UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

  X .  

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

For the quarterly period ended September 30, 2015

      ..

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: 000-54600

FRESH MEDICAL LABORATORIES, INC.

(Exact name of registrant as specified in its charter)

(801) 736–0729

(Registrant’s telephone number, including area code)

Indicate by check mark whether the issuer (1) 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      .

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      .

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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:  As of November 10, 2015, the issuer had 21,067,280 shares of Common Stock, $0.001 par value, outstanding.

FRESH MEDICAL LABORATORIES, INC.

TABLE OF CONTENTS

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PART I – FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

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

3

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

4

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

5

FRESH MEDICAL LABORATORIES, INC. and SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Note 1 – Organization and Summary of Significant Accounting Policies

Organization – Fresh Medical Laboratories, Inc. (the “Company”) is a Delaware corporation that was incorporated on November 22, 2004 and is doing business as “ProLungdx”. The Company’s headquarters are located in Salt Lake City, Utah. The Company’s business is the development and deployment of medical devices and procedures specializing in the immediate, non-invasive evaluation of indeterminate lung masses suspicious for cancer as seen in CT and radiography. The Company’s principal activities have consisted of research and development, developing markets for its products, securing strategic alliances and obtaining financing.  The Company has developed, tested, and is commercializing its non-invasive lung cancer risk stratification test, the “Electro Pulmonary Nodule Scan” (“EPN Scan”).  In April 2013, the Company entered into an agreement to license this technology to a distributor for the China market.  In May 2013, the Company received the “CE” mark in Europe permitting the marketing of the EPN Scan in the European Union and certain other countries.  During the year ended December 31, 2014, the Company commenced selling the EPN Scan to customers in the European Union.  In the United States, the Company has submitted its application for marketing approval to the United States Food and Drug Administration.

During the year ended December 31, 2012, the Company formed a wholly-owned subsidiary, Hilltop Acquisition Corporation, Inc., which has had no activity since its inception and is included in the accompanying condensed consolidated financial statements from the date of its formation.

Basis of Presentation – The accompanying condensed consolidated financial statements have been prepared by management in accordance with rules and regulations promulgated by the U.S. Securities and Exchange Commission and therefore certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the accompanying condensed consolidated financial statements contain all adjustments necessary for them to be presented fairly, with those adjustments consisting only of normal recurring adjustments. These interim financial statements should be read in conjunction with the Company’s annual consolidated financial statements included in the Company’s annual report on Form 10-K for the year ended December 31, 2014. The results of operations for the three and nine months ended September 30, 2015 may not be indicative of the results to be expected for the year ending December 31, 2015.

Basic and Diluted Loss Per Share – The Company computes basic loss per share by dividing net loss by the weighted-average number of common shares outstanding during the period. The Company computes diluted loss per share by dividing net loss by the sum of the weighted-average number of common shares outstanding and the weighted-average dilutive common share equivalents outstanding.  The computation of diluted loss per share does not assume exercise or conversion of securities that would have an anti-dilutive effect.  As of September 30, 2015, there were warrants to purchase 1,423,211 shares of common stock outstanding, 388,199 non-vested shares of common stock, and $2,000,000 of 8% Convertible Debentures (the “Convertible Debentures”) that were excluded from the computation of diluted net loss per common share as they were anti-dilutive.  As of September 30, 2014, there were warrants to purchase 748,211 shares of common stock outstanding, 895,433 non-vested shares of common stock, and $155,000 of convertible notes that were excluded from the computation of diluted net loss per common share as they were anti-dilutive.

Recent Accounting Pronouncements – In July 2015, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2015-11, Simplifying the Measurement of Inventory, (“ASU 2015-11”). Pursuant to ASU 2015-11, the measurement principle for inventory will change from lower of cost or market value to lower of cost and net realizable value.  ASU 2015-11 defines net realizable value as the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.  ASU 2015-11 will be effective for the Company’s fiscal year beginning January 1, 2017 and subsequent interim periods, with early adoption permitted. Management is currently evaluating the impact of the pending adoption of ASU 2015-11 on the Company’s consolidated financial statements.

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FRESH MEDICAL LABORATORIES, INC. and SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

In April 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs, (“ASU 2015-03”). ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts.  ASU 2015-03 will be effective for the Company’s fiscal year beginning January 1, 2016 and subsequent interim periods, with earlier adoption permitted. Management adopted ASU 2015-03 as of April 1, 2015, with no immediate impact of the adoption on the Company’s consolidated financial statements.  When the issuance costs of the recently-issued Convertible Debentures are paid or settled, the issuance costs will be reported as a deduction from the carrying amount of the Convertible Debentures in the consolidated balance sheet.

In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements - Going Concern: Disclosure of Uncertainties About an Entity's Ability to Continue as a Going Concern, (“ASU 2014-15”). ASU 2014-15 requires management to perform interim and annual assessments on whether there are conditions or events that raise substantial doubt about the entity's ability to continue as a going concern within one year of the date the financial statements are issued and to provide related disclosures, if required. ASU 2014-15 will be effective for the Company’s fiscal year beginning January 1, 2016 and subsequent interim periods. Management is currently evaluating the impact of the pending adoption of ASU 2014-15 on the Company’s consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which stipulates that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  To achieve this core principle, an entity should apply the following steps: (1) identify the contract(s) with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when (or as) the entity satisfies a performance obligations.   On July 9, 2015, the FASB approved the deferral of the effective date of ASU 2014-09 by one year.  As a result, ASU 2014-09 will be effective for the Company retrospectively beginning January 1, 2018, with early adoption not permitted.  Management has not yet selected a transition method and is currently evaluating the impact of the pending adoption of ASU 2014-09 on the Company’s consolidated financial statements.

Note 2 – Inventory

Inventory principally consists of the cost of materials purchased and assembled for the EPN Scan which has received regulatory approval in Europe.  The Company has recorded these costs as inventory because regulatory approval has been received and management has determined that a future benefit is probable.  The cost of inventory also includes the costs of direct labor for the assembly of the EPN Scan and certain indirect costs incurred in connection with purchasing of parts and the assembly of products.  Inventory is valued at the lower of cost or market value, with cost determined based on the first-in-first-out method.  Inventory consists of the following:

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FRESH MEDICAL LABORATORIES, INC. and SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Note 3 – Property and Equipment

Property and equipment consists of the following:

In January 2014, the Company ordered tooling having a total cost of $72,700, of which a deposit of $36,350 was paid during the three months ended March 31, 2014.  The tooling is for the purpose of manufacturing the case for the EPN Scan.  In July 2015, the Company settled the outstanding balance with a payment of $20,878.  Depreciation of the tooling commenced in July 2015 on the date that the tooling was placed into service, over an expected useful life of five years.

Effective January 11, 2014, the Company entered into a Master Services Agreement (the “Agreement”) with an entity that provides consulting and professional services.  The entity is owned and managed by a director of the Company.  On March 26, 2014, the Company issued a work order under the Agreement for the development, testing, and deployment of the Internet-based customer service portal.  The work order was planned to be completed in four phases (prototype completion, development completion, testing completion, and deployment) for a total estimated cost of $147,900, payable in amounts specified in the work order upon the completion of each phase or milestone.  The consultant completed the first phase for the prototype completion and was paid the corresponding cost of $26,800.  The Company has paid an additional $23,200 under the Agreement in full satisfaction of amounts owed for additional services provided under the Agreement.  This amount settled the Agreement in full, bringing the total amount paid for the project to $50,000.  

The costs incurred for the development of the Internet-based customer service portal pursuant to the second work order have been accounted for pursuant to generally accepted accounting principles governing the accounting for Website Development Costs and for Internal-Use Software.  Those standards require that costs incurred during the preliminary project stage be expensed as incurred, costs incurred to develop internal-use computer software during the application development stage be capitalized, and costs incurred for training and during the post-implementation operation stage be expensed as incurred.  Since the costs incurred related to the application development stage, the costs were capitalized as property and equipment and will be amortized on a straight-line basis over the estimated useful life of the technology when completed and placed in service, with periodic evaluation for impairment.

Note 4 – Accrued Liabilities

Accrued liabilities consisted of the following:

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FRESH MEDICAL LABORATORIES, INC. and SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Note 5 – Long-term Debt

Long-term debt is summarized as follows:

Convertible Debentures

In February 2015, the Company commenced an offering of Convertible Debentures in an aggregate amount of up to $2,000,000.  As of April 30, 2015, the Company had received subscriptions with respect to $2,000,000 in Convertible Debentures. The Convertible Debentures were issued in April 2015 and bear interest at the rate 8% per annum commencing on the issuance date. Principal and accrued interest are due on the maturity date, which is May 1, 2018. The holder of the Convertible Debenture is entitled, at its option, to convert all or any portion of the outstanding principal of the Convertible Debenture into shares of the Company’s common stock at a conversion price of $0.65 per share.  Interest accruing from the date of issuance to the conversion date shall be paid on the maturity date.  Issuance costs, when paid or settled, will be amortized over the term of the Convertible Debentures using the effective interest method.  The Company evaluated the Convertible Debentures for consideration of any beneficial conversion features as required under generally accepted accounting principles.  The Company determined the beneficial conversion feature to be $0.

Note Payable to Former Director and Founding Shareholder

As of December 31, 2014, the Company was obligated under the terms of a master note to a founding stockholder and former member of its board of directors in the principal amount of $929,536 plus accrued interest of $223,742.  The note and accrued interest of $249,348 were due on April 30, 2015.  The note bore interest at 11.10% and was unsecured.

On May 1, 2015, the Company and the noteholder entered into an Amended and Restated Master Loan Agreement and Promissory Note (the “Revised Note”) in the principal amount of $900,000, which terminated and replaced the previous note. On April 30, 2015, in anticipation of entering into the Revised Note, the Company paid all accrued interest in the amount of $249,348 and principal of $29,536.  Interest under the Revised Note also accrues at the rate of 11.10% per annum and is payable monthly in arrears.  The Company is obligated to make a $250,000 principal payment on January 1, 2016, and the balance of the Revised Note matures on April 30, 2017.  The Revised Note is unsecured and includes standard creditor remedies in the event of default. The Revised Note and any accrued interest was paid off subsequent to September 30, 2015.

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FRESH MEDICAL LABORATORIES, INC. and SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The Company evaluated the modification of the term of the note under generally accepted accounting principles for troubled debt restructurings by debtors and for debt modifications and extinguishments.  The Company determined the modification is not within the scope of a troubled debt restructuring.  The Company also determined that the modification is not substantial, and as such, the transaction should not be accounted for as an extinguishment, and no gain or loss should be recognized.

In total, the Company paid accrued interest of $299,822 and $42,991 during the nine months ended September 30, 2015 and 2014, respectively.  Interest expense for the three months ended September 30, 2015 and 2014 was $25,180 and $26,007, respectively.  Interest expense for the nine months ended September 30, 2015 and 2014 was $76,080 and $77,172, respectively.

In periods prior to January 1, 2015, this note was presented as a related-party arrangement in the Company’s consolidated financial statements.  However, management has concluded that this note no longer meets the definition of a related party transaction under generally accepted accounting principles.

Note Payable to a Relative of an Executive Officer

At September 30, 2015 and December 31, 2014, the Company was obligated under the terms of a master note to an individual related to an executive officer of the Company in the amount of $356,931. The note is secured by all the assets of the Company, bears interest at 15% per annum, and requires the board of directors to retain the current management as long as the note is outstanding. The note was originally due on December 31, 2012, however, on March 27, 2014, the note holder and the Company entered into an amendment of the master note to extend the due date of the note and accrued interest to June 30, 2016.  The balance of accrued interest at September 30, 2015 and December 31, 2014 was $177,654 and $137,610, respectively.  The Company paid accrued interest of $50,000 during the nine months ended September 30, 2014 (none during the nine months ended September 30, 2015).  Interest expense for the three months ended September 30, 2015 and 2014 was $13,495 for each period.  Interest expense for the nine months ended September 30, 2015 and 2014 was $40,045 for each period.

In periods prior to January 1, 2015, this note was presented as a related-party arrangement in the Company’s consolidated financial statements.  However, management has concluded that this note no longer meets the definition of a related party transaction under generally accepted accounting principles.

Convertible Notes

During 2012 and 2013, the Company issued notes payable totaling $679,000 and $5,000, respectively. These notes bore interest at 8% and were unsecured.  The notes and accrued interest were due, if not previously converted, from June through August 2015. The terms of the notes payable were that the notes were originally convertible into common stock at the greater of $0.80 per share or 85% of the closing price for the previous ten trading days prior to the conversion. If the Company’s stock was not publicly traded, then the price would be the average of the three prior private stock purchases of the Company’s common stock for cash.  During the years ended December 31, 2012, 2013, and 2014, notes payable totaling $594,000 and related accrued interest of $40,858 were converted into 951,865 shares of the Company’s common stock, representing a weighted average of approximately $0.67 per share, which resulted in a remaining balance payable on convertible notes of $90,000 at December 31, 2014.  During the nine months ended September 30, 2015, one note payable in the amount of $40,000 and related accrued interest of $9,837 was paid off for cash.  During the nine months ended September 30, 2015, the other remaining note payable in the amount of $50,000 and related accrued interest of $11,935 was converted into 95,283 shares of the Company’s common stock, at $0.65 per share.  During the nine months ended September 30, 2014, one note payable in the amount of $25,000 and related accrued interest of $3,337 was converted into 35,421 shares of the Company’s common stock, at $0.80 per share.

Other Notes Payable

During the three months ended September 30, 2014, the Company received advances from two members of its board of directors in the aggregate amount of $20,000 and advances from two unrelated parties in the aggregate amount of $100,000. The terms of the advances, such as the interest rate, the security, or the conversion terms, were not established at the dates of the advances.

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FRESH MEDICAL LABORATORIES, INC. and SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Note 6 – Preferred Stock

The stockholders of the Company have authorized 10,000,000 shares of preferred stock, par value $0.001 per share. The preferred stock may be issued in one or more series. The board of directors has the right to fix the number of shares of each series (within the total number of authorized shares of the preferred stock available for designation as a part of such series), and designate, in whole or part, the preferences, limitations and relative rights of each series of preferred stock. As of September 30, 2015 and December 31, 2014, the board of directors has not designated any series of preferred stock and there are no shares of preferred stock issued or outstanding.

Note 7 – Common Stock

On December 3, 2014, the Company held an annual and special meeting of stockholders.  At the meeting, the stockholders approved an amendment to increase the number of shares of common stock authorized under the Company’s Second Amended and Restated Certificate of Incorporation to 40 million shares.  The Second Amended and Restated Certificate of Incorporation was filed with the State of Delaware on December 8, 2014.

Common Stock Issued for Cash

During the three months ended March 31, 2015, the Company issued 294,000 shares of common stock for cash.  Proceeds from these issuances total $147,000, or $0.50 per share.

During the six months ended September 30, 2015, the Company issued 881,279 shares of common stock for cash.  Proceeds from these issuances total $660,960, or $0.75 per share.  Certain of these issuances were the result of the Company receiving proceeds in excess of the amount of Convertible Debentures authorized by the Company’s board of directors.  These investors opted to purchase shares of common stock in the Company at $0.75 per share.

Common Stock Issued for Services

Periodically, the Company issues non-vested common stock to directors, officers and consultants as compensation for future services. The Company values the non-vested shares of common stock based on the fair value of the stock on the date of issuance and records compensation over the requisite service period which is usually the vesting period. The non-vested shares are included in the total outstanding shares recorded in the condensed consolidated financial statements.  The Company recognized stock-based compensation related to the vesting of shares issued to directors, officers and consultants for the three months ended September 30, 2015 and 2014 of $58,718 and $111,010, respectively, and for the nine months ended September 30, 2015 and 2014 of $188,652 and $261,144, respectively.

A summary of the status of the Company’s non-vested shares as of September 30, 2015 and changes during the nine months then ended, is presented below:

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FRESH MEDICAL LABORATORIES, INC. and SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

As of September 30, 2015 and December 31, 2014, there was $194,100 and $382,750, respectively, of total unrecognized compensation cost related to the non-vested stock-based compensation arrangements awarded to directors, officers, and consultants. That cost is expected to be recognized over a weighted-average period of 0.9 years from September 30, 2015.

Total stock-based compensation expense from all sources for the three and nine months ended September 30, 2015 and 2014, including stock-based compensation for the warrant discussed below in Note 8, has been included in the condensed consolidated statements of operations as follows:

Note 8 – Common Stock Warrants

The Company has issued warrants to purchase shares of its common stock for payment of consulting services, in connection with the extension of a note payable, as incentives to investors, and for cash. The fair value of each warrant issuance is estimated on the date of issuance using the Black-Scholes option pricing model.  The fair value of warrants issued for consulting services is recognized as consulting expense at the date the warrants become exercisable. The Black-Scholes option pricing model incorporates ranges of assumptions for each input. Expected volatilities are based on the historical volatility of an appropriate industry sector index, comparable companies in the index, and other factors. The Company estimates the expected life of each warrant based on the midpoint between the date the warrant vests and the contractual term of the warrant (the Simplified Method). The Company uses the Simplified Method because it does not have more detailed information about exercise behavior that would allow a more reliable method of predicting the expected life of each warrant.  The risk-free interest rate represents the U.S. Treasury Department’s constant maturities rate for the expected life of the related warrant.  And the dividend yield represents anticipated cash dividends to be paid over the expected life of the warrant.

Effective July 1, 2014, the Company entered into a Consulting Services Agreement (the “Consulting Agreement”) with Leavitt Partners, LLC (“Leavitt Partners”) pursuant to which Leavitt Partners agreed to provide strategic consulting services to the Company.  The Consulting Agreement has a term of four years, but may be terminated by either party as of the first, second, or third anniversary date of the Consulting Agreement, without cause and in the sole discretion of either party.  As consideration for the services, in two transactions during the six months ended December 31, 2014, the Company issued warrants to Leavitt Partners to purchase 900,000 shares of common stock of the Company.  The Consulting Agreement provided that the warrants would stop vesting upon termination of the Consulting Agreement.  The warrants have an exercise price of $0.50 per share and expire 10 years after issuance.  During the three months ended September 30, 2014, the Company issued a warrant, as amended, to purchase 225,000, with all of the shares under the amended warrant exercisable as of September 1, 2014, and with the rights to exercise the warrant expiring on September 1, 2024.

During the three months ended December 31, 2014, the Company issued a second warrant to Leavitt Partners to purchase 675,000 shares of common stock of the Company. This second warrant has an exercise price of $0.50 per share, vests with respect to 15,000 shares per month commencing October 1, 2014, and expires 10 years after issuance.

The fair value of these two warrants was estimated using the Black-Scholes option pricing model.  The fair value of the warrant shares that vested during the six months ended December 31, 2014 was $0.285 per share.  The weighted-average assumptions used for the warrant shares that vested during the six months ended December 31, 2014 were risk-free interest rate of 1.75%, expected volatility of 66%, expected life of 5.2 years, and expected dividend yield of zero.  The fair value of the warrant shares that vested during the nine months ended September 30, 2015 was $0.373 per share.  The weighted-average assumptions used for the warrant shares that vested during the nine months ended September 30, 2015 were risk-free interest rate of 1.85%, expected volatility of 70%, expected life of 5.5 years, and expected dividend yield of zero.

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FRESH MEDICAL LABORATORIES, INC. and SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The Company recognized the prepayment of stock-based compensation through the first anniversary date of the Consulting Agreement by recognizing $109,900 as prepaid compensation expense and additional paid-in capital related to the issuance of the warrants to Leavitt Partners.  The Company also recognized $21,519 as share-based compensation and additional paid-in capital related to the vesting of warrant shares for the three months ended September 30, 2015.  Based on the vesting pattern of the warrants, the Company amortized $81,306 of stock-based compensation during the six months ended December 31, 2014 and amortized an additional $50,113 during the nine months ended September 30, 2015.

A summary of warrant activity for the nine months ended September 30, 2015 is presented below:

The intrinsic value at September 30, 2015 is calculated at $0.75 per share less the exercise price, based on the management’s latest estimate of the fair value of the shares of common stock, which is the latest price the Company issued shares of common stock for cash.

Note 9 – Commitments and Contingencies

Lease Agreement – Prior to August 2014, the Company leased office space under a non-cancelable operating lease that expired in July 2014.  Monthly rental payments were $2,888 per month.  Effective August 1, 2014, the Company entered into a new lease agreement with its landlord, expanding the amount of office space that it occupies at 757 East South Temple, Salt Lake City, Utah to approximately 4,657 square feet.  The new lease agreement has a term of three years, with an option to renew for an additional three years.  Monthly rental payments under the new non-cancelable lease are $3,787 for the initial year and will escalate by 2% per year to $3,940 in the third year.  If the Company exercises the option to renew the lease, the monthly rental payments will further escalate by 3% per year during the additional term.  

Minimum lease commitments at September 30, 2015 for the remaining term of the lease are as follows:

Lease expense charged to operations for the three months ended September 30, 2015 and 2014 was $12,643 and $8,264, respectively and for the nine months ended September 30, 2015 and 2014 was $36,907 and $27,045, respectively.

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FRESH MEDICAL LABORATORIES, INC. and SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

License Agreement – The Company has a license agreement with a party related through a shareholder and former member of the board of directors. Under the agreement, the Company has the right to the exclusive use of certain patents pending and related technology (the “technology”) in its medical devices and other products for an indefinite term. In return, the Company agreed to incur a minimum of $4,750,000 in development costs by the year 2014 to develop and market its products worldwide based on a graduated schedule and to make royalty payments based on a percentage of the aggregate worldwide net sales (as defined in the agreement) of its medical device and other products that utilize the technology.  At September 30, 2015 and December 31, 2014, accrued royalties under this license agreement total $17,873 and $17,350, respectively.

Note 10 – Subsequent Events

On November 6, 2015, the Company issued two convertible promissory notes (the “Convertible Notes”) in the aggregate principal amount of $1,206,931 to two investment entities controlled by a single family.  In the same transaction, the investment entities purchased an aggregate of 66,666 shares of common stock for a purchase price of $50,000, or $0.75 per share.   The Convertible Notes are unsecured and accrue interest at the rate of 8% per annum, with interest payable on the last day of each calendar quarter.  The principal amount under the Notes is due on the five-year anniversary of the issue date.  The Convertible Notes are convertible at any time prior to maturity at the option of the holders at a conversion rate of $0.75 per share.  If the Company’s common stock commences trading and closes at a price of $3.50 per share for five consecutive trading days, the principal amount under the Convertible Notes automatically converts into common stock at the rate of $0.75 per share.   Proceeds from the Convertible Notes are to be used for the purpose of retirement of long-term debt.

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

The following discussion of our plan of operation should be read in conjunction with the financial statements and related notes that appear elsewhere in this Form 10-Q and the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

Certain statements in this Form 10-Q constitute “forward-looking statements.”  Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Factors that might cause such a difference include, among others, uncertainties relating to general economic and business conditions; industry trends; receipt or denial of marketing approval from the FDA and similar agencies; receipt or denial of reimbursement from government agencies and insurance companies; changes in demand for our products and services; uncertainties relating to customer plans and commitments and the timing of orders received from customers; announcements or changes in our pricing policies or that of our competitors; unanticipated delays in the development, market acceptance or installation of our products and services; changes in government regulations; availability of management and other key personnel; availability, terms and deployment of capital; relationships with third-party equipment suppliers; and worldwide political stability and economic growth. The words "believe", "expect", "anticipate", “will”, "intend" and "plan" and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statement was made. We undertake no obligation to update such statements to reflect events that occur or circumstances that exist after the date on which they are made.

Overview

Fresh Medical Laboratories, Inc. was incorporated under the laws of the State of Delaware on November 19, 2004 and does business under the trade name ProLungdx®. We are a medical device company that is developing, testing and commercializing its non-invasive lung cancer risk stratification test (the “Electro Pulmonary Nodule Scan” or “EPN Scan,”).  The EPN Scan is adjunctive to Computed Tomography (“CT”), or what is commonly referred to as a “CT scan” of the chest.  The EPN Scan assists in evaluating the risk associated with a CT finding in the lung that is suspicious for cancer.

As many patients at high risk of lung cancer have suspicious lung findings when evaluated by CT, clarifying the risk of the disease, or risk stratification, has the potential to reduce the cost, anxiety, and/or time associated with the inaccurate and/or delayed diagnosis of lung cancer.  Risk stratification may also play a role in identifying those patients who need to modulate the extent and frequency of follow-up.  On December 31, 2013, the U.S. Preventative Services Task Force recommended CT screening guidelines for lung cancer in adults aged 55 to 80 who have a 30 pack-year history and currently smoke or have quit smoking in the past 15 years.  This guideline is expected to increase the number of patients with suspicious findings in the lung that may be candidates for the EPN Scan.

On May 10, 2013, the EPN Scan received the “CE” mark in Europe for its Electro Pulmonary Nodule Scanner and Probe.  This marking is regulatory approval that clears the marketing and sale of the EPN Scan in the European Economic Area and European Free Trade Association Countries representing 509 million individuals and 31 member states.  The new screening guidelines and Medicare coverage recently announced in the U.S. for lung cancer screening are not available in Europe.

In the United States, we have submitted an application for marketing approval under Section 510(k) from the United States Food and Drug Administration, or FDA.  On February 27, 2015, we received a review letter from the FDA identifying a number of issues, concerns and weaknesses in our application, including the risk classification of the test, the study design and study analysis along with what we consider other less important questions.  On July 16, 2015, we met with the FDA to clarify and refine our understanding of the issues related to our pending application.  Before the FDA can grant approval of our application, we must resolve or negotiate the removal of all issues identified by the FDA and address possible issues to be identified in the future. Certain completed studies address some of the issues identified by the FDA, and we responded to the FDA regarding certain outstanding issues by August 27, 2015.  As of August 27, 2015, the Company, in consultation with the FDA, determined that the remaining issues would require additional time for submission.  Consequently, the device would undergo an automatic withdrawal followed by a re-application once the requested data was available for submission.  The Company is now preparing a response.  According to draft FDA guidelines, a response may be expected in up to 120 days from our submission.

From inception to date, we have generated limited revenues.  During the year ended December 31, 2014, we commenced selling the EPN Scan to customers in the European Union.

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We plan to continue the development and deployment of medical devices and procedures specializing in the immediate, non-invasive evaluation of indeterminate masses in the lung seen in CT and radiography.  We anticipate the need to fund expansion and market growth by raising capital over the next two years.  The amount of capital needed could change based on the opportunities available to us and the ability to expand our markets.  

Results of Operations

The following discussion is included to describe our consolidated financial position and results of operations.  The consolidated financial statements and notes thereto contain detailed information that should be referred to in conjunction with this discussion.

Three Months Ended September 30, 2015 compared to the Three Months Ended September 30, 2014

Revenues and Cost of Revenue.  During the three months ended September 30, 2015, we sold two EPN scan units to our licensee in China for $10,450 pursuant to the pricing provisions of our license and recognized $7,763 in cost of sales related to the sale.  Cost of sales includes the cost of direct materials and labor for the assembly of the units, other indirect costs related to the purchase and assembly of inventory, plus the accrual of royalties under our technology license agreement.

Under the agreement with our licensee for China, we will be entitled to additional payments if the distributor achieves certain cumulative revenues and an annual royalty based on net sales.  However, as of September 30, 2015, there is no additional revenue due from either of these sources.

During the three months ended September 30, 2014, we sold three additional EPN Scan units and associated test kits in the European Union.  Total sales revenue for the three months ended September 30, 2014 was $116,600.  During the three months ended September 30, 2014, we recognized $22,658 in cost of sales related to the EPN Scan units and test kits sold in the European Union.  Cost of sales includes the cost of direct materials and labor for the assembly of the units, other indirect costs related to the purchase and assembly of inventory, plus the accrual of royalties under our technology license agreement.  Our gross margin reflects the uniqueness of our products, our position in this market, the sufficiency of revenue to recover our investment in research and development over the last several years, and the relative low cost of raw materials.

Operating Expenses. Total operating expenses for selling, general and administrative expense and for research and development expense for the three months ended September 30, 2015 were $788,069, compared to the total operating expenses for the three months ended September 30, 2014, of $492,050, representing an increase of $296,019.  This increase was due to 1) an increase of $221,872 for professional fees, principally for consulting services related to our increased clinical, regulatory, and business development activities; 2) an increase of $91,819 in travel costs also related to our increased clinical, regulatory, and business development activities; 3) an increase of $60,527 in other clinical expenses also related to our increased clinical activities; and 4) an increase of $68,697 in remaining operating expenses also related generally to our increased operational activities.  These increased expenses were offset by 1) a decrease in non-cash stock-based compensation of $92,896 that results based on the vesting arrangements of common stock and warrants that have been issued for services and 2) a decrease in non-cash expense of $54,000 for the provision for doubtful accounts for accounts receivable based on management’s estimates of the collectability of accounts receivable at each reporting date.  Operating expenses have been classified by management as either selling, general and administrative expense or as research and development expense based on an assignment of certain expenses directly to these classifications or based on management’s allocation of certain expenses between these classifications.

Other income/(expense).  Other income (expense) amounted to net expense of $81,335 for the three months ended September 30, 2015, as compared to net expense of $59,380 for the three months ended September 30, 2014.  Other income (expense) for the three months ended September 30, 2015 consists of interest expense of $79,004 and a foreign currency exchange loss of $2,331.  Other income (expense) for the three months ended September 30, 2014 consists of interest expense of $42,616 and a foreign currency exchange loss of $16,764.

The increase in interest expense during the three months ended September 30, 2015 principally relates to the interest accrued on the Convertible Debentures.  Otherwise, interest expense represents interest accrued on the notes to a former director and to a relative of an executive officer, as further described in Note 5 to the unaudited consolidated financial statements.

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Accounts receivable for sales of the EPN Scan units and test kits in Europe are denominated in Euros and Swiss Francs, and translated into U.S. Dollars at the date of each sale and at each balance sheet date.  The foreign currency exchange losses of $2,331 and $16,764 for the three months ended September 30, 2015 and 2014, respectively, are the result of the changes in the exchange rates of Euros and Swiss Francs during the three month periods ended on September 30, 2015 and 2014.

Nine Months Ended September 30, 2015 compared to the Nine Months Ended September 30, 2014

Revenues and Cost of Revenue.  During the nine months ended September 30, 2015, we sold two EPN scan units to our licensee in China for $10,450 pursuant to the pricing provisions of our license and recognized $7,763 in cost of sales related to the sale.  Cost of sales includes the cost of direct materials and labor for the assembly of the units, other indirect costs related to the purchase and assembly of inventory, plus the accrual of royalties under our technology license agreement.  Additionally, during the nine months ended September 30, 2015, we provided certain services to our licensee in China and recognized revenue in the amount of $9,000.  We incurred costs related to these services in the amount of $7,800.

Under the agreement with our licensee for China, we will be entitled to additional payments if the distributor achieves certain cumulative revenues and an annual royalty based on net sales.  However, as of September 30, 2015, there is no additional revenue due from either of these sources.

During the nine months ended September 30, 2014, we commenced selling our EPN Scan units and test kits in the European Union.  We also sold additional units under the exclusive license of our technology for China.  Total sales revenue for the nine months ended September 30, 2014 was $331,405 and we recognized $48,317 in cost of sales related to the EPN Scan units and test kits sold in the European Union and in China.  Cost of sales includes the cost of direct materials and labor for the assembly of the units, other indirect costs related to the purchase and assembly of inventory, plus the accrual of royalties under our technology license agreement.  Our gross margin reflects the uniqueness of our products, our position in this market, the sufficiency of revenue to recover our investment in research and development over the last several years, and the relative low cost of raw materials.  

Operating Expenses. Total operating expenses for selling, general and administrative expense and for research and development expense for the nine months ended September 30, 2015 were $1,714,526, compared to the total operating expenses for the nine months ended September 30, 2014, of $1,686,004, representing an increase of $28,522.  This increase was due to 1) an increase of $314,601 for professional fees, principally for consulting services related to our increased clinical, regulatory, and business development activities; 2) an increase of $112,562 in other clinical expenses also related to our increased clinical activities; 3) an increase of $39,805 in travel costs also related to our increased clinical, regulatory, and business development activities; 4) an increase of $30,294 for insurance expense principally related to a new policy to provide director and officer liability insurance coverage; and 5) an increase of $65,017 in remaining operating expenses also related generally to our increased operational activities.  These increased expenses were offset by 1) a decrease in non-cash stock-based compensation of $486,572 (principally from the issuance in 2014 of 804,140 shares of our common stock to officers, directors, and a consultant as compensation for current services valued at $402,070) that results based on the vesting arrangements of common stock and warrants that have been issued for services and 2) a decrease in non-cash expense of $47,185 for the provision for doubtful accounts for accounts receivable based on management’s estimates of the collectability of accounts receivable at each reporting date.  Operating expenses have been classified by management as either selling, general and administrative expense or as research and development expense based on an assignment of certain expenses directly to these classifications or based on management’s allocation of certain expenses between these classifications.

Other income/(expense).  Other income (expense) amounted to net expense of $215,699 for the nine months ended September 30, 2015, as compared to net expense of $143,628 for the nine months ended September 30, 2014.  Other income (expense) for the nine months ended September 30, 2015 consists of interest expense of $193,412 and a foreign currency exchange loss of $22,287.  Other income (expense) for the nine months ended September 30, 2014 consists of interest expense of $126,864 and a foreign currency exchange loss of $16,764.

The increase in interest expense during the nine months ended September 30, 2015 principally relates to the interest accrued on the Convertible Debentures.  Otherwise, interest expense represents interest accrued on the notes to a former director and to a relative of an executive officer, as further described in Note 5 to the unaudited consolidated financial statements.

Accounts receivable for sales of the EPN Scan units and test kits in Europe are denominated in Euros and Swiss Francs, and translated into U.S. Dollars at the date of each sale and at each balance sheet date.  The foreign currency exchange losses of $22,287 and $16,764 for the nine months ended September 30, 2015 and 2014, respectively, are the result of the changes in the exchange rates of Euros and Swiss Francs during the corresponding periods ended on September 30, 2015 and 2014.

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Liquidity and Capital Resources

The following is a summary of our key liquidity measures at September 30, 2015 and 2014:

If we obtain FDA clearance to market in the United States of America, we plan to convert U.S. hospitals with existing investigational placements of our diagnostic to commercial installations selling our ProLung EPN Scan.  The funds required for the United States market launch are estimated to be approximately $4.0 million.  Funds for this purpose, and for ordinary operations, are expected to be obtained in part through the sales of our products and services in Europe but primarily from the sale of debt and equity securities.  During the nine months ended September 30, 2015, we offered and sold $2,000,000 in Convertible Debentures (the “Convertible Debentures”) and $807,960 in common stock.   We have no existing commitment to provide working capital, and given our early stage of development, we may be unable to raise sufficient capital when needed and may be required to pay a high price for capital.

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

·

our ability to obtain regulatory approval in markets outside of Europe;

·

our ability to successfully commercialize our EPN Scan, EPN Scanner and related products and the market acceptance of these products;

·

the pace of our orders, if any, and the pricing and payment terms of those orders;

·

our ability to establish and maintain collaborative arrangements with corporate partners for the development and commercialization of certain product opportunities;

·

the cost of manufacturing and production scale-up;

·

our financial results;

·

the cost and availability of capital generally; and

·

the occurrence of unexpected adverse expenses or events.

Long-Term Debt

Since our inception, the principal source of our financing has come from the issuance of equity securities and from debt financing.  As of September 30, 2015, our outstanding debt financing includes the following borrowing arrangements.

Convertible Debentures

In February 2015, we commenced an offering of Convertible Debentures in an aggregate amount of up to $2,000,000.  As of April 30, 2015, we had completed the offering and issued Convertible Debentures totaling $2,000,000.  The Convertible Debentures bear interest at the rate 8% per annum commencing on the issuance date in April 2015.  Principal and accrued interest are due on the maturity date, which is May 1, 2018. The holder of the Convertible Debenture is entitled, at its option, to convert all or any portion of the outstanding principal of the Convertible Debenture into shares of our common stock at a conversion price of $0.65 per share.  Interest accruing from the date of issuance to the conversion date shall be paid on the maturity date.  

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Note Payable to a Former Director and Founding Shareholder

As of December 31, 2014, we were obligated under the terms of a master note agreement to a founding stockholder and former member of our Board of Directors in the amount of $929,536, plus accrued interest of $223,742.  The note and accrued interest of $249,348 were due on April 30, 2015.  The note bore interest at 11.10% and was unsecured. On May 1, 2015, we and the noteholder entered into an Amended and Restated Master Loan Agreement and Promissory Note (the “Revised Note”) in the principal amount of $900,000, which terminated and replaced the previous note.  On April 30, 2015, in anticipation of entering into the Revised Note, we paid all accrued interest in the amount of $249,348 and principal of $29,536.  Interest under the Revised Note also accrues at the rate of 11.10% per annum and is payable monthly in arrears.  We are obligated to make a $250,000 principal payment on January 1, 2016, and the balance of the Revised Note matures on April 30, 2017.  The Revised Note is unsecured and includes standard creditor remedies in the event of default. The Revised Note and any accrued interest was paid off subsequent to September 30, 2015.

Note Payable to a Relative of an Executive Officer

At September 30, 2015, we were obligated under the terms of a master note agreement to an individual related to an executive officer of the Company in the amount of $356,931. The note is secured by all of our assets and bears interest at 15% per annum.  On March 27, 2014, we entered into an amendment of the master note to extend the due date for payment of the note and accrued interest to June 30, 2016.  The balance of accrued interest on this note at September 30, 2015 was $177,654.

Cash provided by (used in) operating, investing and financing activities for the nine months ended September 30, 2015 and 2014 is as follows:

Operating Activities

For the nine months ended September 30, 2015, the differences between our net loss and net cash used in operating activities were due to net non-cash charges totaling $293,347 included in our net loss for stock-based compensation, depreciation, and provision for doubtful accounts, less changes in non-cash working capital totaling $70,608.  For the nine months ended September 30, 2014, the differences between our net loss and net cash used in operating activities were due to net non-cash charges totaling $823,094 included in our net loss for stock-based compensation, depreciation, and provision for doubtful accounts, less changes in non-cash working capital totaling $407,748.  

Investing Activities

Net cash used in investing activities during the nine months ended September 30, 2015 and 2014 were $62,619 and $63,150, respectively, and was for the purchase of property and equipment.  We currently estimate the amount of capital expenditures for the year ending December 31, 2015 to be approximately $150,000.  

Financing Activities

During the nine months ended September 30, 2015, cash flows from financing activities totaled $2,738,424, related to 1) proceeds of $2,000,000 from the issuance of Convertible Debentures, 2) proceeds of $147,000 from the issuance of 294,000 shares of common stock ($0.50 per share), 3) proceeds of $660,960 from the issuance of 881,279 shares of common stock ($0.75 per share), and 4) the repayment of $69,536 of principal on notes payable and convertible notes payable.

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Critical Accounting Policies and Estimates

The Company’s accounting policies are more fully described in Note 1 of the consolidated financial statements filed in our annual report on Form 10-K for the year ended December 31, 2014.

Estimates – The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Accordingly, actual results could differ from those estimates. The allowance for doubtful accounts is particularly susceptible to change in the near term.  

 Revenue Recognition – Revenue is recognized by the Company when a binding sales or service agreement exists between the parties, services have been rendered, the price for the services is fixed or determinable, collection is reasonably assured, and the Company has no significant obligations remaining with respect to the arrangement.

Trade Receivables and Credit Policies – Accounts receivable are recorded at the invoiced amount, with foreign currencies reflected in U.S. dollars (based on the exchange rate on the date of sale and adjusted to current exchange rates at the end of each reporting period), and do not bear interest.  The Company uses an allowance for doubtful accounts to reflect the Company’s best estimate of the amount of probable credit losses in accounts receivable.  Account balances will be charged off against the allowance when the account receivable is considered uncollectible. The allowance for doubtful accounts is an estimate that is particularly susceptible to change in the near term.  

Stock-based Compensation – The Company measures the cost of employee and consulting services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The awards issued are valued using a fair value-based measurement method. The resulting cost is recognized over the period during which an employee or consultant is required to provide services in exchange for the award, usually the vesting period.

Off Balance Sheet Arrangements

The Company has not had any off balance sheet arrangements.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are a smaller reporting company and, as a result, are not required to provide the information under this item.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

We maintain “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable assurance of achieving the desired control objectives, and we necessarily are required to apply our judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures.

Our management, including our principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2015 and concluded that the disclosure controls and procedures were not effective for the following reasons:

1.

We did not maintain effective entity-level controls as defined by the Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Specifically, we did not effectively segregate certain accounting duties due to the small size of our accounting staff, and did not maintain a sufficient number of adequately-trained personnel necessary to anticipate and identify risks critical to financial reporting.

Changes in Internal Control over Financial Reporting

There has been no change in our internal control over financial reporting that occurred in the three months ended September 30, 2015 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II--OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

There have occurred no events requiring disclosure under this item.

ITEM 1A. RISK FACTORS

We are a smaller reporting company and, as a result, are not required to provide the information under this item.

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

During the three months ended September 30, 2015, we offered and sold an aggregate of 409,999 shares of common stock for cash to an aggregate of seven investors for an aggregate purchase price of $307,500, or $0.75 per share.

The offer and sale of such shares of our common stock were effected in reliance upon the exemptions for sales of securities not involving a public offering, as set forth in Section 4(a)(2) of the Securities Act, based upon the following: (a) each investor confirmed to us that the investor was an “accredited investor,” as defined in Rule 501 promulgated under the Securities Act, were sophisticated, and had such background, education and experience in financial and business matters as to be able to evaluate the merits and risks of an investment in the securities; (b) there was no public offering or general solicitation with respect to each offering; (c) the investors were provided with, or have direct access to as a result of their positions, certain disclosure materials and all other information requested with respect to our company; (d) the investors acknowledged that all securities being purchased were “restricted securities” for purposes of the Securities Act, and agreed to transfer such securities only in a transaction registered under the Securities Act or exempt from registration under the Securities Act; and (e) a legend was placed on the certificates representing each such security stating that it was restricted and could only be transferred if subsequently registered under the Securities Act or transferred in a transaction exempt from registration under the Securities Act.

On November 6, 2015, we issued two convertible promissory notes (the “Convertible Notes”) in the aggregate principal amount of $1,206,931 to two investment entities controlled by a single family.  In the same transaction, the investment entities purchased an aggregate of 66,666 shares of our common stock for a purchase price of $50,000, or $0.75 per share.

The offer and sale of the Convertible Notes and shares of our common stock were effected in reliance upon the exemptions for sales of securities not involving a public offering, as set forth in Section 4(a)(2) of the Securities Act, and Rule 506 of Regulation D under the Securities Act, based upon the following: (a) each investor confirmed to us that the investor was an “accredited investor,” as defined in Rule 501 promulgated under the Securities Act, were sophisticated, and had such background, education and experience in financial and business matters as to be able to evaluate the merits and risks of an investment in the securities; (b) there was no public offering or general solicitation with respect to the offering; (c) the investors were provided with certain disclosure materials and all other information requested with respect to our company; (d) the investors acknowledged that all securities being purchased were “restricted securities” for purposes of the Securities Act, and agreed to transfer such securities only in a transaction registered under the Securities Act or exempt from registration under the Securities Act; (e) a legend was placed on the certificates representing each such security stating that it was restricted and could only be transferred if subsequently registered under the Securities Act or transferred in a transaction exempt from registration under the Securities Act, and (f) the Company expects to file a Form D with the SEC and applicable state authorities.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

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ITEM 5. OTHER INFORMATION

On November 6, 2015, we issued two convertible promissory notes (the “Convertible Notes”) in the aggregate principal amount of $1,206,931 to two investment entities controlled by a single family.  In the same transaction, the investment entities purchased an aggregate of 66,666 shares of common stock for a purchase price of $50,000, or $0.75 per share.   The Convertible Notes are unsecured and accrue interest at the rate of 8% per annum, with interest payable on the last day of each calendar quarter.  The principal amount under the Notes is due on the five-year anniversary of the issue date.  The Convertible Notes are convertible at any time prior to maturity at the option of the holders at a conversion rate of $0.75 per share.  If the Company’s common stock commences trading and closes at a price of $3.50 per share for five consecutive trading days, the principal amount under the Convertible Notes automatically converts into common stock at the rate of $0.75 per share. Proceeds from the Convertible Notes are to be used for the purpose of retirement of long-term debt.

ITEM 6.  EXHIBITS

* Filed herewith

(1)

Incorporated by reference with Form 10 filed February 10, 2012, File No. 12750426.

(2)

Incorporated by reference from an exhibit to our Current Report on Form 8-K filed on December 9, 2014.

(3)

Incorporated by reference from an exhibit to our Annual Report on Form 10-K filed on March 31, 2015.

(4)

Incorporated by reference from an exhibit to our Current Report on Form 8-K filed on May 5, 2015.

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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.

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