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ULURU INC. 10-Q 2013

Documents found in this filing:

  1. 10-Q
  2. Ex-10.1
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32.1
  6. Ex-32.2
  7.  
form10q_093013.htm


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the quarterly period ended:September 30, 2013

OR

[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the transition period from: ___ to ___.

Commission File Number: 001-336180

ULURU Inc.
(Exact Name of Registrant as Specified in its Charter)

Nevada
41-2118656
(State or Other Jurisdiction of
(I.R.S. Employer Identification No.)
Incorporation or Organization)
 

4452 Beltway Drive
Addison, Texas
75001
(Address of Principal Executive Offices)
(Zip Code)

(214) 905-5145
Registrant's Telephone Number, including Area Code

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
    Yes  þ    No  o

Indicate by check mark 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 accelerate filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer o
Accelerated filer o
Non-accelerated filer o
Smaller reporting company þ


Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  þ

As of November 14, 2013, there were 18,444,893 shares of the registrant’s Common Stock, $0.001 par value per share, and nil shares of Series A Preferred Stock, $0.001 par value per share, issued and outstanding.

 
 

 



INDEX TO FORM 10-Q

For the Quarter Ended SEPTEMBER 30, 2013

   
Page
 
     
     
 
 
 
 
     
     
     
     
 
     
     
     
     
     
     
     
     
 
     
     
     
     





Financial Statements.
 
CONDENSED CONSOLIDATED BALANCE SHEETS

   
September 30, 2013
   
December 31, 2012
 
   
(Unaudited)
   
(Audited)
 
ASSETS
           
Current Assets
           
Cash and cash equivalents
  $ 53,001     $ 21,549  
Accounts receivable, net
    216,427       111,898  
Notes receivable and accrued interest, current portion
    488,043       260,444  
Inventory
    487,984       527,643  
Prepaid expenses and deferred charges
    130,996       194,448  
Total Current Assets
    1,376,451       1,115,982  
                 
Property, Equipment and Leasehold Improvements, net
    690,718       845,535  
                 
Other Assets
               
Intangible assets, net
    3,790,600       4,145,985  
Notes receivable and accrued interest, net of current portion
    275,611       1,041,776  
Investment in unconsolidated subsidiary
    ---       ---  
Deferred financing costs, net
    104,929       160,770  
Deposits
    18,069       18,069  
Total Other Assets
    4,189,209       5,366,600  
                 
TOTAL ASSETS
  $ 6,256,378     $ 7,328,117  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Current Liabilities
               
Accounts payable
  $ 1,703,381     $ 2,340,782  
Accrued liabilities
    343,327       372,965  
Accrued interest
    33,983       41,141  
Convertible notes payable, net of unamortized debt discount, current portion
    1,281,445       1,089,619  
Deferred revenue, current portion
    58,959       45,227  
Total Current Liabilities
    3,421,095       3,889,734  
                 
Long Term Liabilities
               
Convertible notes payable, net of unamortized debt discount and current portion
    45,688       751,543  
Deferred revenue, net of current portion
    912,994       835,553  
Total Long Term Liabilities
    958,682       1,587,096  
                 
TOTAL LIABILITIES
    4,379,777       5,476,830  
                 
COMMITMENTS AND CONTINGENCIES
    ---       ---  
                 
STOCKHOLDERS' EQUITY
               
Preferred stock - $0.001 par value; 20,000 shares authorized;
               
Preferred Stock Series A, 1,000 shares designated; nil and 65 shares issued and outstanding, aggregate liquidation value of nil and $701,843, at September 30, 2013 and December 31, 2012, respectively
    ---       ---  
                 
Common Stock - $0.001 par value; 200,000,000 shares authorized;
               
16,693,883 and 10,074,448 shares issued and outstanding at September 30, 2013 and December 31, 2012, respectively
    16,694       10,075  
Additional paid-in capital
    52,623,219       51,336,931  
Promissory notes receivable and accrued interest for common stock issuance
    ---       (985,287 )
Accumulated  (deficit)
    (50,763,312 )     (48,510,432 )
TOTAL STOCKHOLDERS’ EQUITY
    1,876,601       1,851,287  
                 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $ 6,256,378     $ 7,328,117  
                 
The accompanying notes are an integral part of these condensed consolidated financial statements.
 





CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)


   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2013
   
2012
   
2013
   
2012
 
Revenues
                       
License fees
  $ 11,400     $ 11,400     $ 33,827     $ 29,163  
Royalty income
    10,276       16,633       10,276       49,918  
Product sales, net
    88,904       60,889       197,405       126,057  
Total Revenues
    110,580       88,922       241,508       205,138  
                                 
Costs and Expenses
                               
Cost of goods sold
    60,245       113,415       104,236       135,745  
Research and development
    201,244       152,985       577,712       517,196  
Selling, general and administrative
    302,093       375,767       914,509       1,365,836  
Amortization of intangible assets
    119,763       119,763       355,385       356,687  
Depreciation
    59,688       75,219       185,536       225,691  
Total Costs and Expenses
    743,033       837,149       2,137,378       2,601,155  
Operating (Loss)
    (632,453 )     (748,227 )     (1,895,870 )     (2,396,017 )
                                 
Other Income (Expense)
                               
Interest and miscellaneous income
    15,088       30,720       55,564       33,745  
Interest expense
    (125,904 )     (134,218 )     (385,965 )     (191,008 )
Equity in earnings (loss) of unconsolidated subsidiary
    ---       ---       ---       ---  
Gain on sale of equipment
    ---       ---       3,627       ---  
(Loss) Before Income Taxes
    (743,269 )     (851,725 )     (2,222,644 )     (2,553,280 )
                                 
Income taxes
    ---       ---       ---       ---  
Net (Loss)
  $ (743,269 )   $ (851,725 )   $ (2,222,644 )   $ (2,553,280 )
                                 
Less preferred stock dividends
    (6,061 )     (12,288 )     (30,236 )     (35,168 )
Net (Loss) Allocable to Common Stockholders
  $ (749,330 )   $ (864,013 )   $ (2,252,880 )   $ (2,588,448 )
                                 
                                 
Basic and diluted net (loss) per common share
  $ (0.05 )   $ (0.10 )   $ (0.16 )   $ (0.32 )
                                 
Weighted average number of common shares outstanding
    15,659,822       8,267,755       13,677,186       8,106,117  
                                 
The accompanying notes are an integral part of these consolidated financial statements.
 





CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

   
Nine Months Ended September 30,
 
   
2013
   
2012
 
OPERATING ACTIVITIES :
           
Net loss
  $ (2,222,644 )   $ (2,553,280 )
                 
Adjustments to reconcile net loss to net cash used in operating activities:
               
                 
Amortization of intangible assets
    355,385       356,687  
Depreciation
    185,536       225,691  
Share-based compensation for stock and options issued to employees
    10,933       16,494  
Share-based compensation for options issued to non-employees
    45,910       21,745  
Equity in earnings (loss) of unconsolidated subsidiary
    ---       ---  
Amortization of debt discount on convertible note
    134,052       53,029  
Amortization of deferred financing costs
    55,841       20,151  
Cancellation of warrants issued for services
    (48,776 )     ---  
Common stock issued for services
    158,250       130,000  
Common stock issued for wages
    20,000       ---  
Common stock issued for interest due on convertible note
    101,917       44,200  
Gain on sale of equipment
    (3,627 )     ---  
                 
Change in operating assets and liabilities:
               
Accounts receivable
    (104,529 )     (6,621 )
Other receivable
    ---       26,410  
Inventory
    39,659       152,243  
Prepaid expenses and deferred charges
    63,452       9,232  
Notes receivable and accrued interest
    538,566       (31,997 )
Accounts payable
    (637,401 )     353,346  
Accrued liabilities
    (29,638 )     26,114  
Accrued interest
    (7,158 )     23,027  
Deferred revenue
    91,173       195,837  
Total
    969,545       1,615,588  
                 
Net Cash Used in Operating Activities
    (1,253,099 )     (937,692 )
                 
INVESTING ACTIVITIES :
               
Purchase of equipment
    (32,030 )     (64,349 )
Proceeds from sale of equipment
    4,937       ---  
Proceeds from sale of intangible asset
    ---       220,000  
Net Cash  (Used in) Provided by Investing Activities
    (27,093 )     155,651  
                 
FINANCING ACTIVITIES :
               
Proceeds from sale of common stock and warrants, net
    1,391,446       ---  
Proceeds from sale of preferred stock, net
    ---       275,761  
Proceeds from redemption of preferred stock, net
    1,864       ---  
Proceeds from issuance of convertible note and warrants, net
    ---       467,290  
Repayment of principle due on convertible note
    (81,666 )     ---  
Offering cost adjustment – preferred stock sale in 2011
    ---       28,927  
Net Cash Provided by Financing Activities
    1,311,644       771,978  
                 
Net Increase (Decrease) in Cash
    31,452       (10,063 )
                 
Cash,  beginning of period
    21,549       46,620  
Cash,  end of period
  $ 53,001     $ 36,557  
                 
SUPPLEMENTAL CASH FLOW DISCLOSURE:
               
Cash paid for interest
  $ 33,544     $ 3,747  
                 
Non-cash investing and financing activities:
               
Issuance of common stock for promissory note
  $ ---     $ 245,818  
Issuance of common stock for principle due on convertible note
  $ 566,414     $ 39,133  
Issuance of 469,094 shares of common stock pursuant to cashless exercise of warrants to purchase 479,459 shares of common stock
  $ ---          
Redemption of 65 shares of Series A preferred stock by offset of promissory notes receivable ($969,000) and accrued interest thereon.
  $ ---          
                 
The accompanying notes are an integral part of these condensed consolidated financial statements.
 






NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


NOTE 1.
COMPANY OVERVIEW AND BASIS OF PRESENTATION

Company Overview

ULURU Inc. (hereinafter “we”, “our”, “us”, “ULURU”, or the “Company”) is a Nevada corporation.  We are a diversified specialty pharmaceutical company committed to developing and commercializing a broad range of innovative wound care and muco-adhesive film products based on our patented Nanoflex® and OraDiscTM drug delivery technologies, with the goal of improving outcomes for patients, health care professionals, and health care payers.

Basis of Presentation

In the opinion of management, the accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and include the accounts of ULURU Inc., a Nevada corporation, and its wholly-owned subsidiary, Uluru Delaware Inc., a Delaware corporation.  They do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the Company’s financial position as of September 30, 2013 and the results of its operations for the three and nine months ended September 30, 2013 and 2012 and cash flows for the nine months ended September 30, 2013 and 2012 have been made.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, as well as disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods.  Actual results may differ from those estimates and assumptions.  These differences are usually minor and are included in our consolidated financial statements as soon as they are known.  Our estimates, judgments, and assumptions are continually evaluated based on available information and experience. Because of the use of estimates inherent in the financial reporting process, actual results could differ from those estimates.

All intercompany transactions and balances have been eliminated in consolidation.

Operating results for the three and nine months ended September 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013.

These condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, as filed with the Securities and Exchange Commission on March 29, 2013, including the risk factors set forth therein.



NOTE 2.
SIGNIFICANT ACCOUNTING POLICIES

The significant accounting policies used in preparation of these condensed consolidated financial statements for the three and nine months ended September 30, 2013 are consistent with those discussed in Note 2 to the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2012, as filed with the Securities and Exchange Commission on March 29, 2013.

NOTE 3.
THE EFFECT OF RECENTLY ISSUED ACCOUNTING STANDARDS

In September 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-08, “Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment” (“ASU 2011-08”). ASU 2011-08 updated guidance on the periodic testing of goodwill for impairment. This guidance will allow companies to assess qualitative factors to determine if it is more-likely-than-not that goodwill might be impaired and whether it is necessary to perform the two-step goodwill impairment test required under current accounting standards. This new guidance is effective for fiscal years beginning after December 15, 2011; however, early adoption is permitted in certain circumstances.  We adopted the provisions of ASU 2011-08 in the first quarter of 2012.  The adoption of this update does not materially impact our financial statements.

In June 2011, the FASB issued Accounting Standards Update No. 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income” (“ASU 2011-05”). ASU 2011-05 amended existing guidance by allowing only two options for presenting the components of net income and other comprehensive income: (1) in a single continuous financial statement of comprehensive income or (2) in two separate but consecutive financial statements, consisting of an income statement followed by a separate statement of other comprehensive income. Also, items that are reclassified from other comprehensive income to net income must be presented on the face of the financial statements. ASU No. 2011-05 requires retrospective application, and it is effective for fiscal years beginning after December 15, 2011.  We adopted the provisions of ASU 2011-05 in the first quarter of 2012.  The adoption of this update does not materially impact our financial statements.

In May 2011, the FASB issued Accounting Standards Update No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (“ASU 2011-04”). ASU 2011-04 generally provides a uniform framework for fair value measurements and related disclosures between U.S. generally accepted accounting principles and International Financial Reporting Standards. Additional disclosure requirements in the update include: (1) for Level 3 fair value measurements, quantitative information about unobservable inputs used, a description of the valuation processes used by the entity, and a qualitative discussion about the sensitivity of the measurements to changes in the unobservable inputs; (2) for an entity’s use of a nonfinancial asset that is different from the asset’s highest and best use, the reason for the difference; (3) for financial instruments not measured at fair value but for which disclosure of fair value is required, the fair value hierarchy level in which the fair value measurements were determined; and (4) the disclosure of all transfers between Level 1 and Level 2 of the fair value hierarchy. ASU 2011-04 was effective for interim and annual periods beginning on or after December 15, 2011. We adopted the provisions of ASU 2011-04 in the first quarter of 2012.  The adoption of this update does not materially impact our financial statements.

There are no other new accounting pronouncements adopted or enacted during the nine months ended September 30, 2013 that had, or are expected to have, a material impact on our financial statements.



NOTE 4.
SEGMENT INFORMATION

We operate in one business segment: the research, development and commercialization of pharmaceutical products.  Our corporate headquarters in the United States collects product sales, licensing fees, royalties, and sponsored research revenues from our arrangements with external customers and licensees.  Our entire business is managed by a single management team, which reports to the Chief Executive Officer.

Our revenues are currently derived primarily from five licensees for international activities and our domestic sales activities of Altrazeal®.

Revenues per geographic area, along with relative percentages of total revenues, for the three and nine months ended September 30 are summarized as follows:

   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
Revenues
 
2013
   
%
   
2012
   
%
   
2013
   
%
   
2012
   
%
 
Domestic
  $ 17,197       16 %   $ 57,179       64 %   $ 54,594       23 %   $ 155,633       76 %
International
    93,383       84 %     31,743       36 %     186,914       77 %     49,505       24 %
  Total
  $ 110,580       100 %   $ 88,922       100 %   $ 241,508       100 %   $ 205,138       100 %

A significant portion of our revenues are derived from a few major customers.  Customers with greater than 10% of total sales, along with their relative percentage of all sales, for the three and nine months ended September 30 are represented on the following table:

     
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
Customers
Product
 
2013
   
2012
   
2013
   
2012
 
Customer A
Altrazeal®
    70 %     29 %     66 %     15 %
Customer B
Aphthasol®
    ---       19 %     ---       24 %
  Total
      70 %     48 %     66 %     39 %


NOTE 5.
NOTES RECEIVABLE

On June 27, 2012, we entered into a Securities Purchase Agreement related to our issuance of a $2,210,000 Secured Convertible Note (the “June 2012 Note”), with Inter-Mountain Capital Corp., a Delaware corporation (“Inter-Mountain”).  As part of the June 2012 Note transaction, we received $1,500,000 in the form of six promissory notes in favor of the Company, each in the principal amount of $250,000 (the “Investor Notes”) and each of which becomes due as the outstanding balance under the June 2012 Note is reduced to certain levels.  On October 5, 2012, we and Inter-Mountain entered into a First Amendment to Buyer Trust Deed Note #1 (the “Trust Deed Note Amendment”) for the purpose of revising certain terms and conditions contained in the Buyer Trust Deed Note #1, to include receiving payments of $100,000, $100,000, and $50,000 on October 5, 2012, November 30, 2012, and December 31, 2012, respectively, and any interest thereon.

As of September 30, 2013, we had $763,654 in notes receivable which is comprised of $687,500 for three Investor Notes and $76,154 for accrued interest thereon.

Please refer to Note 11 for a more detailed description of the June 2012 Note transaction.




NOTE 6.
INVENTORY

As of September 30, 2013, our inventory was comprised of Altrazeal® finished goods, manufacturing costs incurred in the production of Altrazeal®, and raw materials.  Inventories are stated at the lower of cost (first in, first out method) or market.  We regularly review inventories on hand and write down the carrying value of our inventories for excess and potentially obsolete inventories based on historical usage and estimated future usage.  In assessing the ultimate realization of our inventories, we are required to make judgments as to future demand requirements.  As actual future demand or market conditions may vary from those projected by us, adjustment to inventories may be required.

The components of inventory, at the different stages of production, consisted of the following at September 30, 2013 and December 31, 2012:

Inventory
 
September 30, 2013
   
December 31, 2012
 
  Finished goods
  $ 109,452     $ 303,779  
  Work-in-progress
    346,163       190,794  
  Raw materials
    32,369       33,070  
  Total
  $ 487,984     $ 527,643  


NOTE 7.
PROPERTY, EQUIPMENT and LEASEHOLD IMPROVEMENTS

Property, equipment and leasehold improvements, net, consisted of the following at September 30, 2013 and December 31, 2012:

Property, equipment and leasehold improvements
 
September 30, 2013
   
December 31, 2012
 
  Laboratory equipment
  $ 424,888     $ 424,888  
  Manufacturing equipment
    1,574,665       1,547,572  
  Computers, office equipment, and furniture
    140,360       140,360  
  Computer software
    4,108       4,108  
  Leasehold improvements
    95,841       95,841  
      2,239,862       2,212,769  
  Less: accumulated depreciation and amortization
    ( 1,549,144 )     (1,367,234 )
  Property, equipment and leasehold improvements, net
  $ 690,718     $ 845,535  

Depreciation expense on property, equipment and leasehold improvements was $59,688 and $75,219 for the three months ended September 30, 2013 and 2012, respectively, and was $185,536 and $225,691 for the nine months ended September 30, 2013 and 2012, respectively.





NOTE 8.
INTANGIBLE ASSETS

Intangible assets are comprised of patents acquired in October, 2005.  Intangible assets, net consisted of the following at September 30, 2013 and December 31, 2012:

Intangible assets
 
September 30, 2013
   
December 31, 2012
 
  Patent - Amlexanox (Aphthasol®)
  $ 2,090,000     $ 2,090,000  
  Patent - Amlexanox (OraDisc™ A)
    6,873,080       6,873,080  
  Patent - OraDisc™
    73,000       73,000  
  Patent - Hydrogel nanoparticle aggregate
    589,858       589,858  
      9,625,938       9,625,938  
  Less: accumulated amortization
    ( 5,835,338 )     (5,479,953 )
  Intangible assets, net
  $ 3,790,600     $ 4,145,985  

Amortization expense for intangible assets was $119,763 and $119,763 for the three months ended September 30, 2013 and 2012, respectively, and was $355,385 and $356,687 for the nine months ended September 30, 2013 and 2012, respectively.

The future aggregate amortization expense for intangible assets, remaining as of September 30, 2013, is as follows:
Calendar Years
 
Future Amortization
Expense
 
  2013 (Three months)
  $ 119,763  
  2014
    475,148  
  2015
    475,148  
  2016
    476,450  
  2017
    475,148  
  2018 & Beyond
    1,768,943  
  Total
  $ 3,790,600  


 
- 10 -




NOTE 9.
INVESTMENTS IN UNCONSOLIDATED ENTITIES

We use the equity method of accounting for investments in other companies that are not controlled by us and in which our interest is generally between 20% and 50% of the voting shares or we have significant influence over the entity, or both.

On January 11, 2012, we executed a shareholders’ agreement for the establishment of Altrazeal Trading Ltd., a single purpose entity to be used for the exclusive marketing of Altrazeal® throughout the European Union, Australia, New Zealand, North Africa, and the Middle East.  As a result of this transaction, we received a non-dilutable 25% ownership interest in Altrazeal Trading Ltd.

For the three and nine months ended September 30, 2013, the financial statements of Altrazeal Trading Ltd. were unavailable and our share of any gains or losses of Altrazeal Trading Ltd. for such periods have not been recorded in our financial statements.  The financial activity of Altrazeal Trading Ltd. for the three months and nine months ended September 30, 2013 would not have a material impact on our financial statements.

Based upon unaudited financial statements provided by Altrazeal Trading Ltd. for the year ended December 31, 2012, our share of Altrazeal Trading Ltd. losses exceeded the carrying value of our investment, therefore the equity method of accounting was suspended and no additional losses were charged to our operations.  Our unrecorded share of Altrazeal Trading Ltd. losses for the year ended December 31, 2012 totaled $82,740.

Summarized financial information for our investment in Altrazeal Trading Ltd. assuming 100% ownership is as follows:

Altrazeal Trading Ltd.
 
December 31, 2012
 
Balance sheet
     
Total assets
  $ 415,248  
Total liabilities
  $ 205,991  
Total stockholders’ equity
  $ 209,257  
Statement of operations
       
Revenues
  $ 131,869  
Net (loss)
  $ (330,961 )

On October 19, 2012, we executed a shareholders’ agreement for the establishment of ORADISC GmbH, a single purpose entity to be used for the exclusive development and marketing of OraDisc™ erodible film technology products.  We received a non-dilutable 25% ownership interest in ORADISC GmbH.

As of September 30, 2013, ORADISC GmbH had not begun operations and accordingly the net book value of the investee assets had not been determined and there were no equity method investee gains or losses for the three and nine months ended September 30, 2013.

 
- 11 -



NOTE 10.
ACCRUED LIABILITIES

Accrued liabilities consisted of the following at September 30, 2013 and December 31, 2012:

Accrued Liabilities
 
September 30, 2013
   
December 31, 2012
 
  Accrued taxes – payroll
  $ 106,299     $ 106,299  
  Accrued compensation/benefits
    192,556       213,005  
  Accrued insurance payable
    43,894       52,629  
  Product rebates/returns
    20       81  
  Other
    558       951  
  Total accrued liabilities
  $ 343,327     $ 372,965  


NOTE 11.
CONVERTIBLE DEBT

On June 27, 2012, we entered into a Securities Purchase Agreement (the “Purchase Agreement”), related to our issuance of a $2,210,000 Secured Convertible Note, with Inter-Mountain Capital Corp., a Delaware corporation (“Inter-Mountain”).  The purchase price for the June 2012 Note was paid $500,000 at closing in cash and $1,500,000 in the form of six promissory notes in favor of the Company, each in the principal amount of $250,000 (the “Investor Notes”), each of which bears interest at the rate of 8.0% per annum, and each of which becomes due as the outstanding balance under the June 2012 Note is reduced to certain levels.  The purchase price of the June 2012 Note also reflected a $200,000 original issue discount and $10,000 in attorney’s fees. The Purchase Agreement also includes representations and warranties, restrictive covenants, and indemnification provisions standard for similar transactions.

The June 2012 Note bears interest at the rate of 8.0% per annum, with monthly installment payments of $83,333 commencing on the date that is the earlier of (i) thirty calendar days after the effective date of a registration statement registering the re-sale of the shares issuable upon conversion under the June 2012 Note or (ii) December 24, 2012, but in no event sooner than September 25, 2012.  At our option, subject to certain volume, price, and other conditions, the monthly installment payments on the June 2012 Note may be paid in whole, or in part, in cash or in our common stock.  If the monthly installment is paid in common stock, such shares being issued will be based on a price that is 80% of the average of the three lowest volume weighted average prices of the shares of common stock during the preceding twenty trading days.  The percentage declines to 70% if the average of the three lowest volume weighted average prices of the shares of common stock during the preceding twenty trading days is less than $0.05.

At the option of Inter-Mountain, the outstanding principal balance of the June 2012 Note may be converted into shares of our common stock at a conversion price of $0.35 per share, subject to certain pricing adjustments and ownership limitations.  The initial tranche was $710,000 and the six subsequent tranches are each $250,000, plus interest.  At our option, the outstanding principal balance of the June 2012 Note, or a portion thereof, may be prepaid in cash at 120% of the amount elected to be prepaid.  The June 2012 Note is secured by a Security Agreement pursuant to which we granted to Inter-Mountain a first-priority security interest in the assets held by the Company.

 
- 12 -



Events of default under the June 2012 Note include failure to make required payments or to deliver shares upon conversion, the entry of a $100,000 judgment not stayed within 30 days, breach of representations or covenants under the transaction documents, various events associated with insolvency or failure to pay debts, delisting of our common stock, a restatement of financial statements, and a default under certain other agreements.  In the event of default, the interest rate under the June 2012 Note increases to 18% and the June 2012 Note becomes callable at a premium.  In addition, the holder has all remedies under law and equity, including foreclosing on our assets under a Security Agreement with Inter-Mountain.

As part of the convertible debt financing, Inter-Mountain also received a total of seven warrants (the “Warrants”) to purchase, if they all vest, an aggregate of 3,142,857 shares of common stock, which number of shares could increase based upon the terms and conditions of the Warrants.  The Warrants have an exercise price of $0.35 per share, subject to certain pricing adjustments, and are exercisable, subject to vesting provisions and ownership limitations, until June 27, 2017.  Warrants for 785,714, 392,857, 392,857, and 392,857 shares of common stock vested on June 27, 2012, December 31, 2012, February 26, 2013, and July 15, 2013, respectively.  Each of the three remaining Warrants will vest upon the payment by the holder of each of the remaining three Investor Notes.  For the three months ended September 30, 2013, we issued 469,094 shares of common stock to Inter-Mountain for the cashless exercise of warrants to purchase 479,459 shares of common stock.

As part of the convertible debt financing, we entered into a Registration Rights Agreement whereby we agreed to prepare and file with the SEC a registration statement for the number of shares referred to therein no later than July 27, 2012 and to cause such registration statement to be declared effective no later than ninety days after such filing with the SEC and to keep such registration statement effective for a period of no less than one hundred and eighty days.  The Registration Rights Agreement also grants Inter-Mountain piggy-back registration rights with respect to future offerings by the Company.  In accordance with our obligations under the Registration Rights Agreement, we filed with the SEC a registration statement that was declared effective on July 31, 2012.

On October 5, 2012, we and Inter-Mountain entered into a First Amendment to Buyer Trust Deed Note #1 for the purpose of revising certain terms and conditions contained in the Buyer Trust Deed Note #1, to include an updated schedule for the timing of certain payment obligations by Inter-Mountain contained therein.

 
- 13 -




On July 28, 2011, we completed a convertible debt financing for $125,000 with Mr. Kerry P. Gray, the Company’s Chairman, President, and Chief Executive Officer (the “July 2011 Note”).  The July 2011 Note bears interest at the rate of 10.0% per annum, with annual payments of interest commencing on July 1, 2012.  The full amount of principal and any unpaid interest will be due on July 28, 2014.  The outstanding principal balance of the July 2011 Note may be converted into shares of the Company’s common stock, at the option of the note holder and at any time, at a conversion price of $1.08 per share or 115,741 shares of common stock.  We may force conversion of the July 2011 Note if our common stock trades for a defined period of time at a price greater than $2.16.  The July 2011 Note is collateralized by the grant of a security interest in the inventory, accounts receivables and capital equipment held by the Company.  The securities issuable on conversion have not been registered under the Securities Act of 1933 and may not be sold absent registration or an applicable exemption from the registration requirements.  As part of the convertible debt financing, Mr. Gray also received a warrant to purchase up to 34,722 shares of the Company’s common stock.  The warrant has an exercise price of $1.08 per share and is exercisable at any time until July 28, 2016.

On July 3, 2012, the Company and Mr. Gray entered into a Modification Agreement for the purpose of deferring the annual payment of interest due on July 1, 2012 of $11,542 until such time as Mr. Gray provides written notice to us with such notice being no less than 15 days prior to the relevant payment date.  Moreover, the parties agreed that no Event of Default under the July 2011 Note occurred as a result of any failure by us to make the annual payment of interest due on July 1, 2012.  Commencing on July 1, 2012, interest at the rate of 12.0% per annum accrued on the deferred interest payment of $11,542 until the relevant payment date.  On September 5, 2013, we remitted to Mr. Gray the annual interest due on July 1, 2012 of $11,542 and accrued interest thereon of $1,643.

On July 1, 2013, the Company and Mr. Gray entered into a Modification Agreement for the purpose of deferring the annual payment of interest due on July 1, 2013 of $12,501 until such time as Mr. Gray provides written notice to us with such notice being no less than 15 days prior to the relevant payment date.  Moreover, the parties agreed that no Event of Default under the July 2011 Note occurred as a result of any failure by us to make the annual payment of interest due on July 1, 2013.  Commencing on July 1, 2013, interest at the rate of 12.0% per annum accrued on the deferred interest payment of $12,501 until the relevant payment date.  On October 28, 2013, we remitted to Mr. Gray the annual interest due on July 1, 2013 of $12,501 and accrued interest thereon of $492.




 
- 14 -



On June 13, 2011, we completed a $140,000 convertible debt financing with Mr. Gray (the “June 2011 Note”).  The June 2011 Note bears interest at the rate of 10% per annum, with annual payments of interest commencing on July 1, 2012.  The full amount of principal and any unpaid interest will be due on June 13, 2014.  The outstanding principal balance of the June 2011 Note may be converted into shares of the Company’s common stock, at the option of the note holder and at any time, at a conversion price of $1.20 per share or 116,667 shares of common stock.  We may force conversion of the convertible note if our common stock trades for a defined period of time at a price greater than $1.80.  The June 2011 Note is collateralized by the grant of a security interest in the inventory, accounts receivables, and capital equipment held by the Company.  The securities issuable on conversion have not been registered under the Securities Act of 1933 and may not be sold absent registration or an applicable exemption from the registration requirements.  As part of the convertible debt financing, Mr. Gray also received a warrant to purchase up to 35,000 shares of the Company’s common stock.  The warrant has an exercise price of $1.20 per share and is exercisable at any time until June 13, 2016.

On July 3, 2012, the Company and Mr. Gray entered into a Modification Agreement for the purpose of deferring the annual payment of interest due on July 1, 2012 of $14,653 until such time as Mr. Gray provides written notice to us with such notice being no less than 15 days prior to the relevant payment date.  Moreover, the parties agreed that no Event of Default under the June 2011 Note occurred as a result of any failure by us to make the annual payment of interest due on July 1, 2012.  Commencing on July 1, 2012, interest at the rate of 12.0% per annum accrued on the deferred interest payment of $14,653 until the relevant payment date.  On September 5, 2013, we remitted to Mr. Gray the annual interest due on July 1, 2012 of $14,653 and accrued interest thereon of $2,080.

On July 1, 2013, the Company and Mr. Gray entered into a Modification Agreement for the purpose of deferring the annual payment of interest due on July 1, 2013 of $14,001 until such time as Mr. Gray provides written notice to us with such notice being no less than 15 days prior to the relevant payment date.  Moreover, the parties agreed that no Event of Default under the June 2011 Note occurred as a result of any failure by us to make the annual payment of interest due on July 1, 2013.  Commencing on July 1, 2013, interest at the rate of 12.0% per annum accrued on the deferred interest payment of $14,001 until the relevant payment date.  On October 28, 2013, we remitted to Mr. Gray the annual interest due on July 1, 2013 of $14,001 and accrued interest thereon of $553.




 
- 15 -




We account for convertible debt using specific guidelines in accordance with U.S. GAAP.  We allocated the value of the proceeds received to the convertible instrument and to the warrant on a relative fair value basis.  We calculated the fair value of the warrant issued with the convertible instrument using the Black-Scholes valuation method, using the same assumptions used for valuing employee stock options, except the contractual life of the warrant was used. Using the effective interest method, the allocated fair value was recorded as a debt discount and is being amortized over the expected term of the convertible debt to interest expense.

On the date of issuance of the June 2011 Note, the July 2011 Note, and the June 2012 Note, no portion of the proceeds were attributable to a beneficial conversion feature since the conversion price of the June 2011 Note, the July 2011 Note, and the June 2012 Note exceeded the market price of the Company’s common stock.

Information relating to our convertible notes payable is as follows:
                       
As of September 30, 2013
 
Transaction
 
Initial
 Principal
Amount
   
Interest
Rate
 
Maturity
Date
 
Conversion
Price (1)(2)
   
Principal
Balance
   
Unamortized
Debt
Discount
   
Carrying
Value
 
  June 2011 Note
  $ 140,000       10.0 %
06/13/2014
  $ 1.20     $ 140,000     $ 2,768     $ 137,232  
  July 2011 Note
    125,000       10.0 %
07/28/2014
  $ 1.08       125,000       6,144       118,856  
  June 2012 Note
    2,210,000       8.0 %
03/27/2015
  $ 0.35       1,318,210       247,165       1,071,045  
  Total
  $ 2,475,000                       $ 1,583,210     $ 256,077     $ 1,327,133  

  (1)
The outstanding principal balance of the June 2011 Note and the July 2011 Note may be converted, at the option of Mr. Gray, into shares of common stock at a fixed conversion price of $1.20 per share and $1.08 per share, respectively.
  (2)
The outstanding principal balance of the June 2012 Note may be converted, at the option of Inter-Mountain, into shares of common stock at a conversion price of $0.35 per share, subject to certain pricing adjustments and ownership limitations.

The amount of interest cost recognized from our convertible notes outstanding was $38,032 and $52,121 for the three months ended September 30, 2013 and 2012, respectively, and was $124,677 and $67,227 for the nine months ended September 30, 2013 and 2012, respectively.

The future minimum principle payments relating to our convertible notes payable, as of September 30, 2013, are as follows:

   
Payments Due By Period
 
Transaction
 
Total
   
2013 (Three Months)
   
2014
   
2015
   
2016
   
2017
 
  June 2011 Note
  $ 140,000     $ ---     $ 140,000     $ ---     $ ---     $ ---  
  July 2011 Note
    125,000       ---       125,000       ---       ---       ---  
  June 2012 Note
    1,318,120       441,538       876,582       ---       ---       ---  
  Total
  $ 1,583,120     $ 441,538     $ 1,141,852     $ ---     $ ---     $ ---  


 
- 16 -





NOTE 12.
EQUITY TRANSACTIONS

Common Stock Transactions

On March 14, 2013, we entered into a Securities Purchase Agreement (the “March SPA”) with Kerry P. Gray, the Company’s Chairman, President, and Chief Executive Officer and Terrance K. Wallberg, the Company’s Vice President and Chief Financial Officer (collectively, the “Investors”) relating to an equity investment of $440,000 by the Investors for 1,100,000 shares of our common stock, par value $0.001 per share (the “March Shares”) and warrants to purchase up to 660,000 shares of our common stock (the “March Warrants”) (the “March 2013 Offering”).  Under the March SPA, the purchase and sale of the March Shares and March Warrants will take place at four closings over the next twelve months, with $88,000 being funded at the initial closing under the March SPA, $110,000 being funded on the four-month anniversary of the initial closing, $132,000 being funded on the eight-month anniversary of the initial closing, and $110,000 being funded on the one-year anniversary of the initial closing.  The March Warrants have a fixed exercise price of $0.60 per share, become exercisable in tranches on each of the four funding dates, and expire on the five-year anniversary of the initial closing.  On March 14, 2013, we closed the March 2013 Offering and received the initial funding tranche of $88,000 for the purchase of 220,000 shares of our common stock.  On July 15, 2013, we received the second funding tranche of $110,000 for the purchase of 275,000 shares of our common stock.  On November 14, 2013, we received the third funding tranche of $132,000 for the purchase of 330,000 shares of our common stock.

On December 21, 2012, we entered into a Securities Purchase Agreement (the “SPA”) with IPMD GmbH (“IPMD”) relating to an equity investment of $2,000,000 by IPMD for 5,000,000 shares of our common stock, par value $0.001 per share (the “Shares”) and warrants to purchase up to 3,000,000 shares of our common stock (the “Warrants”) (the “January 2013 Offering”).  Under the SPA, the purchase and sale of the Shares and Warrants will take place at four closings over the next twelve months, with $400,000 being funded at the initial closing under the SPA, $500,000 being funded on the four-month anniversary of the initial closing, $600,000 being funded on the eight-month anniversary of the initial closing, and $500,000 being funded on the one-year anniversary of the initial closing.  The Warrants have a fixed exercise price of $0.60 per share, become exercisable in tranches on each of the four funding dates, and expire on the one-year anniversary of the initial closing.  On January 3, 2013, we closed the January 2013 Offering and received the initial funding tranche of $400,000 for the purchase of 1,000,000 shares of our common stock.  On May 7, 2013, September 6, 2013, and October 24, 2013, we received subsequent funding tranches of $500,000, $300,000, and $300,000 for the purchase of 1,250,000, 750,000, and 750,000 shares of our common stock, respectively.

In the SPA, we also agree to appoint up to two directors nominated by IPMD to serve on our Board of Directors.  On January 17, 2013, the Board of Directors of the Company appointed Helmut Kerschbaumer and Klaus Kuehne to each serve as a director of the Company.  Messrs. Kerschbaumer and Kuehne are the designees of IPMD to serve on the Company’s Board of Directors pursuant to covenants in the SPA with IPMD.


 
- 17 -



NOTE 13.
STOCKHOLDERS’ EQUITY

Common Stock

As of September 30, 2013, we had 16,693,883 shares of common stock issued and outstanding.  We issued 2,236,227 shares of common stock for the three months ended September 30, 2013 comprised of 150,000 shares of common stock issued for consulting services, 750,000 shares of common stock issued to IPMD pursuant to the January 2013 Offering, 275,000 shares of common stock issued to Messrs. Gray and Wallberg pursuant to the March 2013 Offering, 592,133 shares of common stock issued for installment payments due on the June 2012 Note with Inter-Mountain, and 469,094 shares of common stock issued for the cashless exercise of warrants held by Inter-Mountain.

Preferred Stock

As of September 30, 2013, we had no shares of Series A preferred stock issued and outstanding.  For the three months ended September 30, 2013, we did not issue any shares of Series A preferred stock to Ironridge Global pursuant to our agreement related to the purchase of the Series A preferred stock.

On August 15, 2013, we provided notice to Ironridge Global III, LLC (“Ironridge”) for the redemption of all of our Series A Preferred Stock shares (the “Series A Shares”) held by Ironridge, a total of 65 Series A Shares.  An affiliate of Ironridge, the issuer of promissory notes held by us, due 7.5 years from the issue date, in the principal amount of $969,000 (the “Notes”), agreed to accept the cancellation of the Notes held by us as full and final payment for the redemption amounts of the Series A Shares.

Warrants

The following table summarizes the warrants outstanding and the number of shares of common stock subject to exercise as of September 30, 2013 and the changes therein during the nine months then ended:

   
Number of Shares of Common Stock Subject to Exercise
   
Weighted – Average
Exercise Price
 
Balance as of December 31, 2012
    2,041,165     $ 0.98  
Warrants issued
    4,445,714     $ 0.56  
Warrants exercised
    (479,459 )   $ 0.35  
Warrants cancelled
    (250,000 )   $ 0.35  
Balance as of September 30, 2013 (1)
    5,757,420     $ 0.73  

(1)
As part of the June 2012 Note, Inter-Mountain received a total of seven warrants to purchase, if they all vest, an aggregate of 3,142,857 shares of common stock, which number of shares could increase based upon the terms and conditions of the warrants.  The warrants have an exercise price of $0.35 per share, subject to certain pricing adjustments, and are exercisable, subject to vesting provisions and ownership limitations, until June 27, 2017.  Warrants for 785,714, 392,857, 392,857, and 392,857 shares of common stock vested on June 27, 2012, December 31, 2012, February 26, 2013, and July 15, 2013, respectively, and warrants for 479,459 shares of common stock have been exercised.  For the purposes of this Table, only such net vested shares of common stock (1,484,826 shares) have been included, based upon an exercise price of $0.35 per share of common stock.  Each of the other three warrants vest upon the payment by Inter-Mountain of each of the three remaining Investor Notes.

For the nine months ended September 30, 2013, we issued warrants to purchase up to an aggregate of 4,445,714 shares of our common stock which consisted of (i) a warrant issued to IPMD pursuant to the January 2013 Offering to purchase up to an aggregate of 3,000,000 shares of our common stock at an exercise price of $0.60 per share, (ii) a warrant issued to Kerry P. Gray pursuant to the March 2013 Offering to purchase up to an aggregate of 600,000 shares of our common stock at an exercise price of $0.60 per share, (iii) a warrant issued to Terrance K. Wallberg pursuant to the March 2013 Offering to purchase up to an aggregate of 60,000 shares of our common stock at an exercise price of $0.60 per share, (iv) two warrants issued to Inter-Mountain to purchase up to an aggregate of 785,714 shares of our common stock at an exercise price of $0.35 per share.  Also occurring during the nine months ended September 30, 2013 was the exercise of warrants to purchase 479,459 shares of our common stock, at an exercise price of $0.35 per share, by Inter-Mountain and the cancellation of a warrant issued to NUWA Group LLC to purchase up to an aggregate of 250,000 shares of our common stock at an exercise price of $0.35 per share.

Of the warrant shares subject to exercise as of September 30, 2013, expiration of the right to exercise is as follows:
Date of Expiration
 
Number of Warrant Shares of Common Stock Subject to Expiration
 
  January 3, 2014
    3,000,000  
  July 23, 2014
    69,050  
  May 15, 2015
    357,155  
  June 13, 2016
    35,000  
  July 16, 2016
    116,667  
  July 28, 2016
    34,722  
  June 27, 2017
    1,484,826  
  March 14, 2018
    660,000  
  Total
    5,757,420  



 
- 18 -



NOTE 14.
EARNINGS PER SHARE

Basic and Diluted Net Loss Per Share

In accordance with FASB Accounting Standards Codification (“ASC”) Topic 260, Earnings per Share, basic earnings (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the period.  Diluted earnings (loss) per common share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period, increased to include potential dilutive common shares.  The effect of outstanding stock options, restricted vesting common stock, convertible debt, convertible preferred stock, and warrants, when dilutive, is reflected in diluted earnings (loss) per common share by application of the treasury stock method.  We have excluded all outstanding stock options, restricted vesting common stock, convertible debt, convertible preferred stock, and warrants from the calculation of diluted net loss per common share because all such securities are antidilutive for all periods presented.

Shares used in calculating basic and diluted net loss per common share exclude these potential common shares as of September 30, 2013 and December 31, 2012:

   
September 30, 2013
   
December 31, 2012
 
Warrants to purchase common stock (1)
    5,757,420       2,041,165  
Stock options to purchase common stock
    1,014,907       158,409  
Unvested restricted common stock
    ---       300  
Common stock issuable upon the assumed conversion of our convertible note payable from June 2012 (2)
    3,766,316       5,617,974  
Common stock issuable upon the assumed conversion of our convertible notes payable from June 2011 and July 2011 (3)
    309,818       368,637  
Common stock issuable upon the assumed conversion of our Series A preferred stock (4)(5)
    ---       1,002,634  
  Total
    10,848,461       9,189,119  

(1)
As part of the June 2012 Note, Inter-Mountain received a total of seven warrants to purchase, if they all vest, an aggregate of 3,142,857 shares of common stock, which number of shares could increase based upon the terms and conditions of the warrants.  The warrants have an exercise price of $0.35 per share, subject to certain pricing adjustments, and are exercisable, subject to vesting provisions and ownership limitations, until June 27, 2017.  Warrants for 785,714, 392,857, 392,857, and 392,857 shares of common stock vested on June 27, 2012, December 31, 2012, February 26, 2013, and July 15, 2013, respectively, and warrants for 479,459 shares of common stock have been exercised.  For the purposes of this Table, only such net vested shares of common stock (1,484,826 shares) have been included, based upon an exercise price of $0.35 per share of common stock.  Each of the other three warrants vest upon the payment by Inter-Mountain of each of the three remaining Investor Notes.
(2)
The outstanding principal balance and the accrued and unpaid interest of the June 2012 Note may be converted, at the option of Inter-Mountain, into shares of common stock at a conversion price of $0.35 per share, subject to certain pricing adjustments and ownership limitations.  For the purposes of this Table, we have assumed a conversion price of $0.35 per share and no ownership limitations.
(3)
The outstanding principal balance of the June 2011 Note and the July 2011 Note may be converted, at the option of Mr. Gray, into shares of common stock at a fixed conversion price of $1.20 per share and $1.08 per share, respectively.  The accrued and unpaid interest for each convertible note payable may be converted, at the option of Mr. Gray, into shares of common stock at a conversion price based upon the average of the five trading days prior to the payment date, which for the purposes of this Table we have assumed to be September 30, 2013.
(4)
The outstanding Series A preferred stock and the accrued and unpaid dividends thereon are convertible into shares of the Company’s common stock at the Company’s option at any time after six-months from the date of issuance of the Series A preferred stock.  The conversion price for the holder is fixed at $0.70 per share with no adjustment mechanisms, resets, ratchets, or anti-dilution covenants other than the customary adjustments for stock splits.  For the purposes of this Table, we have assumed a conversion price of $0.70 per share.
(5)
On August 15, 2013, we provided notice to Ironridge for the redemption of all of our Series A Shares held by Ironridge, a total of 65 Series A Shares.  An affiliate of Ironridge, the issuer of promissory notes held by us, due 7.5 years from the issue date, in the principal amount of $969,000, agreed to accept the cancellation of the promissory notes held by us as full and final payment for the redemption amounts of the Series A Shares.

 
- 19 -



NOTE 15.
SHARE BASED COMPENSATION

The Company’s share-based compensation plan, the 2006 Equity Incentive Plan (“Equity Incentive Plan”), is administered by the compensation committee of the Board of Directors (“Board”), which selects persons to receive awards and determines the number of shares subject to each award and the terms, conditions, performance measures and other provisions of the award.

Our Board granted the following incentive stock option awards to executives or employees and nonstatutory stock option awards to directors or non-employees for the three and nine months ended September 30:

   
Three Months Ended
September 30,
   
Nine Months Ended
 September 30,
 
   
2013
   
2012
   
2013
   
2012 (3)
 
Incentive Stock Options  (1)
                       
Quantity
    ---       ---       232,500       ---  
Weighted average fair value per share
    ---       ---     $ 0.24       ---  
Fair value
    ---       ---     $ 56,112       ---  
                                 
Nonstatutory Stock Options  (2)
                               
Quantity
    ---       ---       735,000       ---  
Weighted average fair value per share
    ---       ---     $ 0.24       ---  
Fair value
    ---       ---     $ 177,388       ---  

 
(1)
The Company did not award any incentive stock options for the three months ended September 30, 2013 and 2012, respectively.
 
(2)
The Company did not award any nonstatutory stock options for the three months ended September 30, 2013 and 2012, respectively.
 
(3)
The Company did not award any shared-based compensation for the nine months ended September 30, 2012.

We account for share-based compensation under FASB ASC Topic 718, Stock Compensation, which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees, consultants, and directors based on estimated fair values of the award on the grant date.  We use the Black-Scholes option-pricing model to estimate the fair value of share-based awards with the following weighted average assumptions:

   
Nine Months Ended September 30,
 
   
2013
   
2012
 
Incentive Stock Options
           
Expected volatility  (1)
    103.55 %     ---  
Risk-free interest rate %  (2)
    0.81 %     ---  
Expected term (in years)
    5.0       ---  
Dividend yield  (3)
    ---       ---  
Forfeiture rate
    ---       ---  
                 
Nonstatutory Stock Options
               
Expected volatility  (1)
    103.55 %     ---  
Risk-free interest rate %  (2)
    0.81 %     ---  
Expected term (in years)
    5.0       ---  
Dividend yield  (3)
    ---       ---  
Forfeiture rate
    ---       ---  

 
(1)
Expected volatility assumption was based upon a combination of historical stock price volatility measured on a daily basis and an estimate of expected future stock price volatility
 
(2)
Risk-free interest rate assumption is based upon U.S. Treasury bond interest rates appropriate for the term of the stock options.
 
(3)
The Company does not currently intend to pay cash dividends, thus has assumed a 0% dividend yield.


 
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Stock Options (Incentive and Nonstatutory)

The following table summarizes share-based compensation related to stock options for the three and nine months ended September 30:

   
Three Months Ended
 September 30,
   
Nine Months Ended
 September 30,
 
   
2013
   
2012
   
2013
   
2012
 
Research and development
  $ 5,425     $ ---     $ 11,438     $ 6,280  
Selling, general and administrative
    19,662       6,760       44,414       25,753  
  Total share-based compensation expense
  $ 25,087     $ 6,760     $ 55,852     $ 32,033  

At September 30, 2013, the balance of unearned share-based compensation to be expensed in future periods related to unvested stock option awards, as adjusted for expected forfeitures, is approximately $177,530.  The period over which the unearned share-based compensation is expected to be recognized is approximately thirty months.

The following table summarizes the stock options outstanding and the number of shares of common stock subject to exercise as of September 30, 2013 and the changes therein during the nine months then ended:

   
Stock Options
   
Weighted Average Exercise Price per Share
 
Outstanding as of December 31, 2012
    158,409     $ 12.32  
Granted
    967,500       0.33  
Forfeited/cancelled
    (111,002 )     1.03  
Exercised
    ---       ---  
Outstanding as of September 30, 2013
    1,014,907     $ 2.12  


The following table presents the stock option grants outstanding and exercisable as of September 30, 2013:

Options Outstanding
   
Options Exercisable
 
Stock Options Outstanding
   
Weighted Average Exercise Price per Share
   
Weighted Average Remaining Contractual Life in Years
   
Stock Options Exercisable
   
Weighted Average Exercise Price per Share
 
  892,500     $ 0.33       9.5       197,500     $ 0.33  
  53,334       2.38       4.7       46,668       2.36  
  30,002       14.40       3.5       30,002       14.40  
  39,071       33.35       4.1       39,071       33.35  
  1,014,907     $ 2.12       8.8       313,241     $ 6.10  


 
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Restricted Stock Awards

Restricted stock awards, which typically vest over a period of two to five years, are issued to certain key employees and are subject to forfeiture until the end of an established restriction period.  We utilize the market price on the date of grant as the fair market value of restricted stock awards and expense the fair value on a straight-line basis over the vesting period.

The following table summarizes share-based compensation related to restricted stock awards for the three and nine months ended September 30:

   
Three Months Ended
 September 30,
   
Nine Months Ended
 September 30,
 
   
2013
   
2012
   
2013
   
2012
 
Research and development
  $ ---     $ ( 391 )   $ 444     $ 2,814  
Selling, general and administrative
    ---       1,143       547       3,392  
  Total share-based compensation expense
  $ ---     $ 752     $ 991     $ 6,206  

At September 30, 2013, the balance of unearned share-based compensation to be expensed in future periods related to restricted stock awards, as adjusted for expected forfeitures, is nil.

The following table summarizes the non-vested restricted stock awards outstanding and the number of shares of common stock subject to potential issue as of September 30, 2013 and the changes therein during the nine months then ended:

   
Restricted stock
   
Weighted Average Grant Date Fair Value
 
Outstanding as of December 31, 2012
    300     $ 34.59  
Shares granted
    ---       ---  
Shares forfeited/cancelled
    ---       ---  
Shares exercised/issued
    (300 )     34.59  
Outstanding as of September 30, 2013
    ---     $ ---  


Summary of Plans

2006 Equity Incentive Plan

In March 2006, our Board adopted and our stockholders approved our Equity Incentive Plan, which initially provided for the issuance of up to 133,333 shares of our common stock pursuant to stock option and other equity awards.  At the annual meetings of the stockholders held on May 8, 2007, December 17, 2009, June 15, 2010, June 14, 2012, and on June 13, 2013, our stockholders approved amendments to the Equity Incentive Plan to increase the total number of shares of common stock issuable under the Equity Incentive Plan pursuant to stock options and other equity awards by 266,667 shares, 200,000 shares, 200,000 shares, 400,000 shares, and 600,000 shares, respectively, to a total of 1,800,000 shares.

 
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In December 2006, we began issuing stock options to employees, consultants, and directors.  The stock options issued generally vest over a period of one to four years and have a maximum contractual term of ten years.  In January 2007, we began issuing restricted stock awards to our employees.  Restricted stock awards generally vest over a period of six months to five years after the date of grant.  Prior to vesting, restricted stock awards do not have dividend equivalent rights, do not have voting rights and the shares underlying the restricted stock awards are not considered issued and outstanding.  Shares of common stock are issued on the date the restricted stock awards vest.

As of September 30, 2013, we had granted options to purchase 1,376,167 shares of common stock since the inception of the Equity Incentive Plan, of which 1,014,907 were outstanding at a weighted average exercise price of $2.12 per share, and we had granted awards for 68,616 shares of restricted stock since the inception of the Equity Incentive Plan, of which none were outstanding.  As of September 30, 2013, there were 715,647 shares that remained available for future grants under our Equity Incentive Plan.


NOTE 16.
FAIR VALUE MEASUREMENTS

In accordance with ASC Topic 820, Fair Value Measurements, (“ASC Topic 820”) certain assets and liabilities of the Company are required to be recorded at fair value.  Fair value is determined based on the exchange price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants.  The guidance in ASC Topic 820 also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimized the use of unobservable inputs by requiring that the most observable inputs be used when available.

Observable inputs are based on market data obtained from independent sources, while unobservable inputs are based on our market assumptions.  Unobservable inputs require significant management judgment or estimation.  In some cases, the inputs used to measure an asset or liability may fall into different levels of the fair value hierarchy.  In those instances, the fair value measurement is required to be classified using the lowest level of input that is significant to the fair value measurement.  Such determination requires significant management judgment.

The three-tier value hierarchy, which prioritizes the inputs used in the valuation methodologies, is as follows:

 
Level 1
Valuations based on quoted prices (unadjusted) for identical assets or liabilities in active markets.

 
Level 2
Valuations based on observable inputs other than quoted prices in Level 1, such as quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

 
Level 3
Valuations based on unobservable inputs reflecting the Company’s own assumptions, consistent with reasonably available assumptions made by other market participants.


 
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Assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurements.  We review the fair value hierarchy classification on a quarterly basis.  Changes in the observability of valuation inputs may result in a reclassification of levels for certain securities within the fair value hierarchy.

Our financial instruments, including cash, cash equivalents, accounts receivable, and accounts payable are carried at cost, which approximates their fair value because of the short-term maturity of these instruments.  We believe that the carrying value of our other receivable and convertible note payable balances approximates fair value based on a valuation methodology using the income approach and a discounted cash flow model.

The following table summarizes the fair value of our financial instruments at September 30, 2013 and December 31, 2012.

Description
 
September 30, 2013
   
December 31, 2012
 
  Assets:
           
Notes receivable and accrued interest
  $ 763,654     $ 1,302,220  
                 
  Liabilities:
               
Convertible note – June 2011
  $ 137,232     $ 134,154  
Convertible note – July 2011
  $ 118,856     $ 113,084  
Convertible note – June 2012
  $ 1,071,045     $ 1,593,924  


NOTE 17.
INCOME TAXES

There was no current federal tax provision or benefit recorded for any period since inception, nor were there any recorded deferred income tax assets, as such amounts were completely offset by valuation allowances.


 
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NOTE 18.
COMMITMENTS AND CONTINGENCIES

Operating Leases

On January 31, 2006 we entered into a lease agreement for office and laboratory space in Addison, Texas.  The lease commenced on April 1, 2006 and originally continued until April 1, 2013.  The lease required a minimum monthly lease obligation of $9,330, which is inclusive of monthly operating expenses, until April 1, 2011 and at such time increased to $9,776, which is inclusive of monthly operating expenses.  On February 22, 2013, we executed an Amendment to Lease Agreement (the “Lease Amendment”) that renewed and extended our lease until March 31, 2015.  The Lease Amendment requires a minimum monthly lease obligation of $9,128, which is inclusive of monthly operating expenses, until March 31, 2014 and at such time, will increase to $9,314, which is inclusive of monthly operating expenses.  The Lease Amendment includes an option whereby we may convert the term of our lease renewal from a two year term to a five year term by providing written notice on or before October 1, 2013.  If so elected, the minimum monthly lease obligation for the remainder of the first year shall be reduced to $8,751, which is inclusive of monthly operating expenses, effective on the first day of the month following our election and the minimum monthly lease obligation shall increase annually every April 1st thereafter by $186 per month until March 31, 2018.

On December 10, 2010 we entered into a lease agreement for certain office equipment.  The lease, which commenced on February 1, 2011 and continues until February 1, 2015, requires a minimum lease obligation of $744 per month.

The future minimum lease payments under the 2013 office lease and the 2010 equipment lease are as follows as of September 30, 2013:

Calendar Years
 
Future Lease Expense
 
  2013 (Three months)
  $ 29,811  
  2014
    120,917   
  2015
    28,881  
  2016
    ---  
  2017
    ---  
  Total
  $ 179,609  

Rent expense for our operating leases amounted to $31,083 and $32,971 for the three months ended September 30, 2013 and 2012, respectively, and $86,125 and $98,111 for the nine months ended September 30, 2013 and 2012, respectively.

Employment Agreements

As of September 30, 2013, we are party to employment agreements with our Vice President and Chief Financial Officer, Terrance K. Wallberg, and Daniel G. Moro, Vice President – Polymer Drug Delivery.  The employment agreements with Messrs. Wallberg and Moro each have a term of one year and include an automatic one-year term renewal for each year thereafter.  Each employment agreement provides for a base salary, bonus, stock options, stock grants, and eligibility for Company provided benefit programs.  Under certain circumstances, the employment agreements provide for certain severance benefits in the event of termination or a change in control.  The employment agreements also contain non-solicitation, confidentiality and non-competition covenants, and a requirement for the assignment of certain invention and intellectual property rights to the Company.

 
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Separation Agreement

As of September 30, 2013, we continue to be a party to a separation agreement with Kerry P. Gray, dated March 9, 2009.  Mr. Gray currently serves as our Chairman of the Board, Chairman of the Board’s Executive Committee, Chief Executive Officer, and President.  Pursuant to the terms of the separation agreement, we provide or have provided, as applicable, certain benefits to Mr. Gray, including: (i) payments totaling $400,000 during the initial 12 month period following March 9, 2009; (ii) commencing March 1, 2010 and continuing for a period of forty-eight (48) months, a payment of $12,500 per month; (iii) full acceleration of all vesting schedules for all outstanding Company stock options and shares of restricted stock of the Company held by Mr. Gray, with all such Company stock options exercisable by Mr. Gray having expired as of March 1, 2012; and (iv) for a period of twenty-four (24) months following March 9, 2009 we were required to maintain and provide coverage under Mr. Gray’s existing health coverage plan.  The separation agreement contains a mutual release of claims, certain stock lock-up provisions, and other standard provisions.

Indemnification

In the normal course of business, we enter into contracts and agreements that contain a variety of representations and warranties and provide for general indemnifications. Our exposure under these agreements is unknown because it involves claims that may be made against us in the future, but have not yet been made. To date, we have not paid any claims or been required to defend any action related to our indemnification obligations. However, we may record charges in the future as a result of these indemnification obligations.

In accordance with our restated articles of incorporation and our amended and restated bylaws, we have indemnification obligations to our officers and directors for certain events or occurrences, subject to certain limits, while they are serving at our request in their respective capacities. There have been no claims to date and we have a director and officer insurance policy that enables us to recover a portion of any amounts paid for future potential claims. We have also entered into contractual indemnification agreements with each of our officers and directors.

Related Party Transactions

On January 17, 2013, the Board of Directors of the Company appointed Helmut Kerschbaumer and Klaus Kuehne to each serve as a director of the Company.  Messrs. Kerschbaumer and Kuehne currently serve as directors of IPMD, Altrazeal Trading, Ltd., and Melmed Holding AG and thereby have control of, and make investment and business decisions on behalf of IPMD, Altrazeal Trading Ltd., and Melmed Holding AG (collectively, the “Euro Distributors”).

For the nine months ended September 30, 2013 and 2012, respectively, the Company had product sales, in approximate numbers, of $143,000 and $22,000 with Euro Distributors, which represented 59% and 11% of our total revenues.  As of September 30, 2013 and December 31, 2012, respectively, Euro Distributors had an outstanding accounts receivable, in approximate numbers, of $82,000 and $101,000, which represented 35% and 77% of our total outstanding accounts receivables.

On December 21, 2012, we entered into a Securities Purchase Agreement with IPMD as described in more detail in Note 12.

 
- 26 -




Related Party Obligations

Since 2011, our named executive officers and certain key executives have temporarily deferred portions of their compensation as part of a plan to conserve the Company’s cash and financial resources.

As of September 30, 2013, the following table summarizes the compensation temporarily deferred since 2011:

Name
 
2013
   
2012
   
2011
   
Total
 
  Kerry P. Gray (1)
  $ (23,500 )   $ 220,673     $ 140,313     $ 337,486  
  Terrance K. Wallberg
    (11,539 )   $ 24,230     $ 36,539     $ 49,230  
  Key executives
    (20,000 )   $ 27,253     $ 20,986     $ 28,239  
  Total
  $ (55,039 )   $ 272,156     $ 197,838     $ 414,955  

 
(1)
During 2013, Mr. Gray temporarily deferred compensation of $169,000 which consisted of $11,500 earned pursuant to a Separation Agreement and $157,500 for his duties as Chairman of the Executive Committee of the Company’s Board of Directors.  During 2013, Mr. Gray was also repaid $192,500 of temporarily deferred compensation, of which $180,000 was used by Mr. Gray for funding required pursuant to the March 2013 Offering.

The Company’s obligation for temporarily deferred compensation was $414,955, of which $275,000 was included in accounts payable and $139,955 was included in accrued liabilities, and $469,994 of which $310,000 was included in accounts payable and $159,994 was included in accrued liabilities, as of September 30, 2013 and December 31, 2012, respectively.

Contingent Milestone Obligations

We are subject to paying Access Pharmaceuticals, Inc. (“Access”) for certain milestones based on our achievement of certain annual net sales, cumulative net sales, and/or our having reached certain defined technology milestones including licensing agreements and advancing products to clinical development.  As of September 30, 2013, the future milestone obligations that we are subject to paying Access, if the milestones related thereto are achieved, total $4,750,000.  Such milestones are based on total annual sales of 20 and 40 million dollars of certain products, annual sales of 20 million dollars of any one certain product, and cumulative sales of such products of 50 and 100 million dollars.

On March 7, 2008, we terminated the license agreement with ProStrakan Ltd. for Amlexanox-related products in the United Kingdom and Ireland.  As part of the termination, we agreed to pay ProStrakan Ltd. a royalty of 30% on any future payments received by us from a new licensee in the United Kingdom and Ireland territories, up to a maximum of $1,400,000.  On November 17, 2008, we entered into a licensing agreement for Amlexanox-related product rights to the United Kingdom and Ireland territories with MEDA AB.

 
NOTE 19.
LEGAL PROCEEDINGS

From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business. We are not currently a party to any legal proceedings, the adverse outcome of which, in management’s opinion, individually or in the aggregate, would have a material adverse effect on the results of our operations or financial position. There are no material proceedings to which any director, officer or any of our affiliates, any owner of record or beneficially of more than five percent of any class of our voting securities, or any associate of any such director, officer, our affiliates, or security holder, is a party adverse to us or our consolidated subsidiary or has a material interest adverse thereto.


 
- 27 -


 
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
You should read the following discussion and analysis together with all financial and non-financial information appearing elsewhere in this report and with our consolidated financial statements and related notes included in our 2012 Annual Report on Form 10-K, referred to as our 2012 Form 10-K, which has been previously filed with the Securities and Exchange Commission on March 29, 2013, including the risk factors set forth therein.  In addition to historical information, the following discussion and other parts of this report contain forward-looking information that involve risks and uncertainties, including the statement that our cash and cash equivalents are sufficient to fund our operations and capital expenditures through 2013 and beyond.  Our actual results could differ materially from those anticipated by such forward-looking information due to competitive factors and other risks discussed in our 2012 Form 10-K under “Risks Associated with our Business”.

Business Overview

ULURU Inc. (hereinafter “we”, “our”, “us”, “ULURU”, or the “Company”) is a Nevada corporation.  We are a diversified specialty pharmaceutical company committed to developing and commercializing a broad range of innovative wound care and muco-adhesive film products based on our patented Nanoflex® and OraDiscTM drug delivery technologies, with the goal of improving outcomes for patients, health care professionals, and health care payers.

Our strategy is twofold:

§
Establish the foundation for a market leadership position in wound management by developing and commercializing a customer focused portfolio of innovative wound care products based on the Nanoflex® technology to treat the various phases of wound healing; and
§
Develop our oral-transmucosal technology (OraDiscTM) and generate revenues through multiple licensing agreements.

Utilizing our technologies, three of our products have been approved for marketing in various global markets.  In addition, numerous additional products are under development utilizing our patented Nanoflex® and OraDiscTM drug delivery technologies.

Altrazeal® Transforming Powder Dressing, based on our Nanoflex® technology, has the potential to change the way health care providers approach their treatment of wounds.  Launched domestically in September 2008 and internationally in July 2012, the product is indicated for exuding wounds such as partial thickness burns, donor sites, abrasions, surgical, acute and chronic wounds.

Aphthasol®, our Amlexanox 5% paste product is the first drug approved by the FDA for the treatment of canker sores.

OraDisc™ A was initially developed as a drug delivery system to treat canker sores with the same active ingredient (amlexanox) that is used in Aphthasol® paste. We anticipate that higher amlexanox concentrations will be achieved at the disease site, increasing the effectiveness of the product.  OraDisc™ A was approved by the FDA in September 2004.


 
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Recent Developments

Altrazeal® marketing and licensing activities

On September 30, 2013, we executed a License and Supply Agreement with Altrazeal AG to market Altrazeal® in several territories, to include Africa (markets not already licensed), Latin America, the Commonwealth of Independent States, Georgia, Ukraine, and Turkmenistan.  Under the terms of the License and Supply Agreement with Altrazeal AG, we received an up-front licensing payment, will receive certain royalties on product sales within the territories, and will supply Altrazeal® at an agreed upon price.

We completed the initial shipment of Altrazeal® to our Czech Republic/Slovakia marketing partner in September 2013 and to our South African marketing partner in October 2013.

On October 9, 2013, we announced the further expansion of the Altrazeal® international marketing network with Altrazeal AG to include Croatia, Slovenia, Serbia, Montenegro, Macedonia, Bosnia, Kosovo, and Albania.  It is anticipated that Altrazeal® will be launched in a number of these markets in the fourth quarter 2013.

Preferred stock redemption

On August 15, 2013, we provided notice to Ironridge Global III, LLC for the redemption of all of our Series A Preferred Stock held by Ironridge Global, a total of 65 Series A Preferred shares.  An affiliate of Ironridge Global III, LLC, the issuer of promissory notes held by us, due 7.5 years from the issue date, in the principal amount of $969,000, agreed to accept the cancellation of the promissory notes held by us in exchange for the redemption of the Series A Preferred shares.

Common Stock Transactions

On March 14, 2013, we entered into a Securities Purchase Agreement (the “March SPA”) with Kerry P. Gray, the Company’s Chairman, President, and Chief Executive Officer and Terrance K. Wallberg, the Company’s Vice President and Chief Financial Officer (collectively, the “Investors”) relating to an equity investment of $440,000 by the Investors for 1,100,000 shares of our common stock, par value $0.001 per share (the “March Shares”) and warrants to purchase up to 660,000 shares of our common stock (the “March Warrants”) (the “March 2013 Offering”).  Under the March SPA, the purchase and sale of the March Shares and March Warrants will take place at four closings over the next twelve months, with $88,000 being funded at the initial closing under the March SPA, $110,000 being funded on the four-month anniversary of the initial closing, $132,000 being funded on the eight-month anniversary of the initial closing, and $110,000 being funded on the one-year anniversary of the initial closing.  The March Warrants have a fixed exercise price of $0.60 per share, become exercisable in tranches on each of the four funding dates, and expire on the five-year anniversary of the initial closing.  On March 14, 2013, we closed the March 2013 Offering and received the initial funding tranche of $88,000 for the purchase of 220,000 shares of our common stock.  On July 15, 2013, we received the second funding tranche of $110,000 for the purchase of 275,000 shares of our common stock.  On November 14, 2013, we received the third funding tranche of $132,000 for the purchase of 330,000 shares of our common stock.
 
On December 21, 2012, we entered into a Securities Purchase Agreement (the “SPA”) with IPMD GmbH (“IPMD”) relating to an equity investment of $2,000,000 by IPMD for 5,000,000 shares of our common stock, par value $0.001 per share (the “Shares”) and warrants to purchase up to 3,000,000 shares of our common stock (the “Warrants”) (the “January 2013 Offering”).  Under the SPA, the purchase and sale of the Shares and Warrants will take place at four closings over the next twelve months, with $400,000 being funded at the initial closing under the SPA, $500,000 being funded on the four-month anniversary of the initial closing, $600,000 being funded on the eight-month anniversary of the initial closing, and $500,000 being funded on the one-year anniversary of the initial closing.  The Warrants have a fixed exercise price of $0.60 per share, become exercisable in tranches on each of the four funding dates, and expire on the one-year anniversary of the initial closing.  On January 3, 2013, we closed the January 2013 Offering and received the initial funding tranche of $400,000 for the purchase of 1,000,000 shares of our common stock.  On May 7, 2013, September 6, 2013, and October 24, 2013, we received subsequent funding tranches of $500,000, $300,000, and $300,000 for the purchase of 1,250,000, 750,000, and 750,000 shares of our common stock, respectively.




 
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RESULTS OF OPERATIONS

Fluctuations in Operating Results

Our results of operations have fluctuated significantly from period to period in the past and are likely to continue to do so in the future. We anticipate that our quarterly and annual results of operations will be impacted for the foreseeable future by several factors, including the timing and amount of payments received pursuant to our current and future collaborations, and the progress and timing of expenditures related to our development, commercialization, and sale efforts. Due to these fluctuations, we believe that the period-to-period comparisons of our operating results may not be a good indication of our future performance.

Comparison of the three months ended September 30, 2013 and 2012

Total Revenues

Revenues were approximately $111,000 for the three months ended September 30, 2013, as compared to revenues of approximately $89,000 for the three months ended September 30, 2012, and were comprised of, in approximate numbers, licensing fees of $12,000 from Altrazeal® and OraDisc™ licensing agreements, royalty fees of $10,000 from the sale of Altrazeal®, and product sales of $89,000 for Altrazeal®.

The third quarter 2013 revenues represent an overall increase of approximately $22,000 versus the comparative third quarter 2012 revenues.  The increase in revenues is primarily attributable to, in approximate numbers, an increase of $28,000 in Altrazeal® product sales and an increase of $10,000 in Altrazeal® royalties.  These revenue increases were partially offset by a decrease of $16,000 in royalties related to the domestic sale of Aphthasol®.

Costs and Expenses

Cost of Goods Sold

Cost of goods sold for the three months ended September 30, 2013 was approximately $60,000 and was comprised entirely of costs associated with Altrazeal®.  Cost of goods sold for the three months ended September 30, 2012 was approximately $113,000 and was comprised of $34,000 from the sale of our Altrazeal® products and $79,000 from the write-off of out-of-date and obsolete finished goods

Research and Development

Research and development expenses totaled approximately $201,000 for the three months ended September 30, 2013, including $5,000 in share-based compensation, as compared to approximately $153,000 for the three months ended September 30, 2012, which included nil in share-based compensation.  The increase of approximately $48,000 in research and development expenses was primarily due to, in approximate numbers, an increase of $34,000 in direct research costs related to Altrazeal® and an increase of $20,000 in scientific compensation due to higher headcount.  These expense increases were partially offset by a decrease of $3,000 in regulatory costs and a decrease of $3,000 in operating costs.

The direct research and development expenses for the three months ended September 30, 2013 and 2012 were, in approximate numbers, as follows:

   
Three Months Ended September 30,
 
Technology
 
2013
   
2012
 
  Wound care & nanoparticle
  $ 62,000     $ 30,000  
  OraDisc™
    7,000       4,000  
  Aphthasol® & other technologies
    ---       1,000  
  Total
  $ 69,000     $ 35,000  

Selling, General and Administrative

Selling, general and administrative expenses totaled approximately $302,000 for the three months ended September 30, 2013, including $20,000 in share-based compensation, as compared to approximately $376,000 for the three months ended September 30, 2012, which included $8,000 in share-based compensation.

The decrease of approximately $74,000 in selling, general and administrative expenses was primarily due to, in approximate numbers, a decrease of $109,000 in sales & marketing costs due to a revised sales and marketing plan and a lower head count, a decrease of $20,000 related to accruals for bad debt expense, and a decrease of $8,000 in legal costs associated with our patents.  These expense decreases were partially offset by, in approximate numbers, an increase of $35,000 in investor relations consulting, an increase of $11,000 in director fees, an increase of $11,000 related to property tax accruals, and an increase of $6,000 in legal costs.

 
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Amortization of Intangible Assets

Amortization of intangible assets expense totaled approximately $120,000 for the three months ended September 30, 2013 as compared to approximately $120,000 for the three months ended September 30, 2012.  The expense for each period consists of amortization associated with our acquired patents.  There were no additional purchases of patents during the three months ended September 30, 2013 and 2012, respectively.

Depreciation

Depreciation expense totaled approximately $60,000 for the three months ended September 30, 2013 as compared to approximately $75,000 for the three months ended September 30, 2012.  The decrease of approximately $15,000 in depreciation expense is attributable to certain equipment being fully depreciated.

Interest and Miscellaneous Income

Interest and miscellaneous income totaled approximately $15,000 for the three months ended September 30, 2013 as compared to approximately $31,000 for the three months ended September 30, 2012.  The decrease of approximately $16,000 is attributable to a decrease in interest income resulting from a decrease in the outstanding notes receivable from Inter-Mountain.

Interest Expense

Interest expense totaled approximately $126,000 for the three months ended September 30, 2013 as compared to approximately $134,000 for the three months ended September 30, 2012.  Interest expense is comprised of financing costs for our insurance policies, interest costs related to regulatory fees, and interest costs and amortization of debt discount and financing costs related to our convertible debt.  The decrease of approximately $8,000 in interest expense is primarily attributable to a decrease in the outstanding principle balance of the convertible note payable with Inter-Mountain.
 
 
Comparison of the nine months ended September 30, 2013 and 2012

Total Revenues

Revenues were approximately $242,000 for the nine months ended September 30, 2013, as compared to revenues of approximately $205,000 for the nine months ended September 30, 2012, and were comprised of, in approximate numbers, licensing fees of $34,000 from Altrazeal® and OraDisc™ licensing agreement, royalty fees of $10,000 from the sale of Altrazeal®, and product sales of $198,000 for Altrazeal®.

The nine months ended September 30, 2013 revenues represent an overall increase of approximately $36,000 versus the comparative nine months ended September 30, 2012 revenues.  The increase in revenues is primarily attributable to, in approximate numbers, an increase of $71,000 in Altrazeal® product sales, an increase of $10,000 in Altrazeal® royalties, and an increase of $5,000 in Altrazeal® licensing fees.  These revenue increases were partially offset by a decrease of $50,000 in royalties related to the domestic sale of Aphthasol®.

Costs and Expenses

Cost of Goods Sold

Cost of goods sold for the nine months ended September 30, 2013 was approximately $104,000 and was comprised entirely of costs associated with Altrazeal®.  Cost of goods sold for the nine months ended September 30, 2012 was approximately $136,000 and was comprised of $48,000 from the sale of our Altrazeal® products and $88,000 from the write-off of out-of-date and obsolete finished goods.

 
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Research and Development

Research and development expenses totaled approximately $578,000 for the nine months ended September 30, 2013, including $12,000 in share-based compensation, as compared to approximately $517,000 for the nine months ended September 30, 2012, which included $9,000 in share-based compensation.  The increase of approximately $61,000 in research and development expenses was primarily due to, in approximate numbers, an increase of $171,000 in direct research costs related to Altrazeal®.  This expense increase was partially offset by a decrease of $86,000 in scientific compensation related to share-based compensation and a lower head count, a decrease of $20,000 in clinical study costs, and a decrease of $4,000 in regulatory costs.

The direct research and development expenses for the nine months ended September 30, 2013 and 2012 were, in approximate numbers, as follows:

   
Nine months Ended September 30,
 
Technology
 
2013
   
2012
 
  Wound care & nanoparticle
  $ 216,000     $ 46,000  
  OraDisc™
    14,000       12,000  
  Aphthasol® & other technologies
    2,000       3,000  
  Total
  $ 232,000     $ 61,000  
 
Selling, General and Administrative

Selling, general and administrative expenses totaled approximately $915,000 for the nine months ended September 30, 2013, including $45,000 in share-based compensation, as compared to approximately $1,366,000 for the nine months ended September 30, 2012, which included $29,000 in share-based compensation.

The decrease of approximately $451,000 in selling, general and administrative expenses was primarily due to, in approximate numbers, a decrease of $323,000 in sales & marketing costs due to a revised sales and marketing plan and a lower head count, a decrease of $58,000 in investor relations consulting, a decrease of $43,000 in insurance costs, a decrease of $28,000 in bad debt expenses related to costs associated with the early remittance in March 2012 of the receivable from our divestiture of the Zindaclin® technology, a decrease of $14,000 in legal costs related to our patents, a decrease of $12,000 in consulting costs related to XBRL reporting, a decrease of $8,000 in occupancy costs, a decrease of $7,000 in accounting fees associated with our annual audit, a decrease of $6,000 in compensation costs related to share-based compensation, a decrease of $4,000 in fees associated with listing exchange fees, a decrease of $3,000 in costs associated with our annual meeting of stockholders, and a decrease of $3,000 due to reduced corporate travel.  These expense decreases were partially offset by, in approximate numbers, an increase of $21,000 in costs for director fees, an increase of $17,000 in legal fees related to a licensing agreement dispute, an increase of $12,000 related to property tax accruals, and an increase of $8,000 in consulting fees related to licensing agreement procurement.

 
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Amortization of Intangible Assets

Amortization of intangible assets expense totaled approximately $355,000 for the nine months ended September 30, 2013 as compared to approximately $357,000 for the nine months ended September 30, 2012.  The expense for each period consists primarily of amortization associated with our acquired patents.  There were no additional purchases of patents during the nine months ended September 30, 2013 and 2012, respectively.

Depreciation

Depreciation expense totaled approximately $186,000 for the nine months ended September 30, 2013 as compared to approximately $226,000 for the nine months ended September 30, 2012.  The decrease in depreciation expense of approximately $40,000 is attributable to certain equipment being fully depreciated.

Interest and Miscellaneous Income

Interest and miscellaneous income totaled approximately $56,000 for the nine months ended September 30, 2013 as compared to approximately $34,000 for the nine months ended September 30, 2012.  The increase of approximately $22,000 is attributable to an increase in interest income resulting from interest recognized from the outstanding notes receivable from Inter-Mountain.

Interest Expense

Interest expense totaled approximately $386,000 for the nine months ended September 30, 2013 as compared to approximately $191,000 for the nine months ended September 30, 2012.  Interest expense is comprised of financing costs for our insurance policies, interest costs related to regulatory fees, and interest costs and amortization of debt discount and financing costs related to our convertible debt.  The increase in interest expense of approximately $195,000 is primarily attributable to costs associated with our convertible debt and interest costs relating to regulatory fees.


 
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LIQUIDITY AND CAPITAL RESOURCES

We have funded our operations primarily through the public and private sales of convertible debentures and common stock.  Product sales, royalty payments, contract research, licensing fees and milestone payments from our corporate alliances have provided, and are expected in the future to provide, funding for operations. Our principal source of liquidity is cash and cash equivalents.  As of September 30, 2013 our cash and cash equivalents were approximately $53,000 which is an increase of approximately $31,000 as compared to our cash and cash equivalents at December 31, 2012 of approximately $22,000.  Our working capital (current assets less current liabilities) was approximately $(2,045,000) at September 30, 2013 as compared to our working capital at December 31, 2012 of approximately $(2,774,000).

Consolidated Cash Flow Data
   
Nine months Ended September 30,
 
Net Cash Provided by (Used in)
 
2013
   
2012
 
  Operating activities
  $ (1,253,000 )   $ (938,000 )
  Investing activities
    (27,000 )     156,000  
  Financing activities
    1,311,000       772,000  
  Net increase (decrease) in cash and cash equivalents
  $ 31,000     $ ( 10,000 )

Operating Activities

For the nine months ended September 30, 2013, net cash used in operating activities was approximately $1,253,000.  The principal components of net cash used for the nine months ended September 30, 2013 were, in approximate numbers, our net loss of $2,223,000, a decrease in accounts payable of $637,000 due to timing of vendor payments, an increase in accounts receivable of $105,000, a decrease in accrued liabilities of $30,000 due primarily to the final installment payments on our insurance premium financing, a decrease in accrued interest of $7,000 due to annual interest payments on our convertible notes, and the cancellation of a warrant issued for service for $49,000.  Our net loss for the nine months ended September 30, 2013 included substantial non-cash charges of approximately $1,064,000 in the form of share-based compensation, amortization of patents, depreciation, amortization of debt discount, amortization of deferred financings costs, common stock issued for services, and interest due on convertible notes settled with common stock.  The aforementioned net cash used for the nine months ended September 30, 2013 was partially offset by, in approximate numbers, a decrease in notes receivable of $539,000 due to remittance of Investor Notes by Inter-Mountain, a net increase in deferred revenues of $91,000 due primarily to the receipt of a licensing milestone, a decrease in prepaid expenses of $64,000 due to amortization of expenses, and a decrease in inventory of $40,000 related to product sales.

For the nine months ended September 30, 2012, net cash used in operating activities was approximately $938,000.  The principal components of net cash used in operating activities for the nine months ended September 30, 2012 were, in approximate numbers, our net operating loss of $2,553,000 and an increase in notes receivable of $32,000 due to the accrual of interest income.  Our net loss for the nine months ended September 30, 2012 included substantial non-cash charges of approximately $868,000 in the form of share-based compensation, amortization of patents, depreciation, amortization of debt discount, amortization of deferred financings costs, and common stock issued for services.  The aforementioned net cash used for the nine months ended September 30, 2012 was partially offset by, in approximate numbers, an increase in accounts payable of $353,000 due to timing of vendor payments, an increase in deferred revenue of $196,000 due primarily to the receipt of licensing milestone payments, an increase in accrued liabilities of $26,000, an increase in accrued interest of $23,000 relating to our convertible debt, a decrease in inventory of $152,000 due primarily to the write-off of out-of-date and obsolete inventory and product sales, a decrease in receivables of $20,000, and a decrease in prepaid expenses of $9,000 due primarily to expense amortization.

 
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Investing Activities

Net cash used in investing activities for the nine months ended September 30, 2013 was approximately $27,000 and is comprised of the purchase of manufacturing equipment for $32,000 and partially offset by the proceeds of $5,000 from the sale of manufacturing equipment.

Net cash provided by investing activities for the nine months ended September 30, 2012 was approximately $156,000 and is comprised of the fourth and final payment to us of $220,000 from the divestiture of our Zindaclin® intangible asset and a purchase of manufacturing equipment for approximately $64,000.

Financing Activities

Net cash provided by financing activities for the nine month ended September 30, 2013 was approximately $1,311,000 and was comprised of, in approximate numbers, net proceeds of $1,195,000 from the sale of common stock and warrants pursuant to the January 2013 Offering, net proceeds of $196,000 from the sale of common stock and warrants pursuant to the March 2013 Offering, net proceeds of $2,000 from the redemption of preferred stock, and payment of $82,000 for principle payments due on our convertible note with Inter-Mountain.

Net cash provided by financing activities for the nine months ended September 30, 2012 was approximately $772,000 and was comprised of, in approximate numbers, $276,000 from the net proceeds of our sale of preferred stock in January 2012, $467,000 of net proceeds from the convertible debt transaction in June 2012, and $29,000 from a decrease in the estimate of offering costs associated with the sale of preferred stock in 2011.

Liquidity

As of September 30, 2013, we had cash and cash equivalents of approximately $53,000.  We expect to use our cash, cash equivalents, and investments on working capital, general corporate purposes, property and equipment, and the payment of contractual obligations.  Our long-term liquidity will depend to a great extent on our ability to fully commercialize our Altrazeal® and OraDisc™ technologies; therefore we are continuing to look both domestically and internationally for opportunities that will enable us to expand our business.  At this time, we cannot accurately predict the effect of certain developments on the rate of sales growth, if any, during 2013 and beyond, such as the speed and degree of market acceptance, patent protection and exclusivity of our products, the impact of competition, the effectiveness of our sales and marketing efforts, and the outcome of our current efforts to develop, receive approval for, and successfully launch our near-term product candidates.

Based on our existing liquidity, the expected level of operating expenses, projected sales of our existing products combined with other revenues, proceeds from the convertible debt transaction in June 2012, proceeds from the January 2013 Offering, and proceeds from the March 2013 Offering, we believe these factors will provide us with adequate financial resources to continue to fund our business plan and meet our operating requirements through 2013 and beyond.  We do not expect any material changes in our capital expenditure spending during 2013.  However, we cannot be sure that revenues or proceeds from capital transactions will reach anticipated levels.

 
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As we continue to expend funds to advance our business plan, there can be no assurance that changes in our development plans, capital expenditures or other events affecting our operations will not result in the earlier depletion of our funds.  In appropriate situations, we may seek financial assistance from other sources, including contribution by others to joint ventures and other collaborative or licensing arrangements for the development, testing, manufacturing and marketing of products under development.  Additionally, we may explore alternative financing sources for our business activities, including the possibility of loans and public and/or private offerings of debt and equity securities.  Other than outstanding Investor Notes from Inter-Mountain, proceeds from the January 2013 Offering, and proceeds from the March 2013 Offering, we have no agreements with respect to our potential receipt of additional capital.  We cannot be certain that necessary funding will be available on terms acceptable to us, or at all.

Our future capital requirements and adequacy of available funds will depend on many factors including:

§ 
our ability to successfully commercialize our wound management and burn care products and the market acceptance of these products;
§ 
our ability to establish and maintain collaborative arrangements with corporate partners for the development and commercialization of certain product opportunities;
§ 
continued scientific progress in our development programs;
§ 
the costs involved in filing, prosecuting and enforcing patent claims;
§ 
competing technological developments; and
§ 
the cost of manufacturing and production scale-up.


Contractual Obligations

The following table summarizes our outstanding contractual cash obligations as of September 30, 2013, which consists of a lease agreement for office and laboratory space in Addison, Texas which commenced on April 1, 2006, a lease agreement for office equipment, a separation agreement with our current chief executive officer, Kerry P. Gray, and the principal balance due for our three convertible note agreements.  These obligations and commitments assume non-termination of agreements and represent expected payments based on current operating forecasts, which are subject to change:

   
Payments Due By Period
 
Contractual Obligations
 
Total
   
Less Than
1 Year
   
1-2
Years
   
3-5
Years
   
After 5
Years
 
  Operating leases
  $ 179,609     $ 120,359     $ 59,250     $ ---     $ ---  
  Separation agreement
    124,986       124,986       ---       ---       ---  
  Convertible notes
    1,637,316       1,510,641       126,675       ---       ---  
  Total contractual cash obligations
  $ 1,941,911     $ 1,755,986     $ 185,925     $ ---     $ ---  


Capital Expenditures

Our expenditures for property, equipment, and leasehold improvements were, in approximate numbers, $32,000 and $64,000 for the nine months ended September 30, 2013 and 2012, respectively.  At this time, we believe that our capital expenditures for the remainder of 2013 will be approximately $10,000 and consist of equipment related to the manufacture of our products.
 
Off-Balance Sheet Arrangements

As of September 30, 2013, we did not have any off balance sheet arrangements.

Impact of Inflation

We have experienced only moderate price increases over the last three fiscal years under our agreements with third-party manufacturers as a result of raw material and labor price increases.  However, there can be no assurance that possible future inflation would not impact our operations.


 
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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Management’s Discussion and Analysis of Financial Condition and Results of Operations addresses our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information. The preparation of our financial statements requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, we evaluate these estimates and judgments. We base our estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.  Our critical accounting policies are summarized in our Annual Report on Form 10-K for the year ended December 31, 2012 as filed with the Securities and Exchange Commission on March 29, 2013.  We had no significant changes in our critical accounting policies since our last annual report.
 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This quarterly report on Form 10-Q (including documents incorporated by reference) and other written and oral statements the Company makes from time to time contain certain “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. You can identify these forward-looking statements by the fact they use words such as “should”, “expect”, “anticipate”, “estimate”, “will”, “target”, “may”, “project”, “guidance”, “intend”, “plan”, “believe” and other words and terms of similar meaning and expression in connection with any discussion of future operating or financial performance. One can also identify forward-looking statements by the fact that they do not relate strictly to historical or current facts.  Such forward-looking statements are based on current expectations and involve inherent risks and uncertainties, including factors that could delay, divert or change any of them, and could cause actual outcomes to differ materially from current expectations. These statements include, among other things, statements regarding the Company’s expected cash and cash equivalents and working capital being sufficient to fund our operations and capital expenditure requirements through 2013 and beyond, and other statements, including the Company’s goals, plans and projections regarding its financial position, results of operations, cash flows, market position, product development, product approvals, sales efforts, expenses, performance or results of current and anticipated products and the outcome of contingencies such as legal proceedings, and financial results, which are based on current expectations that involve inherent risks and uncertainties, including internal or external factors that could delay, divert or change any of them in the next several years.  The Company has included important factors in the cautionary statements included in its 2012 Annual Report on Form 10-K, particularly under “Risk Associated with our Business” that the Company believes could cause actual results to differ materially from any forward-looking statement.
 
Although the Company believes it has been prudent in its plans and assumptions, no assurance can be given that any goal or plan set forth in forward-looking statements can be achieved and readers are cautioned not to place undue reliance on such statements, which speak only as of the date made.  The Company undertakes no obligation to release publicly any revisions to forward-looking statements as a result of new information, future events or otherwise.

 
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Quantitative and Qualitative Disclosures About Market Risk.

Concentrations of Credit Risk

Concentration of credit risk with respect to financial instruments, consisting primarily of cash and cash equivalents, potentially expose us to concentrations of credit risk due to the use of a limited number of banking institutions and due to maintaining cash balances in banks, which, at times, may exceed the limits of amounts insured by the Federal Deposit Insurance Corporation.  Currently, we utilized Bank of America, N.A. and Bank of America Investment Services, Inc. as our banking institutions.  At September 30, 2013 and December 31, 2012 our cash and cash equivalents totaled $53,001 and $21,549, respectively.  We also invest cash in excess of immediate requirements in money market accounts, certificates of deposit, corporate commercial paper with high quality ratings, and U.S. government securities.  These investments are not held for trading or other speculative purposes.  We are exposed to credit risk in the event of default by these institutions.

Concentration of credit risk with respect to trade accounts receivable are customers with balances that exceed 5% of total consolidated trade accounts receivable at September 30, 2013 and at December 31, 2012.  As of September 30, 2013, three customers exceeded the 5% threshold, with 53%, 31%, and 7%, respectively.  Two customers exceeded the 5% threshold at December 31, 2012, with 77% and 13%, respectively.  To reduce risk, we routinely assess the financial strength of our most significant customers and monitor the amounts owed to us, taking appropriate action when necessary.  As a result, we believe that accounts receivable credit risk exposure is limited.  We maintain an allowance for doubtful accounts, but historically have not experienced any significant losses related to an individual customer or group of customers.

Concentrations of Foreign Currency Risk

Currently, a portion of our revenue and all of our expenses are denominated in U.S. dollars, although we are recently experiencing an increase in revenues in international territories denominated in a foreign currency.  Certain of our licensing and distribution agreements in international territories are denominated in Euros.  Currently, we do not employ forward contracts or other financial instruments to mitigate foreign currency risk.  As our international operations continue to grow, we may engage in hedging activities to hedge our exposure to foreign currency risk.
 
 
Controls and Procedures.

Evaluation of Disclosure Controls and Procedures.

Our chief executive officer and our chief financial officer, after evaluating the effectiveness of our “disclosure controls and procedures” (as defined in Rule 13a-15(e) and Rule 15d015(e) of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this quarterly report, concluded that our disclosure controls and procedures were (1) designed to ensure that material information relating to us, including our consolidated subsidiaries, is made known to our chief executive officer and chief financial officer by others within the Company, particularly during the period in which this report was being prepared, and (2) effective, in that they provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

Changes in Internal Controls.

There were no changes in our internal controls over financial reporting during the quarter ended September 30, 2013 that have materially affected, or are reasonably likely to material affect, our internal controls over financial reporting.
 

 

 
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 Legal Proceedings.

From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business.  We are not currently a party to any legal proceedings, the adverse outcome of which, in management’s opinion, individually or in the aggregate, would have a material adverse effect on the results of our operations or financial position.  There are no material proceedings to which any director, officer or any of our affiliates,