
     
Year
 
Shares
   
Price
 
2005
   
17,956
    $
1.67
 
2006
   
23,942
     
1.67
 
2007
   
5,984
     
.35-1.67
 
2008
   
1,243,292
     
.01-.35
 
2009
   
175,000
     
.35
 
Total
   
1,466,174
    $
.01-$1.67
 
                 
Warrants:
               
Year
 
Shares
   
Price
 
2005
   
8,979
    $
1.67
 
2006
   
71,826
     
.02-1.67
 
2007
   
28,502
     
.35
 
2008
   
5,075,204
     
.02-.46
 
2009
   
1,903,202
     
.35-.65
 
Total
   
7,087,813
    $
.02-$1.67
 

NOTE 4- RESTRICTED CASH IN ESCROW

Under terms of the escrow agreement established in connection with the October 2008 financing, certain amounts were to be withheld to pay legal, accounting and placement agent fees as well as to pay for investor relations activities that will commence upon receiving an effective registration of the Company’s stock and an initial listing with the OTC Bulletin Board. All amounts related to legal, accounting and placement agent fees have been disbursed and the current balance is solely being held to fund investor relations activities.

The balance in this escrow account will be released to the Company if we should withdraw our registration statement to become a public company or otherwise by mutual agreement of the investors who established the escrow as a condition of the October 2008 financing.

NOTE 5 - LOSS PER SHARE

The following table presents the shares used in the basic and diluted loss per common share computations:
 
13

 
                           
From
 
   
Three Months Ended
   
Nine Months Ended
   
April 23, 2002
 
   
September 30,
   
September 30,
   
(Inception) To
 
   
2009
   
2008
   
2009
   
2008
   
September 30, 2009
 
Numerator
                             
Net Loss available in basic and
  $ (773,015 )   $ (447,535 )   $ (2,515,440 )   $ (955,354 )   $ (5,652,578 )
diluted calculation
                                       
                                         
Denominator
                                       
Weighted average common shares
                                       
oustanding-basic
    9,634,828       5,582,437       8,903,119       2,758,557       2,041,540  
                                         
Effect of dilutive stock options and
                                       
warrants (1)
    -       -       -       -       -  
                                         
Weighted average common shares
                                       
outstanding-diluted
    9,634,828       5,582,437       8,903,119       2,758,557       2,041,540  
                                         
Loss per common share-basic
                                       
and diluted
  $ (0.08 )   $ (0.08 )   $ (0.28 )   $ (0.35 )   $ (2.77 )

(1) The number of options and warrants outstanding as of September 30, 2009 and September 30, 2008 are 8,553,987 and 6,339,843 respectively. The effect of the shares that would be issued upon exercise has been excluded from the calculation of diluted loss per share because those shares are anti-dilutive.
 
NOTE 6 – INCOME TAXES
 
The provision for income taxes consists of an amount for taxes currently payable and a provision for tax consequences deferred to future periods.  Deferred income taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.

There is no income tax provision in the accompanying statement of operations due to the cumulative operating losses that indicate a 100% valuation allowance for the deferred tax assets and state income taxes is appropriate.
 
Federal and state income tax return operating loss carryovers as of December 31, 2008, were approximately $3,145,000 and will begin to expire in 2017.
 
The valuation allowance has been recorded due to the uncertainty of realization of the benefits associated with the net operating losses. Future events and changes in circumstances could cause this valuation allowance to change.
 
The components of deferred income taxes at September 30, 2009 and December 31, 2008 are as follows:

   
September 30,
   
December 31,
 
   
2009
   
2008
 
   
(Unaudited)
   
 
 
Deferred Tax Asset:
           
Net Operating Loss
  $ 1,266,000     $ 747,000  
Total Deferred Tax Asset
    1,266,000       747,000  
Less Valuation Allowance
    1,266,000       747,000  
Net Deferred Income Taxes
  $     $  

NOTE 7 –NOTES PAYABLE
 
The Company has a convertible debenture with Andcor Companies, Inc. (“Andcor”) of $10,000 with interest at 10.25% that matured in 2007. The debenture is convertible to the Company’s common stock at the lower of $0.90 per share or the price per share at which the next equity financing agreement is completed, and is now re-set to $.35 per share. The convertible debenture has not yet been paid, and it is currently in default. While Andcor could demand payment on this note at any time, they have verbally expressed an interest in working with us to wait until additional funds are secured by the Company. Further, Andcor has left open the possibility of converting the note into shares of the Company’s common stock, which would require no cash outlay by the Company.
 
14

 
NOTE 8 – LONG-TERM DEBT
 
Long-term debt is as follows: 
 
   
September 30,
2009
   
December 31,
2008
 
   
(Unaudited)
   
 
 
Notes payable to seven individuals due April 2008 including 8% fixed interest and are now delinquent. The notes are convertible into 620,095 shares of the Company’s common stock and automatically convert at the effective date of this registration statement.
  $ 170,000     $ 170,000  
Note payable to bank in monthly installments of $1,275/including variable interest at 2% above the prevailing prime rate (3.25% at December 31, 2008) to August 2011 when the remaining balance is payable. The note is personally guaranteed by former executives of the Company.
    31,486       38,183  
Notes payable to two individuals, net of discounts of $19,619 and $26,157 with interest only payments at 12% to March 2012 when the remaining balance is payable. The notes are convertible into 285,715 shares of stock in the Company at $.35 per share.
   
 
80,381
      73,843  
Notes payable to four shareholders of the Company that are overdue. The notes are convertible into 11,429 shares of stock in the Company at $.35 per share.
    4,000       4,000  
Total
    282,441       286,026  
Less amount due within one year
    187,620       187,620  
Long-Term Debt
  $ 94,821     $ 98,406  
 
Cash payments for interest were $5,175 for the year ended December 31, 2008 and $1,351 for the nine months ended September 30, 2009 compared to $3,890 for the nine months ended September 30, 2008. The notes payable of $10,000 (discussed in Note 6), $170,000 and $4,000 (shown in the table above) are delinquent and could be called by the holders, putting additional strains on our liquidity. The note for $170,000 contains provisions for a one-time penalty of $25,000 if this registration statement is not filed within 120 days of August 31, 2008 and $5,000 per 30 day period, after February 27, 2009, until the registration statement is declared effective by the SEC. The total amount accrued as additional interest expense is $20,500 at June 30, 2009.  There is no maximum penalty.  In addition, beginning March 2009 the Company was obligated to issue additional shares to the investors who purchased units in October 2008 financing equal to 2% of the units sold for each month until the registration is declared effective. This represents 91,057 shares per month to a maximum of 728,458 shares, or 16% of the total units sold. The Company is obligated to issue 710,248 shares as a result of an effective registration on October 19, 2009. Payment of the accrued interest and penalties will occur upon receipt of a significant portion of the $3 million funding subsequent to our listing on the OTC Bulletin Board and issuance of the additional shares will occur by December 31, 2009.

Principal payments required during the years 2009 to 2013 are:

2009 -
 
$
197,620
 
2010 - 
 
$
14,353
 
2011 - 
 
$
10,210
 
2012 -
 
$
100,000
 
2013 - 
 
$
0
 
 

15

 
NOTE 9 – RENT OBLIGATION

The Company leases it principal office under a non-cancelable lease that extends 5 years.  In addition to rent the Company also pays real estate taxes, repairs and maintenance on the leased property.
 
The Company’s rent obligation for the years 2009 to 2013 is as follows:

2009
 
$
35,000
 
2010
   
29,000
 
2011
   
30,000
 
2012
   
30,000
 
2013
   
26,000
 

NOTE 10 – LIABILITY FOR EQUITY-LINKED FINANCIAL INSTRUMENTS

The Company adopted Emerging Issues Task Force (EITF) Issue No. 07-5, Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock , on January 1, 2009. EITF 07-5 mandates a two-step process for evaluating whether an equity-linked financial instrument or embedded feature is indexed to the entity's own stock. It is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years, which is our first quarter of 2009. Most of the warrants issued by the Company contain a strike price adjustment feature, which upon adoption of EITF 07-5, changed the current classification (from equity to liability) and the related accounting for warrants with a $479,910 estimated fair value of as of January 1, 2009. 
The Company determined that the fair value on January 1, 2009 of 4,689,291 warrants was $479,910, or $.1023 per share. An adjustment was made to remove $486,564 from paid-in capital (the cumulative value of the warrants on their grant dates), we booked a positive adjustment of $6,654 to accumulated deficit, representing the gain on valuation from the grant date to January 1, 2009, and booked the net of $479,910 as a liability. The January 1, 2009 valuation was computed using the Black-Scholes valuation model based upon a 2.5 year expected term, an expected volatility of 63%, an exercise price of $.46 per share a, a stock price of $.35, a zero dividend rate and a 1.37% risk free interest rate. On March 31, 2009 the company recomputed the value of the warrants using the Black-Scholes valuation model with an expected volatility of 66%, an expected term of 2.25 years, a stock price of $.50 per share and a risk free interest rate of .895%. Primarily due to the increase in the underlying stock price the valuation per share was $.2082 or a total of $976,412.The $496,502 increase in the liability was reflected as a Loss on the valuation of the liability for equity-linked instruments, on a separate line in the Income Statement for the three months ended March 31, 2009. On June 30, 2009 the Company recomputed the value of the warrants using the Black-Scholes valuation model with an expected volatility of 66%, an expected term of 2 years, a risk free interest rate of 1.11%, a zero dividend rate and a stock price of $.50. The computed value per share of $.1967 produced a liability of $922,344 as of June 30, 2009 for a net gain of $54,067. In addition, the Company placed a valuation on their grant date, on warrants issued during the second quarter of $169,654 and recomputed their value as of June 30, 2009. The value on June 30, 2009 was $163,842 for a net gain of $6,012. The June 30, 2009 valuation of the warrants issued during the second quarter was $.1689 per share using a 63% expected volatility, a 2.83 year expected term, a zero dividend rate, an exercise price of $.65 per share, a stock price of $.50 per share and a 1.26% risk free interest rate. The combination of the net gains during the second quarter resulting from these new valuations was $60,079 and reduced the loss for the six month period ended June 30, 2009 to $436,423. This loss on valuation of equity-linked financial instruments was shown as a separate line on the statement of operations.  The total valuation of equity linked financial instruments as of September 30, 2009 was determined to be $1,059,979 using a Black-Scholes valuation model with volatility ranging from 63 to 66%, a risk free interest rate of .85 to 1.375% and an expected term of 1.74 to 2.85 years.  The net gain on valuation of equity linked financial instruments was $65,949 during the three months ended September 30, 2009, reducing the loss on valuation of equity-linked financial instruments to $370,474 for the nine months ended September 30, 2009.

ITEM 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview
 
Our Company was incorporated in Minnesota in April 2002. We are an early-stage development company developing an environmentally conscientious system for the collection and disposal of infectious fluids that result from surgical procedures and post-operative care. We achieved our first sale in June 2009. Since our inception in 2002, we have invested significant resources into product development and in preparing for approval from the FDA. We believe that our success depends upon converting the traditional process of collecting and disposing of infectious fluids from the operating rooms of medical facilities to our wall-hung Fluid Management System (“FMS”) and use of our proprietary cleaning fluid.
 
Since inception, we have been unprofitable. We incurred a net loss of approximately $1,763,000 for the fiscal year ended 2008 and a net loss of approximately $2,515,000 for the nine months ended September 30, 2009 compared to approximately $955,000 for the nine months ended September 30, 2008.  As of September 30, 2009, we had an accumulated deficit of approximately $5,653,000.  As a company in the early stage of development, our limited history of operations makes prediction of future operating results difficult. We believe that period to period comparisons of our operating results should not be relied on as predictive of our future results.
 
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We are an early-stage development stage company and we have been focused on finalizing our production and obtaining final FDA clearance to sell our product to the medical facilities market. FDA final clearance was obtained on April 1, 2009.  Our innovative FMS will be sold through experienced, independent medical distributors and manufacturers representatives that are intended to enhance acceptability in the marketplace. We are currently in the process of signing agreements with independent sales representative and product installation organizations and conducting training sessions. We achieved our first billable shipment in June 2009 and are hopeful to receive several orders during the fourth quarter of 2009.  Since our FDA clearance to sell our FMS product was only received on April 1, 2009 it is too early to know with a high degree of confidence how quickly, and in what amounts, new orders will develop.
 
Since we do not expect to generate sufficient revenues in 2009 to fund our capital requirements, our capital needs for the next 12 months are expected to be approximately $3 million even though we plan to use outside third party contract manufacturers to produce the FMS and independent sales representatives to sell the FMS. Our future cash requirements and the adequacy of available funds will depend on our ability to sell our FMS and related products now that FDA final clearance has been obtained. We expect that we will require additional funding to finance operating expenses and to enter the international marketplace.
 
As of December 31, 2008, we have funded our operations through a bank loan of $41,400, an equity investment of $68,000 from the Wisconsin Rural Enterprise Fund (“WREF”) and $30,000 in early equity investment from several individuals. WREF had also