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EXCEL - IDEA: XBRL DOCUMENT - Zivo Bioscience, Inc.Financial_Report.xls
EX-32.1 - EX 32.1 SECTION 906 CERTIFICATIONS - Zivo Bioscience, Inc.f093011q_ex32z1.htm
EX-31.2 - EX 31.2 SECTION 302 CERTIFICATIONS - Zivo Bioscience, Inc.f093011q_ex31z2.htm
EX-10.2 - EX 10.2 SENIOR SECURED PROMISSORY NOTE - Zivo Bioscience, Inc.f093011q_ex10z2.htm
EX-31.1 - EX 31.1 SECTION 302 CERTIFICATIONS - Zivo Bioscience, Inc.f093011q_ex31z1.htm
EX-10.1 - EX 10.1 SECURITY AGREEMENT - Zivo Bioscience, Inc.f093011q_ex10z1.htm
EX-32.2 - EX 32.2 SECTION 906 CERTIFICATIONS - Zivo Bioscience, Inc.f093011q_ex32z2.htm

U.S. Securities and Exchange Commission

Washington, D.C.  20549

Form 10-Q


(Mark One)


  X .

QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011


      .  

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from _____________ to ______________


Commission file number:  000-30415


Health Enhancement Products, Inc.

(Exact name of small business issuer as specified in its charter)


Nevada

87-0699977

(State or other jurisdiction of

(IRS Employer Identification No.)

incorporation or organization)

 


7740 East Evans Road, Scottsdale, Arizona  85260

(Address of principal executive offices)


480-385-3800

(Issuer’s telephone number)


Not Applicable

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


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


Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted an posted pursuant to Rule 405 of regulation ST (Sec. 232.405)  during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes £ No  S


Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-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 issuer is a shell company (as defined in Rule 12-b2 of the Exchange Act).

  

  Yes      . No   X  .


APPLICABLE ONLY TO CORPORATE ISSUERS


There were 98,598,621 shares of common stock, $0.001 par value, outstanding at November 17, 2011.





FORM 10-Q

HEALTH ENHANCEMENT PRODUCTS, INC.


INDEX




PART I – FINANCIAL INFORMATION

2

ITEM 1.  CONSOLIDATED FINANCIAL STATEMENTS

2

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

13

ITEM 4T. CONTROLS AND PROCEDURES

15

PART II – OTHER INFORMATION

16

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

16

ITEM 6. EXHIBITS

16


 


(Inapplicable items have been omitted)



-i-





SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS


Some of the statements contained in this report are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements involve known and unknown risks, uncertainties and other factors which may cause our or our industry’s actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Forward-looking statements include, but are not limited to statements regarding:


 

our ability to raise the funds we need to continue our operations;

 

 

our goal to increase our revenues and become profitable;

 

 

regulation of our product;

 

 

our ability to expand the production of our product;

 

 

market acceptance of our product;

 

 

future testing of our product;

 

 

the anticipated performance and benefits of our product and

 

 

our financial condition or results of operations.

 

 In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “projects,” “predicts,” “potential” and similar expressions intended to identify forward-looking statements. These statements are only predictions and involve known and unknown risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by such forward-looking statements. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this report. Except as otherwise required by law, we expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statement contained in this report to reflect any change in our expectations or any change in events, conditions or circumstances on which any of our forward-looking statements are based.  We qualify all of our forward-looking statements by these cautionary statements.



1





 Item 1.  Consolidated Financial Statements


HEALTH ENHANCEMENT PRODUCTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEET

 

 

 

 

 

 

 

September 30, 2011

 

December 31, 2010

 

 

(Unaudited)

 

 

ASSETS

 

 

 

 

CURRENT ASSETS:

 

 

 

 

    Cash

$

60,132

$

15,603

    Inventories

 

15,710

 

10,554

    Prepaid Expenses

 

16,538

 

10,855

                Total Current Assets

 

92,380

 

37,012

PROPERTY AND EQUIPMENT, NET

 

124,788

 

170,259

OTHER ASSETS:

 

 

 

 

    Definite-life intangible Assets, net

 

7,443

 

8,168

    Deferred Finance Costs, net

 

16,323

 

-

    Deposits

 

125,117

 

124,482

                 Total Other Assets

 

148,883

 

132,650

 

$

366,051

$

339,921

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS' DEFICIT

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

    Accounts Payable

$

609,423

$

455,589

    Customer deposits

 

27,837

 

25,194

    Loan Payable, related party

 

83,106

 

12,000

    Convertible Note payable

 

100,863

 

-

    Obligation to issue common stock and warrants

 

-

 

50,000

    Deferred revenue

 

15,000

 

15,000

    Convertible Debenture Payable, less Discount of $7,089 and $18,936 at September 30, 2011 and December 31, 2010

 

78,011

 

157,064

    Current portion, long term debt

 

595

 

3,516

    Accrued Payroll

 

46,109

 

32,892

    Accrued Payroll Taxes

 

23,902

 

5,305

    Accrued Liabilities

 

24,576

 

23,980

                   Total Current Liabilities

 

1,009,422

 

780,540

LONG TERM LIABILITIES:

 

 

 

 

    Convertible Debenture Payable, less Discount of $119,413 and $71,037 at September 30, 2011 and December 31, 2010

 

281,087

 

104,063

    Deferred revenue, noncurrent

 

223,750

 

235,000

    Deferred rent expense

 

149,004

 

171,995

                   Total Long Term Liabilities

 

653,841

 

511,058

COMMITMENTS AND CONTINGENCIES

 

 

 

 

TOTAL LIABILITIES

 

1,663,263

 

1,291,598

STOCKHOLDERS' DEFICIT:

 

 

 

 

    Common stock, $.001 par value, 150,000,000 shares authorized  97,761,358 and 92,705,351 issued and outstanding at September 30, 2011 and December 31, 2010

 

97,761

 

92,705

    Additional Paid-In Capital

 

26,458,041

 

25,485,816

    Accumulated deficit

 

(27,853,016)

 

(26,530,198)

                   Total Stockholders' Deficit

 

(1,297,214)

 

(951,677)

 

$

366,051

$

339,921


The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.



2








HEALTH ENHANCEMENT PRODUCTS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

 

 

 

 

 

 

 

 

 

For the three

 

For the three

 

For the Nine

 

For the Nine

 

 

Months ended

 

Months ended

 

Months Ended

 

Months ended

 

 

September 30, 2011

 

September 30, 2010

 

September 30, 2011

 

September 30, 2010

 

 

 

 

 

 

 

 

 

REVENUES:

 

 

 

 

 

 

 

 

  Net Sales

$

31,898

$

19,291

$

88,587

$

52,451

  Licensing Fee

 

3,750

 

-

 

11,250

 

-

      Total Revenues

 

35,648

 

19,291

 

99,837

 

52,451

 

 

 

 

 

 

 

 

 

COSTS AND EXPENSES:

 

 

 

 

 

 

 

 

  Cost of Sales

 

25,433

 

15,433

 

99,060

 

35,343

  Selling

 

3,297

 

29,295

 

11,823

 

95,190

  General and Administrative

 

150,179

 

249,316

 

333,021

 

960,625

  Professional and Consulting

 

74,799

 

183,533

 

386,355

 

2,000,489

  Research and Development

 

66,717

 

94,529

 

246,000

 

294,053

 

 

 

 

 

 

 

 

 

      Total Expenses

 

320,425

 

572,106

 

1,076,259

 

3,385,700

 

 

 

 

 

 

 

 

 

LOSS FROM OPERATIONS

 

(284,777)

 

(552,815)

 

(976,422)

 

(3,333,249)

 

 

 

 

 

 

 

 

 

OTHER INCOME  (EXPENSE):

 

 

 

 

 

 

 

 

  Fair Value Adjustment of Derivative Liability

 

-

 

-

 

-

 

(2,223,991)

  Amortization of Bond Discount

 

(30,062)

 

(32,483)

 

(93,892)

 

(132,063)

  Amortization of Deferred Finance Costs

 

(19,018)

 

-

 

(41,383)

 

-

  Finance costs paid in warrants, related party

 

(203,069)

 

-

 

(203,069)

 

(405,925)

  Interest expense - related party

 

(906)

 

-

 

(1,365)

 

-

  Interest expense

 

(4,521)

 

(3,780)

 

(6,684)

 

(12,553)

 

 

 

 

 

 

 

 

 

         Total Other Income (Expense)

 

(257,576)

 

(36,263)

 

(346,393)

 

(2,774,532)

 

 

 

 

 

 

 

 

 

NET (LOSS)

$

(542,353)

$

(589,078)

$

(1,322,815)

$

(6,107,781)

 

 

 

 

 

 

 

 

 

BASIC AND DILUTED LOSS PER SHARE

$

(0.01)

$

(0.01)

$

(0.01)

$

(0.07)

 

 

 

 

 

 

 

 

 

WEIGHTED AVERAGE BASIC AND DILUTED SHARES OUTSTANDING

 

97,549,401

 

89,607,271

 

95,732,703

 

89,243,185


The accompanying notes are an integral part of these unaudited condensed consolidated financial statements



3






HEALTH ENHANCEMENT PRODUCTS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

 

 

 

 

 

 

 

 For the Nine

 

 For the Nine

 

 

 Months Ended

 

 Months Ended

 

 

September 30, 2011

 

September 30, 2010

 

 

(Unaudited)

 

(Unaudited)

Cash Flows for Operating Activities:

 

 

 

 

  Net (Loss)

$

(1,322,815)

$

(6,107,781)

  Adjustments to reconcile net loss to net cash used by operating activities:

 

 

 

 

      Stock and warrants issued for services rendered

 

33,584

 

1,608,792

      Finance costs paid in warrants, related party

 

203,069

 

405,925

      Amortization of prepaid consulting fees

 

-

 

73,325

      Amortization of deferred finance costs

 

41,383

 

-

      Amortization of bond discount

 

93,892

 

132,063

      Amortization of intangibles

 

725

 

725

      Vendor settlement

 

-

 

(4,117)

      Depreciation expense

 

50,192

 

25,187

      Fair value adjustment of Derivative Liability

 

-

 

2,223,991

      (Decrease) in deferred rent

 

(22,991)

 

11,747

      Changes in assets and liabilities:

 

 

 

 

        (Increase) in inventories

 

(5,156)

 

(9,996)

        (Increase) in prepaid expenses

 

(5,683)

 

(363)

        (Increase) in security deposits

 

(635)

 

(3,815)

        Increase (decrease) in accounts payable

 

153,831

 

(49,825)

        Increase in customer deposits

 

2,643

 

-

        Increase (decrease) in payroll and payroll taxes

 

31,814

 

(151,573)

        Increase in obligation to issue common stock

 

-

 

552,555

        (Decrease) in sales tax payable

 

(1,275)

 

-

        (Decrease) in deferred revenue

 

(11,250)

 

-

        (Decrease) in accrued liabilities

 

(11,770)

 

(800)

              Net Cash (Used) by Operating Activities

 

(770,442)

 

(1,293,960)

Cash Flows from Investing Activities:

 

 

 

 

  Capital expenditures

 

(4,721)

 

(2,152)

              Net Cash (Used) by Investing Activities

 

(4,721)

 

(2,152)

Cash Flow from Financing Activities:

 

 

 

 

  Proceeds of Loan Payable, related party

 

85,105

 

166,824

  Repayment of Loan Payable, related party

 

(14,000)

 

-

  Proceeds from other borrowings

 

125,169

 

-

  Cash overdraft

 

-

 

(7,106)

  Repayment of Loans Payable, Other

 

-

 

(36,571)

  Payments of other borrowings

 

(13,582)

 

(4,765)

  Proceeds from issuance of convertible debentures

 

134,500

 

-

  Proceeds from sale of common stock and exercise of warrants

 

502,500

 

1,177,730

              Net Cash Provided by Financing Activities

 

819,692

 

1,296,112

Increase (Decrease) in Cash

 

44,529

 

-

Cash at Beginning of Period

 

15,603

 

-

Cash at End of Period

$

60,132

$

-

Supplemental Disclosures of Cash Flow Information:

 

 

 

 

  Cash paid during the period for:

 

 

 

 

      Interest

$

3,455

$

3,780

      Income Taxes

$

50

$

-


The accompanying notes are an integral part of these unaudited condensed consolidated financial statements




4





HEALTH ENHANCEMENT PRODUCTS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS [Continued]


Supplemental Disclosure of Non-Cash Investing and Financing Activities: 


Nine Months Ended September 30, 2011:


During the quarter ended March 31, 2011, The Company issued convertible debentures for $62,500 in principal and recorded a discount on the debentures of $62,500.   As an inducement to further invest in the Company, warrants were repriced from $.25 to $.15, resulting in deferred finance costs of $57,706.


During the quarter ended June 30, 2011, the Company issued convertible debentures in the principal amount of $52,000 and recorded a discount on the debentures of $52,000.   In addition, the Company issued 333,334 shares of common stock in satisfaction of an obligation to issue common stock valued at $50,000.


During the quarter ended June 30, 2011, several three year 1% convertible notes in the aggregate principal amount of $196,000, with various maturity dates during 2011were extended for an additional three years at the request of the noteholder.  The Company incurred no additional cost as a result of these extensions.  


During the quarter ended September 30, 2011, the Company issued convertible debentures in the principal amount of $20,000 and recorded a discount on the debentures of $15,921.


Nine Months Ended September 30, 2010:


During the quarter ended March 31, 2010, $15,000 of convertible debentures and $121 in accrued interest were converted into 302,425 shares of common stock. The Company issued 750,000 shares of stock in satisfaction of an obligation to issue common stock. The Company satisfied a $6,500 loan due to a related party by offsetting it against proceeds due from the related party upon exercise of warrants to purchase common stock. In addition, the Company issued 50,000 shares upon exercise of warrants at $.10 per share. The consideration given for the exercise price was a reduction of indebtedness in the form of accounts payable. The Company recorded an obligation to issue 65,000 shares of common stock in payment of finder’s fees and valued these shares at $36,400. The Company also issued 30,000 shares of common stock valued at $14,035 in payment of finder’s fees. In addition, an obligation to issue 160,000 shares of common stock was recorded in payment of finder’s fees. This stock was valued at $129,050. The Company also issued 500,000 shares of common stock valued at $160,000 in satisfaction of an obligation to issue common stock.


During the quarter ended June 30, 2010, the Company issued 180,000 shares of common stock valued at $149,550 in satisfaction of obligations to issue common stock.


During the six months ended June 30, 2010, the Company recognized an additional derivative liability valued at $3,048,306 warrants issued in excess of its authorized shares.


During the quarter ended September 30, 2010, $100,000 of convertible debentures and $3,016 in accrued interest were converted into 206,033 shares of common stock.  











The accompanying notes are an integral part of these unaudited condensed consolidated financial statements



5





HEALTH ENHANCEMENT PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1 – BASIS OF PRESENTATION


The accompanying unaudited condensed consolidated financial statements include the accounts of Health Enhancement Products, Inc. and its wholly-owned subsidiaries, Health Enhancement Corporation and HEPI Pharmaceuticals, Inc. (collectively, the “Company”).  All significant inter-company accounts and transactions have been eliminated in consolidation.  In the opinion of the Company’s management, the financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the information set forth therein.  These consolidated financial statements are condensed, and therefore do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s December 31, 2010 consolidated audited financial statements and supplementary data included in the Annual Report on Form 10-K filed with the SEC on April 15, 2011.


The results of operations for the nine months ended September 30, 2011 are not necessarily indicative of the results to be expected for the fiscal year ending December 31, 2011, or any other period.


The Company incurred a net loss of $1,322,815 for the nine months ended September 30, 2011, and had net loss of $6,107,781 (net loss of $3,883,790 excluding the effect of the Fair Value Adjustment of Derivative Liability) for the nine months ended September 30, 2010.  In addition, the Company had a working capital deficiency of $917,042 and a stockholders’ deficit of $1,297,214 at September 30, 2011.  These factors continue to raise substantial doubt about the Company's ability to continue as a going concern.  During the first nine months of 2011, the Company raised $502,500 in net proceeds from the sale of common stock and exercise of common stock warrants, and $134,500 from the issuance of convertible debentures.  There can be no assurance that the Company will be able to continue to raise additional capital.


Although the Company recently signed an exclusive worldwide distribution agreement, it has not yet realized the revenue it was expecting from such distribution arrangement. There can be no assurance that sufficient funds required during the next year or thereafter will be generated from operations or that funds will be available from external sources such as debt or equity financings or other potential sources. The lack of additional capital resulting from the inability to generate cash flow from operations or to raise capital from external sources would force the Company to substantially curtail or cease operations and would, therefore, have a material adverse effect on its business. Furthermore, there can be no assurance that any such required funds, if available, will be available on attractive terms or that they will not have a significant dilutive effect on the Company’s existing stockholders.


The accompanying condensed consolidated financial statements do not include any adjustments related to the recoverability or classification of asset-carrying amounts or the amounts and classifications of liabilities that may result should the Company be unable to continue as a going concern.


Certain reclassifications have been made to prior-year and prior period comparative financial statements to conform to the current year and period presentation.  These reclassifications had no effect on previously reported results of operations or financial position.


  NOTE 2 – INVENTORIES


Inventories at September 30, 2011 and  December 31, 2010 consist of the following:


 

 

September 30, 2011

 

December 31, 2010

 

 

 (Unaudited)

 

 

Raw materials

$

12,458

$

5,650

Work in process

 

3,179

 

-

Finished goods

 

73

 

4,904

 

$

15,710

$

10,554


NOTE 3 - PROPERTY AND EQUIPMENT


Property and equipment at September 30, 2011 and December 31, 2010 consists of the following:


 

 

September 30, 2011

 

December 31, 2010

 

 

 (Unaudited)

 

 

Furniture and fixtures

$

51,617

$

51,617

Equipment

 

112,879

 

112,879

Leasehold improvements

 

148,359

 

143,639

 

 

 

 

 

 

 

312,856

 

308,135

Less accumulated depreciation and amortization

 

(188,068)

 

(137,876)

 

 

 

 

 

 

$

124,788

$

170,259




6





 

Depreciation and amortization was $50,192 and $25,187 for the nine months ended September 30, 2011 and 2010 respectively.


 

NOTE 4 - DEFINITE-LIFE INTANGIBLE ASSETS


Definite-life intangible assets at September 30, 2011 and December 31, 2010 consist of the following:

 

 

 

September 30, 2011

 

December 31, 2010

 

 

(Unaudited)

 

 

Patent applications pending

$

14,500

$

14,500

Less:  Accumulated amortization

 

(7,057)

 

(6,332)

 

 

 

 

 

 

$

7,443

$

8,168


The Company’s definite-life intangible assets are amortized, upon being placed in service, over the 15 year estimated useful lives of the assets, with no residual value. Amortization expense was $725 for each of the nine months ended September 30, 2011 and 2010.


NOTE 5 – LOAN PAYABLE – RELATED PARTY


In April of 2010 the Company entered into a line of credit agreement with a significant shareholder.  Under the terms of this line of credit agreement, the shareholder agreed to advance, upon request, a maximum of $675,000 as needed.   The company’s ability to draw from this line of credit expired April 24, 2011, and advances are to be repaid on or before April 24, 2012 with interest accrued at the rate of 7% annually.  During 2010 the Company received advances totaling $299,700, and accrued interest totaling $4,209.  During the quarter ended December 31, 2010,  the Company issued an aggregate of 1,940,000 shares of common stock to the shareholder as follows:  (i) 838,986 shares were issued upon exercise of outstanding warrants at an average exercise price of $.23 per share (the shareholder paid the exercise price by forgiving $188,898 in indebtedness owing to the shareholder), and 1,101,014 shares (valued at $374,344) were issued in full satisfaction of the approximately $110,000 in remaining principal amount plus accrued interest owing to this related party in connection with advances made to  the Company.  In connection with this loan repayment, the Company incurred finance charges of $259,293.  


The balance due under this line of credit agreement as of April 24, 2011 was $26,716.  Since the expiration of the line of credit, the Company has received an additional $69,241 in loans from this significant shareholder, accrued additional interest of $1,149 and repaid $14,000.  The balance owing this shareholder as of September 30, 2011 is $81,741 in principal and $1,365 in accrued interest.  Of this principal balance, $26,716 is due and payable on April 24, 2012, and the remaining principal balance of $55,025 represents additional advances after the expiration of the loan agreement, and is due and payable upon demand.

 

NOTE 6 – CONVERTIBLE NOTE PAYABLE


On September 8, 2011, the Company issued a Senior Secured Convertible Demand Promissory Note in the principal amount of $100,000 to HEP Investments, LLC, a Michigan limited liability company, in connection with the advance to the Company of $100,000.  The Note bears interest at 15% per annum and is payable on demand, and is convertible at the rate of $.12 per share into the Company’s common stock.   The note is secured by all of the Company assets.  As of September 30, 2011, the Company had recorded accrued interest of $863.


NOTE 7 – LONG TERM DEBT:


Long term debt consists of the following:  


Installment note, bearing interest at 8.8% per annum and

 

September 30, 2011

 

December 31, 2010

due November 2011.  The loan is secured by certain of the

 

(Unaudited)

 

 

Company's equipment

$

595

$

3,517

Less current portion

 

595

 

3,517

 

 

 

 

 

 

$

-

$

-




7





NOTE 8 – CONVERTIBLE DEBT


During the first quarter of 2011, the Company sold for aggregate consideration of $62,500, five 1% convertible notes of $12,500 each (Notes), and warrants to purchase 750,000 shares of common stock, at an exercise price of $.125 (Warrants) for a term of three years.  The Convertible Notes accrue interest at the rate of 1% per annum, are non-amortizing, have a term of 3 years, subject to the Company’s right to extend the term for an additional three years, cannot be prepaid, and are convertible, at any time prior to the maturity date, as the same may be extended,  upon 75 days written notice of the holder, into shares of common stock, at a rate equal to $.125 per share. Accrued interest will be paid on the maturity date in shares of common Stock, valued at $.125 per share, and, unless the Convertible Note is converted prior to its maturity date, the principal amount of the Note may be repaid in cash or converted into common stock at a rate equal to $.125 per share, at the Company’s discretion.


During the second quarter of 2011, the Company sold for aggregate consideration of $52,000, 1% convertible notes and warrants to purchase 624,000 shares of common stock, at an exercise price of $.125 for a term of three years.  The Convertible Notes accrue interest at the rate of 1% per annum, are non-amortizing, have a term of 3 years, subject to the Company’s right to extend the term for an additional three years, cannot be prepaid, and are convertible, at any time prior to the maturity date, as the same may be extended, upon 75 days written notice of the holder, into shares of common stock, at a rate equal to $.125 per share. Accrued interest will be paid on the maturity date in shares of common Stock, valued at $.125 per share, and, unless the Convertible Note is converted prior to its maturity date, the principal amount of the Note may be repaid in cash or converted into common stock at a rate equal to $.125 per share, at the Company’s discretion.  


During the third quarter of 2011, the Company sold for aggregate consideration of $20,000, 1% convertible notes and warrants to purchase 240,000 shares of common stock, at an exercise price of $.125 for a term of three years.  The Convertible Notes accrue interest at the rate of 1% per annum, are non-amortizing, have a term of 3 years, subject to the Company’s right to extend the term for an additional three years, cannot be prepaid, and are convertible, at any time prior to the maturity date, as the same may be extended, upon 75 days written notice of the holder, into shares of common stock, at a rate equal to $.125 per share. Accrued interest will be paid on the maturity date in shares of common Stock, valued at $.125 per share, and, unless the Convertible Note is converted prior to its maturity date, the principal amount of the Note may be repaid in cash or converted into common stock at a rate equal to $.125 per share, at the Company’s discretion.  


The Company recorded a deferred debt discount in the amount of $130,421, to reflect the beneficial conversion feature of the convertible debt and fair value of the warrants pursuant to Emerging Issues Task Force (“EITF”) 00-27: Application of EITF 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features on Contingently Adjustable Conversion Rates”, to certain convertible instruments. In accordance with EITF 00-27, the Company valued the beneficial conversion feature and recorded the amount of $47,283 as a reduction to the carrying amount of the convertible debt and as an addition to paid-in capital. Additionally, the relative fair value of the warrants ($83,138) was calculated and recorded as a further reduction to the carrying amount of the convertible debt and an addition to additional paid-in capital. The Company is amortizing the debt discount over the term of the debt.   Amortization of discounts was $93,892 for the nine months ended September 30, 2011.   


In addition, as an inducement to make this investment, the Company agreed to reprice 1,240,000 warrants, reducing the exercise price from $.25 to $.15.  The Company incurred deferred finance costs of $57,707.  These costs will be amortized over the remaining life of the warrants.  For the nine months ended September 30, 2011, the Company recognized $41,383 in deferred finance cost. The balance of the finance costs ($16,323) is recorded in other assets.


Convertible debt consists of the following:


 

 

September 30, 2011

 

December 31, 2010

 

 

(Unaudited)

 

 

Convertible notes payable, net of unamortized discount

 

 

 

 

  of $126,502 and $89,973 respectively

$

359,098

$

261,127

Less:  Current portion

 

78,011

 

157,064

 

 

 

 

 

            Long term portion

$

281,087

$

104,063


During the quarter ended June 30, 2011, several three year 1% convertible notes in the aggregate principal amount of $196,000, with various maturity dates during 2011were extended for an additional three years at the request of the noteholder.  The Company incurred no additional cost as a result of these extensions.  


NOTE 9 – DEFERRED REVENUE


The Company received a license fee of $255,000 during the fourth quarter of 2010.  This license fee is being amortized over the term of the license agreement’s term of 17 years.  The Company recognized $5,000 in revenue during the year ended December 31, 2010, and has recognized $11,250 in revenue for the nine months ended September 30, 2011.  


 



8





NOTE 10 - RELATED PARTY TRANSACTIONS


Line of Credit


In April of 2010 the Company entered into a line of credit agreement with Chris Maggiore, a significant shareholder.  Under the terms of this line of credit agreement, the shareholder agreed to advance, upon request, a maximum of $675,000 as needed.   The company’s ability to draw from this line of credit expired April 24, 2011, and advances are to be repaid on or before April 24, 2012 with interest accrued at the rate of 7% annually.  During 2010 the Company received advances totaling $299,700, and accrued interest totaling $4,209.During the quarter ended December 31, 2010,  the Company issued an aggregate of 1,940,000 shares of common stock to the shareholder as follows:  (i) 838,986 shares were issued upon exercise of outstanding warrants at an average exercise price of $.23 per share (the shareholder paid the exercise price by forgiving $188,898 in indebtedness owing to the shareholder), and 1,101,014 shares (valued at $374,344) were issued in full satisfaction of the approximately $110,000 in remaining principal amount plus accrued interest owing to this related party in connection with advances made to  the Company.  In connection with this loan repayment, the Company incurred finance charges of $259,293.  As of June 30, 2011, there is a principal balance due of $29,500, and accrued interest totaling $459.


The balance due under this line of credit agreement as of April 24, 2011 was $26,716.  Since the expiration of the line of credit, the Company has received an additional $69,241 in loans from this significant shareholder, accrued additional interest of $1,149 and repaid $14,000.  The balance owing this shareholder as of September 30, 2011 is $81,741 in principal and $1,365 in accrued interest.  Of this principal balance, $26,716 is due and payable on April 24, 2012, and the remaining principal balance of $55,025 represents additional advances after the expiration of the loan agreement, and is due and payable upon demand.


In July, 2011, the Company issued Mr. Maggiore warrants to purchase 3,000,000 shares at an exercise price of $.25 per share for a term of three years.  These warrants were issued to Mr. Maggiore in consideration Mr. Maggiore providing financing to the Company which prevented him from being able to avail himself of a company offer to certain warrant holders to exercise their warrants on a reduced exercise price basis.  The Company recognized finance costs of $203,069 in connection with the grant.


License Agreement


On September 2, 2010, the Company entered into a multi-year exclusive worldwide License Agreement (“Agreement”) for its ProAlgaZyme ® product (“Product”) with a distributor of health and nutritional products, Zus Health, LLC (“Zus”) (this agreement was assigned by Zus to Ceptazyme, LLC (Zus’ successor).  Chris Maggiore, a significant shareholder of the Company, has an equity interest in Ceptazyme, LLC.  See  Note 11, License Agreement,


Office Space


We are leasing office and production space located in Scottsdale, Arizona from a significant shareholder, Howard Baer, pursuant to an Amended and Restated Sublease that expires on February 9, 2020, subject to our unilateral right to terminate the Lease on March 31, 2013. Under the original terms of the Amended and Restated Sublease, the annual base rent for the 15,000 square foot facility was approximately $237,000, payable in equal monthly installments of approximately $20,000. The annual base rent is subject to increase annually in an amount equal to the greater of 2.5% of the prior year’s base rent and the percentage increase in the Consumer Price Index. We paid an additional security deposit of approximately $110,000. The Amended and Restated Sublease is a “net lease”, which means that we are responsible for the real estate taxes, maintenance, insurance and repairs related to the premises we are leasing.


In October, 2009, we and Mr. Baer agreed in principle to (i) reduce from 15,000 to 11,000 the square footage of the space we are occupying and (ii) to reduce the base rent from $20,000 to $16,720 monthly (not including real estate taxes (currently $1,480 per month)).   In addition, the lessor has assumed the responsibility for maintenance and repairs for the building and we are obligated to reimburse the lessor for 70% of such expenses.  We incurred approximately $55,000 in rent expense during the first quarter of 2011.  


In May of 2011 we and Mr. Baer agreed to (i) further reduce from 11,000 to 5,600 the square footage we are occupying, and (ii) reduce our rent to $12,320 (not including real estate taxes of $1,480 per month).  We incurred approximately $78,000 in rent expense during the second and third quarters of 2011.


In April of 2011 the Company signed a lease for new office and warehouse facilities.  This lease calls for deferred rent payments until September 1, 2011, to allow us time to finish tenant improvements.  Monthly rental is approximately $5,400 per month, and is for a term of 42 months.  The Company has not yet completed the tenant improvements necessary to occupy the space due to a shortage of funds.  We anticipate moving in late in the fourth quarter of 2011.  In connection with this lease, we incurred approximately $5,400 in rent expense during the third quarter of 2011.




9





NOTE 11 – LICENSE AGREEMENT


On September 2, 2010, the Company entered into a multi-year exclusive worldwide License Agreement (“Agreement”) for its ProAlgaZyme ® product (“Product”) with a distributor of health and nutritional products, Zus Health, LLC (“Zus”) (this agreement was assigned by Zus to Ceptazyme, LLC (Zus’ successor).  As disclosed in Note 10, Related Party Transactions, Chris Maggiore, a significant shareholder of the Company, has an equity interest in Ceptazyme, LLC.  Under the terms of the Agreement, Ceptazyme, LLC has the exclusive right to distribute the Product to customers and distributors worldwide, excluding pharmaceutical applications and food, supplement and medicinal ingredient applications outside of multi-level, network or affiliate marketing (“MLM”).  The Company reserved the right to market and sell isolates and natural and synthetic derivatives of the Product in pharmaceutical applications, as well as ingredient applications outside of MLM.  The Agreement prohibits the Company from selling ProAlgaZyme for the benefit of customers and distributors worldwide, other than for pharmaceutical and ingredient applications. The Company is also prohibited from selling any product in the MLM market.  In November, 2010, the Company received a payment of $255,000, as provided in the Agreement, for the exclusive distribution rights.  $242,500 of this payment has been recorded as deferred revenue, and is being amortized over seventeen years.  Our receipt of minimum payments under the Ceptazyme, LLC Agreement is subject to among other conditions our product meeting the FDA’s GRAS standard, which we are currently working on. The Agreement remains in effect until the expiration of the last patent with respect to the Product, subject to earlier termination as provided in the Agreement.  The minimum payment provisions under the Agreement have not been operative as we do not yet meet the GRAS standard.  We anticipate GRAS compliance by the end of the second quarter, 2012, at which time we expect to begin shipments under the contract.  


NOTE 12 - STOCKHOLDERS’ DEFICIT


During the quarter ended March 31, 2011, the Company issued 1,866,667 shares of common stock and received proceeds of $180,000 for the exercise of warrants.  In addition, the Company issued 400,000 shares of common stock and received proceeds of $50,000 from investors.  Pursuant to a private placement, convertible debentures were issued during the quarter ended March 31, 2011, for which a discount of $62,500 was recorded, and warrants to purchase 1,240,000 shares of common stock were repriced, resulting in deferred finance costs of $57,706.   Finally, the Company issued 100,000 shares of common stock for services, valued at $25,000.


During the quarter ended June 30, 2011, the Company issued 740,000 shares of common stock and received $92,500 in proceeds from investors.  The Company issued 500,000 shares of common stock and received $50,000 in proceeds upon the exercise of warrants.  Pursuant to a private placement, convertible debentures were issued during the quarter ended June 30, 2011, for which a discount of $52,000 was recorded. The Company issued warrants to purchase 75,000 shares of common stock valued at $8,584 for services, and issued 333,334 shares of common stock in satisfaction of an obligation to issue common stock valued at $50,000.


During the quarter ended September 30, 2011, the Company issued 1,100,000 shares of common stock and received $130,000 in proceeds from investors.  The Company issued 16,000 shares of common stock upon the cashless exercise of 24,000 common stock warrants.  Pursuant to a private placement, convertible debentures were issued during the quarter ended September 30, 2011, for which a discount of $15,921 was recorded. In addition, in July, 2011, the Company issued a significant shareholder, Chris. Maggiore, warrants to purchase 3,000,000 shares at an exercise price of $.25 per share for a term of three years.  These warrants were issued to Mr. Maggiore in consideration Mr. Maggiore providing financing to the Company which prevented him from being able to avail himself of a company offer to certain warrant holders to exercise their warrants on a reduced exercise price basis.  The Company recognized finance costs of $203,069 in connection with the grant.


A summary of the status of the Company’s warrants is presented below.


 

September 30, 2011

December 31, 2010

 

 Number of

 Weighted Average

 Number of

 Weighted Average

 

 Warrants

 Exercise Price

 Warrants

 Exercise Price

Outstanding, beginning of year

      15,856,999

 $                   0.17

    22,723,401

 $                 0.50

Issued

        7,799,000

                      0.17

      3,880,000

                    0.21

Exercised

       (2,740,000)

                      0.10

     (9,951,402)

                    0.13

Repriced $.15 warrants

        1,240,000

                      0.15

 

 

Repriced $.25 warrants

       (1,240,000)

                    (0.25)

 

 

Expired

       (3,258,666)

                      0.09

       (795,000)

                    0.50

 

 

 

 

 

Outstanding, end of period

      17,657,333

 $                   0.20

    15,856,999

 $                 0.17




10





Warrants outstanding and exercisable by price range as of September 30, 2011 were as follows:


 

 Outstanding Warrants

 Exercisable Warrants

 

 

 

 

 

 

 

 

 Average  

 

 

 

 

 

 Weighted

 

 

 

 

 

 Remaining

 

 

 Weighted

 

 

 Contractual

 Exercise

 

 Average

 Range of

 Number

 Life in Years

 Price

 Number

 Exercise Price

 

 

 

 

 

 

0.10

1,170,000

.79

0.10

1,170,000

$              0.10

0.125

4,724,000

2.61

0.125

4,724,000

0.125

0.15

3,323,333

1.29

0.15

3,223,333

0.15

0.225

600,000

2.32

0.225

600,000

0.225

0.25

6,825,000

1.59

0.25

6,825,000

0.25

0.50

1,015,000

1.24

0.50

1,015,000

0.50

 

 

 

 

 

 

 

17,657,333

1.76

 

17,657,333

$              0.12


NOTE 13- COMMITMENTS AND CONTINGENCIES


Product Liability Insurance - We have only limited product liability insurance.  If a product claim were successfully made against us, there could be a material adverse effect on our financial condition given our liquidity and cash limitations.  


Office Lease - We are leasing office and production space located in Scottsdale, Arizona from a significant shareholder, Howard Baer, pursuant to an Amended and Restated Sublease that expires on February 9, 2020, subject to our unilateral right to terminate the Lease on March 31, 2013. Under the original terms of the Amended and Restated Sublease, the annual base rent for the 15,000 square foot facility was approximately $237,000, payable in equal monthly installments of approximately $20,000. The annual base rent is subject to increase annually in an amount equal to the greater of 2.5% of the prior year’s base rent and the percentage increase in the Consumer Price Index. We paid an additional security deposit of approximately $110,000. The Amended and Restated Sublease is a “net lease”, which means that we are responsible for the real estate taxes, maintenance, insurance and repairs related to the premises we are leasing.


In October, 2009, we and Mr. Baer agreed in principle to (i) reduce from 15,000 to 11,000 the square footage of the space we are occupying and (ii) reduce the base rent from $20,000 to $16,720 monthly (not including real estate taxes (currently $1,480 per month)).   In addition, the lessor has assumed the responsibility for maintenance and repairs for the building and we are obligated to reimburse the lessor for 70% of such expenses.  We incurred approximately $55,000 in rent expense during the first quarter of 2011.


In May of 2011 we and Mr. Baer agreed to (i) further reduce from 11,000 to 5,600 the square footage we are occupying, and (ii) reduce our rent to $12,320 (not including real estate taxes of $1,480 per month).  We incurred approximately $78,000 in rent expense during the second and third quarters of 2011.


The Company was leasing, on a month to month basis, a warehousing and bottling facility. The lease called for monthly rentals of $2,700, plus annual common area maintenance fees.   Rent expense under this lease for the quarter ended March 31, 2011 was approximately $9,550.  This building was vacated on April 1, 2011.  


In April of 2011 the Company signed a lease for new office and warehouse facilities.  This lease calls for deferred rent payments until September 1, 2011, to allow us time to finish tenant improvements.  Monthly rental is approximately $5,400 per month, and is for a term of 42 months.  The Company has not yet completed the tenant improvements necessary to occupy the space due to a shortage of funds.  We anticipate moving in late in the fourth quarter of 2011.  In connection with this lease, we incurred approximately $5,400 in rent expense during the third quarter of 2011.


The Company’s future minimum lease payments are as follows:


Year Ending December 31,

 

 

2011

$

  53,242

2012

 

  216,925

2013

 

   95,121

2014

 

   48,156

 

$

413,444




11





Business Services Agreement


On October 19, 2009, the Registrant and Great Northern Reserve Partners, LLC (“GNRP”) entered into a Business Services Agreement (“Agreement”), which supersedes the prior agreement between them entered into in February, 2009 (“February Agreement”).


The Registrant entered into the Agreement to continue the pursuit of its strategic product and business development objectives.  GNRP was issued 500,000 shares of the Registrant’s Common Stock in connection with the execution of the Agreement, in full payment of any and all amounts owing under the February Agreement (approximately $142,000 per GNRP) and in recognition of GNRP’s contribution to the achievement of recent product testing results.  In addition, GNRP will be compensated based on hours expended, sales and other payments (licensing payments, etc.) received by the Registrant, and the achievement of specified milestones.


On August 17, 2011, the Company received notice from GNRP (see Note 12) claiming that the Company owes it $220,000 for services rendered from October, 2009 to August 2011, although the Company has never received a bill detailing any services rendered.  Once the Company receives detailed billing records, it will determine the amount if any owed to GNRP.


Workers’ Compensation – The Company does not carry workers’ compensation insurance, which covers on the job injury.


Guarantees – In May, 2010, we entered into an indemnity agreement under which we indemnified a significant stockholder, Howard Baer, for any liability incurred by him in connection with guarantying company obligations.  We also issued Mr. Baer warrants to purchase 500,000 shares of common stock as compensation for prior loan guarantees he made with respect to company indebtedness. These warrants have an exercise price of $.15 (cashless) and a term of 3 years. The warrants were valued at $405,925 using the Black Scholes pricing model with the following assumptions: volatility 137.66%; annual rate of dividends 0%; discount rate 3.1%.


NOTE 14 – LOSS PER SHARE


Loss per common share is based upon the weighted average number of common shares outstanding during the period.  Diluted loss per common share is the same as basic loss per share, as the effect of potentially dilutive securities (Convertible debt – 5,512,956 shares and 6,622,000 shares at September 30, 2011 and 2010, respectively; and warrants – 17,657,333 shares and 16,840,985 shares at September 30, 2011 and 2010, respectively) is anti-dilutive.


NOTE 15 - SUBSEQUENT EVENTS


The Company issued 37,594 shares of common stock to a consultant, valued at $7,519.  The Company issued 800,000 shares of common stock and received proceeds of $100,000.  




12





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


SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS


The Securities and Exchange Commission (“SEC”) encourages companies to disclose forward-looking information so that investors can better understand future prospects and make informed investment decisions.  This report contains these types of statements.  Words such as “may,” “will,” “expect,” “believe,” “anticipate,” “estimate,” “project,” or “continue” or comparable terminology used in connection with any discussion of future operating results or financial performance identify forward-looking statements.  You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this report.  All forward-looking statements reflect our present expectation of future events and are subject to a number of important factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements.


Critical Accounting Policies 

 

The accompanying discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("US GAAP"). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses, and related disclosure of contingent assets and liabilities. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We base our estimates and judgments on historical experience and all available information. However, future events are subject to change, and the best estimates and judgments routinely require adjustment. US GAAP requires us to make estimates and judgments in several areas, including those related to recording various accruals, income taxes, the useful lives of long-lived assets, such as property and equipment and intangible assets, and potential losses from contingencies and litigation. We believe the policies discussed below are the most critical to our financial statements because they are affected significantly by management's judgments, assumptions and estimates. 

 

Results of Operations for the nine months ended September 30, 2011 and 2010.


Net Sales.  Net sales for the nine months ended September 30, 2011 were $88,587 as compared to $52,451 for the comparable prior period.  These sales reflect principally revenues from the distribution of our ProAlgaZyme® product.  The increase in our revenue for 2011 is due to our exclusive distributorship agreement with Ceptazyme, LLC to distribute our product.  In the fourth quarter of 2010 we received an initial licensing fee payment of $255,000 under the terms of this exclusive distributorship agreement.  We recognized $11,250 in revenue from this licensing fee during the first nine months of 2011.  


Although we anticipate the realization of increasing revenues from our exclusive distributorship agreement with Ceptazyme, LLC, our ability to realize any such increased revenue is dependent upon the satisfaction of certain conditions, including our product’s meeting the FDA’s GRAS standard or receiving New Diet Ingredient (“NDI”) status form the FDA, which we have not satisfied as of this date, though we are working on meeting the GRAS standard.   The minimum payment provisions under the distributorship agreement have not been operative because we do not yet meet the GRAS standard.  We anticipate GRAS compliance by the end of the second quarter, 2012, at which time we expect to begin shipments under the contract.  If we are unable to meet he GRAS standard (or NDI status), there will be a material adverse affect on our business, financial condition and results of operations.    


Throughout 2010 and 2011, we were adversely impacted by a shortage of funds which has severely impeded our ability to market, test and expand the production of our ProAlgaZyme® product.  Although we signed an exclusive distribution agreement in September of 2010, we intend to explore additional potential marketing opportunities, consistent with the limitations placed upon us by our exclusive distribution agreement with Ceptazyme, LLC.  We believe that our ability to generate sales of the ProAlgaZyme® product will depend upon, among other things, further characterization of the product, identification of its method of action and further evidence of its efficacy, as well as advertising.  The testing necessary to further characterize the product, identify its method of action and further substantiate its effectiveness is ongoing.


Cost of Sales.  Cost of Sales was $99,060 for the nine months ended September 30, 2011, as compared to $35,343 for the comparable prior period.  Cost of Sales represents primarily costs related to raw materials, labor and the laboratory and controlled production environment necessary for the growing of the algae cultures that constitute the source of the biological activity of the ProAlgaZyme® product, and for conducting the necessary harvesting and production operations in preparing the product for sale.  The increase in cost of sales for 2011 is due to an increase in overall production, combined with additional costs incurred in bottling our product offsite until the improvements to our new warehouse facility are completed.  


Research and Development Expenses.   For the nine months ended September 30, 2011, we incurred $246,000 on research and development expenses, as compared to $294,053 for the comparable period in 2010.  These expenses are mainly comprised of costs associated with external research.  Our research and development costs declined de to our limited cash resources..  This research was initiated to further explore ProAlgaZyme®’s potential efficacy on the management of cholesterol levels.  We have identified several potential bioactive compounds, but additional research aimed at isolating the compound further is expected to be completed during the fourth quarter of 2011.


Selling and Marketing Expenses. Selling and marketing expenses were $11,823 for the nine months ended September 30, 2011, as compared to $95,190 for the comparable prior period.  The decrease in 2011 was due to the reclassification of wages paid to our Executive Vice President, combined with shifting available resources to research, resulting in our de-emphasizing marketing.  




13





In the past we were only accustomed to nominal sales of our sole product, ProAlgaZyme.  In September of 2010, we signed an exclusive distribution agreement to sell our product.  This exclusive distribution agreement called for an initial licensing fee of $255,000 (received  in October of 2010) and monthly orders which increase as our ability to produce product increases, subject to satisfaction of certain conditions, including satisfaction of the GRAS standard (or NDI status); we are still working on meeting GRAS.  An initial order of $51,100 was received in December of 2010.   Due to several delays in the design of new packaging, this order was shipped in full during the month of April, 2011.  During the second quarter of 2011 we received orders for 15,000 bottles, and shipped approximately 6,600 bottles.  The balance of this order is pending payment from the distributor.  During the third quarter of 2011 we received orders for 4,354 bottles, and shipped approximately 4,400 bottles.  We anticipate further orders in the near term, subject to the ability of Ceptazyme to remit payment as required under the terms of the contract.  However, we do not expect the distributor to begin purchasing the minimums until we satisfy the FDA’s GRAS standard (Note 11).


We intend to explore additional third party distribution channels for our product, consistent with the limitations placed upon us by our exclusive distribution agreement with Ceptazyme, LLC. The limit on our ability thus far to advertise our product (due in part to the need for additional testing) has had and, until we are able to advertise our product based upon the results of “class of compound” testing and identification of the bioactive ingredient, will continue to have, a material adverse effect on sales revenue and operating results. We intend to continue to pursue clinical study of our product and, subject to the results of such testing, increase advertising in 2011, subject to availability of sufficient funding, which we do not currently have.


General and Administrative Expenses. General and administrative expense was $333,021 for the nine months ended September 30, 2011, as compared to $960,625 for the comparable prior period.  The decrease in general and administrative expense during 2011 is due primarily to an approximate $530,000 decrease in administrative salaries, of which approximately $500,000 was in the form of stock based compensation, a non-cash expense, combined with a decrease of $45,000 in costs associated with our 2010 stockholders meeting , and a $50,000 decrease in our rent expense.   


Professional and Consulting Expenses.   Professional and consulting expense was $386,355 for the nine months ended September 30, 2011, as compared to $2,000,489 for the comparable prior period.  The decrease in professional and consulting expense during 2011 is due primarily to a decrease in stock based compensation of approximately $1,500,000, and a decrease in legal fees of approximately $180,000, offset by an increase in accounting fees of approximately $49,000.


Liquidity and Capital Resources


Historically, we have not generated any material revenues from operations and have been in a precarious financial condition. Our unaudited condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. We have had recurring losses from operations. Our primary source of funds during the nine months ended September 30, 2011 was from the sale and issuance of equity securities as well as proceeds from the issuance of convertible debentures. We anticipate that our operations and costs through the 4th quarter of 2011 will be funded from the proceeds from private placements and warrant exercises as well as the issuance of new debentures.  We have an immediate and urgent need for additional capital.  If we are unable to raise the capital necessary to fund our continuing operations, we will not be able to continue as a going concern and you will suffer a total loss of your investment.


As of November 18, 2011, we had a cash balance of approximately $40,000.  We have had only limited revenue ($88,587 for the nine months ended September 30, 2011) and have incurred significant net losses since inception, including a net loss of $1,322,815 for the nine months ended September 30, 2011. Subject to our product’s meeting the FDA’s GRAS standard or receiving New Diet Ingredient (“NDI”) status form the FDA (neither of which standards do we currently meet), the revenue guaranteed to us under the exclusive distribution agreement is expected to contribute significantly to funding our normal operations.  However, we have, since inception, consistently incurred negative cash flow from operations. During the nine months ended September 30, 2011, we incurred negative cash flows from operations of $770,442.  As of September 30, 2011, we had a working capital deficiency of $917,042 and a stockholders’ deficiency of $1,297,214. Although we recently raised a limited amount of capital, we have an immediate and urgent need for additional capital.


 During the nine months ended September 30, 2011, our operating activities used $770,442 in cash, a decrease of $523,518 from the comparable prior period.  The approximate $520,000 decrease in cash used by operating activities was primarily attributable to the following (all of which are approximated): a $4.8 million decrease in net loss, a $388,000 increase in accrued payroll taxes expenses and accounts payable, partially offset by a $2.2 million decrease fair value adjustment of derivative liability (a noncash expense), a $1.6 million decrease in stocks and warrants issued for services (a noncash expense), a $203,000 decrease in finance costs paid with warrants, and a $550,000 decrease in obligations to issue common stock.


During the nine months ended September 30, 2011, our financing activities generated $819,692, a $476,420 decrease from the comparable prior period. The decrease in cash provided by financing activities was due primarily to a decrease in proceeds from sales of securities and convertible debt.


Although we raised a limited amount of capital during the first nine months of 2011, we continue to experience a severe shortage of capital, which is materially and adversely affecting our ability to run our business. As noted above, we have been largely dependent upon external sources for funding. We have in the past had great difficulty in raising capital from external sources.  Subject to our ability to meet the FDA’s GRAS standard, which we do not yet meet, our exclusive distribution agreement should generate revenue to help cover at least a portion of our normal operating expenses; however we will still be reliant upon external financing for the continuation of our research program. With the leasing of our new manufacturing and office facilities, we anticipate being able to increase our production as necessary to meet the minimum requirements called for in our distribution agreement, subject to having sufficient capital, which we do not currently have.




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In September 2011, we issued a Senior Secured Note in the principal amount of $100,000.  This Note is secured by all our assets and is payable within ten days of the lender’s written demand.  We currently do not have the funds to repay this loan.  If the lender demands payment and we are unable to raise the funds needed to repay the loan, the lender could foreclose on our assets, in which case you would suffer a total loss of your investment.   

    

We estimate that we will require approximately $1,500,000 in cash over the next 12 months in order to fund our normal operations. In addition, we will require additional funding in the range of $500,000 to $1,000,000 to fund our research initiatives. Based on this cash requirement, we have an immediate and urgent need for additional funding.  Historically, we have had great difficulty raising funds from external sources; however, we recently were able to raise a limited amount of capital from outside sources.


In addition, we have only limited product liability insurance.  If a product claim were successfully made against us, there could be a material adverse effect on our financial condition given our liquidity and cash limitations.


Significant elements of income or loss not arising from our continuing operations


Except as set forth below, we do not expect to experience any significant elements of income or loss other than those arising from our continuing operation.  For the nine months ended September 30, 2010, we recognized $2,223,991 of expenses for financial statement purposes based on the change in fair value of derivative liabilities.  


Seasonality


Our product is directed to the improvement of the health of our consumers, and we do not expect that operating results will be affected materially by seasonal factors.  In addition, ProAlgaZyme® is cultivated in a climate-controlled laboratory environment, not subject to seasonal growing effects or influences


Staffing


We have conducted all of our activities since inception with a minimum level of qualified staff.  We currently do not expect a significant increase in staff.  


Off-Balance Sheet arrangements


We have no off-balance sheet arrangements that would create contingent or other forms of liability.


Item 4

T. Controls and Procedures


Management’s Report on Disclosure Controls and Procedures. We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Securities Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Financial Officer, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, we recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as ours are designed to do, and we necessarily were required to apply our judgment in evaluating the cost-benefit relationship of possible changes or additions to our controls and procedures.


As of September 30, 2011, we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive/principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934. Based upon that evaluation, our principal executive/principal financial officer concluded that our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, are effective in enabling us to record, process, summarize and report information required to be included in our periodic SEC filings within the required time period.


Changes in Internal control Over Financial Reporting.  There have been no changes in our internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



15





PART II – OTHER INFORMATION


Item 2. Unregistered Sales of Equity Securities and Use of Proceeds


During the quarter ended March 31, 2011, the Company issued 1,866,667 shares of common stock and received proceeds of $180,000 upon the exercise of warrants.  In addition, the Company issued 400,000 shares of common stock and received proceeds of $50,000 from investors. During the quarter ended March 31, 2011,  the Company issued (i) Convertible debentures  in the principal amount of $62,500  (convertible into common stock at $.125 per share), and  (ii) warrants to purchase 750,000 shares of common stock (at an exercise price of $.125 per share), all for gross proceeds of $62,500.  In addition, the company re-priced 1,240,000 warrants from $.25 to $.15 per share to induce the convertible note investment.   Finally, the Company issued 100,000 shares of common stock for services, valued at $25,000.


During the quarter ended June 30, 2011, The Company issued 740,000 shares of common stock and received $92,500 in proceeds from investors.  The Company issued 500,000 shares of common stock and received $50,000 in proceeds upon the exercise of warrants.  Pursuant to a private placement, convertible debentures were issued during the quarter ended June 30, 2011, for which a discount of $52,000 was recorded. The Company issued warrants valued at $8,584 for services, and issued 333,334 shares of common stock in satisfaction of an obligation to issue common stock.


During the quarter ended September 30, 2011, the Company issued 1,100,000 shares of common stock and received $130,000 in proceeds from investors.  The Company issued 16,000 shares of common stock upon the cashless exercise of 24,000 common stock warrants.  Pursuant to a private placement, convertible debentures were issued during the quarter ended September 30, 2011, for which a discount of $15,921 was recorded. In addition, in July, 2011, the Company issued a significant shareholder warrants to purchase 3,000,000 shares at an exercise price of $.25 per share for a term of three years.  These warrants were issued to the shareholder in consideration of his providing financing to the Company which prevented him from being able to avail himself of a company offer to certain warrant holders to exercise their warrants on a reduced exercise price basis.  


We believe that the foregoing transactions were exempt from the registration requirements under Rule 506 of Regulation D promulgated under the Securities Act of 1933, as amended (“the Act”) or Section 4(2) under the Act, based on the following facts: there was no general solicitation, there was a limited number of investors, each of whom was an “accredited investor” (within the meaning of Regulation D under the “1933 Act”, as amended) and was (either alone or with his/her purchaser representative) sophisticated about business and financial matters, each such investor had the opportunity to ask questions of our management and to review our filings with the Securities and Exchange Commission, and all shares issued were subject to restrictions on transfer, so as to take reasonable steps to assure that the purchasers were not underwriters within the meaning of Section 2(11) under the 1933 Act.


Item 5.  Other Information


Item 6. Exhibits


Exhibit Number

Description

 

 

3.1

Articles of Incorporation of Health Enhancement Products, Inc., as amended (1)

3.2

Amended and Restated By-laws of the Company (2)

10.1

Security Agreement related to Senior Secured Promissory Note

10.2

Senior Secured Promissory Note Dated September 8, 2011

31.1*

Certification of the Principal Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended

31.2*

Certification of the Principal Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended

32.1*

Certification of the Principal Executive Officer pursuant to U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2*

Certification of the Principal Financial Officer pursuant to U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002


(1)  Filed as Exhibit 3.1 to the Registrant’s Form 10Q, for the quarter ended June 30, 2011, filed with the Commission on August 22, 2011 and incorporated by this reference.


(2)  Filed as Exhibit 3.2 to the Registrant’s Form 10Q, for the quarter ended March 31, 2010, filed with the Commission on May 17, 2010 and incorporated by this reference

             

*furnished herewith (all other exhibits are deemed filed).



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SIGNATURES


Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


HEALTH ENHANCEMENT PRODUCTS, INC.




Date: November 18, 2011

By:  /s/ John Gorman                  

Executive Vice President





Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.


Signature

Title

Date



By: /s/ John Gorman              

(John Gorman)

Executive Vice President

November 18, 2011





17





LIST OF EXHIBITS



Exhibit Number

Description

 

 

3.1

Articles of Incorporation of Health Enhancement Products, Inc., as amended (1)

3.2

Amended and Restated By-laws of the Company (2)

10.1

Security Agreement related to Senior Secured Promissory Note

10.2

Senior Secured Promissory Note Dated September 8, 2011

31.1*

Certification of the Principal Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended

31.2*

Certification of the Principal Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended

32.1

Certification of the Principal Executive Officer pursuant to U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2

Certification of the Principal Financial Officer pursuant to U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



(1)  Filed as Exhibit 3.1 to the Registrant’s Form 10Q, for the quarter ended June 30, 2011, filed with the Commission on August 22, 2011 and incorporated by this reference.


(2)  Filed as Exhibit 3.2 to the Registrant’s Form 10Q, for the quarter ended March 31, 2010, filed with the Commission on May 17, 2010 and incorporated by this reference


*furnished herewith (all other exhibits are deemed filed)