PINX:ACAR ActiveCare Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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

FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended: June 30, 2012
or
 
o
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: 0-53570

ActiveCare, Inc.
(Exact name of registrant as specified in its charter)

Delaware
 
87-0578125
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
     
  5095 West 2100 South West Valley City, Utah     84120
(Address of principal executive offices)
    (Zip Code)

(801) 974-9474
(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 x  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 x  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 accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o
Accelerated filer o
Non-accelerated filer o
Smaller reporting company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.)  Yes  o   No  x

As of August 20, 2012, the registrant had 45,369,771 shares of Common Stock outstanding.

 
 

 

ActiveCare, Inc.

Quarterly Report on Form 10-Q

Table of Contents

 
 
Page
   
PART I – FINANCIAL INFORMATION
3
Item 1.  Financial Statements
3
Condensed Consolidated Balance Sheets (unaudited)
3
Condensed Consolidated Statements of Operations (unaudited)
5
Condensed Consolidated Statements of Cash Flows (unaudited)
6
Notes to Condensed Consolidated Financial Statements (unaudited)
8
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations
20
Item 3.  Quantitative and Qualitative Disclosures About Market Risk
29
Item 4.  Controls and Procedures
29
   
PART II – OTHER INFORMATION
30
   
Item 1.  Legal Proceedings
30
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
30
Item 3.  Defaults Upon Senior Securities
30
Item 5.  Other Information
30
Item 6.  Exhibits
31
SIGNATURES
32

 
2

 

ActiveCare, Inc.
Balance Sheets
(unaudited)
             
             
   
June 30,
2012
   
September 30,
2011
 
Assets
           
  Current assets:
           
    Cash
  $ 76,916     $ 178,131  
    Accounts receivable, net of allowance for doubtful accounts of $14,647 and $6,820, respectively
    265,414       103,044  
    Inventories, net of inventory valuation of $6,232 and $4,404, respectively
    142,130       116,010  
    Prepaid expenses and other assets
    3,340       2,217  
      Total current assets
    487,800       399,402  
                 
    Property and equipment, net of accumulated depreciation of $511,077 and $464,276, respectively
    186,606       232,182  
    Deposits
    29,870       30,831  
    Domain name, net of amortization of $1,966 and $1,430, respectively
    12,334       12,870  
    Leased equipment, net of amortization of $85,527 and $54,549, respectively
    64,841       112,955  
Patent, net of amortization of $196,870 and $81,310,  respectively
    725,508       218,690  
Contracted customer, net of amortization of $13,837 and $0, respectively
    96,858       -  
Goodwill
    479,305       -  
      Total assets
  $ 2,083,122     $ 1,006,930  

 
See accompanying notes to condensed consolidated financial statements
 
 
3

 
 
 
ActiveCare, Inc.
 
Balance Sheets
 
(unaudited) Continued
 
             
             
   
June 30,
2012
   
September 30,
2011
 
Liabilities and Stockholders’ Equity / (Deficit)
           
  Current liabilities:
           
    Accounts payable
  $ 655,556     $ 452,034  
    Accounts payable - related party
    13,675       -  
    Accrued expenses
    823,502       494,919  
Dividents payable
    40,842       -  
Derivative liability
    1,346,174       -  
    Deferred revenue
    7,369       1,365  
    Note payable
    1,315,778       300,000  
    Note payable - related party
    1,143,037       -  
    Accrued payable on license agreement
    -       300,000  
      Total current liabilities
    5,345,933       1,548,318  
      Total liabilities
    5,345,933       1,548,318  
                 
Stockholders’ equity (deficit)
               
    Preferred stock; $.00001 par value, 10,000,000 shares authorized; 480,000 and 0 shares of Series C, 55,000 and 0 shares of Series D, issued and outstanding, respectively
    6       -  
    Common stock, $.00001 par value, 70,000,000 shares authorized; 45,369,771 and 38,568,160 shares issued and outstanding,  respectively
    454       386  
    Additional paid in capital
    30,124,008       24,394,501  
    Accumulated deficit
    (33,387,279 )     (24,936,275 )
      Total stockholders’ equity (deficit)
    (3,262,811 )     (541,388 )
      Total liabilities and stockholders’ equity (deficit)
  $ 2,083,122     $ 1,006,930  
 
 
See accompanying notes to condensed consolidated financial statements
 
 
4

 

ActiveCare, Inc.
 
Statements of Operations
 
(unaudited)
 
                         
                         
   
Three months ended
   
Nine months ended
 
   
June 30,
   
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
                         
Revenues:
                       
Care Services
  $ 66,035     $ 80,107     $ 190,662     $ 247,702  
Reagents
    135,636       104,792       357,374       325,965  
Chronic Illness Monitoring
    230,625       -       233,743       -  
          Total revenues
    432,296       184,899       781,779       573,667  
                                 
Cost of Revenue
                               
Care Services
    165,038       172,886       495,743       503,600  
Reagents
    94,330       89,550       291,137       285,875  
Chronic Illness Monitoring
    169,264       -       170,544       -  
          Total cost of revenues
    428,632       262,436       957,424       789,475  
               Gross deficit
    3,664       (77,537 )     (175,645 )     (215,808 )
                                 
 Operating expenses
                               
Research and development
    63,906       45,601       112,807       273,611  
Selling, general and administrative (including $61,563,  $1,904,687,  $4,185,673, $3,561,287, respectively, of compensation expense paid in stock or as a result of amortization of stock options/warrants)
    838,167       2,681,098       6,316,341       5,592,111  
                                 
           Loss from operations
    (898,409 )     (2,804,236 )     (6,604,793 )     (6,081,530 )
                                 
Other income (expenses):
                               
Loss on derivative liability
    (1,320,918 )     -       (1,346,174 )     -  
Loss on disposal of equipment
    -       -       -       (4,236 )
Interest income
    21       425       102       782  
Interest expense (including $141,061 and $93,103, $306,130, and $99,265 respectively, of non cash expenses)
    (223,400 )     (98,728 )     (459,297 )     (110,224 )
Other expense
    -       -       -       (50,000 )
                                 
Net loss
  $ (2,442,706 )   $ (2,902,539 )   $ (8,410,162 )   $ (6,245,208 )
Dividends on preferred stock
  $ (14,057 )   $ -     $ (40,842 )   $ -  
Net loss attributable to common shareholders
  $ (2,456,763 )   $ (2,902,539 )   $ (8,451,004 )   $ (6,245,208 )
                                 
 Net loss per common share – basic and diluted
  $ (0.06 )   $ (0.10 )   $ (0.20 )   $ (0.24 )
                                 
 Weighted average shares – basic and diluted
    44,346,000       28,554,314       41,535,000       26,473,653  
 
 
See accompanying notes to condensed consolidated financial statements

 
5

 

ActiveCare, Inc.
Condensed Consolidated Statements of Cash Flows
(unaudited)
  
           
             
   
Nine Months Ended
 
   
June 30,
 
   
2012
   
2011
 
Cash flows from operating activities:
           
Net loss
  $ (8,410,162 )   $ (6,245,208 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Depreciation and amortization
    231,353       153,837  
Derivative valuation loss
    1,346,174       -  
Stock based compensation expense
    4,185,673       3,486,287  
Loss on impairment of investment
    -       50,000  
Amortization of debt discount recorded as interest expense
    306,130       99,265  
Loss on disposal of property & leased equipment
    -       5,085  
Changes in operating assets and liabilities:
               
Accounts receivable
    (162,370 )     (10,945 )
Inventories
    (26,120 )     (48,834 )
Prepaid expenses and other assets
    (162 )     308,943  
Accounts payable
    217,198       (135,535 )
Accrued expenses
    377,796       76,218  
Deferred revenue
    6,004       (24,618 )
 Net cash used in operating activities
    (1,928,486 )     (2,285,505 )
                 
Cash flows from investing activities:
               
Purchase of assets for operations
    (1,224 )     (209,457 )
Purchase of leased equipment
    (6,505 )     (124,520 )
Acquistion of 4G Biometrics, LLC
    (200,000 )     -  
Net cash used in investing activities
    (207,729 )     (333,977 )
                 
Cash flows from financing activities:
               
Proceeds from sale of common stock, net of commissions
    -       456,501  
Payment to related-party note payable
    (85,000 )     (25,000 )
Proceeds from related-party note payable (net of loan origination fees)
    920,000       300,002  
Proceeds from unrelated-party note payable (net of loan origination fees)
    1,200,000       -  
Payment on  note payable
    -       (30,000 )
Proceeds from exercise of warrants
    -       522,499  
Net cash provided by financing activities
    2,035,000       1,224,002  
                 
Net decrease in cash
    (101,215 )     (1,395,480 )
Cash, beginning of period
    178,131       1,713,923  
                 
Cash, end of period
  $ 76,916     $ 318,443  
 
 
See accompanying notes to condensed consolidated financial statements
 
 
6

 
 
ActiveCare, Inc.
 
(Formerly Volu-Sol Reagents Corporation)
 
Condensed Consolidated Statements of Cash Flows
 
(unaudited) cont.
 
             
   
Nine Months Ended
 
   
June 30,
 
   
2012
   
2011
 
Supplemental Cash Flow Information:
           
Cash paid for income taxes
  $ -     $ -  
Cash paid for interest
  $ 5,448     $ 10,349  
                 
Non-Cash Investing and Financing:
               
Exercise of warrants from accrued board fees
  $ -     $ 15,000  
Issuance of stock for settlement of accrued board fees
          $ 75,000  
Issuance of stock for purchase of patents
  $ 622,378     $ -  
Issuance of stock for settlement of liabilities
  $ 612,000     $ -  
Conversion of note payable into common stock
  $ 92,400     $ -  
Conversion of note payable into Series D Preferred Stock
  $ 110,000     $ -  
 
See accompanying notes to condensed consolidated financial statements

 
7

 

ActiveCare, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited)


1.   Basis of Presentation
 
The unaudited interim condensed consolidated financial information of ActiveCare, Inc. (the “Company” or “ActiveCare”) has been prepared in accordance with Article 10 of Regulation S-X promulgated by the Securities and Exchange Commission. Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the accompanying interim condensed consolidated financial information contains all adjustments, consisting only of normal recurring adjustments necessary to present fairly the Company’s financial position as of June 30, 2012, and results of its operations for the three months and nine months ended June 30, 2012 and 2011. These financial statements should be read in conjunction with the annual consolidated financial statements and notes thereto that are included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2011. The results of operations for the three months and nine months ended June 30, 2012 may not be indicative of the results for the fiscal year ending September 30, 2012.
 
Going Concern
 
Even though the Company had a positive gross margin for the three months ended June 30, 2012, the Company incurred a negative gross margin and has negative cash flows from operating activities for the years ended September 30, 2011 and 2010, and for the nine months ended June 30, 2012. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
 
In order for the Company to remove substantial doubt about its ability to continue as a going concern, the Company must continue to improve gross margins and generate positive cash flows from operations and obtain the necessary funding to meet its projected capital investment requirements. Management’s plans with respect to this uncertainty include raising additional capital by issuing secured debt and increasing the sales of the Company services and products. There can be no assurance that the Company will be able to raise sufficient capital or that revenues will increase rapidly enough to offset operating losses and repay debts. If the Company is unable to increase revenues or obtain additional financing, it will be unable to continue the development of its products and may have to cease operations.
 
Use of Estimates in the Preparation of Financial Statements
 
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
 
Fair Value of Financial Statements
 
The carrying amounts reported in the condensed consolidated balance sheets for accounts receivable, accounts payable, and accrued liabilities approximate fair value because of the immediate or short-term maturity of these financial instruments. The carrying amounts reported for notes payable approximate fair value because the underlying instruments are at interest rates which approximate current market rates.
 
For assets and liabilities measured at fair value, GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Additionally, the inputs used to measure fair value are prioritized based on a three-level hierarchy. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels on inputs used to measure fair value are as follows:
 
·  
Level 1 — Quoted prices in active markets for identical assets or liabilities.
 
·  
Level 2 — Observable inputs other than quoted prices included in Level I. Assets and liabilities included in this level are valued using dealer and broker quotations, bid prices, quoted prices for similar assets and liabilities in active markets, or other inputs that are observable or can be corroborated by observable market data.
 
·  
Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
 
 
8

 
 
In valuing certain contracts, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. For disclosure purposes, assets and liabilities are classified in their entirety in the fair value hierarchy level based on the lowest level of input that is significant to the overall fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the placement within the fair value hierarchy levels.
 
2.   Net Loss per Common Share
 
Net loss per common share is computed by dividing net loss attributable to common shareholders by the sum of the weighted average number of common shares outstanding and the weighted-average dilutive common share equivalents then outstanding.  The computation of loss per share does not assume exercise or conversion of securities that would have an anti-dilutive effect.
 
Common share equivalents consist of shares of Common Stock issuable upon the exercise of stock purchase warrants.  As of June 30, 2012 and 2011, there were 57,137,557 and 14,289,000 outstanding common share equivalents, respectively, that were not included in the computation of diluted net loss per common share as their effect would be anti-dilutive. The Common Stock equivalents outstanding as of June 30, 2012 and 2011, consisted of the following:
 
   
June 30,
   
June 30,
 
   
2012
   
2011
 
Conversion of debt
    35,084,686       -  
Conversion of Series D Preferred Stock
    2,750,000       -  
Conversion of Series C Preferred Stock
    4,800,000       -  
Exercise of outstanding Common Stock options and warrants
    13,865,871       13,652,000  
Issuance of employee restricted shares
    637,000       637,000  
Total Common Stock equivalents
    57,137,557       14,289,000  
 
3.   Recent Accounting Pronouncements
 
The Company has reviewed all recently issued, but not yet effective, accounting pronouncements and does not believe the future adoptions of any such pronouncements are expected to cause a material impact on the Company’s financial condition or the results of operations.
 
4.   Acquisitions, Goodwill and Other Intangible Assets
 
On March 8, 2012, the Company acquired 4G Biometrics, LLC, a Texas limited liability company (“4G”). Pursuant to the acquisition agreement, the Company acquired 100 percent of the member interests of 4G and 4G will be operated as a wholly owned subsidiary of the Company. As amended, the purchase price for the member interests of 4G was comprised as follows:
 
·
  $350,000 in cash (as of the date of this report, the Company have paid $200,000 and the balance owed is $150,000);
 
·
  $50,000 of liabilities payable in cash;
 
·
  160,000 shares of Series D convertible preferred stock;
 
·
  Options for the purchase of up to 4,333,333 shares of Common Stock of the Company at $0.10 per share to each of the three sellers, exercisable once 4G has 4,300 members, as follows:
 
o
  Options for 433,333 shares vest when an additional 5,000 4G members as added, or a total of 9,300 members;
 
o
  Options for 433,333 shares vest when an additional 5,000 4G members are added, or a total of 14,300 members; and
 
o
  Options for 433,333 shares vest when an additional 5,000 4G members are added, or a total of 19,300 members; and
 
o
  so forth until fully vested.
 
Three of the 4G key managers will continue to manage the operations of 4G under written employment agreements. In addition, on October 1, 2012, one of the key managers will be appointed to serve as a member of our Board of Directors if 4G has sales of at least $1,000,000 for the nine months ending September 30, 2012. 
 
Under the purchase method of accounting, the total purchase price will be allocated to 4G’s intangible assets based on their estimated fair values as of the closing date of the acquisition. The excess of the purchase price over intangible assets will be recorded as goodwill.
 
As of June 30, 2012, the purchase price for 4G reflects a total consideration transferred of $590,000, which has been preliminarily allocated as $479,305 of goodwill and $110,695 of acquired customer contracts.
 
 
9

 
 
The fair value of the assets acquired and the liabilities assumed were measured based on significant inputs that are not observable in the market and are considered Level 3 fair value inputs. The fair value of the assets acquired, liabilities assumed and goodwill was as follows:
 
Assets acquired - Acquired customer contract
  $ 110,695  
Liabilities assumed
    (50,000 )
Fair value of net assets acquired
    60,695  
         
Fair value of consideration given
    540,000  
         
Goodwill
  $ 479,305  

The following table presents the unaudited pro forma consolidated results of operations for the three and nine months ended June 30, 2012 and 2011, as though the acquisition of 4G Biometrics, LLC had been completed as of the beginning of each period presented. This unaudited pro forma information is presented for illustrative purposes only and is not necessarily indicative of the combined results of operations to be expected in any future period or the results of operations that actually would have been realized had the entities been combined during the periods ended June 30, 2012 and 2011:
 
ActiveCare, Inc. and Subsidiaries
 
Unaudited Pro Forma Condensed Consolidated Statement of Operations
 
(unaudited)
 
   
Three months ended
   
Nine months ended
 
   
June 30,
   
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
Revenue
  $ 432,296     $ 205,942     $ 808,075     $ 631,838  
Net loss
  $ (2,442,706 )   $ (3,048,772 )   $ (8,678,189 )   $ (6,673,739 )
Net loss per common share – basic and diluted   $ (0.06   $ (0.11 )   $ (0.21 )   $ (0.25 )
 
5.   Inventory
 
Inventories are recorded at the lower of cost or market, cost being determined on a first-in, first-out (“FIFO”) method. Inventories consisted of raw materials, work-in-process, and finished goods.  Inventories as of June 30, 2012 and September 30, 2011, were as follows:
 
   
June 30,
2012
   
September 30,
2011
 
CareServices (ActiveHome™) Inventory
  $ 65,058     $ 68,264  
Chronic Illness Monitoring Inventory
    19,877       -  
Reagent Inventory
               
   Raw materials
    41,203       38,433  
   Work in process
    6,608       7,131  
   Finished goods
    15,616       6,586  
   Reserve for inventory obsolescence
    (2,157 )     (329 )
   Inventory valuation
    (4,075 )     (4,075 )
Total inventory
  $ 142,130     $ 116,010  
 
 
10

 
 
When required, provisions are made to reduce excess and obsolete inventories to their estimated net realizable values.  Due to competitive pressures and technological innovation, it is possible that estimates of the net realizable value could change in the near term.
 
6.    Property and Equipment
 
Property and equipment are stated at cost, less accumulated depreciation and amortization.  Depreciation and amortization are determined using the straight-line method over the estimated useful lives of the assets, typically three to seven years.  Leasehold improvements are amortized over the shorter of the estimated useful lives of the asset or the term of the lease.  Expenditures for maintenance and repairs are expensed while renewals and improvements over $500 are capitalized.  When property and equipment are disposed, any gains or losses are included in the results of operations.
 
Property and equipment consisted of the following as of June 30, 2012 and September 30, 2011:
 
   
June 30,
2012
   
September 30,
2011
 
Equipment
  $ 230,454     $ 229,229  
Software
    25,111       25,111  
Leasehold improvements
    402,016       402,016  
Furniture and fixtures
    40,102       40,102  
 
    697,683       696,458  
Accumulated depreciation
    (511,077 )     (464,276 )
Property and equipment, net of accumulated depreciation
  $ 186,606     $ 232,182  
 
Depreciation expense for the nine months ended June 30, 2012, and 2011, was $46,800, and $25,318 respectively.
 
7. Leased Equipment
 
Leased equipment at June 30, 2012 and September 30, 2011, is as follows:
 
   
June 30,
2012
   
September 30,
2011
 
Leased equipment
  $ 150,368     $ 167,504  
Less accumulated depreciation
    (85,527 )     (54,549 )
Leased Equipment, net
  $ 64,841     $ 112,955  
 
The Company began leasing monitoring equipment to customers for CareServices in October 2009.  The leased equipment is depreciated on the straight-line method over the estimated useful lives of the related assets over three years regardless whether the equipment is leased to a customer or remaining in stock.  Customers have the right to cancel the service agreements at anytime.  The leased equipment depreciation expense is recorded under Cost of Revenue for CareServices.  Leased equipment depreciation expense for the nine months ended June 30, 2012 and 2011, was $42,974 and $47,832, respectively.
 
8.   Patent License Agreement
 
During the year ended September 30, 2009, the Company licensed the use of certain patents from a third party. This license agreement was to aid the Company as it furthers its business plan. Under the license agreement, the Company was required to pay $300,000 plus a 5% royalty on the net sales of all licensed products. At September 30, 2009, the Company had recorded the license agreement fee as a long-term asset and had also recorded a corresponding liability as the fee was not yet paid.
 
During the nine months ended June 30, 2012, the Company agreed to purchase the patents and settle amounts owed under the license agreement by issuing 600,000 shares of Common Stock and 480,000 shares of Series C.  The total value of the patents on the purchase date was $922,378, based on a valuation conducted by an independent valuation expert.  The value of the Common Stock issued was $240,000, based on the market price of the Common Stock on the date of issuance. The implied value of the Series C was $682,378, was based on the difference between the value of the patents and the Common Stock issued in settlement of the existing liability.
 
The Company is amortizing the cost over the remaining useful life of the patents, which expire in 2018. The Company recognized $196,870 of amortization expense relating to the patents as of June 30, 2012.
 
The Company’s future patent amortization as of June 30, 2012, is approximately as follows:
 

 
11

 


Year Ending September 30:
     
2012
  $ 31,718  
2013
    126,870  
2014
    126,870  
2015
    126,870  
2016
    126,870  
Thereafter
    186,310  
    $ 725,508  
 
9.   Notes Payable
 
As of June 30, 2012, the Company owed the following notes payable:
 
(1)  
During the quarter ended June 30, 2011, the Company borrowed $300,000 from a shareholder.  The $300,000 note had an annual interest rate of 12% and was due on June 30, 2011.  Any unpaid balance of the loan and interest expense after the due date has an annual interest rate of 18%.  In connection with the $300,000 loan, the Company issued 225,000 shares of Common Stock with a total value of $93,103 as a loan origination fee.  The loan origination fee is recorded as a discount to the loan.  The Company fully amortized the loan origination fee during the quarter ended June 30, 2011.
 
During the quarter ended March 31, 2012, the due date of the loan was extended to April 30, 2012, with an additional $30,000 of loan origination fee added to the principal of the loan, which was recorded as a discount to the loan.  In addition, $45,852 of unpaid interest was added to the principal before the extension.  During the three months ended June 30, 2012, the Company amortized the remaining $16,667 of the $30,000 loan origination fee and accrued $15,301 interest expense related to this loan.  The loan principal of $375,852 and accrued interest of $18,266 are currently past due and have not been paid by the Company.
 
The lender is under the control of David Derrick, who became the Company’s Chief Executive Officer and Chairman in July 2012.
 
(2)  
During the nine months ended June 30, 2012, the Company borrowed $340,000 from another entity controlled by Mr. Derrick. This loan had an annual interest rate of 20% and was due on February 3, 2012.  After February 2, 2012, the lender has the right to convert the loan into the Company’s Common Stock at the lesser of 50% of fair market value on the date of conversion or $0.25 per share.  The conversion feature related to this note results in a derivative liability.  Also in connection with this loan, the Company granted warrants to purchase of 341,000 shares of Common Stock as a loan origination fee recorded as a discount on the loan.  These warrants vested immediately and are exercisable at $0.44 per share through November 3, 2016.  The fair value of the warrants at the date of grant was $107,130, and was measured using the Black-Scholes valuation model with the following assumptions: exercise price of $0.44; risk-free interest rate of 0.39%; expected life of 2.5 years; expected dividend of zero; a volatility factor of 134.57%; and market price on date of grant of $0.44.  Expected volatilities are based on historical volatility of a peer company’s common stock, among other factors.  The Company uses the simplified method within the valuation model due to the Company’s short trading history.  The risk-free rate for periods within the contractual life of the warrants is based on the U.S. Treasury yield curve in effect at the time of grant.  During the quarter ended March 31, 2012, the Company repaid $85,000 of the principal, and the lender converted $60,000 of the loan amount to 1,500,000 shares of Common Stock and transferred $50,000 of the note to another party (see (3) below).
 
During the three months ended June 30, 2012, the remaining $145,000 of the convertible loan, together with interest, plus $50,000 of services payable and additional borrowings of $154,000 (including a $14,000 loan origination fee) were rolled into a new convertible loan under a promissory note.  The total amount of the new loan is $403,586.  The note has an annual interest rate of 15%.  $187,000 of the loan is due on May 31, 2012, and the remaining balance of the loan is due on June 30, 2012.  The loan can be converted into Common Stock at 50% of fair market value or $0.04 per share, whichever is less.
 
During the nine months ended June 30, 2012, the lender converted $32,400 to 810,000 shares of Common Stock, $110,000 to 55,000 shares of Series D Preferred Stock.  During the nine months ended June 30, 2012, the Company accrued $13,680 interest expense related to this loan.  As of June 30, 2012, the loan principal of $261,186 and accrued interest of $9,205 is currently past due and has not been paid by the Company.
 
 
12

 
 
(3)  
During the quarter ended June 30, 2012, the Company borrowed an additional $400,000 from Mr. Derrick’s affiliate in (2) above under a promissory note due on July 31, 2012.  The note includes a 10% loan origination fee of $40,000 that was added to the principal of the loan and recorded as a discount, and a 15% annual interest rate.  The loan can be converted into Common Stock at 50% of fair market value or $0.04 per share, whichever is less.  During the nine months ended June 30, 2012, the Company amortized $40,000 of the loan origination fee.  As of June 30, 2012, the principal balance of the note is $440,000 and accrued interest is $4,475.  This note remains unpaid.
 
(4)  
During the quarter ended June 30, 2012, the Company borrowed $30,000 loan from James Dalton, its former Chief Executive Officer, under a promissory note.  The Company paid a $3,000 loan origination fee and the note carries an annual interest rate of 15%.  The loan is due on May 31, 2012.  The loan can be converted into Common Stock at 50% of fair market value or $0.04 per share, whichever is less.  As of June 30, 2012, the principal balance of the note is $33,000 and accrued interest is $990.  This note remains unpaid and is currently past due.
 
(5)  
During the quarter ended June 30, 2012, the Company borrowed $30,000 from Michael Acton, its Chief Financial Officer, under a promissory note.  The Company paid a $3,000 loan origination fee and the note carries an annual interest rate of 15%.  The loan is due on June 30, 2012. The loan can be converted into Common Stock at 50% of fair market value or $0.05 per share, whichever is less.  As of June 30, 2012, the principal balance of the note is $33,000 and accrued interest is $692.  This note remains unpaid and is currently past due.
 
(6)  
During the quarter ended March 31, 2012, the Company borrowed $550,000 from an unrelated party under a promissory note, which included principal of $50,000 assigned from another note (see (2) above).  The $550,000 note is unsecured and is due on April 30, 2012.  The note includes a 10% loan origination fee of $55,000 that was added to the principal of the loan and recorded as a discount, and a 15% annual interest rate.  During the nine months ended June 30, 2012, the Company amortized all of the loan origination fee.  As of June 30, 2012, the principal balance of the note is $605,000 and accrued interest is $30,333.  This note remains unpaid and is currently past due.
 
(7)  
During the quarter ended March 31, 2012, the Company borrowed $300,000 from an unrelated party under a promissory note.  The note is unsecured and was due on April 30, 2012.  The note includes a 10% loan origination fee of $30,000, which was added to the principal of the loan and recorded as a discount on the loan.  The loan also has a 15% annual interest rate.  During the three months ended June 30, 2012, this loan has been extended to a new due date of June 30, 2012, with payment of an additional loan origination fee of $11,000.  Additionally, the principal and accrued interest, and an additional $11,000 of loan origination fee and additional borrowings of $110,000 (including $10,000 loan origination fee in relation to the additional amounts) were rolled into a new convertible loan.  The total amount of the new loan agreement is $460,778 with annual interest rate of 15%.  $115,000 of the loan is due on May 31, 2012, and the remaining balance of the loan is due on June 30, 2012.  The loan can be converted into Common Stock at 50% of fair market value or $0.04 per share, whichever is less.  As of June 30, 2012, the principal balance of the note is $460,778 and accrued interest of $11,275 remains unpaid and is currently past due.
 
(8)  
During the quarter ended March 31, 2012, the Company borrowed $250,000 from an unrelated party.  The $250,000 note is unsecured, has a 12% annual interest rate, and is due June 30, 2012.  As of June 30, 2012, the unpaid principal balance of the note is $250,000 and accrued interest is $14,630.
 
10.    Derivative Liabilities
 
As described in Note 9 to these condensed consolidated financial statements, the Company has issued convertible notes.  The Company has determined that these notes are subject to derivative liability treatment and are required to be accounted for at fair value.  The Company has determined the aggregate fair value of the embedded derivative liability represented by these notes as $1,346,174 at June 30, 2012.  The Company has recorded a loss on the change in the derivative liability of $1,320,918 and $1,346,174, for the three months and the nine months ended June 30, 2012, respectively.
 
The Company estimated the fair value of the embedded derivative using the Black Scholes option pricing model using the following assumptions: conversion price at $0.035 per share; risk free interest rate of 0.09%; expected life of 0.17 years; expected dividend of zero; a volatility factor of 182.71%; and market price on date of grant of $0.07.  The expected life of the notes is equal to the average term of the conversion feature, as allowed for under the simplified method prescribed by Staff Accounting Bulletin 107.  The expected volatility is based on the historical price volatility of the Company’s Common Stock.  The risk-free interest rate represents the U.S. Treasury constant maturities rate for the expected life of the related conversion feature. The dividend yield represents anticipated cash dividends to be paid over the expected life of the conversion feature.
 
 
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As part of the embedded derivative feature contained in the convertible loans, the Company is unable to guarantee that there would be enough shares of stock to settle other “freestanding instruments.”  Accordingly, all warrants and options outstanding or issued during the period ended June 30, 2012 (except for stock options issued to employees) should be measured at their fair value and recorded as additional liability. However, the fair value of these warrants was insignificant at June 30, 2012.
 
11.   Preferred Stock
 
The Company is authorized to issue 10,000,000 shares of Preferred Stock, with a par value of $0.00001 per share.  Pursuant to the Company’s Certificate of Incorporation, the Board of Directors has the authority to amend the Company’s Certificate of Incorporation, without further shareholder approval, to designate and determine the preferences, limitations and relative rights of the Preferred Stock before any issuance of the Preferred Stock and to create one or more series of Preferred Stock, fix the number of shares of each such series, and determine the preferences, limitations and relative rights of each series of Preferred Stock, including dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, redemption prices, and liquidation preferences.
 
Series C Convertible Preferred Stock
 
On October 4, 2011, the Company issued 480,000 shares of Series C Convertible Preferred Stock (“Series C”) in connection with the patent license agreement settlement (see Note 8, above.)  The par value of the Series C is $0.00001 per share.  The fair market value of the Series C on the date of grant was $682,378.  The value of the Series C was measured based on the value difference of the patents and the Common Stock issued in connection with the patent license agreement settlement.  The Series C is non-voting stock.  Each share of Series C may be converted into 10 shares of Common Stock, provided, however, that a holder may not convert shares of Series C which, upon conversion, would result in the holder becoming the beneficial owner of more than 4.99% of the issued and outstanding Common Stock of the Company.
 
During the three months ended March 31, 2012, the Company amended the rights and preferences of the Series C as follows:
 
·  
Required payment of dividends at a rate of 8% per annum in either cash or Common Stock at the Company’s discretion.  If paid in Common Stock, the price of the Common Stock will be the average closing price of the last 10 trading days of each quarter; and
 
·  
Permitted conversion of the Series C into Common Stock at any time after June 30, 2012.
 
During the nine months ended June 30, 2012, the Company accrued, but did not pay $40,432 of dividends associated with the Series C.
 
Series D Convertible Preferred Stock
 
On October 4, 2011, the Board of Directors designated 1,000,000 shares of Preferred Stock as “Series D Convertible Preferred Stock” (“Series D”).  As originally designated, the Series D was to be vested immediately upon issuance, and each share of Series D could be converted into 10 shares of Common Stock.  The original designation also provided that the Series D would be non-voting and would not pay a dividend.  In addition, conversion of the Series D was limited to not more than 4.99% of the issued and outstanding Common Stock.
 
During the three months ended March 31, 2012, the Board of Directors approved the following amendments to the designation of the rights and preferences of the Series D prior to the issuance of any of the shares:
 
·  
Changed the conversion ratio from 10 shares of Common Stock for one share of Series D to 50 shares of Common Stock for each share of Series D;
 
·  
Added an annual dividend rate of 8%, payable quarterly beginning April 1, 2012;
 
·  
Changed the shares from non-voting to voting, on an as-converted basis;
 
 
 
14

 
·  
Eliminated the 4.99% conversion limitation;
 
·  
Permitted conversion of the Series D, commencing April 1, 2012;
 
·  
Permitted the Company to redeem the Series D shares at a redemption price equal to 120% of original purchase with 15 days notice.
 
The Company issued 55,000 shares of Series D upon conversion of debt during the three months ended June 30, 2012.  During the nine months ended June 30, 2012, the Company accrued, but did not pay $410 of dividends associated with the Series D.
 
Liquidation Preference
 
Upon any liquidation, dissolution or winding up of the Company, before any distribution or payment may be made to the holders of the Common Stock, the holders of the Series C and Series D are entitled to be paid out of the assets an amount equal to $1.00, per share plus all accrued but unpaid dividends.  If the assets of the Company are insufficient to make payment in full to all holders of Preferred Stock, then the assets shall be distributed among the holders of Preferred Stock at the time outstanding, ratably in proportion of the full amounts to which they would otherwise be respectively entitled.
 
12.   Common Stock
 
During the nine months ended June 30, 2012, the Company issued the following shares of Common Stock:
 
·  
600,000 shares for settlement under the patent license agreement, with value on the date of grant of $240,000;
 
·  
1,291,611 shares for consulting services, with value on the date of grant of $218,906;
 
·  
600,000 shares for settlement of $312,000 of accrued liabilities;
 
·  
2,000,000 shares in connection with a settlement agreement.  During the fiscal year ended September 30, 2010, the Company granted Class D warrants for the purchase of 1,584,159 shares of Common Stock and Class E warrants for the purchase of 415,841 shares of Common Stock.  During the three months ended March 31, 2012, the Company entered into a settlement agreement with the holders of these warrants to resolve claims of the holders regarding their conversion of shares of Preferred Stock.  Under the settlement agreement, the holders exchanged the Class D and Class E warrants for 2,000,000 shares of Common Stock and the warrants were cancelled.  The Company recognized $500,000 of expense due to the conversion during the quarter ended March 31, 2012; and
 
·  
2,310,000 shares from conversion of a related party short term note payable in the amount of $92,400.
 
During June 2011, the Company entered into a service contract with its former Chief Executive Officer for services to be rendered from October 2010 through September 2014.  As part of this service contract, the Company issued 4,000,000 shares of restricted Common Stock with a fair value on the date of grant of $1,840,000, as payment for past and future services.  During the nine months ended June 30, 2012, the Company accelerated the vesting of the shares and recognized the residual compensation expense of $1,380,000 related to the issuance of these shares.
 
During 2010, the Company awarded certain employees restricted stock grants totaling 679,000 shares, valued at $916,650, or $1.35 per share, in connection with their employment agreements.  During the year ended September 30, 2011, the Company reduced the non-vested stock by 42,000 shares due to the change of employment status of several individuals.  During the nine months ended June 30, 2012, the Company recognized $117,187 of compensation expense due to the grant.  As of June 30, 2012, the unrecognized stock-based compensation was $284,713 and will be recognized over the remaining estimated lives of the performance measures.  The weighted average remaining term of the grant is 2 years.
 
13.   Stock Options and Warrants
 
The fair value of each stock option (warrant) grant is estimated on the date of grant using the Black-Scholes option-pricing model.  The expected life of stock options (warrants) represents the period of time that the stock options (warrants) are expected to be outstanding, based on the simplified method allowed under GAAP.  Expected volatilities are based on historical volatility of a peer company’s common stock, among other factors.  The Company uses the simplified method within the valuation model due to the Company’s short trading history.  The risk-free rate for periods within the contractual life of the warrants is based on the U.S. Treasury yield curve in effect at the time of grant.  The dividend yield of all the warrants the Company has granted is zero.
 
For the nine months ended June 30, 2012 and 2011, the Company recognized non-cash expense of $2,076,709 and $187,966, respectively, related to the vesting and re-pricing of all stock options and warrants granted in current and prior years.
 
During the nine months ended June 30, 2012, the Company granted the following stock purchase warrants:
 
 
15

 
·  
Warrants for the purchase of 3,000,000 shares of Common Stock to the Company’s former Chief Executive Officer at an exercise price of $0.44 per share with total fair market value on the date of grant of $822,218.  The fair value of the warrants was measured using the Black-Scholes valuation model using the following assumptions: exercise price of the warrants at $0.44; risk free interest rate of 0.40%; expected life of 2.5 years; expected dividend of zero; a volatility factor of 130.61%; and market price on date of grant of $0.40.  Expected volatilities are based on historical volatility of a peer company’s common stock, among other factors. The Company uses the simplified method within the valuation model due to the Company’s short trading history.  The risk-free rate for periods within the contractual life of the warrants is based on the U.S. Treasury yield curve in effect at the time of grant. These warrants vested over three years and were exercisable through October 3, 2016.  The executive resigned from the Company in March 2012.  A total of 1,252,871 warrants vested before his resignation and the Company recognized $343,378 as compensation expense related to the grant.
 
·  
Warrants for the purchase of 3,600,000 shares of Common Stock to the Company’s former Chairman of the Board of Directors at $0.40 per share, with fair market value on the date of grant of $1,007,564.  The warrants vested immediately and are exercisable through October 3, 2016.  The fair value of the warrants was measured using the Black-Scholes valuation model using the following assumptions: exercise price of the warrants at $0.40; risk free interest rate of 0.40%; expected life of 2.5 years; expected dividend of zero; a volatility factor of 130.61%; and market price on date of grant of $0.40.  Expected volatilities are based on historical volatility of a peer company’s common stock, among other factors. The Company uses the simplified method within the valuation model due to the Company’s short trading history.  The risk-free rate for periods within the contractual life of the warrants is based on the U.S. Treasury yield curve in effect at the time of grant.
 
·  
Warrants for the purchase of 341,000 shares of Common Stock to an entity that is controlled by our new Chief Executive Officer, in connection with a loan agreement.  The value of the warrants was $107,130 at the grant date.  These warrants are exercisable at a price of $0.44 per share through November 3, 2016.  The fair value of the warrants was measured using the Black-Scholes valuation model using the following assumptions: exercise price of the warrants at $0.44; risk free interest rate of 0.39%; expected life of 2.5 years; expected dividend of zero; a volatility factor of 134.57%; and market price on date of grant of $0.44.  Expected volatilities are based on historical volatility of a peer company’s common stock, among other factors. The Company uses the simplified method within the valuation model due to the Company’s short trading history.  The risk-free rate for periods within the contractual life of the warrants is based on the U.S. Treasury yield curve in effect at the time of grant. The Company amortizes the expense over the life of the loan.  The Company recognized $107,130 as a loan origination fee related to the grant of the warrants.  See note 9 for details.
 
During the nine months ended June 30, 2012, the Company re-priced previously granted warrants as follows:
 
·  
Board of Directors – warrants for the purchase of 320,000 shares of Common Stock were re-priced from an original exercise price of $1.25 per share to $0.50 per share, resulting in additional compensation expense of $3,297.
 
·  
Transfer – warrants for the purchase of 750,000 shares of Common Stock were transferred by an executive officer to members of the Company’s Board of Directors; as a result, the Company revalued these warrants and incurred additional compensation expense of $21,765.
 
During June 2011, the Company entered into a service contract with its former Chief Executive Officer for services to be rendered from October 2010 through September 2014.  As payment for past and future services under this service contract, the Company granted warrants to purchase 3,000,000 shares of Common Stock at an exercise price of $0.50 per share, with a fair value on the date of grant of $791,434.  The fair value of the warrants was measured using the Black-Scholes valuation model using the following assumptions: exercise price of the warrants at $0.50; risk free interest rate of 0.68%; expected life of 2.5 years; expected dividend of zero; a volatility factor of 104%; and market price on date of grant of $0.46.  Expected volatilities are based on historical volatility of a peer company’s common stock, among other factors. The Company uses the simplified method within the valuation model due to the Company’s short trading history.  The risk-free rate for periods within the contractual life of the warrants is based on the U.S. Treasury yield curve in effect at the time of grant.  During the nine months ended June 30, 2012, the Company accelerated the vesting of the warrants and recognized the residual compensation expense of $593,576 related to the issuance of these warrants.
 

 
16

 
 
The following table summarizes information about stock options and warrants outstanding as of June 30, 2012:
 
Warrants/Options
 
Number of Shares
 Issuable Under Options and Warrants
   
Weighted-Average
 Exercise Price
 
Outstanding as of September 30, 2011
    10,672,000     $ 0.58  
Granted
    6,941,000     $ 0.42  
Exercised
    -       -  
Exchanged
    (2,000,000 )     -  
Forfeited
    (1,747,129 )   $ 0.44  
Outstanding as of June 30, 2012
    13,865,871     $ 0.44  
 
As of June 30, 2012, the total aggregate intrinsic value of the outstanding warrants is $0, and the weighted average remaining term of the warrants is 3.37 years.
 
14.   Segment Information
 
The Company is organized into three business segments based primarily on the nature of the Company’s products. The Stains and Reagents segment is engaged in the business of manufacturing and marketing medical diagnostic stains, solutions and related equipment to hospitals and medical testing labs.  The CareServices segment is engaged in the business of developing, distributing and marketing mobile health monitoring and concierge services to distributors and customers.  The Chronic Illness Monitoring segment is primarily engaged in the monitoring of diabetic patients on a real time basis.
 
The following table reflects certain financial information relating to each reportable segment for the three-month and nine-month periods ended June 30, 2012 and 2011:
 
    CareServices     Stains and Reagents     Chronic Illness Monitoring     Total  
Three Months Ended June 30, 2012
                       
Sales to external customers
  $ 66,035     $ 135,636     $ 230,625     $ 432,296  
Segment loss
    (2,223,137 )     (3,629 )     (215,940 )     (2,442,706 )
Segment assets
    1,100,539       203,664       778,919       2,083,122  
Depreciation and amortization
    38,734       11,271       13,837       63,842  
                                 
Three Months Ended June 30, 2011
                               
Sales to external customers
  $ 80,107     $ 104,792     $ -     $ 184,899  
Segment loss
    (2,865,807 )     (36,732 )     -       (2,902,539 )
Segment assets
    817,959       397,718       -       1,215,677  
Depreciation and amortization
    38,589       3,636       -       42,225  
                                 
Nine months Ended June 30, 2012
                               
Sales to external customers
  $ 190,662     $ 357,374     $ 233,743     $ 781,779  
Segment loss
    (8,011,028 )     (104,968 )     (294,166 )     (8,410,162 )
Segment assets
    1,100,539       203,664       778,919       2,083,122  
Depreciation and amortization
    153,551       40,394       13,837       207,782  
                                 
Nine months Ended June 30, 2011
                               
Sales to external customers
  $ 247,702     $ 325,965     $ -     $ 573,667  
Segment loss
    (6,138,658 )     (106,550 )     -       (6,245,208 )
Segment assets
    817,959       397,718       -       1,215,677  
Depreciation and amortization
  $ 113,273     $ 10,791     $ -     $ 124,064  
 

 
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15.   Commitments and Contingencies
 
The Company leases a CareCenter facility and an office facility with lease contracts expiring in February 2014, and November 2015, respectively.  The Company is also party to two equipment lease contracts expiring in June 2012 and August 2013.  Future minimum rental payments under the non-cancelable operating lease as of June 30, 2012, are approximately as follows:
 
Lease Obligations
     
Year Ending September 30:
     
2012
  $ 36,366  
2013
    141,497  
2014
    104,259  
2015
    87,171  
2016
    15,970  
        Total
  $ 385,263  
 
Rent expense related to the CareCenter and office facility leases was approximately $37,415 and $41,329 including base real property taxes for the quarters ended June 30, 2012 and 2011, respectively.  For the nine months ended June 30, 2012 and 2011, this expense was $109,212 and $99,529, respectively.
 
16.   Fair Value Measurements
 
GAAP establishes a fair value hierarchy that prioritizes the inputs used to measure fair value (see Note 1). The Company measured the fair values using the hierarchy level as follows:
 
Level 1
The Company does not have any fair value balances classified as Level 1.
Level 2
The Company’s embedded derivative is measured on a recurring basis using Level 2 inputs.
Level 3
The Company’s goodwill is measured using Level 3 inputs (see note 4).
 
The Company’s embedded derivative liability is remeasured to fair value at each reporting date until the contingency is resolved.  See Notes 10 and 13 above for more information about this liability and the inputs used for calculating fair value.
 
17.   Subsequent Event
 
Subsequent to June 30, 2012, the Company entered the following additional agreements and transactions:
 
(1)  
The Company borrowed $20,000 from its Chief Financial Officer.  The loan is due on August 31, 2012.  The loan carries a 5% loan origination fee and 12% annual interest rate.  If the loan carries longer than 30 days, the loan origination fee will be increased to 10% and added to the principal.  The lender has the right to convert any past due balance of the loan into the Company’s Common Stock at 50% of the market price or $0.05 per share, whichever is less.
 
(2)  
The Company borrowed $325,000 from two unrelated parties.  The loans have an annual interest rate of 12% and include a loan origination fee of $26,000 added to the principal.  These loans will be due on December 31, 2012.
 
(3)  
The Company borrowed $150,000 from two unrelated parties.  These loans are due on August 31, 2012.  The loans carry a 5% loan origination fee and 12% annual interest rate.  If the loans carry longer than 30 days, the loan origination fee will be increased to 10% and added to the principal.  The lenders have the right to convert any past due balance of the loan into the Company’s Common Stock at 50% of the market price or $0.04 per share, whichever is less.
 
Subsequent to June 30, 2012, the Company amended its agreement with 4G as follows:
 
(1)  
$350,000 in cash (paid $200,000, balance owed is $150,000)
 
(2)  
$50,000 of liabilities payable in cash
 
 
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(3)  
160,000 shares of Series D convertible preferred stock
 
(4)  
Options for the purchase of up to 4,333,333 shares of Common Stock of the Company at $0.10 per share to each of the three sellers, vesting as follows:
 
·  
Options for 433,333 shares vest when an additional 5,000 4G members have been added, or a total of 9,300 members.
 
·  
Options for 433,333 options vest when an additional 5,000 4G members are added, or a total of 14,300 members.
 
·  
433,333 options vest when an additional 5,000 4G members are added, or a total of 19,300 members.
 
·  
And so forth until fully vested.
 
Subsequent to June 30, 2012, the board of directors approved the following:
 
(1)  
Approved the re-pricing of all outstanding options and warrants previously issued to officers and directors to $0.10 per share.  The trading price of the Company’s Common Stock on the date of such re-pricing as reported by the OTCBB was $0.08.
 
(2)  
Accepted the resignation of James Dalton as Chief Executive Officer and Chairman of the Board of the Company.
 
(3)  
Appointed David G. Derrick as the Chief Executive Officer and as director and Chairman of the Board.
 
(4)  
Approved certain actions below in connection with loans made to the Company by Mr. Derrick and his affiliates in excess of $1,100,000 as of June 30, 2012.  The Company has treated the loans as related party notes payable in the financial statements as of June 30, 2012.  The Board also approved and authorized the following transactions with respect to such loans:
 
a.  
The $748,855 amount loaned by one of Mr. Derrick’s affiliates will be rolled into a $2,000,000 line of credit with the following terms:
 
·  
12% annual interest rate
 
·  
10% loan origination fee paid by issuing 80,000 shares of Series D; provided, that Mr. Derrick shall agree that such shares cannot be converted into Common Stock for 6 months.
 
·  
At anytime, the balance can be converted by the lender or the Company into common shares at $0.05 per share.
 
·  
The effective date of the line of credit will be August 1, 2012.
 
·  
Re-pricing of stock purchase options previously granted to ADP Management Corp., an affiliate of Mr. Derrick, to $0.10 per share.
 
(5)  
The Board also approved the execution of an employment agreement with Mr. Derrick to govern the terms of his employment, to include the following:
 
a.  
A signing bonus of 80,000 Series D shares; provided, however, that the agreement shall provide that such shares cannot be converted into Common Stock until such time as the Company has 20,000 members.
 
b.  
The grant of an option to purchase up to 10,000,000 shares of the Company’s Common Stock at an exercise price of $0.10 per share, vesting at the rate of 1,000,000 shares for every 5,000 members added by the Company during Mr. Derrick’s employment by the Company.
 
c.  
Annual salary of $300,000, plus $15,000 per month of expenses.
 
 
19

 
 
Item 2.      Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader better understand our operations and our present business environment.  This MD&A is provided as a supplement to, and should be read in conjunction with, our audited consolidated financial statements for the fiscal years ended September 30, 2011, and 2010, and the accompanying notes thereto contained in our Annual Report on Form 10-K. Unless otherwise indicated, the terms “ActiveCare,” the “Company,” “we,” and “our” refer to ActiveCare, Inc., a Delaware corporation.
 
Overview
 
Historically, our core business has been the manufacture, distribution and sale of medical diagnostic stains and solutions.  In February 2009, we were spun off from our former parent, SecureAlert, Inc., formerly known as RemoteMDx, Inc. (“SecureAlert”).  In connection with the spin-off, we acquired from SecureAlert the exclusive license rights to certain technology, including patent rights utilizing GPS and cellular communication and monitoring technologies for use in the healthcare and personal security markets.  In May 2009, we obtained worldwide and exclusive rights to additional patents and patent applications, including the Panic Button Phone, Emergency Phone with Single Button Activation, Emergency Phone for Automatically Summoning Multiple Emergency Response Services, and Emergency Phone with Alternate Number Calling Capability.  With regard to intellectual property, we believe that the 12/614,242 patent we developed and filed in November 2009 is extremely important.  These Systems and Devices for Emergency Tracking and Health Monitoring patent serves as an “umbrella” and incorporates much of our intellectual property.  Our business plan is to develop and market products for monitoring the health of and providing assistance to mobile and homebound seniors and the chronically ill, including those who may require a personal assistant to check on them during the day to ensure their safety and well being.
 
Recent Developments
 
We have financed operations primarily through equity security sales and short-term debt.  Accordingly, if our revenues continue to be insufficient to meet our needs, we will attempt to secure additional financing through traditional bank financing or through the sale of equity securities or debt offerings.  However, because of the development stage nature of our business and our current financial condition, our attempts may be unsuccessful in obtaining such financing or the amount of the financing obtained may be inadequate to continue to implement our plan of operations.  There can be no assurance that we will be able to obtain financing on satisfactory terms or at all, or raise funds through a debt or equity offering.  In addition, if we only have nominal funds with which to conduct our business activities, this will negatively impact the results of operations and our financial condition.
 
On March 8, 2012, we acquired 4G Biometrics, LLC, a Texas limited liability company (“4G”).  Pursuant to the acquisition agreement, we acquired 100 percent of the member interests of 4G and 4G will be operated as a wholly owned subsidiary of the Company.  As amended, the purchase price for the member interests of 4G was comprised as follows:
 
·  
$350,000 in cash (as of the date of this report, we have paid $200,000 and the balance owed is $150,000);
 
·  
$50,000 of liabilities payable in cash;
 
·  
160,000 shares of Series D convertible preferred stock;
 
·  
Options for the purchase of up to 4,333,333 shares of Common Stock of the Company at $0.10 per share to each of the three sellers, exercisable once 4G has 4,300 members, as follows:
 
o  
Options for 433,333 shares vest when an additional 5,000 4G members as added, or a total of 9,300 members;
 
o  
Options for 433,333 shares vest when an additional 5,000 4G members are added, or a total of 14,300 members; and
 
o  
Options for 433,333 shares vest when an additional 5,000 4G members are added, or a total of 19,300 members; and
 
o  
so forth until fully vested.
 
Three of the 4G key managers will continue to manage the operations of 4G under written employment agreements.  In addition, on October 1, 2012, one of the key managers will be appointed to serve as a member of our Board of Directors if 4G has sales of at least $1,000,000 for the nine months ending September 30, 2012.
 
 
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Under the purchase method of accounting, the total purchase price will be allocated to 4G’s intangible assets based on their estimated fair values as of the closing date of the acquisition.  The excess of the purchase price over intangible assets will be recorded as goodwill.
 
As of June 30, 2012, the purchase price for 4G reflects a total consideration transferred of $590,000, which has been preliminarily allocated as $479,305 of goodwill and $110,695 of acquired customer contracts. 
 
Marketing and Market
 
We market our products through a number of distribution channels including to self-insured employers, direct-to-consumer, medical device and equipment distributors, and health care providers and other caregivers.
 
Self-Insured Companies
 
As a result of the acquisition of 4G, we expanded our fundamental business to include the monitoring of the well being of the rapidly growing number of diabetics in this country.  This business meshes well with our broader view towards furthering the improved health of the total population.
 
Our strategy is to develop a relationship with third party administrators (TPAs).  TPAs administer the claims, payments, co-pays, and medical coding for self-insured companies.  They effectively act as the medical benefits administrators for their customers, most of which are not large enough to justify a fully operational in-house department.  Our strategy is achieved by demonstrating to the TPA the benefits to be realized by all parties.  We work with a TPA and each of their customers and generate reports regarding claims history and expenses.  The report illustrates how much the insurer can save by taking actions that will result in compliance by following the recommended protocols.  The key to savings is the CareCenter which operates 24/7 and is integral to chronic illness monitoring. The CareCenter is the real-time recipient of the test results.  The patients that are not testing are identified by our CareCenter and this information is passed on to the TPA and the insurer.  In addition, the plan includes direct distribution of diabetic supplies under the 4G Diabetic Wellness Program at costs no more than the customers are currently spending on their diabetic supplies.  Our ultimate objective is to become a chronic illness monitor for the TPA’s customers, measuring not only blood sugar for diabetics, but also blood pressure, weight and blood oxygen.
 
Direct-to-Consumer
 
We sell our products and services directly to consumers through a variety of direct-to-consumer methods including on-line sales, direct mail and direct response advertising –– and have limited outbound telemarketing initiatives.  With the exception of web sales, direct-to-consumer sales tend to be expensive, with a high acquisition cost per customer.  We are focusing our efforts on utilizing other distribution channels to drive new sales at the most efficient cost.
 
Medical Equipment/Device Distributors
 
Our sales team has established a distributor network, and we are growing this distributor network as we build relationships across the United States.  We are targeting distributors that serve the Medicare and Medicaid markets, distributors that target home medical equipment and supplies, and distributors that service healthcare providers.
 
Distributor relationships provide access to established markets and potential customers in a variety of settings.  We leverage their existing relationships and investments in marketing to support our products.
 
Healthcare Providers/Caregivers
 
We believe that caregivers will be an important outlet for our products.  Caregivers include home health agencies, hospice organizations, skilled nursing facilities, hospitals and physician offices.  Often the patient is reluctant to purchase the product on their own volition.  With the counseling of the caregiver, the patient and or the family member may be more accepting of the product and their condition.  We are initiating tests with healthcare providers in the skilled nursing and hospice categories.
 
Research and Development Program
 
General Information
 
GPS technology utilizes highly accurate clocks on 24 satellites orbiting the earth owned and operated by the U.S. Department of Defense.  These satellites are designed to transmit their identity, orbital parameters and the correct time to earthbound GPS receivers at all times.  Supporting the satellites are several radar-ranging stations maintaining exact orbital parameters for each satellite and transmitting that information to the satellites for rebroadcast at frequencies between 1500 and 1600 MHz. 
 
A GPS receiver (or engine) scans the frequency range for GPS satellite transmissions.  If the receiver can detect three satellite transmissions, algorithms within the engine deduce its location, usually in terms of longitude and latitude, on the surface of the earth as well as the correct time.  If the receiver can detect four or more GPS satellite transmissions, it can also deduce its own elevation above sea level.  The effectiveness of GPS technology is limited by obstructions between the device and the satellites and, therefore, service can be interrupted or may not be available at all if the user is located in the lower floors of high-rise buildings or underground.
 
 
21

 
 
During the nine months ended June 30, 2012, we spent approximately $112,807, compared to $273,611 during the same period in 2011, on research and development (“R&D”).  R&D involved the ActiveOne™, a one-button actuated GPS/Cellular communications device (“Companion Device”) that links to our CareCenter.  This device includes fall detection, Geo Fencing, automatic calls to the CareCenter, text messaging, hands free speakerphone and other features.  Also in development is the ActiveOne+™ (ActiveOnePlus), which will communicate through Bluetooth with the Companion Device.  The wrist device is water resistant, includes fall detection, speakerphone, vibration alerts, audible alerts, and LED’s for status monitoring.  Our goal is to develop a wristwatch-size monitoring device for senior citizens.  The watch will be universal for women and men with an adjustable strap.  The expanded CareCenter and the related products will be developed by our team.  We have identified and are working with several vendors for services that will further our objectives.  
 
An important part of this R&D program is our relationship with Quectel Wireless Solutions, Ltd. (“Quectel”), to assist us in development of the ActiveOne™ and the next generation device, the ActiveOne+™.
 
Quectel’s focus is on the wireless machine-to-machine (“M2M”) market sector; Quectel designs and manufactures a variety of wireless modules to fulfill many industrial standards and requirements.  Quectel products have been developed for the wireless M2M sectors such as smart metering, automotive, sales and payment, security, tracking and tracing, remote control and monitoring, and mobile computing.
 
The core team members of Quectel are the pioneers of the wireless module industry in China.  Quectel’s R&D team is dedicated to quality and reliability, and realizes that these are the key factors to continued success in the wireless M2M business.
 
CareCenter
 
In concert with the development of our products, we also created the CareCenter.  In contrast to a typical monitoring center, the CareCenter is equipped with hardware and software that pinpoints the location of the incoming caller by utilizing GPS and/or cellular triangulation technology.  This capability is referred to as telematics.  The operator (or CareSpecialist) is able to locate the caller’s precise location on a detailed map.  In addition the CareCenter software can identify the caller, provide location services, emergency dispatch, medical history to emergency responders, and concierge services.
 
We believe the CareCenter is the cornerstone of our business.  The CareCenter services include highly trained CareSpecialists to assist the elderly and the chronically ill in managing their daily lives 24 hours per day, seven days per week.  In order for the CareCenter to service our customers, we have developed and continue to develop numerous products designed to assist our customers in maintaining a more active and mobile lifestyle.  The first product that we introduced is the ActiveOne™ device.  The ActiveOne™ is a patented mobile personal emergency response (“PERS”) device that allows the user to contact our CareCenter at the push of a button.  The ActiveOne™ constantly communicates its location to the CareCenter by utilizing GPS technology.  This allows the CareCenter Specialists to constantly help and assist the customers no matter where they may be.  Additionally, the CareCenter monitors the chronically ill with a variety of other products.
 
Our plan is to continue to invest monies into R&D and patents as we broaden the services offered by our CareCenter.  Eventually we intend to add to the functionality of the ActiveOne™ to allow for vital sign monitoring for the chronically ill and additional services to assist both the mobile and homebound seniors, including those who may require a personal assistant to check on them during the day to ensure their safety and well being and know where they are at all times.
 
Chronic Illness Monitoring
 
Chronic illness monitoring is creating algorithms and software to help individuals with one or more chronic illnesses manage their disease in real time.  The CareCenter will assist the individual by alerting them when predefined protocols and specifications are not within established limits and criteria.
 
ActiveOne+
 
ActiveOne+™ is the second-generation PAL (“Personal AssistanceLink”) handset, which includes one button connection to the CareCenter, GPS locating and fall detection technology all in one unit.  The ActiveOne+™ features enhanced fall detection to better detect when a fall occurs as well as enhanced locating technology that combines both GPS and cellular triangulation that allows our CareCenter to locate a member within several meters 24 hours per day, 7 days a week, to better respond to any emergency condition.  In addition the ActiveOne+™ has built-in receptors utilizing Bluetooth technologies to accommodate body-worn devices that can communicate vital sign data to the CareCenter.  We have obtained FCC certification for the ActiveOne+™.
 
 
 
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ActiveWatch
 
The ActiveWatch™ incorporates all of the core features of the PAL handsets into an easy to wear wrist device.  The ActiveWatch™ combines GPS, Cellular and fall detection technology that communicates directly to the CareCenter.  The device is also water resistant and can be worn in the shower, providing protection wherever the member may be.  The ActiveWatch™ also incorporates heart rate sensors that can alert the CareCenter when the heart rate is irregular; it also incorporates Bluetooth technology that accommodates other body-worn devices.
 
ActiveHome
 
Our comprehensive in-home wellness solution complements and integrates with our current CareCenter service and ActiveOne™ mobile health products.  The ActiveHome™ solution integrates several in-home health and wellness monitoring and convenience products and services available from various manufacturers and service providers to ensure members’ well-being, safety and convenience, including the following: (1) remote home monitoring to detect changes in members’ activity patterns that might indicate health emergency situations so our CareSpecialists can proactively avert emergencies; (2) an electronic pillbox to ensure prescription compliance; (3) remote in-home actions initiated from our CareCenter, such as locking and unlocking doors and turning off unattended stoves; (4) electronic conveniences, including automatic illumination of house lights; and (5) wireless transmission of chronic illness monitoring data including weight, blood pressure, and blood glucose so our trained CareSpecialists can act upon potentially life-threatening changes.  In addition to technological solutions, the ActiveHome™ comprehensive offering includes installation of in-home safety and convenience items including easy access bathtubs and bed and chair support rails.
 
All ActiveHome™ components are linked through Bluetooth and wireless connections to an easy to use portal in the home, and the entire home is linked 24/7 to trained CareSpecialists at our ActiveCare CareCenter through the portal and the ActiveOne™ mobile unit.
 
Critical Accounting Policies
 
The following summary includes accounting policies that we deem to be most critical to our business.  Management considers an accounting estimate to be critical if:
 
·  
It requires assumptions to be made that were uncertain at the time the estimate was made, and
 
·  
Changes in the estimate or different estimates that could have been selected could have a material impact on its consolidated results of operations or financial condition.
 
Use of Estimates in the Preparation of Financial Statements
 
We have prepared and included with this report condensed consolidated unaudited financial statements in conformity with GAAP.
 
The preparation of financial statements requires management to make significant estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses during the reporting period.  By their nature, these estimates and judgments are subject to an inherent degree of uncertainty.  On an on-going basis, we evaluate our estimates, including those related to bad debts, inventories, intangible assets, warranty obligations, product liability, revenue recognition, and income taxes.  We base our estimates on historical experience and other facts and circumstances that are believed to be reasonable and the results provide a basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates under different assumptions or conditions, and these differences may be material.
 
With respect to concentration of credit risk, allowances for doubtful accounts receivable, inventories, impairment of assets, revenue recognition, and research and development, those material accounting policies that we believe are critical to an understanding of our financial results and condition are as described below.
 
Concentration of Credit Risk
 
We have cash in bank accounts that, at times, may exceed federally insured limits.  We have not experienced any losses in such accounts.
 
In the normal course of business, we provide credit terms to our customers.  Accordingly, we perform ongoing credit evaluations of customers’ financial condition and require no collateral from customers.  We maintain an allowance for uncollectable accounts receivable based upon the expected collectability of all accounts receivable.
 
Accounts Receivable
 
Accounts receivable are carried at original invoice amount less an estimate made for doubtful receivables based on a review of all outstanding amounts on a monthly basis.  Specific reserves are estimated by management based on certain assumptions and variables, including the customer’s financial condition, age of the customer’s receivables and changes in payment histories.  Trade receivables are written off when deemed uncollectible.  Recoveries of trade receivables previously written off are recorded when received.  A trade receivable is considered to be past due if any portion of the receivable balance has not been received by the contractual pay date.  Interest is not charged on trade receivables that are past due.
 
 
 
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Inventories
 
Inventories are recorded at the lower of cost or market, cost being determined on a first-in, first-out (“FIFO”) method. Reagent inventories consist of raw materials, work-in-process, and finished goods.  CareServices inventory consist of ActiveHome inventories.  Chronic Illness Monitoring inventory consist of diabetic supplies.  Provisions, when required, are made to reduce excess and obsolete inventories to their estimated net realizable values.  Due to competitive pressures and technological innovation, it is possible that estimates of the net realizable value could change in the near term. 
 
Property and Equipment
 
Property and equipment are stated at cost, less accumulated depreciation and amortization.  Depreciation and amortization are determined using the straight-line method over the estimated useful lives of the assets, typically three to seven years.  Leasehold improvements are amortized over the shorter of the estimated useful lives of the asset or the term of the lease.  Expenditures for maintenance and repairs are expensed while renewals and improvements over $500 are capitalized.  When property and equipment are disposed, any gains or losses are included in the results of operations.
 
Leased Equipment
 
Our leased equipment is stated at cost less accumulated depreciation and amortization.  We amortize the cost of leased equipment on the straight line method over thirty nine months, which is the estimated useful life of the equipment.  Amortization of leased equipment is recorded as cost of sales.
 
Revenue Recognition
 
Our revenue has historically been from two sources: (i) sales from CareServices; (ii) sales of medical diagnostic stains from our Stains and Reagents segment; (iii) sales of Chronic Illness Monitoring services and supplies.
 
CareServices
 
“CareServices” include contracts in which we provides monitoring services to end users and sells devices to distributors.  We typically enter into contracts on a month-to-month basis with customers (members) that use our CareServices.  However, these contracts may be cancelled by either party at anytime with 30 days notice.  Under our standard contract, the device becomes billable on the date the customer (member) orders the product, and remains billable until the device is returned to us.  We recognize revenue on devices at the end of each month that CareServices have been provided.  In those circumstances in which we receive payment in advance, the Company records these payments as deferred revenue.
 
We recognize CareServices revenue when persuasive evidence of an arrangement with the customer exists, title passes to the customer, prices are fixed or determinable and collection is reasonably assured.  Shipping and handling fees are included as part of net sales.  The related freight costs and supplies directly associated with shipping products to customers are included as a component of cost of goods sold.  Customers order our products by phone or website.  All CareServices sales are made with net 30-day payment terms.
 
In connection with GAAP, to qualify for the recognition of revenue at the time of sale, we note the following:
 
·  
The Company’s price to the buyer is fixed or determinable at the date of sale.
 
·  
The buyer has paid the Company, or the buyer is obligated to pay the Company within 30 days, and the obligation is not contingent on resale of the product.
 
·  
The buyer’s obligation to the Company would not be changed in the event of theft or physical destruction or damage of the product.
 
·  
The buyer acquiring the product for resale has economic substance apart from that provided by the Company.
 
·  
The Company does not have significant obligations for future performance to directly bring about resale of the product by the buyer.
 
·  
The amount of future returns can be reasonably estimated and they are negligible.
 
Accounting standards state that, “an enterprise shall report revenues from external customers for each product and service or each group of similar products and services unless it is impractical to do so.”  In the CareServices revenue line, the vast majority of sales are service revenue.  Because equipment sales are not material to the financial statements, we disclose services and equipment sales as one line item.
 
 
24

 
 
Our revenue recognition policy for sales to distributors of CareServices is the same as the policy for sales to end-users.
 
A customer qualifies as a distributor by completing a distributor application and proving its sales tax status.  Our distributors are not required to maintain specified amounts of product on hand, and distributors are not required to make minimum purchases to maintain distributor status.  Distributors have no stock rotation rights or additional rights of return.  Revenues from products sold with long-term service contracts are recognized ratably over the expected life of the contract.  Sales to distributors are recorded net of discounts.
 
Sales returns have been negligible, and any and all discounts are known at the time of sale.  Sales are recorded net of sales returns and sales discounts.  There are no significant judgments or estimates associated with the recording of revenues.
 
The majority of our CareServices revenue transactions do not have multiple elements.  On occasion, we have revenue transactions that have multiple elements (such as device sales to distributors).  In these situations, we provide the distributor with the ActiveOne™ device and a monthly monitoring service, which are both included in the contracted pricing.  In these multiple element revenue arrangements, we will consider whether: (i) the deliverables have value on a standalone basis to the distributors, and (ii) the distributors have a general right of return.  We determined that these elements do have standalone value to distributors and that the delivery of undelivered items is probable and substantially within our control.  Therefore, in accordance with accounting standards, we have determined that these revenue elements should be considered as separate units of accounting.  Accounting standards state that arrangement consideration is to be allocated at the inception of the arrangement to all deliverables on the basis of their relative selling price.  When applying the relative selling price method, the selling price for each deliverable is determined using vendor-specific objective evidence of selling price, if it exists; otherwise, third-party evidence of the selling price is used to determine the selling price.  If neither vendor-specific objective evidence nor third-party evidence of the selling price exists for a deliverable, then the best estimate of the selling price is used for that deliverable.
 
We do not currently sell, nor do we intend to sell the ActiveOne™ device separately from the monthly monitoring service, therefore we are not able to determine vendor-specific objective evidence of selling price.  We are also unable to determine third-party evidence of selling price, because there is not a similar product in the market.  The ActiveOne™ device is the only device in the market with fall detection technology.  We are therefore required to determine its best estimate of selling price in order to determine the relative selling price of the separate deliverables in its revenue arrangements.  In order to determine the best estimate of selling price of the ActiveOne™ device, we included the following cost components in our estimate: production costs, development costs, PTCRB certification costs, and estimated gross margin.  In order to determine the best estimate of the monthly monitoring service, we included the following components in our estimate: monthly communication costs, monitoring labor costs, PSAP database and monthly maintenance costs, and estimated gross margin.  We allocate the arrangement costs based on these best estimates of selling price.  The relative selling price allocated to the sale of the ActiveOne™ device is recognized when the device is delivered to the distributor.  The relative selling price of the monitoring service is recognized monthly when the services have been provided.
 
Stains and Reagents
 
We recognize Stains and Reagents revenue when persuasive evidence of an arrangement with the customer exists, title passes to the customer, prices are fixed or determinable and collection is reasonably assured.
 
Shipping and handling fees are included as part of net sales.  The related freight costs and supplies directly associated with shipping products to customers are included as a component of cost of goods sold.  Neither the sale of diagnostic equipment nor the sale of medical diagnostic stains contains multiple deliverables.
 
Customers order diagnostic stain product lines by purchase order.  We do not enter into long-term contracts for Stains and Reagents sales.  Stains and Reagents sales were $135,636 for the quarter ended June 30, 2012.  All Stains and Reagents sales are made with net 30-day payment terms.
 
With respect to Stains and Reagents revenues, to qualify for the recognition of revenue under GAAP at the time of sale, we note the following:
 
·  
The price to the buyer is fixed or determinable at the date of sale.
 
·  
The buyer has paid, or the buyer is obligated to pay the Company within 30 days, and the obligation is not contingent on resale of the product.
 
·  
The buyer’s obligation to the Company would not be changed in the event of theft or physical destruction or damage of the product.
 
·  
The buyer acquiring the product for resale has economic substance apart from that provided by the Company.
 
 
 
25

 
·  
The Company does not have significant obligations for future performance to directly bring about resale of the product by the buyer.
 
·  
The amount of future returns can be reasonably estimated and they are negligible.
 
·  
Customers may return diagnostic equipment within 30 days of the purchase date. Customers may return the medical diagnostic stains within 30 days of the purchase date provided that the stain’s remaining life is at least eight months. Customers must obtain prior authorization for a product return.
 
Our diagnostic stain products have not been modified significantly for several years.  There is significant history on which to base our estimates of sales returns.  These sales returns have been negligible.
 
We have 70 types of products based on the number of individual stock-keeping units (“SKUs”) in our inventory.  Most of these 70 SKUs are for medical diagnostic stain inventory.  For example, certain medical diagnostic stains are packaged in different sizes, and each packaged size (i.e. 16 oz., 32 oz., and 48 oz.) has a unique SKU in inventory.  Accounting standards state that, “an enterprise shall report revenues from external customers for each product and service or each group of similar products and services unless it is impractical to do so.”  The vast majority of our stains sales are of medical diagnostic stains, with a minimal portion of sales being diagnostic equipment.  
 
Although not the focus of our new business model, we also sell diagnostic devices in certain situations.  We recognize device sales revenue when persuasive evidence of an arrangement with the customer exists, title passes to the customer and the customer cannot return the devices, prices are fixed or determinable and collection is reasonably assured.  Because diagnostic equipment sales are not material to the financial statements, we disclose the sales as one line item for “Reagents” in the statement of operation.
 
Our revenue recognition policy for Stains and Reagents sales to distributors is the same as the policy for sales to end-users.
 
A customer qualifies as a distributor by completing a distributor application and proving its sales tax status.  Upon qualifying as a distributor, a customer receives a 35% discount from retail prices, and the distributor receives an additional 5% discount when product is purchased in case quantities.  Our Stains and Reagents distributors are not required to maintain specified amounts of product on hand, and distributors are not required to make minimum purchases to maintain distributor status.  Distributors have no stock rotation rights or additional rights of return.  Sales to distributors are recorded net of discounts.
 
Sales returns have been negligible, and any and all discounts are known at the time of sale.  Sales are recorded net of sales returns and sales discounts.  There are no significant judgments or estimates associated with the recording of revenues.
 
Chronic Illness Monitoring
 
 We began sales through 4G upon our acquisition of the company in the quarter ended March 31, 2012.  We recognize Chronic Illness Monitoring revenue when persuasive evidence of an arrangement with the customer exists, title passes to the customer, prices are fixed or determinable and collection is reasonably assured.
 
Shipping and handling fees are included as part of net sales.  The related freight costs and supplies directly associated with shipping products to customers are included as a component of cost of goods sold.  The sale of the Chronic Illness Monitoring does not contain multiple deliverables.
 
We enter into agreements with self-insured companies (“Customers”) to lower medical expenses by distributing diabetic testing supplies to their employees (members) and monitoring their test results.  The Customers are obligated to pay for the supplies that we distribute to the members on a quarterly basis.  The term of these contracts is one year and unless terminated by either party, will automatically renew for another year.
 
The Chronic Illness Monitoring segment sales for the quarter ended June 30, 2012 were $230,625.  All of our Chronic Illness Monitoring sales are made with net 30-day payment terms.
 
With respect to Chronic Illness Monitoring revenues, to qualify for the recognition of revenue under GAAP at the time of sale, we note the following:
 
·  
The price to the contracted Customer is fixed or determinable at the date of sale.
 
·  
The Customer has paid, or is obligated to pay us within 30 days.
 
·  
The Customer’s obligation to the Company would not be changed in the event of theft or physical destruction or damage of the product.
 
·  
Once the product is shipped out, the end user does not have the right of return.
 
 
 
26

 
 
Results of Operations
 
Three Months Ended June 30, 2012 and 2011
 
Net Sales
 
During the fiscal quarter ended June 30, 2012, we had net sales of $432,296, compared to $184,899 in the fiscal quarter ended June 30, 2011.  Stains and Reagents revenue accounted for $135,636 and $104,792 in the quarters ended June 30, 2012 and 2011, respectively.  CareServices revenues, including revenue for the ActiveOne™ service, accounted for $66,035 and $80,107 of the total revenues in the quarters ended June 30, 2012 and 2011, respectively.  Chronic Illness Monitoring revenue accounted for $230,625 and $0, in the quarters ended June 30, 2012 and 2011, respectively.  The reason for the total revenue increase is due to increased sales of Stains and Reagents to distributors and the acquisition of the Chronic Illness Monitoring segment during the quarter ended June 30, 2012.
 
Cost of Revenue
 
Cost of revenue totaled $428,632 in the fiscal quarter ended June 30, 2012, compared to $262,436 for the quarter ended June 30, 2011.  During the quarter ended June 30, 2012, of the total cost of revenues, Stains and Reagents accounted for $94,330, CareServices accounted for $165,038, and Chronic Illness Monitoring accounted for $169,264.  In comparison, during the fiscal quarter ended June 30, 2011, Stains and Reagents accounted for $89,550, CareServices accounted for $172,886, and Chronic Illness Monitoring accounted for $0.  The increase of the total cost of revenue in the quarter ended June 30, 2012, is higher sales of Stains and Reagents and the acquisition of the Chronic Illness Monitoring business.
 
Research and Development Expenses
 
During the quarter ended June 30, 2012, we incurred research and development expenses of $63,906, compared to $45,601 in research and development expense incurred during the fiscal quarter ended June 30, 2011.  Research and development expenses in the quarter ended June 30, 2012, were higher than the prior year period due to development of the Chronic Illness Monitoring segment during the quarter ended June 30, 2012.
 
Selling, General and Administrative Expenses
 
During the three months ended June 30, 2012, selling, general and administrative expenses totaled $838,167, compared to $2,681,098 in the same period one year ago.  The decrease is due to the decrease of non-cash compensation expenses during the current period.  For the quarters ended June 30, 2012 and 2011, the non-cash expense associated with the issuance of stock and warrants totaled $61,653 and $1,904,687, respectively.
 
Other Income and Expense
 
Derivative loss was $1,320,918 and $0, in the quarters ended June 30, 2012 and 2011, respectively.  We have borrowed increasing amounts under convertible debt instruments, which are recorded as derivative liabilities.  Interest expense was $223,400 and $98,728 in the quarters ended June 30, 2012 and 2011, respectively.  The increase was due to the accrued loan origination fees and interest related to the loans obtained during the quarter ended June 30, 2012.
 
Net Loss
 
We had a net loss for the three months ended June 30, 2012, totaling $2,442,706, compared to a net loss of $2,902,539 for the same period one year ago.  This decrease in net loss is due to the items described above.
 
Dividends on Preferred Stock
 
We accrued $14,057 of dividends on Series C and Series D for the three months ended June 30, 2012, compared to $0 for the same period one year ago during which there were no shares of Preferred Stock outstanding.
 
Nine months Ended June 30, 2012 and 2011
 
Net Sales
 
During the nine months ended June 30, 2012, we had net sales of $781,779, compared to $573,667 in the nine months ended June 30, 2011.  Stains and Reagents revenue accounted for $357,374 and $325,965 in the nine months ended June 30, 2012 and 2011, respectively.  CareServices revenues, including revenue for the ActiveOne™ service, accounted for $190,662 and $247,702 of the total revenues in the nine months ended June 30, 2012 and 2011, respectively.  The revenue of Chronic Illness Monitoring accounted for $233,743 and $0 for the nine months ended June 30, 2012 and 2011, respectively.  The reason for the total revenue increase is due to increased sales of Stains and Reagents and increased revenue from the newly acquired Chronic Illness Monitoring segment during the nine months ended June 30, 2012.
 
 
 
27

 
 
Cost of Revenue
 
Cost of revenue totaled $957,424 in the nine months ended June 30, 2012, compared to $789,475 for the nine months ended June 30, 2011.  During the nine months ended June 30, 2012, of the total cost of revenues, Stains and Reagents accounted for $291,137, CareServices accounted for $495,743, and Chronic Illness Monitoring accounted for $170,544, respectively.  During the nine months ended June 30, 2011, Stains and Reagents accounted for $285,875, CareServices accounted for $503,600, and Chronic Illness Monitoring accounted for $0, respectively, of cost of revenue.  The increase of the cost of revenue between the comparable periods is due to increased sales of Stains and Reagents and Chronic Illness Monitoring during the nine months ended June 30, 2012.
 
Research and Development Expenses
 
During the nine months ended June 30, 2012, we incurred research and development expenses of $112,807 compared to $273,611 in research and development expense incurred during the nine months ended June 30, 2011.  Research and development expenses in the nine months ended June 30, 2012 were lower than the prior year period when we incurred expenses related to the development of the ActiveOne+™.
 
Selling, General and Administrative Expenses
 
During the nine months ended June 30, 2012, selling, general and administrative expenses totaled $6,316,341 compared to the same period one year ago, which totaled $5,592,111.  For the nine months ended June 30, 2012 and 2011, the non-cash expense associated with the issuance of stock and warrants of $4,185,673 and $3,561,287, respectively.  The increase is due primarily to acceleration of non-cash compensation granted to our former Chief Executive Officer during the nine months ended June 30, 2012.
 
Other Income and Expense
 
Derivative loss was $1,346,174 and $0 in the nine months ended June 30, 2012 and 2011, respectively.  We have increased borrowings under convertible debt instruments, which are recorded as derivative liabilities.  Interest expense was $459,297 and $110,224, in the nine months ended June 30, 2012 and 2011, respectively.  The increase was due to accrued loan origination fees and interest related to the loans obtained during the nine months ended June 30, 2012.  Other expenses were $0 and $50,000 for the nine months ended June 30, 2012 and 2011, respectively.  The decrease in the current period is due to the impairment of investment in Vista Therapeutics during the nine months ended June 30, 2011.
 
Net Loss
 
We had a net loss for the nine months ended June 30, 2012 totaling $8,410,162, compared to a net loss of $6,245,208 for the same period one year ago.  This increase in net loss is due to the items described above.
 
Dividends on Preferred Stock
 
We accrued $40,842 of dividends on Series C and Series D Preferred Stock for the nine months ended June 30, 2012, compared to $0 of for the same period one year ago.  This increase is due to issuance of Series C and Series D Preferred Stock with dividends during the nine months ended June 30, 2012.
 
Liquidity and Capital Resources
 
Our primary sources of liquidity are the proceeds from the sale of our equity securities and from borrowing.  We have not historically financed operations from cash flows from operating activities.  We anticipate that we will continue to seek funding to supplement revenues from the sale of our products and services through the sale of our securities until we begin to have positive cash flows from operating activities.
 
At June 30, 2012, we had cash of $76,916, compared to cash of $178,131 at September 30, 2011.  At September 30, 2011, we had a working capital deficit of $1,148,916, compared to a working capital deficit of $4,858,133 at June 30, 2012.  The decrease of cash was due to negative cash flow from operating activities during the nine months June 30, 2012, compared to the fiscal year ended September 30, 2011.  The increase of capital deficit was due to increased liabilities during the nine months ended June 30, 2012 and fiscal year ended September 30, 2011.
 
During the nine months ended June 30, 2012 and 2011, operating activities used cash of $1,928,486 and $2,285,505, respectively.  The decreased cash used in operating activities was due to stretching out payment schedule of accounts payable during the nine months ended June 30, 2012, compared to the same period in 2011.  Investing activities for the nine months ended June 30, 2012 and 2011, used cash of $207,729 and $333,977, respectively.  The decreased use of cash in investing activities was due to the addition of fixed assets and leased equipment during the nine months ended June 30, 2011.  Financing activities for the nine months ended June 30, 2012 and 2011, provided cash of $2,035,000 and $1,224,002, respectively.  The increase was due to the short-term loans secured during the nine months ended June 30, 2012.
 
 
28

 
 
For the nine months ended June 30, 2012, we had a net loss of $8,410,162 and negative cash flows from operating activities totaling $1,928,486, compared to a net loss of $6,245,208 and negative cash flows from operating activities of $2,285,505 for the nine months ended June 30, 2011.  The increase in net loss and decrease of cash flow deficit from operating activities was due primarily to the higher non-cash compensation expenses incurred during the nine months ended June 30, 2012.
 
As of June 30, 2012, we had an accumulated deficit of $33,387,279 compared to $24,936,275 at September 30, 2011.  Stockholders’ deficit at June 30, 2012 was $3,262,811, compared to stockholder’s deficit of $541,388 at September 30, 2011.  These changes were due to continued negative cash flow from operating activities during the nine months ended June 30, 2012.
 
Recent Accounting Pronouncements
 
We have reviewed all recently issued, but not yet effective, accounting pronouncements and do not believe the future adoptions of any such pronouncements are expected to cause a material impact on our financial condition or the results of operations.
 
Item 3.    Quantitative and Qualitative Disclosures about Market Risk
 
Information about the Company’s exposure to market risk was disclosed in its Annual Report on Form 10-K for the year ended September 30, 2011, which was filed with the Securities and Exchange Commission on December 27, 2011. There have been no material quantitative or qualitative changes in market risk exposure since the date of that filing.
 
Item 4.    Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures
 
Under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that, as of the end of the period, our disclosure controls and procedures were not effective, for the reasons discussed below.  
 
During the audit process for the year ended September 30, 2011, we identified material weaknesses weaknesses in internal control over financial reporting as follows:
 
Control Environment
 
We did not maintain an effective control environment for internal control over financial reporting.  Specifically, we concluded that we did not have appropriate controls in the following areas:
 
·  
Ineffective controls over period end financial disclosure and reporting processes.
 
·  
Ineffective controls over communication of material transactions between management and accounting personnel.
 
Financial Reporting Process 
 
We did not maintain an effective financial reporting process to prepare financial statements in accordance with generally accepted accounting principles.  Specifically, we initially failed to appropriately account for and disclose the valuation and recording of certain equity and financing arrangements, as well as the accounting and disclosure of the acquisition of 4G Biometrics, LLC.
 
Management has not made any correcting changes to Internal Control over Financial Reporting and the above material weaknesses remain at June 30, 2012.
 
Report of Management on Internal Control over Financial Reporting
 
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) or 15d-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.  Our internal control over financial reporting includes those policies and procedures that:
 

 
29

 
 
(i)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;
 
(ii)
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and
 
(iii)
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the financial statements.
 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
 
Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.  A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement to our annual or interim financial statements will not be prevented or detected.
 
We are in the process of improving our internal control over financial reporting in an effort to eliminate these material weaknesses through improved supervision and training of our staff, but additional effort and staffing is needed to fully remedy these deficiencies. Our management, audit committee, and directors will continue to work with our auditors and outside advisors to ensure that our controls and procedures are adequate and effective.
 
PART II – OTHER INFORMATION
 
Item 1.      Legal Proceedings
 
We are not involved in any legal proceedings which management believes will have a material effect upon our financial condition, nor are any such material legal proceedings anticipated.  We are not aware of any contemplated legal or regulatory proceeding by a governmental authority in which we may be involved.
 
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds
 
Recent Sales of Unregistered Securities
 
During the nine months ended June 30, 2012, we issued the following shares of Common Stock without registration under the Securities Act of 1933 (the “Securities Act”):
 
·  
600,000 shares to the licensor under a patent license agreement in settlement of amounts owed by the Company under the agreement, valued on the date of grant at $240,000;
 
·  
1,641,611 shares for consulting services, with value on the date of grant of $508,406; and
 
·  
2,000,000 shares for a settlement agreement, with value on the date of grant of $500,000.  
 
We also issued shares of Preferred Stock without registration under the Securities Act during the nine months ended June 30, 2012, as follows:
 
·  
480,000 shares of Series C Preferred Stock in connection with a patent license agreement settlement.  The value of the Series C Preferred Stock on the date of grant is $682,378; and
 
·  
55,000 shares of Series D Preferred Stock for debt conversion, with value on the date of grant of $110,000.
 
The securities issued in the above transactions were not registered under the Securities Act in reliance upon exemptions from registration under Section 4(2) of the Securities Act and rules and regulations promulgated thereunder.
 
Item 3.     Defaults Upon Senior Securities
 
None.
 
Item 5.      Other Information
 
None.
 
 
 
30

 
 
Item 6. Exhibits
 
Exhibit Number                                                                Description

31.1
 
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
     
31.2
 
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
     
32
 
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
101 INS   XBRL Instance Document*
     
101 SCH   XBRL Schema Document*
     
101 CAL   XBRL Calculation Linkbase Document*
     
101 DEF   XBRL Definition Linkbase Document*
     
101 LAB   XBRL Labels Linkbase Document*
     
101 PRE   XBRL Presentation Linkbase Document*
 

*           The XBRL related information in Exhibit 101 shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to liability of that section and shall not be incorporated by reference into any filing or other document pursuant to the Securities Act of 1933, as amended, except as shall be expressly set forth by specific reference in such filing or document.

 
 
31

 


SIGNATURES

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

     
 
     ActiveCare, Inc.
   
     
     
   
/s/  David G. Derrick
   
David G. Derrick
Chief Executive Officer (Principal Executive Officer) and
Chairman of the Board of Directors
 
Date: August 20, 2012
 
     
   
/s/  Michael G. Acton
   
Michael G. Acton
Chief Financial Officer (Principal Financial and Accounting Officer)
 
Date: August 20, 2012
 
 
 
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PINX:ACAR ActiveCare Inc Quarterly Report 10-Q Filling

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PINX:ACAR ActiveCare Inc Quarterly Report 10-Q Filing - 6/30/2012
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