U.S. Securities and Exchange Commission

Washington, D.C.  20549

Form 10-Q


(Mark One)


 X .

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


For the quarterly period ended March 31, 2009


     .

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


For the transition period from _____________ to ______________


Commission file number:  000-30415


Health Enhancement Products, Inc.

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


Nevada

 

87-0699977

(State or other jurisdiction of

 

(IRS Employer Identification No.)

incorporation or organization)

 

 


7740 East Evans Road, Scottsdale, Arizona  85260

(Address of principal executive offices)


480-385-3800

(Issuer’s telephone number)


Not Applicable

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


Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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      .


Check whether the issuer 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 (Check one):


Large accelerated filer       .

Accelerated filer      .

Non-accelerated filer      .

Smaller reporting company  X .


Indicate by check mark whether the issuer is a shell company (as defined in Rule 12-b2 of the Exchange Act).

       

Yes      . No  X .


APPLICABLE ONLY TO CORPORATE ISSUERS


There were 67,615,058 shares of common stock, $0.001 par value, outstanding at June 12, 2009.




FORM 10-Q

HEALTH ENHANCEMENT PRODUCTS, INC.

INDEX


PART I – FINANCIAL INFORMATION

4

Item 1. Consolidated Financial Statements

4

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

13

Item 3. Controls and Procedures

15

PART II – OTHER INFORMATION

16

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

16

Item 6. Exhibits

16


SIGNATURES

18


(Inapplicable items have been omitted)



2



SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS


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


 

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

 

 

our goal to increase our revenues and become profitable;

 

 

regulation of our product;

 

 

our ability to expand the production of our product;

 

 

market acceptance of our product;

 

 

future testing of our product;

 

 

the anticipated performance and benefits of our product;

 

 

our financial condition or results of operations

 

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



3



PART I – FINANCIAL INFORMATION


Item 1. Consolidated Financial Statements


HEALTH ENHANCEMENT PRODUCTS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEET

 

 

 

 

 

 

 

March 31, 2009

 

December 31, 2008

 

 

(Unaudited)

 

 

ASSETS

 

 

 

 

CURRENT ASSETS:

 

 

 

 

Cash

$

2,015

$

-

Accounts Receivable

 

 

 

49,334

Inventories

 

42,149

 

43,769

Prepaid Expenses

 

2,510

 

14,725

Total Current Assets

 

46,674

 

107,828

 

 

 

 

 

PROPERTY AND EQUIPMENT, NET

 

188,032

 

195,196

OTHER ASSETS:

 

 

 

 

Definite-life intangible Assets, net

 

9,860

 

10,101

Deposits

 

122,015

 

122,015

Total Other Assets

 

131,874

 

132,116

 

$

366,580

$

435,140

LIABILITIES AND STOCKHOLDERS' DEFICIT

 

 

 

 

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

Accounts Payable

$

513,128

$

509,262

Loan Payable, other

 

15,000

 

15,000

Common Stock Subscribed

 

38,010

 

40,500

Current portion, long term debt

 

6,873

 

6,718

Sales Tax Payable

 

1,981

 

1,981

Accrued Payroll and Payroll Taxes

 

45,411

 

76,834

Accrued Liabilities

 

31,641

 

34,848

Total Current Liabilities

 

652,045

 

685,143

 

 

 

 

 

LONG TERM LIABILITIES:

 

 

 

 

Notes payable, less current portion

 

8,388

 

10,166

Convertible Debenture Payable, less Discount of $213,020

 

 

 

 

and $125,177 at December 31, 2008 and March 31, 2009

 

218,323

 

132,980

Deferred rent expense

 

137,866

 

126,446

Total Long term Liabilities

 

364,577

 

269,592

COMMITMENTS AND CONTINGENCIES

 

 

 

 

TOTAL LIABILITIES

 

1,016,621

 

954,735

STOCKHOLDERS' DEFICIT:

 

 

 

 

Common stock, $.001 par value,

 

 

 

 

100,000,000 shares authorized

 

 

 

 

59,478,045 and 65,038,611 issued and outstanding at

 

 

 

 

December 31, 2008 and March 31, 2009

 

65,038

 

59,478

Additional Paid-In Capital

 

17,956,955

 

17,411,793

Accumulated deficit

 

(18,672,034)

 

(17,990,866)

Total Stockholders' Deficit

 

(650,042)

 

(519,595)

 

$

366,580

$

435,140


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



4




HEALTH ENHANCEMENT PRODUCTS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

 

 

 

 

 

For the three

 

For the three

 

 

Months ended

 

Months ended

 

 

March 31, 2009

 

March 31, 2008

 

 

 

 

 

NET SALES

$

23,130

$

35,551

 

 

 

 

 

COST OF SALES

 

16,322

 

30,500

 

 

 

 

 

GROSS PROFIT

 

6,808

 

5,051

 

 

 

 

 

OPERATING EXPENSES:

 

 

 

 

Selling

 

108,930

 

65,960

General and Administrative

 

318,756

 

201,077

Research and Development

 

108,090

 

16,488

 

 

 

 

 

Total Operating Expenses

 

535,776

 

283,525

 

 

 

 

 

LOSS FROM OPERATIONS

 

(528,968)

 

(278,474)

 

 

 

 

 

OTHER INCOME (EXPENSE):

 

 

 

 

Other income - rent

 

6,300

 

19,047

Amortization of Bond Discount

 

(157,054)

 

(405,028)

Interest Expense

 

(1,446)

 

(2,959)

 

 

 

 

 

Total Other Income (Expense)

 

(152,200)

 

(388,940)

 

 

 

 

 

NET LOSS

$

(681,168)

$

(667,414)

 

 

 

 

 

BASIC AND DILUTED LOSS

 

 

 

 

PER SHARE

$

(0.01)

$

(0.01)

 

 

 

 

 

WEIGHTED AVERAGE

 

 

 

 

BASIC AND DILUTED

 

 

 

 

SHARES OUTSTANDING

 

62,346,277

 

46,440,168


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



5




HEALTH ENHANCEMENT PRODUCTS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

 

 

 

 

 

 

 

For the Three

 

For the Three

 

 

Months Ended

 

Months Ended

 

 

March 31, 2009

 

March 31, 2008

Cash Flows for Operating Activities:

 

 

 

 

Net Loss

$

(681,168)

$

(667,414)

Adjustments to reconcile net loss to net cash used

 

 

 

 

by operating activities:

 

 

 

 

Non-cash - stock issued for services rendered

 

197,070

 

-

Stock issued to employees for services

 

106,083

 

12,676

Amortization of bond discount

 

157,054

 

405,028

Amortization of intangibles

 

242

 

241

Depreciation expense

 

7,164

 

7,508

Deferred rent

 

11,420

 

9,970

Changes in assets and liabilities:

 

 

 

 

Decrease in accounts receivable

 

49,333

 

-

Decrease in inventories

 

1,620

 

7,855

(Increase) Decrease in prepaid expenses

 

12,215

 

(14,151)

Increase(Decrease) in accounts payable

 

9,865

 

(85,843)

Increase (Decrease) in payroll and payroll taxes

 

24,327

 

(29,364)

(Decrease) in accrued liabilities

 

(2,400)

 

(29,353)

Net Cash (Used) by Operating Activities

 

(107,173)

 

(382,847)

 

 

 

 

 

Cash Flows from Investing Activities:

 

 

 

 

Capital expenditures

 

-

 

(19,117)

Net Cash (Used) by Investing Activities

 

-

 

(19,117)

 

 

 

 

 

Cash Flow from Financing Activities:

 

 

 

 

Proceeds from common stock subscribed

 

38,010

 

 

Payments of other borrowings

 

(1,622)

 

(21,480)

Proceeds from issuance of convertible debentures

 

47,500

 

110,000

Proceeds from sale of common stock and exercise of warrants

 

25,300

 

353,499

Net Cash Provided by Financing Activities

 

109,188

 

442,019

 

 

 

 

 

Increase (Decrease) in Cash

 

2,015

 

40,055

 

 

 

 

 

Cash at Beginning of Period

 

-

 

5,110

 

 

 

 

 

Cash at End of Period

$

2,015

$

45,165

Supplemental Disclosures of Cash Flow Information:

 

 

 

 

Cash paid during the period for:

 

 

 

 

Interest

$

1,477

$

959

Income Taxes

$

-

$

-

 

 

 

 

 

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



6



HEALTH ENHANCEMENT PRODUCTS, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS [Continued]


Supplemental Disclosure of Non-Cash Investing and Financing Activities:

 

First Quarter 2009:


During the three month period of time ending on March 31, 2009, the Company converted $50,000 of convertible debentures and $807 in accrued interest with the issuance of 203,227 shares of common stock. The Company issued convertible debentures for $47,500 principal and recorded a discount on the debentures of $39,500.


The Company issued 557,500 shares of common stock to employees for payment of accrued salaries valued at $55,750. The Company issued 66,667 shares of common stock for payment of accounts payable in the amount of $6,000. The Company issued 810,000 shares of common stock against common stock subscribed totaling $40,500. The Company recorded a debt discount of $110,539 in connection with restructured convertible debt.


First Quarter 2008:


During the three month period of time ending on March 31, 2008 the Company issued 2,281,720 shares of common stock upon conversion of $575,000 in principal and $2,481 in interest as a result of conversions of debt.


The Company recorded a combined debt discount of $110,000 to reflect the beneficial conversion feature of the convertible debt and value of the related warrants.


The Company issued 70,000 shares of stock as finders fees, valued at $21,000.


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



7



HEALTH ENHANCEMENT PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1 – BASIS OF PRESENTATION


The accompanying unaudited condensed consolidated financial statements include the accounts of Health Enhancement Products, Inc. and its wholly-owned subsidiaries (collectively, the “Company”). All significant inter-company accounts and transactions have been eliminated in consolidation. In the opinion of the Company’s management, the financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the information set forth therein. These consolidated financial statements are condensed, and therefore do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The condensed consolidated financial statements should be read in conjunction with the Company’s December 31, 2008 consolidated audited financial statements and supplementary data included in the Annual Report on Form 10-K as of that date.


The results of operations for the three months ended March 31, 2009 are not necessarily indicative of the results to be expected for the fiscal year ending December 31, 2009, or any other period.


In February, 2007, we established HEPI Pharmaceuticals, Inc. as a wholly owned subsidiary of HEPI (“HEPI Pharma”). The purpose of the pharmaceutical subsidiary will be to develop potential pharmaceutical applications for HEPI’s primary product, ProAlgaZyme®(PAZ). In connection with the formation of HEPI Pharma, we entered into a Pharmaceutical Development Agreement with our new subsidiary. Under the Development Agreement, we granted the subsidiary the right to develop the potential pharmaceutical applications of PAZ and its derivatives. In exchange for these rights, we became the sole stockholder of the subsidiary and are entitled to certain payments based on the attainment of specified development milestones and sales revenues.


The Company incurred net losses of $681,168 and $667,414 for the three months ended March 31, 2009 and 2008, respectively. In addition, the Company had a working capital deficiency of $605,371 and a stockholders’ deficit of $650,042 at March 31, 2009. These factors continue to raise substantial doubt about the Company's ability to continue as a going concern. The Company is endeavoring to increase the likelihood that it will be able to continue as a going concern by seeking to increase its sales revenue, and by raising additional capital. During the first quarter of 2009, the Company raised approximately $111,000 in net proceeds from the private sale of its common stock, the issuance of convertible debentures, and the receipt of stock subscriptions. There can be no assurance that the Company will be able to increase its sales or raise additional capital.


There can be no assurance that sufficient funds will be generated during the next year or thereafter from operations or that funds will be available from external sources such as debt or equity financings or other potential sources. The lack of additional capital could force the Company to curtail or cease operations and would, therefore, have a material adverse effect on its business. Furthermore, there can be no assurance that any such required funds, if available, will be available on attractive terms or that they will not have a significant dilutive effect on the Company's existing stockholders.


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


NOTE 2 – INVENTORIES


Inventories at March 31, 2009 and December 31, 2008 consist of the following:


 

 

March 31, 2009

 

December 31, 2008

 

 

(Unaudited)

 

 

Raw materials

$

34,418

$

35,850

Work in process

 

-

 

-

Finished goods

 

7,731

 

7,919

 

$

42,149

$

43,769



8



HEALTH ENHANCEMENT PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


NOTE 3 - PROPERTY AND EQUIPMENT


Property and equipment at March 31, 2009 and December 31, 2008 consists of the following:


 

 

March 31, 2009

 

December 31, 2008

 

 

(Unaudited)

 

 

Furniture and fixtures

$

49,466

$

49,466

Equipment

 

85,402

 

85,402

Leasehold improvements

 

129,252

 

129,252

 

 

 

 

 

 

 

264,120

 

264,120

Less accumulated depreciation and amortization

 

(76,088)

 

(68,924)

 

 

 

 

 

 

$

188,032

$

195,196


Depreciation and amortization was $7,164 and $7,508 for the three months ended March 31, 2009 and 2008, respectively.

 

NOTE 4 - DEFINITE-LIFE INTANGIBLE ASSETS


Definite-life intangible assets at March 31, 2009 and December 31, 2008 consist of the following:


 

 

March 31, 2009

 

December 31, 2008

 

 

(Unaudited)

 

 

Patent applications pending

$

14,500

$

14,500

Less: Accumulated amortization

 

(4,640)

 

(4,399)

 

 

 

 

 

 

$

9,860

$

10,101


The Company’s definite-life intangible assets are amortized, upon being placed in service, over the 15 year estimated useful lives of the assets, with no residual value. Amortization expense for the three months ended March 31, 2009 and 2008 was $242 and $241, respectively. The Company estimates that amortization expense for existing assets for each of the next five years will be approximately $1,000 per year.


NOTE 5 – LONG TERM DEBT:


Long term debt consists of the following:


Installment notes, bearing interest at 8.8% and 9.5%

 

 

 

 

per annum and due November 2010 and March 2011,

 

March 31, 2009

 

December 31, 2008

respectively. The loans are secured by certain of the

 

(Unaudited)

 

 

Company's equipment

$

15,261

$

16,884

 

 

 

 

 

Less current portion

 

6,873

 

6,718

 

$

8,388

$

10,166


Maturities of the long-term debt are as follows:


March 31,

 

 

2010

$

6,873

2011

 

8,388

 

$

15,261



9



HEALTH ENHANCEMENT PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


NOTE 6 – CONVERTIBLE DEBT


In the first quarter of 2009, convertible debentures in the principal amount of $196,000 were restructured. The conversion rate was reduced to $.05 per share from $.10 per share, and the warrants were cancelled. As a result, the Company wrote off the unamortized portion of debt discount related to the relative fair value of the warrants amounting to $110,539 and recalculated the debt discount with respect to the new beneficial conversion feature in the amount of $122,284. The newly calculated debt discount is being amortized over the remaining period of the notes. In addition, amortization of debt discount for the convertible notes for the three months ended March 31, 2009 was $11,211.


Also during the first quarter of 2009, the Company sold for aggregate consideration of $47,500, 1% convertible notes in the aggregate principal amount of $47,500. The Convertible Notes accrue interest at the rate of 1% per annum, are non-amortizing, have a term of 3 years, subject to the Company’s right to extend the term for an additional three years, cannot be prepaid, and are convertible, at any time prior to the maturity date, as the same may be extended, at the discretion of the holder, into shares of common stock, at a rate equal to $.05 per share. Accrued interest will be paid on the maturity date, as the same may be extended, in shares of Common Stock, valued at $.05 per share, and, unless the Convertible Note is converted prior to its maturity date, as the same may be extended, at the Company’s option, the principal amount of the Note may, on the maturity date, as extended, be repaid in cash or converted into common stock at a rate equal to $.05 per share. The Company recorded a deferred debt discount in the amount of $39,500, to reflect the beneficial conversion feature of the convertible debt. The Company is amortizing the debt discount over the term of the debt. Amortization of debt discount was $2,085 for the three months ended March 31, 2009.


During the three month period of time ending on March 31, 2009, the Company converted $50,000 of convertible debentures and $807 in accrued interest with the issuance of 203,227 shares of common stock.

 

NOTE 7 – RELATED PARTY TRANSACTIONS


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


Of the 15,000 square feet currently leased, we are occupying approximately 9,800 square feet. We are subleasing approximately 2,000 square feet on a month to month basis back to this significant shareholder, Howard Baer at a rate of approximately $2,100 per month. This sublease has not yet been formalized, and is currently on a month to month basis. We incurred $59,232 in rent expense and recognized $6,300 in sublet rent income during the first quarter of 2009.


Equipment - The Company uses and, in consideration of such use, makes lease and rent payments for, telephone equipment that is leased by an entity owned by the Company’s former CEO. During the quarter ended March 31, 2009 and 2008 respectively, equipment rental and lease expense paid to the entity amounted to $1,836 and $2,657, respectively. The lease and rental payments equal the debt service on the equipment. The former CEO intends to transfer the equipment to the Company, for no consideration, once the note is paid in full.




10



HEALTH ENHANCEMENT PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


Marketing Consultant Agreement – The Company has entered into an agreement with a significant shareholder, Howard Baer and former CEO to provide marketing services whereby the Company shall pay commissions at the rate of $.50 per bottle for every bottle sold under this agreement. In April of 2009, we amended this agreement to grant worldwide distribution and marketing rights to our product. This agreement calls for minimum monthly sales levels and is in effect for two years.


Financing - Periodically during 2009 the Company received loans from Mr. Baer. In addition, the Company owed Mr. Baer for unpaid rent and other expenses paid on behalf of the Company by Mr. Baer. The balance owing Mr. Baer at March 31, 2009 is $25,847 and is reflected in accounts payable.


NOTE 8 - STOCKHOLDERS’ DEFICIT


During the quarter ended March 31, 2009 the Company issued 1,618,333 shares of its common stock, valued at $161,833 to employees for both current and previously accrued salaries. The company issued 923,000 shares of common stock, valued at $83,070, to consultants for research. The Company issued 1,316,000 shares of stock for proceeds of $25,300 and $40,500 for previously paid subscriptions. The Company issued 1,500,000 shares, valued at $120,000, to a marketing consultant for services. Convertible debentures were converted during the quarter ended March 31, 2009, and the Company issued 203,227 shares of common stock and retired $50,000 of debt and $807 in accrued interest.


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


 

March 31, 2009

 

March 31, 2008

 

Number of

 

Weighted

Average

 

Number of

 

Weighted

Average

 

Warrants

 

Exercise Price

 

Warrants

 

Exercise Price

 

 

 

 

 

 

 

 

Outstanding, beginning of year

20,107,373

 

0.27

 

13,595,109

 

0.75

 

 

 

 

 

 

 

 

Issued

-

 

0.10

 

9,269,998

 

0.10

 

 

 

 

 

 

 

 

Exercised

-

 

0.10

 

-

 

-

 

 

 

 

 

 

 

 

Expired

(150,000)

 

0.10

 

-

 

-

 

 

 

 

 

 

 

 

Outstanding, end of period

19,957,373

 

0.27

 

22,865,107

 

0.83


Warrants outstanding and exercisable by price range as of March 31, 2009 were as follows:


 

 

Outstanding Warrants

 

Exercisable Warrants

 

 

 

 

Average

 

 

 

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

 

 

 

 

 

Remaining

 

 

 

 

 

Weighted

 

 

 

 

Contractual

 

 

 

 

 

Average

 

 

 

 

Life

 

Exercise

 

 

 

Exercise

Range of

 

Number

 

in Years

 

Price

 

Number

 

Price

0.10

 

16,556,014

 

2.02

 

0.10

 

16,556,014

 

0.10

0.50

 

3,401,359

 

1.25

 

0.50

 

3,401,359

 

0.50

 

 

 

 

 

 

 

 

 

 

 

 

 

19,957,373

 

1.89

 

 

 

19,957,373

 

0.17

 

 

 

 

 

 

 

 

 

 

 




11



HEALTH ENHANCEMENT PRODUCTS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


NOTE 9 - COMMITMENTS AND CONTINGENCIES


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


Of the 15,000 square feet currently leased, we are occupying approximately 9,800 square feet. We are subleasing approximately 2,000 square feet on a month to month basis back to this significant shareholder, Howard Baer at a rate of approximately $2,100 per month. This sublease has not yet been formalized, and is currently on a month to month basis. We incurred $59,232 in rent expense and recognized $6,300 in sublet rent income during the first quarter of 2009.


The Company is leasing, on a month to month basis, a warehousing and bottling facility. The lease calls for monthly rentals of $2,167. Rent expense under this lease for the quarter ended March 31, 2009 was approximately $7,581.


The future minimum lease payments related to the Amended and Restated Sublease and the warehouse lease, are as follows:

 

Year Ending March 31,

 

 

2010

$

258,454

2011

 

264,915

2012

 

271,538

2013

 

278,326

2014

 

285,285

Thereafter

 

1,812,740

 

$

3,171,258


NOTE 10 – LOSS PER SHARE


Loss per common share is based upon the weighted average number of common shares outstanding during the period. Diluted loss per common share is the same as basic loss per share, as the effect of potentially dilutive securities (convertible debt – 5,270,000 and warrants – 19,957,373 at March 31, 2009 and convertible debt – 1,900,000 and warrants – 22,865,107 at March 31, 2008) are anti-dilutive.


NOTE 10 - SUBSEQUENT EVENTS

 

During May of 2009 the Company issued 918,247 shares of common stock, valued at $91,825, to employees for accrued and current payroll. The Company issued 958,200 shares of stock and received $47,910 in proceeds. The Company issued 200,000 shares of common stock, valued at $18,000, to a consultant as payment of accrued fees owed. The Company issued 500,000 shares of common stock, valued at $55,000, in payment of legal fees.




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


Critical Accounting Policies 

 

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

 

Income taxes 

 

We account for income taxes using the asset and liability method described in SFAS No. 109, "Accounting For Income Taxes," the objective of which is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting and the tax basis of assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. A valuation allowance related to deferred tax assets is recorded when it is more likely than that some portion or all of the deferred tax assets will not be realized. 


We have provided a 100% valuation allowance for deferred tax assets, because the ultimate realization of those assets are uncertain. Utilization of net operating loss carry-forwards are subject to a substantial annual limitation due to the “change in ownership” provisions of the Internal Revenue Code. The annual limitation may result in the expiration of net operating loss carry-forwards before utilization.

 

Results of Operations for the three months ended March 31, 2009and March 31, 2008.


Net Sales. Net sales for the three months ended March 31, 2009 were $23,130 as compared to $35,551 for the three months ended March 31, 2008. These sales reflect principally revenues from the ProAlgaZyme product. We currently market our product over the Internet, and by telephone. We have recently had limited success with retail grocery store outlets and expect to expand our presence in the retail market in 2009.


Throughout 2008 and 2009, we have been adversely impacted by a shortage of funds which has severely impeded our ability to market and test our ProAlgaZyme® product, contributing to a low level of net sales. Although the ProAlgaZyme® product is available for sale and we are exploring various potential marketing opportunities, we are currently advertising on a limited basis and expect only limited sales revenue until at least the third quarter of 2009. We believe that our ability to generate sales of the ProAlgaZyme® product will depend upon, among other things, further characterization of the product, identification of its method of action and further evidence of its efficacy, as well as advertising. The testing necessary to further characterizing the product, identifying its method of action and establishing its effectiveness is ongoing.


Cost of Sales. Cost of Sales was $16,322 for the three months ended March 31, 2009, as compared to $30,500 for the comparable period in 2008. Cost of Sales represents primarily costs related to raw materials, labor and the laboratory and controlled production environment necessary for the growing of the algae cultures that constitute the source of the biological activity of the ProAlgaZyme product, and for conducting the necessary harvesting and production operations in preparing the product for sale. The decrease in cost of sales for 2009 is a direct result of our decreased sales volume.


Gross Profit. Gross profit was $6,808 for the three months ended March 31, 2009, as compared to $5,051 for the comparable period in 2008. The increased gross profit for 2009 is due to improvements in our production efficiency.



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Research and Development Expenses. For the three months ended March 31, 2009, we incurred $108,090 on research and development expenses (of which approximately $50,070 was noncash stock issuance), as compared to $16,488 for the comparable period in 2008. These expenses are comprised of costs associated with internal and external research. The increase in our research and development is due to a research project contracted in the first quarter of 2009.


We have in the past had difficulty raising substantial funds from external sources; however, we recently raised a limited amount of capital. We may not be able to raise the funding that we need to undertake further research and development activities. In the event that we are not able to secure sufficient funding to meet our research needs, we will be unable to pursue necessary research activities, in which case our ability to market ProAlgaZyme® with objective clinical support for its efficacy will be impeded, thereby hindering our ability to generate sales revenue and impacting negatively our operating results.


Selling and Marketing Expenses. Selling and marketing expenses were $108,930 for the three months ended March 31, 2009 (of which approximately $65,000 was noncash stock issuance), as compared to $65,960 for the comparable period in 2008. The increase in 2009 was due to costs associated with a national marketing consultant to increase our national exposure. We intend to continue to direct our in house selling efforts to existing ProAlgaZyme® users during 2009. The consultants will provide us with exposure in the media through the use of radio and television segments.


We are currently pursuing outside distributors for our product, to begin a nationwide campaign to raise awareness of our product. However, we intend to continue to direct selling efforts to existing ProAlgaZyme® users, by soliciting reorders from existing customers by telephone or mail in our inbound/outbound call center. In addition, we are continuing our efforts in the retail market arena, and exploring the establishment of additional distribution channels for ProAlgaZyme®. The limit on our ability thus far to advertise our product (due to the need for additional testing) has had and, until we are able to advertise our product based upon the results of clinical trials further demonstrating its efficacy, will continue to have, a material adverse effect on sales revenue and operating results. We intend to continue to pursue clinical study of our product and, subject to the results of such testing, increase advertising in 2008, subject to availability of sufficient funding, which we do not currently have.


General and Administrative Expenses. General and administrative expense was $318,756 for the three months ended March 31, 2009, as compared to $201,077 for the comparable period in 2008. The increase in general and administrative expenses is due primarily to a $120,000 increase in stock based compensation issued to consultants, an adjustment to pricing on invoices, offset by a decrease in our legal fees.


Liquidity and Capital Resources


The condensed consolidated financial statements contained in this Report have been prepared on a “going concern” basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. We have an immediate and urgent need for additional capital. For the reasons discussed herein, there is a significant risk that we will be unable to continue as a going concern, in which case, you would suffer a total loss of your investment in our company.


We have had limited revenue ($11,888 for the three months ended March 31, 2009) and have incurred significant net losses since inception, including a net loss of $681,168 during the three months ended March 31, 2009. We expect only limited sales revenue until at least the third quarter of 2009. Further, we have incurred recurring negative cash flow from operations. During the three months ended March 31, 2009, we incurred negative cash flows from operations of $107,173. As of June 12, 2009, we had no cash balance. We had a working capital deficiency of $605,371 and a stockholders’ deficit of $650,042 as of March 31, 2009. Although we recently raised a limited amount of capital, we have in the past had difficulty in raising capital from external sources. These factors raise substantial doubt about our ability to continue as a going concern.



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During the three months ended March 31, 2009 and 2008, our operating activities used $107,173 and $382,847 in cash, respectively. Our financing activities generated $109,188 and $442,019 during the three months ended March 31, 2009 and 2008, respectively. The approximate $338,000 decrease in cash generated by our financing activities is primarily attributable to a decrease in proceeds from the sale of common stock and warrants. In addition, we received gross proceeds from equity and debt financing of $110,810 during the three months ended March 31, 2009.


We estimate that we will require approximately $1,250,000 in cash over the next 12 months in order to fund our operations. In addition, if we are to initiate the clinical research for our subsidiary, we will require an additional $3,000,000. Based on this cash requirement, we have an immediate and urgent need for additional funding. For the foreseeable future, we do not expect that sales revenues will be sufficient to fund our cash requirements. Historically, we have had difficulty raising funds from external sources; however, we recently were able to raise a limited amount of capital from outside sources. If we are not able to raise additional funds in the immediate future we may be unable to continue as a going concern, in which case you will suffer a total loss of your investment in our company.


We have only limited product liability insurance. If a product claim were successfully made against us, there could be a material adverse effect on our financial condition.


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


We do not expect to experience any significant elements of income or loss other than those arising from our continuing operation.


Seasonality


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


Staffing


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


Off-Balance Sheet arrangements


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


Item 3. Controls and Procedures


(a)     Evaluation of Disclosure Controls and Procedures. The Company’s management, with the participation of the principal executive officer and the principal accounting officer, carried out an evaluation of the effectiveness of the Company’s “disclosure, controls and procedures” (as defined in the Securities Exchange Act of 1934 (the “Exchange Act”) Rules 13a-15(e) and 15-d-15(e)) as of the end of the period covered by this quarterly report (the “Evaluation Date”). Based upon that evaluation, the principal executive officer and the principal accounting officer concluded that, as of the Evaluation Date, the Company’s disclosure, controls and procedures are effective, providing them with material information relating to the Company as required to be disclosed in the reports the Company files or submits under the Exchange Act on a timely basis.


(b)     Changes in Internal Control over Financial Reporting. There were no changes in the Company’s internal controls over financial reporting, known to the principal executive officer or the principal accounting officer that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.



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PART II – OTHER INFORMATION


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


During the quarter ended March 31, 2009 the Company issued 1,618,333 shares of its common stock, valued at $161,832 to employees for salaries. The company issued 923,000 shares of common stock, valued at $92,300, to consultants for research. The Company issued 1,316,000 shares of stock and received $65,800 in proceeds. The Company issued 1,500,000 shares, valued at $120,000, to a marketing consultant for services. Convertible debentures were converted during the quarter ended March 31, 2009, and the Company issued 203,227 shares of common stock and retired $50,000 of debt and $807 in accrued interest.


The Company believes that the foregoing transactions were exempt from the registration requirements under Rule 506 of Regulation D promulgated under the Securities Act of 1933, as amended (“the Act”), based on the following facts: there was no general solicitation, there was a limited number of purchasers, all of whom were “accredited investors” (within the meaning of Regulation D under the Act and all of whom were sophisticated about business and financial matters, and all shares issued were subject to restriction on transfer, so as to take reasonable steps to assure that the purchaser was not an underwriter within the meaning of Section 2(11) of the Act.


6. Exhibits


Exhibit Number

Description

 

 

2.1

Agreement and Plan of Reorganization

 

(1)

3.1

Articles of Incorporation of Health Enhancement Products, Inc., as amended

 

(2)

3.2

By-laws of the Company

 

(3)

31.1

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

 

 

31.2

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

 

 

32.1

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

 

 

32.2

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

 

 


(1)

Filed as Exhibit 2.1 to our current Report on Form 8-K, Filed with the Commission on December 9, 2003 and incorporated by this reference.


(2)

Filed as Exhibit 3.1 to our Form 10-QSB, filed with the Commission on August 30, 2004 and incorporated by this reference.


(3)

Filed as Exhibit 3.2 to our Form 10SB, filed with the Commission on April 20, 2000 and incorporated by this reference.



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SIGNATURES


In accordance with the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


 

HEALTH ENHANCEMENT PRODUCTS, INC.

 

 

Date: June 12, 2009

By: /s/ Janet L. Crance              

 

Principal Accounting Officer

 

Principal Administrative Officer



17



LIST OF EXHIBITS


Exhibit Number

Description

 

 

2.1

Agreement and Plan of Reorganization

 

(1)

3.1

Articles of Incorporation of Health Enhancement Products, Inc., as amended

 

(2)

3.2

By-laws of the Company

 

(3)

31.1

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

 

 

31.2

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

 

 

32.1

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

 

 

32.2

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

 

 


(1)

Filed as Exhibit 2.1 to our current Report on Form 8-K, Filed with the Commission on December 9, 2003 and incorporated by this reference.


(2)

Filed as Exhibit 3.1 to our Form 10-QSB, filed with the Commission on August 30, 2004 and incorporated by this reference.


(3)

Filed as Exhibit 3.2 to our Form 10SB, filed with the Commission on April 20, 2000 and incorporated by this reference.



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