NEWS OUT!!!
Form 10KSB for PEDIATRIC PROSTHETICS INC
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27-Oct-2006
Annual Report
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION PLAN OF OPERATIONS
During October 2005, our management contracted with three (3) consultants to commence a national multi-media publicity campaign based upon the success stories of the children for which we have provided services. Management's goal is to provide awareness of our commitment to provide superior pediatric prosthetic care on a national level. We paid the consultants an aggregate of 7,000,000 shares of our common stock in connection with such contracts.
We have established working relationships with fourteen Host Affiliates operating in approximately 19 states. In establishing the relationships with the fourteen Host Affiliates, we also provided one-on-one pediatric training to
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twelve prosthetists who are employed by those Host Affiliates. We currently plan to hire one more certified prosthetist and two additional support personnel during the next twelve months, funding permitting, of which there can be no assurance.
As of June 2006, based on our current monthly gross profits generated in connection with fitting prosthetic limbs, which approximately totals our monthly overhead of $54,000, we believe we will be able to continue our operations throughout fiscal 2007. Due to the receipt of $600,000 on May 30, 2006, (less closing costs and structuring fees), from the sale of certain Convertible Debentures described above, we expect to increase our fiscal 2007 cash advertising and marketing budget five fold over fiscal 2006 advertising budget. We believe the five fold increase in our advertising and marketing budget will generate a substantial ramp-up of our monthly prosthetic fittings rate and resulting gross profits due to a growing national awareness of our specialization in personalized pediatric services, combined with the re-fitting of the growing number of clients we have already fitted.
The increases in our advertising and marketing budget have allowed us to undertake the following advertising and marketing activities:
o The composition of and distribution of certain feature newspaper articles through our agreement with Global, pursuant to which we agreed to pay Global an aggregate of $160,000 worth of our common stock, based on the trading value of our common stock on certain payment dates, as described in greater detail above under "Recent Events," of which approximately $48,750 in common stock has been issued to date; and
o Publicity and marketing campaign, pursuant to which we previously issued 7,000,000 shares of common stock to certain consultants.
Additionally, we believe the increases in our advertising and marketing budget will allow us to undertake the following activities during the next twelve (12) months:
o The production, filming, editing and narration of informational videos on the value of modern prosthetic options for children, which videos describe the success stories we have had in helping children overcome limb loss by fitting such children with artificial limbs, as well as the distribution of such videos to fellow pediatric professionals such as nurses, physical therapists, doctors and hospital-based family counselors nationally, at a cost of approximately $300,000;
o Costs associated with publicizing and scholarships for our four day "whole family summer get-together" for children with a limb-loss and their families, at a cost of approximately $50,000;
o Travel and associated costs involved with appearances on television shows, medical conventions and nursing schools at a cost of approximately $20,000; and
o Sponsorship costs of non-profit organizations such as the "Amputee Coalition of American" and the Para-Olympics, at a cost of approximately $50,000.
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We also anticipate receiving approximately $900,000 in subsequent tranches in connection with the funding agreement described above, however, investors should keep in mind that any amounts of funding we receive pursuant to the funding will be reduced by fees paid to the lending source in connection with closing costs and legal and accounting costs associated with our need to file and obtain effectiveness of a Form SB-2 Registration Statement to register the Debentures convertible into common stock in connection with the sale of a Convertible Secured Term Note and the shares issuable in connection with the exercise of the Warrants.
We anticipate using the $900,000, which we anticipate receiving through the sale of additional Convertible Debentures in connection with subsequent funding tranches, on continued and sustained marketing and advertising efforts and the anticipated increases in our components inventory, which we will require as a result of our increased marketing and advertising efforts, and the resulting increase in fittings, which we believe such increased marketing efforts will create.
CRITICAL ACCOUNTING POLICIES
Our financial statements and accompanying notes are prepared in accordance with U.S. GAAP. Preparing financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by management's application of accounting policies. Critical accounting policies for us relate primarily to revenue recognition.
REVENUE RECOGNITION
We recognize revenues from the sale of prosthetic devices and related services generated through the billing departments of the Host-Affiliates upon the performance of services by that Host-Affiliate.
When we directly bill customers or bill customers through our Host-Affiliates, the revenue from the sale of prosthetic devices and related services to patients, are recorded when the device is accepted by the patient, provided that
(i) there are no uncertainties regarding customer acceptance; (ii) persuasive evidence of an arrangement exists; (iii) the sales price is fixed and determinable; and (iv) collection is deemed probable. We require each patient to sign a standard acknowledgement of delivery of device form in connection with each sale at the time of sale, which provides that the patient has 1) received the device and 2) is satisfied with the device. Our patients normally accept our products upon delivery.
When we directly bill customers or bill customers through our Host-Affiliates, revenue is recorded at "usual and customary" rates, expressed as a percentage above Medicare procedure billing codes. Billing codes are frequently updated and as soon as we receive updates we reflect the change in our billing system. There is generally a "co-payment" component of each billing for which the patient-family is responsible. When the final appeals process to the third party payors is completed, we bill the patient family for the remaining portion of the "usual and customary" rate. As part of our preauthorization process with third-party payors, we validate our ability to bill the payor, if applicable, for the service provided before we deliver the device. Subsequent to billing for devices and services, problems may arise with pre-authorization or with other
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insurance issues with payors. If there has been a lapse in coverage, or an outstanding "co-payment" component, the patient is financially responsible for the charges related to the devices and services received. If we are unable to collect from the patient, a bad debt expense is recognized.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standard Board (FASB) issued a revision to Statement of Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation" (SFAS 123R). SFAS 123R eliminates our ability to use the intrinsic value method of accounting under APB 25, and generally requires us to reflect in our income statement, instead of pro forma disclosures in our financial footnotes, the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. We will estimate the grant-date fair value using option-pricing models adjusted for the unique characteristics of those equity instruments. Among other things, SFAS 123R requires us to estimate the number of instruments for which the requisite service is expected to be rendered, and if the terms or conditions of an equity award are modified after the grant date, to recognize incremental compensation cost for such a modification by comparing the fair value of the modified award with the fair value of the award immediately before the modification. In addition, SFAS 123R amends FASB Statement No. 95, "Statement of Cash Flows," to require that we treat excess tax benefits as a financing cash inflow rather than as a reduction of taxes paid in our statement of cash flows. SFAS 123R was effective for us beginning July 1, 2005. The Company had no outstanding warrants or options at the date of adoption of SFAS 123R and, accordingly, the adoption had no impact on us.
In May 2005, the Financial Accounting Standards Board ("FASB") issued SFAS Statement No. 154 ("SFAS 154"), Accounting Changes and Error Corrections. SFAS 154 requires that, when a company changes its accounting policies, the change must be applied retrospectively to all prior periods presented instead of a cumulative effect adjustment in the period of the change. SFAS 154 may also apply when the FASB issues new rules requiring changes in accounting. If the new rule allows cumulative effect treatment, it will take precedence over SFAS
154. This statement is effective for fiscal years beginning after December 15, 2005. The adoption of SFAS 154 is not expected to have a significant impact on the Company's financial position or its results of operations.
In June 2006, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 48, Accounting for Uncertainty in Income taxes ("FIN 48"). FIN 48, which is an interpretation of SFAS No. 109, "Accounting for Income Taxes," provides guidance on the manner in which tax positions taken or to be taken on tax returns should be reflected in an entity's financial statements prior to their resolution with taxing authorities. The Company is required to adopt FIN 48 during the first quarter of fiscal 2008. The Company is currently evaluating the requirements of FIN 48 and has not yet determined the impact, if any; this interpretation may have on its consolidated financial statements.
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RESULTS OF OPERATIONS FOR THE YEAR ENDED JUNE 30, 2006 COMPARED TO THE YEAR ENDED JUNE 30, 2005
We had revenue of $716,107 for the year ended June 30, 2006, compared to revenue of $566,001 for the year ended June 30, 2005, an increase in revenue of $150,106 or 26.5% from the prior period. The increase in revenue for the year ended June 30, 2006, compared to the year ended June 30, 2005, was mainly due to increased fees received from our Host Affiliates in connection with increased fittings due to our national awareness and marketing program, as well as a significant number of re-fittings of existing patients due to such patient's physical growth.
We had total operating expenses of $1,613,442 for the year ended June 30, 2006, compared to total operating expenses of $4,897,329 for the year ended June 30, 2005, a decrease in total operating expenses of $3,283,887 or 67.0% from the previous year. The decrease in total operating expenses was mainly due to the $3,299,352 or 70.61% decrease in selling, general and administrative expenses, which amount included a significant decrease in share-based compensation of $482,360 for the year ended June 30, 2006, from $4,020,265 for the year ended June 30, 2005. Also included in total operating expenses for the year ended June 30, 2006 were depreciation expenses of $20,231 and $16,388 for the year ended June 30, 2005, which was an increase of $3,843 or 23.5% from the prior period.
Additionally, our cost of sales, except for separately stated items increased to $219,272 for the year ended June 30, 2006, compared to $207,650 for the year ended June 30, 2005, an increase of $11,622 or 5.6% from the prior period. Costs of sales increased for the year ended June 30, 2006, compared to the year ended June 30, 2005 due to increased purchases of parts and components during the year ended June 30, 2006 in connection with our increased sales.
Selling, general and administrative expenses as a percentage of revenue for the year ended June 30, 2006 were 191.9%, compared to selling, general and administrative expenses as a percentage of revenue of 825.7% for the year ended June 30, 2005, which represented a decrease in selling, general and administrative expenses as a percentage of revenue of 633.8% from the prior period. This decrease was mainly due to the 26.5% increase in revenue for the year ended June 30, 2006 and the 67.0% decrease in total operating expenses for the year ended June 30, 2006, compared to the year ended June 30, 2005. We expect our selling, general and administrative expenses as a percentage of revenue to initially be higher than future percentages due to early stage startup costs associated with building an administrative infrastructure.
We had a total loss from operations of $857,128 for the year ended June 30, 2006, compared to a total loss from operations of $4,331,328 for the year ended June 30, 2005, a decrease of $3,474,200 or 80.2% from the prior period. The decrease in loss from operations was mainly caused by the $3,537,905 or 88.0% decrease in share-based compensation from the year ended June 30, 2006, compared to the year ended June 30, 2005.
We had total other expense of $3,516,082 for the year ended June 30, 2006, compared to total other expense of $25,191 for the year ended June 30, 2005, which represented an increase in other expenses of $3,490,891 for the year ended June 30, 2006, compared to the year ended June 30, 2005. The increase in net
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other expenses was mainly due to the $3,742,205 increase in change in value of derivative financial instruments in connection with the value of our outstanding Convertible Debentures, and $81,873 of interest expense also in connection with our outstanding Convertible Debentures, which was offset by $310,799 of gain on extinguishment of debt for the year ended June 30, 2006. In November 2005, we entered into a Settlement Agreement and Release with Secured Releases, LLC ("Secured" and the "Release"). Pursuant to the Release, we and Secured agreed to settle our claims against each other in connection with a convertible promissory note issued in February 2001. In connection with the Release, we agreed to pay Secured $30,000, which has been paid to date and we and Secured agreed to release each other, our officers, directors, shareholders, members, agents, employees, representatives and assigns from any and all causes of action, suits, claims, demands, obligations, liabilities, damages of any nature, whatsoever, known or unknown in connection with the promissory note or any other dealings, negotiations or transactions between us and Secured. Under the settlement agreement, we paid $30,000 for the complete discharge of $201,045 of convertible debt and $139,754 of related accrued interest, resulting in a gain on extinguishment of debt of $310,799 for the year ended June 30, 2006.
We had a total net loss of $4,413,417 for the year ended June 30, 2006, compared to a total net loss of $4,356,519 for the year ended June 30, 2005, an increase in net loss of $56,898 or 1.3% from the previous year. The increase in net loss was mainly due to the $3,490,891 or 13,857.7% increase in total other expenses, which was mainly due to the $3,742,205 of change in the value of derivative financial instruments in connection with the fair value of our Convertible Debentures, which expense was not sufficiently offset by our $3,283,887 or 67.0% decrease in total operating expenses and our $150,106 or 26.5% increase in sales for the year ended June 30, 2006, compared to the year ended June 30, 2005.
LIQUIDITY AND CAPITAL RESOURCES
We had total assets of $964,844 as of June 30, 2006, compared with total assets of $235,390 as of June 30, 2005, which represented a $729,454 or 309.9% increase in total assets.
Total assets as of June 30, 2006, included current assets of $666,372 and furniture and equipment, net of accumulated depreciation, of $59,138. Current assets included cash and cash equivalents of $274,641, trade and accounts receivable, net of $268,642, and prepaid expenses and other current assets of $123,089.
We had total liabilities of $5,600,571 as of June 30, 2006, compared to total liabilities of $488,804 at June 30, 2005, representing an increase in total liabilities of $5,111,767 or 1,045.8%.
Total liabilities as of June 30, 2006 included current liabilities of $5,580,712, consisting of trade accounts payable of $143,167; accrued liabilities of $257,680, which included deferred salary payable to our officers; convertible debt of $60,000 which includes the loans entered into in March 2006, as described in greater detail below; amounts due to related party of $500, which amounts were owed to our Chief Executive Officer, Linda Putback-Bean, in connection with the initial funding of our corporate bank account, which amounts have not been repaid to date; and derivative financial instruments of $5,119,365, in connection with our Convertible Debentures and
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Warrants (explained in greater detail below); and non-current liabilities consisting of deferred rent of $12,575 and long term portion of convertible debt of $7,284.
We had a working capital deficit of $4,914,340 and an accumulated deficit of $12,499,329 as of June 30, 2006.
In April 2006, we borrowed $50,000 from a shareholder of the Company, and issued that individual a promissory note and warrants in connection with such loan. The promissory note bears interest at the rate of 12% per annum, and is due and payable on September 29, 2006. The promissory note was renewed for an additional six months, at the option of the holder, through March 2007. The shareholder has the option to convert this loan into 1,428,571 shares of our common stock at the rate of one share for each $0.035 then owed. The shareholder also has 1,428,571 outstanding warrants to purchase shares of our common stock at an exercise price of $0.045 per share, which warrants expire if unexercised on May 22, 2008.
On March 1, 2006, and March 21, 2006, we entered into two separate loans for $17,500, with two separate shareholders to provide us with an aggregate of $35,000 in funding. The loans bear interest at the rate of 12% per annum, and are due sixty (60) days from the date of issuance. Both loans have been extended through November of 2006. The loans are convertible into an aggregate of 1,000,000 shares of our common stock at the rate of one share for each $0.035 owed.
We had total net cash used by operating activities of $436,226 for the year ended June 30, 2006, which was mainly due to $4,413,417 of net loss; $310,799 of gain on extinguishment of debt; and $231,116 of changes in accounts receivable offset by $3,742,205 in change in value of the derivative financial instruments, and $482,360 of stock-based compensation, which included 10,000,000 shares of common stock issued to consultants for services in connection with such consultants making families of limb loss patients aware of the Company's services, of which 2,000,000 shares were subsequently cancelled by a consultant in connection with such consultant's notice to the Company that he would not be able to spend as much time on the Company's marketing campaign as previously anticipated.
We had net cash used in investing activities of $951 for the year ended June 30, 2006, which was used solely in connection with the purchase of furniture and equipment.
We had net cash provided by financing activities of $682,000 for the year ended June 30, 2006, which included $220,000 of proceeds from the sale of 4,700,000 shares of common stock to certain individuals for aggregate consideration of $220,000 and proceeds from convertible debt of $685,000 in connection with the sale of the Convertible Debentures and certain other of our convertible loans during the year ended June 30, 2006, offset by $30,000 of payment in settlement of convertible debt in connection with the Release, described above and $193,000 in payment of debt origination costs in connection with closing costs and finders fees in connection with our Convertible Debentures.
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In April 2006, we borrowed $50,000 from a shareholder of the Company, and issued that individual a promissory note and warrants in connection with such loan. The promissory note bears interest at the rate of 12% per annum, and is due and payable on September 29, 2006. The promissory note was renewed for an additional six months, at the option of the holder, through March 2007.
In May 2006, we entered into a Securities Purchase Agreement with certain third parties to provide us $1,500,000 in convertible debt financing (the "Purchase Agreement"). Pursuant to the Purchase Agreement, we agreed to sell the investors an aggregate of $1,500,000 in Convertible Debentures, which are to be payable in three tranches, $600,000 upon signing the definitive agreements on May 30, 2006, which are due May 30, 2009, $400,000 upon the filing of a registration statement to register shares of common stock which the Convertible Debentures are convertible into as well as the shares of common stock issuable in connection with the Warrants (defined and described in greater detail above), and $500,000 upon the effectiveness of such registration statement. The Convertible Debentures are to be convertible into shares of our common stock at a discount to the then trading value of our common stock. Additionally, in connection with the Securities Purchase Agreement, we agreed to issue the third parties warrants to purchase an aggregate of 50,000,000 shares of our common stock at an exercise price of $0.10 per share (the "Warrants").
We have historically been dependent upon the sale of common stock for funding our operations. In connection with such funding, we issued 4,700,000 shares of common stock at prices ranging from $0.035 to $0.05 per share during the year ended June 30, 2006, for aggregate net proceeds of $220,000. Additionally, we issued 8,696,437 shares of common stock to consultants ranging from $0.08 and $0.11 per share during the year ended June 30, 2006 and recognized compensation expense of $482,360.
As of October 2006, we believe we can operate for approximately twelve (12) months due to the $600,000 (less closing costs and finders fees), we received upon the sale of certain Convertible Debentures on May 30, 2006, described above based on our current approximate overhead of $54,000 per month, and monthly gross profits of approximately $50,000 per month we receive in connection with fittings of our prosthetic limbs. We were also able to increase our yearly advertising and marketing budget approximately five fold, for the fiscal year ending June 30, 2006, compared to the fiscal year ending June 30, 2005, by utilizing $250,000 from both the first tranche of the funding, as well as our working capital. We also anticipate receiving approximately $900,000 in subsequent tranches in connection with such funding, which we believe will allow us to increase our monthly sales and gross profits substantially over the next fiscal year, due to our increased advertising and marketing of our services, explained above. However, investors should keep in mind that any amounts of funding we receive pursuant to the Convertible Debentures will be reduced by fees paid to the lending source and legal and accounting costs associated with our need to file and obtain effectiveness of a Form SB-2 Registration Statement
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to register the Debentures convertible into common stock in connection with the sale of a Convertible Secured Term Note and the shares issuable in connection with the exercise of Warrants.
Other than the funding transaction described above, no additional financing has been secured. The Company has no commitments from officers, directors or affiliates to provide funding. However, management does not see the need for any additional financing in the foreseeable future, other than the money the Company will receive from the sale of the Debentures. We currently anticipate that our operations will continue to grow as a result of our increased advertising and marketing expenditures, which has allowed a greater number of potential clients to become aware of our operations and services, as we have already seen a higher volume of sales due to such advertising over the past several months.
RISK FACTORS
You should carefully consider the following risk factors and other information in this annual report on Form 10-KSB before deciding to become a holder of our Common Stock. If any of the following risks actually occur, our business and financial results could be negatively affected to a significant extent. Our business and the value of our common stock are subject to the following Risk Factors:
WE HAVE EXPERIENCED SUBSTANTIAL OPERATING LOSSES AND MAY INCUR ADDITIONAL OPERATING LOSSES IN THE FUTURE.
During the fiscal years ended June 30, 2006 and 2005, we incurred net losses of $4,413,417 and $4,356,519, respectively, and experienced negative cash flows from operations of $436,226 and $298,454, respectively. Our losses are related to three primary factors as follows: 1) we are not currently generating sufficient revenue to cover our fixed costs and we believe that the break-even point from a cash flow standpoint may require that we fit as many as 100 clients, up from 79 fitted in fiscal 2006; 2) we have issued a significant number of our shares of common stock to compensate employees and consultants and those stock issuances have resulted in charges to income of $482,360 and $4,020,264 during the years ended June 30, 2006 and 2005, costs that we believe will not be recurring in future periods. In the event we are unable to increase our gross margins, reduce our costs and/or generate sufficient additional revenues, we may continue to sustain losses and our business plan and financial condition will be materially and adversely affected.
WE WILL NEED ADDITIONAL FINANCING TO REPAY THE $1,500,000 IN CONVERTIBLE DEBENTURES WHICH WE AGREED TO SELL IN MAY 2006, AND GROW OUR OPERATIONS.
We have limited financial resources. In May 2006, we sold certain third party investors an aggregate of $600,000 in Convertible Debentures with 3 year terms, and agreed to sell them an additional $900,000 in Convertible Debentures. These Convertible Debentures and interest may be converted into shares of our common stock at a discount to market. However, if such Convertible Debentures are not converted into shares of our common stock, we will need to obtain outside
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financing to fund our business operations and to repay the Convertible Debentures. If we are forced to raise additional debt or equity financing, such financing may be dilutive to our shareholders. The sale of equity securities, including the conversion of outstanding amounts under the Convertible . . .
