UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended:
September 30, 2005
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from __________________ to ________________
Commission file number
0-21151
PROFILE TECHNOLOGIES, INC.
---------------------------------------------------------------
(Exact name of small business issuer as specified in its charter)
DELAWARE 91-1418002
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2 Park Avenue, Suite 201
Manhasset, New York 11030
------------------------ -----
(Address of Principal (Zip Code)
Executive Office)
516-365-1909
------------
(Issuer's telephone number)
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
--- ---
As of October 31, 2005, the number of shares outstanding of the issuer's common
stock, the only class of common equity, were 8,543,445.
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [ X ]
TABLE OF CONTENTS
Description Page Number
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheet (Unaudited) -
At September 30, 2005...........................................3
Statements of Operations (Unaudited) -
Three Months Ended September 30, 2005 and 2004..................4
Statements of Cash Flows (Unaudited) -
Three Months Ended September 30, 2005 and 2004..................5
Notes to Financial Statements (Unaudited)............................6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.................11
Item 3. Controls and Procedures.......................................17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................18
Item 2. Unregistered Sales of Equity Securities and
Use of Proceeds...............................................18
Item 3. Defaults Upon Senior Securities...............................18
Item 4. Submission of Matters to a Vote of Shareholders...............18
Item 5. Exhibits......................................................18
SIGNATURES ..................................................................21
CERTIFICATIONS
2
PROFILE TECHNOLOGIES, INC.
Balance Sheet
(unaudited)
September 30,
2005
-------------
Assets
Current assets:
Cash $ 318,239
Prepaid expenses and other current assets 21,264
------------
Total current assets 339,503
Equipment, net of accumulated depreciation of $540,230 6,336
Deferred financing fees 1,050
Other assets 2,415
------------
Total assets $ 349,304
============
Liabilities and Stockholders' Deficit
Current Liabilities:
Accounts payable $ 195,132
Notes payable to stockholders 653,990
Current portion of convertible debt 127,500
Deferred wages 661,710
Accrued professional fees 174,150
Accrued interest 110,307
Other accrued expenses 14,344
------------
Total current liabilities 1,937,133
Long-term convertible debt, net of unamortized
discount of $95,454 46
Stockholders' deficit:
Common stock, $0.001 par value. Authorized 25,000,000
shares; issued and outstanding 8,081,445 shares 8,081
Common stock issuable; 297,000 shares 297
Additional paid-in capital 10,420,949
Accumulated deficit (12,017,202)
------------
Total stockholders' deficit (1,587,875)
Commitments, contingencies and subsequent events
------------
Total liabilities and stockholders' deficit $ 349,304
============
See accompanying notes to financial statements.
3
PROFILE TECHNOLOGIES, INC.
Statements of Operations
(unaudited)
For the three months ended
September 30,
2005 2004
------------ -----------
Revenue $ -- $ --
Cost of revenues -- --
----------- -----------
Gross profit -- --
----------- -----------
Operating expenses:
Research and development 57,100 22,870
General and administrative 160,306 180,602
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Total operating expenses 217,406 203,472
----------- -----------
Loss from operations (217,406) (203,472)
Interest expense 194,657 105,763
----------- -----------
Net loss $ (412,063) $ (309,235)
=========== ===========
Basic and diluted net loss per share $ (0.06) $ (0.06)
Weighted average shares outstanding used to
calculate basic and diluted net loss per share 7,254,048 5,494,661
See accompanying nots to financial statements.
4
PROFILE TECHNOLOGIES, INC.
Statements of Cash Flows
(unaudited)
For the three months ended
September 30,
2005 2004
---------- -----------
Cash flows from operating activities:
Net loss $(412,063) $(309,235)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 1,299 2,439
Accreted discount on convertible debt 24 3
Amortization of convertible debt discount included in interest expense 169,961 84,998
Accrued interest on convertible debt converted to equity 370 522
Amortization of debt issuance costs 10,310 3,110
Equity issued for services 68,178 --
Changes in operating assets and liabilities:
Prepaid expenses and other current assets (3,613) (11,272)
Accounts payable (1,233) 18,064
Deferred wages 22,584 81,738
Accrued professional fees 6,000 10,500
Accrued interest 6,955 15,190
Other accrued expenses (6,250) (2,177)
--------- ---------
Net cash used in operating activities (137,478) (106,120)
Cash flows from financing activies:
Allocated proceeds from issuance of convertible debt -- 32,185
Allocated proceeds from issuance of warrants attached to convertible debt -- 37,815
Convertible debt issuance costs -- (23,600)
Common stock issuance costs (119,828) --
Allocated proceeds from issuance of common stock 190,595 --
Allocated proceeds from issuance of warrants attached to issuance of common stock 357,905 --
Proceeds from issuance of notes payable to stockholders -- 16,500
Repayments of note payable to stockholders -- (10,479)
--------- ---------
Net cash provided by financing activities 428,672 52,421
--------- ---------
Increase (decrease) in cash 291,194 (53,699)
Cash at beginning of period 27,045 59,813
--------- ---------
Cash at end of period $ 318,239 $ 6,114
========= =========
Supplemental disclosure of cash flow information:
Debt discount recorded for beneficial conversion feature $ -- $ 32,185
Cash paid for interest $ 5,024 $ --
Convertible debt converted into 360,740 and 171,044 shares of common stock
during the three months ended September 30, 2005 and 2004, respectively $ 180,370 $ 85,522
See accompanying notes to financial statements.
5
PROFILE TECHNOLOGIES, INC
September 30, 2005
Notes to Financial Statements (Unaudited)
1. Description of Business
Profile Technologies, Inc. (the "Company"), was incorporated in 1986 and
commenced operations in fiscal year 1988. The Company is in the business of
inspecting pipelines for corrosion and is in the final stages of researching and
developing a patented, non-destructive and non-invasive, high speed scanning
process, using electro magnetic waves to remotely inspect buried, encased and
insulated pipelines for corrosion.
2. Basis of Presentation
The unaudited interim financial statements and related notes of the Company
have been prepared pursuant to the instructions to Form 10-QSB. Accordingly,
certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been omitted pursuant to such instructions.
The preparation of financial statements requires the Company to make estimates
and judgments that affect the reported amounts of assets, liabilities, revenues,
and expenses. On an on-going basis, the Company evaluates its estimates,
including contract revenue recognition and impairment of long-lived assets.
Actual results and outcomes may differ materially from these estimates and
assumptions.
The financial statements and related notes should be read in conjunction
with the audited financial statements and notes thereto included in the
Company's annual report on Form 10-KSB for the year ended June 30, 2005. The
information furnished reflects, in the opinion of management, all adjustments,
consisting of only normal recurring items, necessary for fair presentation of
the results of the interim periods presented. Interim results are not
necessarily indicative of results for a full year.
3. Significant Accounting Policies
Contract Revenue Recognition
The Company recognizes revenue from service contracts using the percentage
of completion method of accounting. Contract revenues earned are measured using
either the percentage of contract costs incurred to date to total estimated
contract costs or, when the contract is based on measurable units of completion,
revenue is based on the completion of such units. This method is used because
management considers total cost or measurable units of completion to be the best
available measure of progress on contracts. Because of the inherent
uncertainties in estimating costs, it is at least reasonably possible that the
estimates used may change in the near term.
Anticipated losses on contracts, if any, are charged to earnings as soon as
such losses can be estimated. Changes in estimated profits on contracts are
recognized during the period in which the change in estimate is known.
Cost of revenues include contract costs incurred to date as well as any
idle time incurred by personnel scheduled to work on customer contracts.
The Company records claims for additional compensation on contracts upon
revision of the contract to include the amount to be received for the additional
work performed. Contract costs include all direct material and labor costs and
those indirect costs related to contract performance, such as indirect labor,
supplies, tools and repairs, and depreciation costs. Selling, general, and
administrative costs are charged to expense as incurred. Service contracts
generally extend no more than six months.
Research and Development
Research and development costs are expensed when incurred. During the three
months ended September 30, 2005 and 2004, the Company incurred $57,100 and
$22,870, respectively on research and development activities.
6
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
The Company reviews long-lived assets, such as equipment and purchased
intangibles subject to amortization, for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to estimated undiscounted future
cash flows expected to be generated by the asset. If the carrying amount of an
asset exceeds its estimated future cash flows, an impairment charge is
recognized by the amount by which the carrying amount of the asset exceeds the
fair value of the asset.
Valuation of Warrants and Options
The Company estimates the value of warrants and option grants using a
Black-Scholes pricing model based on management assumptions regarding the
warrant and option lives, expected volatility, and risk free interest rates.
4. Stock Based Compensation
The Company has elected to follow the measurement principles of Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and
related interpretations in accounting for its employee stock options rather than
the alternative fair value accounting provided for by Statements of Financial
Accounting Standards No. 123 (SFAS No. 123), Accounting for Stock Based
Compensation. Compensation cost for stock options issued to employees is
measured as the excess, if any, of the fair market price of the Company's stock
at the date of grant over the amount an employee must pay to acquire the stock.
The Company did not grant any stock options to employees during the three months
ended September 30, 2005 and 2004 so net loss as reported is the same as the
Company's pro forma net loss as determined in accordance with SFAS No. 123.
Therefore, no reconciliation in accordance with SFAS No. 123 is required to be
presented.
5. Net Loss Per Share
Basic net loss per share is computed by dividing the net loss by the
weighted average number of common shares outstanding during the period. Diluted
net loss per share is computed by dividing the net loss by the weighted average
number of common and dilutive common equivalent shares outstanding during the
period. As the Company had a net loss attributable to common shareholders in
each of the periods presented, basic and diluted net loss per share are the
same.
Excluded from the computation of diluted net loss per share for the three
months ended September 30, 2005, because their effect would be antidilutive, are
options and warrants to acquire 7,912,618 shares of common stock with a
weighted-average exercise price of $1.22 per share. Also excluded from the
computation of diluted net loss per share for the three months ended September
30, 2005 are 446,000 shares of common stock that may be issued if investors
exercise their conversion right under the Debentures related to the 2003
Offering as discussed in footnote 7 because their effect would be antidilutive.
Excluded from the computation of diluted net loss per share for the three
months ended September 30, 2004, because their effect would be antidilutive, are
options and warrants to acquire 3,718,818 shares of common stock with a
weighted-average exercise price of $1.55 per share. Also excluded from the
computation of diluted net loss per share for the three months ended September
30, 2004 are 660,000 shares of common stock that may be issued if investors
exercise their conversion right under the Debentures related to the 2003
Offering as discussed in footnote 7 because their effect would be antidilutive.
For the three months ended September 30, 2005 and 2004, additional
potential dilutive securities that were excluded from the diluted net loss per
share computation are the exchange rights discussed in footnote 7 that could
result in options to acquire up to 223,000 shares of common stock with an
exercise price of $1.00 per share at September 30, 2005 and 2004.
7
6. Notes Payable - Stockholders
In April 2002, the Company issued a non-interest bearing bridge note
payable to an officer of the Company in the amount of $7,500. The note is
payable in full when the Company determines it has sufficient working capital to
do so. On September 29, 2002, the officer who was owed the $7,500 died.
The Company has entered into various loan agreements with Murphy Evans,
President, a director and stockholder of the Company. On March 6, 2003, the
Company's Board of Directors approved the Loan Amendment and Promissory Note
(the "Amended Evans Loan") between the Company and Murphy Evans. The Amended
Evans Loan aggregates all previous debt and supercedes and replaces all of the
terms of the previous loans with Mr. Evans, including any conversion features.
The Amended Evans Loan bears interest on the aggregate principal balance at a
rate of 5% per annum, payable on June 30 and December 31 of each year, with the
principal balance due and payable in full on December 31, 2003. The Amended
Evans Loan is exempt from registration under Section 4(2) of the Securities Act.
During the three months ended September 30, 2005, Mr. Evans converted
$475,000 of the Amended Evans Loan pursuant to the terms of the 2005 Offering.
Accordingly, Mr. Evans received 950,000 shares of common stock and warrants to
purchase 950,000 shares of common stock at an exercise price of $0.75 per share.
The warrants are exercisable any time prior to the fifth anniversary from the
date of grant.
Accrued interest and the outstanding principal balance of the Amended Evans
Loan were $107,063 and $596,490, respectively as of September 30, 2005. Due to
insufficient funds, the Company has not made the interest payments due on the
Amended Evans Loan on June 30 and December 31 of each year and did not repay the
outstanding principal balance. Corresponding interest expense related to the
Amended Evans Loan was $8,734 and $10,730 for the three months ended September
30, 2005 and 2004, respectively. All advances from Mr. Evans are convertible
into any debt or equity offerings made by the Company. Mr. Evans has not made
any demand for payment, or exercised any of his remedies, under the Amended
Evans Loan.
On May 9, 2002, the Company cancelled 150,000 warrants held by Mr. Evans
with exercise prices ranging from $3.00 per share to $7.50 per share issued
under the terms of a previous loan with Mr. Evans ("Old Warrants"), and issued
to Mr. Evans 150,000 five-year warrants with an exercise price of $1.05 per
share, which expire on May 13, 2007.
The cancellation of the Old Warrants is an effective re-pricing and will be
accounted for as a "variable plan" until such time as the warrants are
exercised, expire or are forfeited. Variable plan accounting will result in
intrinsic value associated with the warrants being adjusted to compensation
expense based on each reporting period's ending stock value. As of September 30,
2005 and 2004, no intrinsic value had been recorded related to these warrants as
the stock price was equal to or below the exercise price.
In September 2002, the Company entered into two non-interest bearing bridge
loans in the respective principal amounts of $40,000 and $10,000 (the
"Stockholder Loans") payable to two stockholders of the Company. The terms of
the Stockholder Loans provide for payment at such time as the Company determines
it has sufficient working capital to repay the principal balances of the
Stockholder Loans. The Stockholder Loans are convertible into 57,142 and 14,286
equity units, respectively, at any time prior to re-payment. Each equity unit is
comprised of one share of the Company's common stock, with a detachable 5-year
warrant to purchase one additional share at an exercise price of $1.05 per
share. Neither stockholder has converted either Stockholder Loan into equity
units.
On June 19, 2003, the Board of Directors approved a promissory note (the
"2003 Gemino Note") in the principal amount of $34,047 payable to Henry E.
Gemino, the Chief Executive Officer, Chief Financial Officer and a director and
stockholder of the Company. From time to time, Mr. Gemino loaned the Company
additional money and the Company repaid various amounts under the terms of the
2003 Gemino Note. The 2003 Gemino Note bears interest at the rate of 5% per
annum, payable on June 30 and December 31 of each year. During the year ended
June 30, 2005, the Company repaid the then outstanding principal balance of
$48,270 and accrued interest to Mr. Gemino. Interest expense related to the 2003
Gemino Note was $0 and $552 for the three months ended September 30, 2005 and
2004, respectively.
8
The following is a summary of notes payable to stockholders as of September
30, 2005.
Amended Evans Loan $596,490
2003 Gemino Note --
Deceased Officer Note 7,500
Stockholder Loans 50,000
--------
Total $653,990
========
7. Liquidity and Subsequent Events
The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. The Company incurred cumulative losses
of $12,017,202 through September 30, 2005 and had negative working capital of
$1,597,630 as of September 30, 2005. Additionally, the Company has expended a
significant amount of cash in developing its technology and patented processes.
These conditions raise substantial doubt about the Company's ability to continue
as a going concern. Management recognizes that in order to meet the Company's
capital requirements, and continue to operate, additional financing, including
seeking industry-partner investment through joint ventures or other possible
arrangements, will be necessary. The Company is evaluating alternative sources
of financing to improve its cash position and is undertaking efforts to raise
capital. If the Company is unable to raise additional capital or secure
additional revenue contracts and generate positive cash flow, it is unlikely
that the Company will be able to continue as a going concern. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
Deferred Wages and Accrued Professional Fees
To reduce cash outflows, certain of the Company's employees, officers,
consultants, and directors have agreed to defer a portion of their salaries and
professional fees until the Company has sufficient resources to pay the amounts
owed or to exchange such amounts into options as described below. At September
30, 2005, the Company has accrued $835,860 related to the deferred payment of
salaries and professional fees of which $661,710 is included under deferred
wages and $174,150 in accrued professional fees. On March 18, 2002, the Board
approved a conversion right on all deferred wages and accrued professional fees
deferred as of March 18, 2002. Pursuant to this conversion right, employees,
officers, consultants, and directors may elect to convert $1.00 of fees owed to
them as of March 18, 2002 for an option to purchase two shares of the Company's
common stock, at an exercise price of $1.00 per share for a term of five years.
Deferred salaries and fees as of March 18, 2002 were $111,500, resulting in the
potential issuance of 223,000 options under the terms mentioned above. No
conversions have occurred to date. At March 18, 2002, there was no intrinsic
value associated with these exchange rights. As such, no additional compensation
cost was recorded.
Long-Term Convertible Debt
On June 19, 2003, the Board of Directors approved the offering (the "2003
Offering") of $1,000,000 in convertible debentures (the "Debentures"). The
Debentures are convertible into that number of shares of the Company's common
stock equal to the amount of the converted indebtedness divided by $0.50 per
share. The Debentures bear interest at a rate of 5% per annum, payable
quarterly. Delinquent interest payments bear interest at a rate of 12% per
annum. The Company is required to redeem each Debenture on the 5th anniversary
of the date of the Debenture. The Company may, in its discretion, redeem any
Debenture at any time prior to the mandatory redemption date of the Debenture by
providing no less than 60 days' prior written notice to the holder of the
Debenture. Certain events of default will result in the Debentures being
redeemable by the Company upon demand of the holder.
Upon the purchase of, and for each $0.50 of the Debenture's principal
amount, the Company issued to each investor a warrant (the "Warrant") to
purchase one (1) share of the Company's common stock at an exercise price of
$0.75 per share. The Warrants are exercisable at any time prior to the 5th
anniversary date of the redemption of the Debenture.
9
Warrants issued in connection with the 2003 Offering were recorded based on
their relative fair value as compared to the fair value of the debt at issuance.
The relative fair value of the warrants was recorded as paid-in capital,
estimated at $0 and $37,815 for the three months ended September 30, 2005 and
2004, respectively. The fair value of the warrants issued during the three
months ended September 30, 2004, was determined based on an option pricing model
with the following assumptions: warrant lives of 10 years, risk free interest
rates ranging from 4.24% to 4.30%, volatility of 120%, and a zero dividend
yield. The intrinsic value of the Debentures results in a beneficial conversion
feature that reduces the book value of the convertible debt to not less than
zero. Accordingly, the Company recorded a discount of $0 and $32,185 during the
three months ended September 30, 2005 and 2004, respectively on the convertible
debt issued under the 2003 Offering. The Company amortizes the discount using
the effective interest method over the five-year life of the Debentures.
During the quarter ended March 31, 2005, the Board of Directors terminated
the 2003 Offering. As of the closing date of the 2003 Offering, the Company had
raised $503,000 from the 2003 Offering.
During the three months ended September 30, 2005, four investors exercised
their conversion right under the terms of the Debentures. Accordingly, the
carrying value of the convertible debt was reclassified as equity upon
conversion. Since the convertible debt instruments include a beneficial
conversion feature, the remaining unamortized discount of approximately $170,000
at the conversion date was recognized as interest expense.
During the three months ended September 30, 2004, four investors exercised
their conversion right under the terms of the Debentures. Accordingly, the
carrying value of the convertible debt was reclassified as equity upon
conversion. Since the convertible debt instruments include a beneficial
conversion feature, the remaining unamortized discount of approximately $85,000
at the conversion date was recognized as interest expense.
As of September 30, 2005, accrued interest on the Debentures was $3,245.
The Company recorded interest expense related to the accretion of the discount
on the Debentures and amortization of the convertible debt discount of $169,985
and $100,583 for the three months ended September 30, 2005 and 2004,
respectively. As of September 30, 2005 the carrying value of the long-term debt
debenture was $46, net of unamortized debt discount of $95,454.
Common Stock
On January 19, 2005, the Board of Directors approved the offering (the
"2005 Offering") of 2,000,000 units (the "Units") for a total offering price of
$1,000,000, consisting of shares of common stock and attached warrants. The
purchase price of one Unit is $0.50. Each Unit consists of one share of common
stock and a warrant to purchase one share of common stock at an exercise price
of $0.75 per share. The warrants are exercisable at any time prior to the fifth
anniversary from the date of grant.
During the three months ended September 30, 2005, the Company raised
$548,500 under the terms of the 2005 Offering. Accordingly, the Company issued
1,097,000 shares of common stock and warrants to purchase up to 1,097,000 shares
of common stock at an exercise price of $0.75 per share.
The Company engaged a brokerage firm to help in the fund raising efforts of
the 2005 Offering. Pursuant to the terms of the agreement with the brokerage
firm, the Company will pay the brokerage firm a ten percent cash commission on
all funds that the brokerage firm helps raise. Additionally, the Company will
issue warrants to purchase shares of common stock at $0.75 per share equal to
ten percent of the total warrants issued in connection with the 2005 Offering.
The warrants may be exercised up to five years from the date of issuance, which
is the date the proceeds are received under the 2005 Offering. During the three
months ended September 30, 2005, the Company incurred $51,650 of fees to be paid
in cash to the brokerage firm and issued warrants to purchase 103,300 shares of
common stock. The Company recorded $68,178 as a reduction to paid-in capital for
the fair value of the warrant grants. The fair value of the warrant grants were
estimated using the Black-Scholes option pricing model with the following
weighted average assumptions: expected volatility of 168%, risk-free interest
rate of 4.14%, expected life of five years, and a 0% dividend yield.
10
Subsequent Events
Subsequent to September 30, 2005, one investor exercised their conversion
right under the terms of the 2003 Offering. Accordingly, $40,000 of principal
was converted into 80,000 shares of common stock.
Subsequent to September 30, 2005, the Company has raised $57,000 and issued
114,000 shares of common stock and warrants to purchase up to 114,000 shares of
common stock in accordance with the terms of the 2005 Offering. Additionally,
pursuant to an agreement with a brokerage firm, the Company has incurred $5,200
of commission related fees and issued warrants to purchase 10,400 shares of
common stock at $0.75 per share.
Subsequent to September 30, 2005, Mr. Evans provided a notice of conversion
to the Company to convert $422,000 of the outstanding principal balance and
$78,000 of accrued interest on the Amended Evans Loan pursuant to the terms of
the 2005 offering. Accordingly, Mr. Evans will receive 1,000,000 shares of
common stock and warrants to purchase 1,000,000 shares of common stock at an
exercise price of $0.75 per share.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
General
Profile Technologies, Inc. (the "Company"), a Delaware corporation, was
incorporated in 1986 and commenced operations in fiscal year 1988. The Company
is in the business of inspecting pipelines for corrosion and is in the final
stages of researching and developing a patented, non-destructive and
non-invasive, high speed scanning process using electro magnetic waves to
remotely inspect buried, encased and insulated pipelines for corrosion (the "EMW
Inspection"). The EMW Inspection process analyzes the waveforms of electrical
impulses by extracting point-to-point information along a segment of pipeline to
determine the integrity of the entire pipeline. During the EMW Inspection
process electromagnetic pulses are directed along the length of a pipeline from
either one ("Single-Pulse") or two ("Dual-Pulse") directions. In Dual-Pulse
mode, the intersecting point of the two electro magnetic pulses is moved down
the pipeline by computerized delays of one pulse and data received from these
locations is analyzed to determine if an anomaly on the pipeline exists and
whether such anomaly is likely to be identified as corrosion.
The EMW Inspection process provides a corrosion inspection method which
does not require the inspector to physically remove the pipeline's insulation or
otherwise dig up the pipeline to visually inspect for corrosion. In certain
instances, limited access points to buried pipelines exist for reasons unrelated
to corrosion inspection. As a result, corrosion inspection may be conducted at
these access points. Where such access points are not already available, the EMW
Inspection process permits the inspection of pipelines with a minimal amount of
disturbance to the coating or insulation on the pipeline. In addition, the EMW
Inspection process permits corrosion inspection over the entire pipeline, as
opposed to other technologies, which only provide for spot point inspections.
Such "spot inspections" are not necessarily accurate in indicating the overall
condition of a pipeline.
Refineries, chemical plants, utilities, natural gas transmission companies
and the petroleum industry have millions of miles of pipeline much of which may
be exposed to harsh and severe environments subjecting such pipeline to higher
incidence of corrosion. As a result of such environments these industries are
continually challenged to ensure that the quality of its pipeline meets
applicable standards established by relevant regulatory bodies to protect
operating personnel and the environment.
During the summer of 1998, the Company completed work on its first
commercial contract with ASCG Inspection, Inc. testing British Petroleum
pipelines at approximately 100 road and caribou crossings located on the North
Slope of Alaska. During the summer of 1999, the Company continued work testing
pipelines under a contract with another large multi-national oil company related
to the inspection of approximately 250 below-grade pipelines. During the summer
of 2000, the Company expanded its Alaska efforts by testing a total of 372
below-grade pipelines. In 2001, the Company completed the testing of
approximately 441 pipelines in Alaska and in 2002 the Company inspected 364
pipelines.
Based on estimates provided by its then current Alaska customers based on
their recently completed road and caribou crossing inspections, the Company was
expected to complete the inspection of approximately 400 to 500 below-grade
pipelines in Alaska during the 2003 calendar year. However, the Company was able
to successfully test only 250 below-grade pipelines during this time period as a
result of lack of current budgeting for the remainder of such program.
The remainder of the inspection work is expected to be completed at some
future date. In anticipation of this possibility, the Company designed,
fabricated, and began testing new hardware for the inspection of direct-buried
pipe in the lower-48 states. The new hardware has been designed with a view
toward improving efficiency, ease of use, portability, accuracy of test data and
customer acceptance.
11
More importantly, the new hardware provides a different pulse waveform
specifically tailored to the buried pipe requirement. The improved waveform has
increased low frequency energy content, which enables efficient wave propagation
through sand, soil, and moist earth.
The new hardware was designed to be much smaller than the previous
generation hardware used in Alaska. The entire test hardware package weighs less
than 25 pounds including data acquisition digitizer and battery power supply.
The new hardware can be hand-carried and operated by a single person and does
not require the gasoline powered AC generator, utility trailer, and external
computer data acquisition system which were necessary with the previous
generation hardware. The portable system is designed to allow testing of both
underground and above-grade pipelines with one test set.
The buried pipe inspection hardware is currently being tested at the
Company's Ferndale, Washington pipe test facility. The new hardware has
demonstrated good results in initial testing. Proper pulse waveforms have been
transmitted through several hundred feet of pipe buried in moist earth. The
hardware is now being optimized and evaluated for ability to detect various
types of anomalies. This work is currently the focus of the research effort at
Ferndale. When this work is successfully completed, the improved highly portable
system will increase field productivity, reduce operator training time, and
significantly reduce the cost of field operations. The new system will also be
compatible with production in quantity and operation with minimal training,
enabling licensing of the technology to the industry.
Although several important milestones have been achieved in the fabrication
and testing of this new hardware, there can be no assurance that the remaining
portion of the testing program can be funded or that the new hardware can be
successfully tested and deployed on a commercial basis. Failure to do so could
have a serious and material effect on the business and financial condition of
the Company.
On December 15, 2003, the U.S Department of Transportation ("DOT") issued
regulations under the Pipeline Safety Improvement Act of 2002 requiring
regulated companies to gather baseline integrity data on pipelines in so-called
"high consequence areas" ("HCA's") (e.g., populated areas) initially over a
ten-year period and then every seven years thereafter. Based on consultations
with industry representatives, the Company believes that its new buried pipe
inspection hardware will provide such regulated companies with a superior tool
for gathering required baseline integrity data.
Pending the deployment of its new hardware and the receipt of new
contracts, and in an effort to reduce its out-of-pocket expenses to the lowest
practicable level, the Company has furloughed all of its field crews. If and
when commercial contracts are obtained, the Company may re-hire former crew
personnel or may hire and train new crews.
Throughout its development stage, the Company has filed and continues to
file many patents in order to protect the proprietary nature of its technology.
Pipeline Corrosion
A combination of federal state, and industry rules combine to regulate
corrosion protection. The U.S. Department of Labor, operating through the
Occupational Safety and Health Administration has jurisdiction over numerous
plants and facilities containing corrosion protected pipeline that, if breached,
could cause serious bodily injury or death to on-site workers. The U.S.
Department of Transportation has jurisdiction over interstate natural gas and
hazardous liquids pipelines. Counterpart state agencies have jurisdiction over
intrastate natural gas and hazardous liquids pipelines. In addition, the
American Petroleum Institute has promulgated a comprehensive Piping Inspection
Code which requires that extensive corrosion testing be done by all members
(which includes the vast majority of the petroleum and petrochemical
industries). As a result of extensive regulation and testing requirements, the
industry is faced with the requirement to engage in extensive testing for
corrosion. In 1993, the American Petroleum Institute imposed even stricter test
standards regarding the problem of corrosion under the insulation on pipelines.
When pipeline is uninsulated and above ground, external corrosion can be
identified visually. The petroleum and other related industries, however,
insulate much of their piping to conserve energy and to prevent injury to
personnel from high temperature levels on the pipelines. As soon as piping is
insulated, a very complex situation is created. Corrosion can occur underneath
the insulation due to moisture or corrosive products that find their way through
broken or poorly sealed insulation. This corrosion under insulated pipelines is
12
very difficult and costly to locate. In the past, testing for this problem had
been on a limited sample basis and relied upon inspection processes that were
very cumbersome and costly.
Two prevalent testing methods used to detect corrosion under insulated
pipelines are X-ray and eddy current methods, which are methods of detecting
defects in pipe by analyzing visual image and decay. After physically stripping
away coating for visual inspection, depth gauges, ultrasonics and X-ray are then
used to determine the severity of corrosion on questionable pipe. However, the
stripping of insulation to determine corrosion is a costly testing method for
the industry because it often involves the assembly of scaffolding for testing
otherwise inaccessible above ground pipe (particularly in refineries and
petrochemical plants) or an actual dig-up on below ground pipe. The Company's
technology enables it to test pipe segments in a refinery setting for a distance
up to three hundred feet and to use "cherry pickers" instead of costly
scaffolding.
Corrosion under insulated pipelines presents a very complicated testing
problem because corrosion cannot be easily identified by statistical sampling.
If, for example, a segment of pipe has a small insulation part removed every ten
feet and is visually inspected using eddy current or x-ray techniques, there is
no statistical basis to assume that the external condition of the piping between
the removed insulation parts is good or bad. The American Petroleum Institute
testing standard adopted in 1993, in essence, mandates either stripping even
larger amounts of coating or using an alternate system that will identify
corrosion under the insulation without stripping the coating on suspected and
unsuspected pipe. Because of the enormous cost involved in using the stripping
and visual testing process, the Company believes that the industry will be
receptive to an alternate testing system that is reliable and less costly. The
Company believes that its EMW process provides an alternate testing system that
could be widely accepted by the Industry. However, while the Company has
obtained some commercial contracts and prospects for expanded commercial
contracts in the future appear strong, there can be no assurance that such
acceptance will continue to grow or that competitors will not develop newer and
better technologies.
The Company's EMW Inspection Technology
The Company has developed two basic EMW inspection techniques, namely, Dual
Pulse or Pulse Propagation Analyzer and Single-Pulse or Calibration Mark Z. For
above-grade piping, the Company uses both the Dual-Pulse and CMZ to determine
the condition of a given pipe segment in the open field as well as in a
refinery, chemical plant or power plant. For below-grade piping under streets
and road crossings, the Company uses only the Dual Pulse technique. The results
of our two basic techniques provide an assessment of the overall integrity of
the pipe in question and the location and classification of electromagnetic
anomalies which, in most instances, are related to external corrosion.
The Single-Pulse Technique
The Single-Pulse technique requires fixing the source location on one end
of the pipe segment in question and adjusting the signal receiver generally at
an equal incremental distance from the source across the length of pipe segment.
From the characteristics of the electromagnetic waves as a result of wave
propagation, attenuation, and dispersion, we determine whether electromagnetic
anomalies exist, as in the case of the Dual-Pulse techniques.
As simple as these concepts may appear, the Company believes that the EMW
process is not intuitively obvious. The petroleum industry has spent significant
funds trying to solve the problem of finding corrosion under insulation.
Correlating pipeline corrosion information using the Company's technology
requires a combination of state-of-the-art instrumentation plus an understanding
of the physical phenomena that are being measured. Although the principles of
the EMW process are simple to explain, management believes that the EMW
measurement and analysis are on the leading edge of inspection technology.
The Company believes that its technology has at least two significant
competitive advantages. First, its technology can inspect certain pipelines that
are inaccessible to other testing methods. Second, with respect to insulated,
coated, encased or buried facilities that are accessible to other inspection
technologies, because the Company's technology does not require the removal of
such insulation, coatings or encasements or pipeline excavation as a
prerequisite to testing, it has a much lower cost of site preparation and,
therefore, a significant cost advantage over other technologies. Research and
13
development efforts will continue in the development of new applications for the
Company's technology and to develop new products for the petroleum industry and
other industries.
The Dual-Pulse Technique
The Dual-Pulse process extracts corrosion related information from segments
of both accessible and inaccessible pipelines underneath the entire insulation
barrier by analyzing the intersection of two electrical current pulses traveling
in opposite directions along the pipeline. This corrosion related information is
extracted without the need for removing the insulation protecting the pipeline.
Through laboratory and field testing the Company established that the electrical
response, called characteristic transfer function ("CTF"), of two intersecting
pulses traveling along the pipeline is uniquely defined with location specific
information that relates to the integrity of the pipeline at the point of
intersection. Constructive interference occurs when the two current impulses run
into and interfere with each other at the point of intersection on a pipeline.
The CTF is determined, not only by the nature and characteristics of the
original pulses, but by the physical characteristics of the pipeline segment in
its environment at the point of intersection.
The EMW process was developed to evaluate the condition and integrity of
pipelines. Electro-magnetic pulses are applied at both ends of the pipe segment
being tested. Under computer control, the timing of the pulses is controlled so
that the intersection point of the two pulses moves sequentially from one end of
the pipe to the other end. A unique CTF is obtained for each intersection point
of the pipeline segment being tested on some predetermined interval, such as, in
one foot intervals. When this data is geophysically displayed, it provides a
visual display of data related to the physical condition of the pipe at each
point of intersection. Information can also be derived using the EMW process to
determine the condition of the coating and the effectiveness of the existing
corrosion protection system that is being used to protect each point of
intersection. Where there are indications of problems, closer interval
inspection can be performed and/or one of the other location specific processes
used in the industry may be utilized before the insulation is removed to inspect
the pipe condition.
Revenues
The Company derives revenue solely from the sale of the EMW inspection
technology service. The Company relies solely upon several employees, including
the Chief Executive Officer and the Chief Operating Officer to conduct the
Company's sales activities.
The Company did not have revenues during the three months ended September
30, 2005 and 2004, respectively.
Sales and Marketing
The Company's sales and marketing strategy has been to position the
Company's EMW inspection process as the method of choice to detect pipeline
corrosion where the pipelines are either inaccessible to other inspection tools
or much more costly to inspect with tools other than the Company's EMW
technology. Pipelines are commonly found in refinery and chemical plants (such
as insulated, overhead pipes), natural gas distribution systems (such as pipes
buried in city streets), and natural gas transmission systems (such as road,
bridge and stream crossings and concrete-encased pipes).
As described above, the Company has fabricated new buried pipe inspection
hardware and is actively seeking industry and other financing sources in order
to rigorously and scientifically test that hardware. In order to obtain
additional revenue generating contracts, the Company intends to emphasize the
reliability of its buried pipeline testing method, the flexibility of the
method's application, and its cost effectiveness as compared to other methods.
The Company intends to concentrate its fiscal year 2006 marketing efforts on the
pipeline and utility buried pipe inspection markets in the lower-48 states,
particularly in "high consequence areas" as defined in the federal Department of
Transportation's regulations ("HCAs"). However, there can be no assurance that
the Company will be successful in concentrating its marketing efforts for the
EMW technology on natural gas utility and pipeline markets.
14
Results of Operations
The Company's operating results depend exclusively on its ability to market
its EMW inspection technology services. If the Company is not able to automate
completely the EMW inspection process and fully implement its new technology,
the Company may not be able to obtain future contracts to sell or license its
EMW technology. Since the Company's revenues are derived solely from sales of
its EMW technology, any failure to obtain future contracts will have a material
adverse effect on the business and financial condition of the Company.
The Company did not generate any revenues during the three months ended
September 30, 2005 and 2004, respectively, as the Company was engaged solely in
the redevelopment and improvement of its testing hardware and software.
The Company did not have any cost of revenues for the three months ended
September 30, 2005 and 2004, respectively. The Company did not have any
employees working in the field because the Company did not have any revenue
generating contracts during these periods.
Research and development expenses for the three months ended September 30,
2005 and 2004 were $57,100 and $22,870, respectively. The increase of $34,230
for the three months ended September 30, 2005 as compared to the three months
ended September 30, 2004 is substantially the result of the Company retaining
the services of a consultant and scientist to focus increased efforts on the
design, fabrication, and testing of the Company's new hardware.
General and administrative expenses for the three months ended September
30, 2005 and 2004 were $160,306 and $180,602, respectively. The decrease of
$20,296 for the three months ended September 30, 2005 as compared to the three
months ended September 30, 2004 is the result of a general reduction of
operating expenditures as the Company continues to focus on reducing its overall
burn rate. There were significant decreases in professional fees of
approximately $12,300 and insurance premiums of approximately $2,300 for the
three months ended September 30, 2005 as compared to the three months ended
September 30, 2004.
Loss from operations for the three months ended September 30, 2005 and 2004
was $217,406 and $203,472, respectively. In general, loss from operations
increased for the three months ended September 30, 2005 as compared to the three
months ended September 30, 2004 as a result of an increase in research and
development activities, offset by reductions in professional fees and other
operating expenses as discussed above.
Interest expense for the three months ended September 30, 2005 and 2004 was
$194,657 and $105,763, respectively. The increase of $88,894 for the three
months ended September 30, 2005 as compared to the three months ended September
30, 2004 is substantially the impact of investors exercising their conversion
right in accordance with the terms of the Convertible Debentures. Accordingly,
during the three months ended September 30, 2005, approximately $170,000 of
unamortized discount was recognized as interest expense upon conversion as
compared to approximately $85,000 during the three months ended September 30,
2004.
Liquidity and Capital Resources
The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. The Company incurred cumulative losses
of $12,017,202 through September 30, 2005 and had negative working capital of
$1,597,630 as of September 30, 2005. Additionally, the Company has expended a
significant amount of cash in developing its technology and patented processes.
These conditions raise substantial doubt about the Company's ability to continue
as a going concern. Management recognizes that in order to meet the Company's
capital requirements, and continue to operate, additional financing, including
seeking industry-partner investment through joint ventures or other possible
arrangements, will be necessary. The Company is evaluating alternative sources
of financing to improve its cash position and is undertaking efforts to raise
capital. If the Company is unable to raise additional capital or secure
additional revenue contracts and generate positive cash flow, it is unlikely
that the Company will be able to continue as a going concern. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
15
Deferred Wages and Accrued Professional Fees
To reduce cash outflows, certain of the Company's employees, officers,
consultants, and directors have agreed to defer a portion of their salaries and
professional fees until the Company has sufficient resources to pay the amounts
owed or to exchange such amounts into options as described below. At September
30, 2005, the Company has accrued $835,860 related to the deferred payment of
salaries and professional fees of which $661,710 is included under deferred
wages and $174,150 in accrued professional fees. On March 18, 2002, the Board
approved a conversion right on all deferred wages and accrued professional fees
deferred as of March 18, 2002. Pursuant to this conversion right, employees,
officers, consultants, and directors may elect to convert $1.00 of fees owed to
them as of March 18, 2002 for an option to purchase two shares of the Company's
common stock, at an exercise price of $1.00 per share for a term of five years.
Deferred salaries and fees as of March 18, 2002 were $111,500, resulting in the
potential issuance of 223,000 options under the terms mentioned above. No
conversions have occurred to date. At March 18, 2002, there was no intrinsic
value associated with these exchange rights. As such, no additional compensation
cost was recorded.
Long-Term Convertible Debt
On June 19, 2003, the Board of Directors approved the offering (the "2003
Offering") of $1,000,000 in convertible debentures (the "Debentures"). The
Debentures are convertible into that number of shares of the Company's common
stock equal to the amount of the converted indebtedness divided by $0.50 per
share. The Debentures bear interest at a rate of 5% per annum, payable
quarterly. Delinquent interest payments bear interest at a rate of 12% per
annum. The Company is required to redeem each Debenture on the 5th anniversary
of the date of the Debenture. The Company may, in its discretion, redeem any
Debenture at any time prior to the mandatory redemption date of the Debenture by
providing no less than 60 days' prior written notice to the holder of the
Debenture. Certain events of default will result in the Debentures being
redeemable by the Company upon demand of the holder.
Upon the purchase of, and for each $0.50 of the Debenture's principal
amount, the Company issued to each investor a warrant (the "Warrant") to
purchase one (1) share of the Company's common stock at an exercise price of
$0.75 per share. The Warrants are exercisable at any time prior to the 5th
anniversary date of the redemption of the Debenture.
Warrants issued in connection with the 2003 Offering were recorded based on
their relative fair value as compared to the fair value of the debt at issuance.
The relative fair value of the warrants were recorded as paid-in capital,
estimated at $0 and $37,815for the three months ended September 30, 2005 and
2004, respectively. The fair value of the warrants issued during the three
months ended September 30, 2004, were determined based on an option pricing
model with the following assumptions: warrant lives of 10 years, risk free
interest rates ranging from 4.24% to 4.30%, volatility of 120%, and a zero
dividend yield. The intrinsic value of the Debentures results in a beneficial
conversion feature that reduces the book value of the convertible debt to not
less than zero. Accordingly, the Company recorded a discount of $0 and $32,185
during the three months ended September 30, 2005 and 2004, respectively on the
convertible debt issued under the 2003 Offering. The Company amortizes the
discount using the effective interest method over the five-year life of the
Debentures.
During the quarter ended March 31, 2005, the Board of Directors terminated
the 2003 Offering. As of the closing date of the 2003 Offering, the Company had
raised $503,000 from the 2003 Offering.
During the three months ended September 30, 2005, four investors exercised
their conversion right under the terms of the Debentures. Accordingly, the
carrying value of the convertible debt was reclassified as equity upon
conversion. Since the convertible debt instruments include a beneficial
conversion feature, the remaining unamortized discount of approximately $170,000
at the conversion date was recognized as interest expense.
During the three months ended September 30, 2004, four investors exercised
their conversion right under the terms of the Debentures. Accordingly, the
carrying value of the convertible debt was reclassified as equity upon
conversion. Since the convertible debt instruments include a beneficial
conversion feature, the remaining unamortized discount of approximately $85,000
at the conversion date was recognized as interest expense.
16
As of September 30, 2005, accrued interest on the Debentures was $3,245.
The Company recorded interest expense related to the accretion of the discount
on the Debentures and amortization of the convertible debt discount of $169,985
and $85,000 for the three months ended September 30, 2005 and 2004,
respectively. As of September 30, 2005 the carrying value of the long-term debt
debenture was $46, net of unamortized debt discount of $95,454.
Common Stock
On January 19, 2005, the Board of Directors approved the offering (the
"2005 Offering") of 2,000,000 units (the "Units") for a total offering price of
$1,000,000, consisting of shares of common stock and attached warrants. The
purchase price of one Unit is $0.50. Each Unit consists of one share of common
stock and a warrant to purchase one share of common stock at an exercise price
of $0.75 per share. The warrants are exercisable at any time prior to the fifth
anniversary from the date of grant.
During the three months ended September 30, 2005, the Company raised
$548,500 under the terms of the 2005 Offering. Accordingly, the Company issued
1,097,000 shares of common stock and warrants to purchase up to 1,097,000 shares
of common stock at an exercise price of $0.75 per share.
The Company engaged a brokerage firm to help in the fund raising efforts of
the 2005 Offering. Pursuant to the terms of the agreement with the brokerage
firm, the Company will pay the brokerage firm a ten percent cash commission on
all funds that the brokerage firm helps raise. Additionally, the Company will
issue warrants to purchase shares of common stock at $0.75 per share equal to
ten percent of the total warrants issued in connection with the 2005 Offering.
The warrants may be exercised up to five years from the date of issuance, which
is the date the proceeds are received under the 2005 Offering. During the three
months ended September 30, 2005, the Company incurred $51,650 of fees to be paid
in cash to the brokerage firm and issued warrants to purchase 103,300 shares of
common stock. The Company recorded $68,178 as a reduction to paid-in capital for
the fair value of the warrant grants. The fair value of the warrant grants were
estimated using the Black-Scholes option pricing model with the following
weighted average assumptions: expected volatility of 168%, risk-free interest
rate of 4.14%, expected life of five years, and a 0% dividend yield.
Other Commitments
The Company's other contractual obligations consist of commitments under an
operating lease and repayment of loans payable to certain officers, directors
and stockholders.
As of to September 30, 2005, the Company had outstanding loans payable to
certain officers, directors and stockholders with principal amounts, in the
aggregate, equal to $653,990. The terms of the various notes are described above
under "Note 6: Notes Payable - Stockholders."
As of to September 30, 2005, the Company has future minimum lease payments
of approximately $6,078 under its operating lease.
Capital will be expended to support operations until the Company can
generate sufficient cash flows from operations. In order for the Company to
generate cash flows from operations, the Company must generate additional
revenue generating contracts. Management is currently directing the Company's
activities towards obtaining additional service contracts, which, if obtained,
will necessitate the Company attracting, hiring, training and outfitting
qualified technicians. If additional service contracts are obtained, it will
also necessitate additional field test equipment purchases in order to provide
the services. The Company's intention is to purchase such equipment for its
field crews for the foreseeable future, until such time as the scope of
operations may require alternate sources of financing equipment. The Company
expects that if additional contracts are secured, and revenues increase, working
capital requirements will increase. There can be no assurance that the Company's
process will gain widespread commercial acceptance within any particular time
frame, or at all. The Company will incur additional expenses as it hires and
trains field crews and support personnel related to the successful receipt of
commercial contracts. Additionally, the Company anticipates that cash will be
17
used to meet capital expenditure requirements necessary to develop
infrastructure to support future growth. There can be no assurance that the
Company will be able to secure additional revenue generating contracts to
provide sufficient cash.
Pending the deployment of the Company's new hardware (as discussed in the
"General" section) and the receipt of new contracts, and in an effort to reduce
its out-of-pocket expenses to the lowest practicable level, the Company has
furloughed all of its field crews. If and when revenue-generating contracts are
obtained, the Company will re-hire former crew personnel or may hire and train
new crews. The Company was not obligated to make any severance payments for
salaries, health benefits or accrued vacation and sick time related to the
termination of any of its employees.
Off Balance Sheet Arrangements
The Company has no off-balance sheet arrangements.
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-QSB contains "forward-looking statements."
These forward-looking statements can generally be identified as such because the
context of the statement will include words such as the Company "believes,"
"anticipates," "expects" or words of similar import. Similarly, statements that
describe the Company's projected future results, future plans, objectives or
goals or future conditions or events are also forward looking statements. Actual
results are inherently difficult to predict. Any such forward-looking statements
are subject to the risks and uncertainties that could cause actual results of
operations, financial condition, acquisitions, financing transactions,
operations, expenditures, expansion and other events to differ materially from
those expressed or implied in such forward-looking statements. Any such
forward-looking statements would be subject to a number of assumptions
regarding, among other things, future economic, competitive and market
conditions generally. Such assumptions would be based on facts and conditions as
they exist at the time such statements are made as well as predictions as to
future facts and conditions, the accurate prediction of which may be difficult
and involve the assessment of events beyond the Company's control.
The forward-looking statements contained in this report are based on
current expectations that involve a number of risks and uncertainties. Such
forward-looking statements are based on assumptions that the Company will obtain
or have access to adequate financing to continue its operations, that the
Company will market and provide products and services on a timely basis, that
there will be no material adverse competitive or technological change with
respect to the Company's business, demand for the Company's products and
services will significantly increase, that the Company will be able to secure
additional fee-for-services or licensing contracts, that the Company's executive
officers will remain employed as such by the Company, that the Company's
forecast accurately anticipate market demand, and that there will be no material
adverse change in the Company's operations, business or governmental regulation
affecting the Company or its customers. The foregoing assumptions are based on
judgments with respect to, among other things, future economic, competitive and
market conditions and future business decisions, all of which are difficult or
impossible to predict accurately and many of which are beyond the Company's
control. Although the Company believes the expectations reflected in the
forward-looking statements are reasonable, the Company cannot guarantee future
results, levels of activity, performance or achievements.
Item 3. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
The term "disclosure controls and procedures" is defined in Rules 13a-15(e)
and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). This term refers to the controls and procedures of a
company that are designed to ensure that information required to be
disclosed by a company in the reports that it files under the Exchange Act
is recorded, processed, summarized, and reported within the required time
periods. Our Chief Executive Officer and our Chief Financial Officer have
evaluated the effectiveness of our disclosure controls and procedures as of
the end of the period covered by this report. They have concluded that, as
18
of that date, our disclosure controls and procedures were effective at
ensuring that required information will be disclosed on a timely basis in
our reports filed under the Exchange Act.
(b) Changes in Internal Control over Financial Reporting
No change in our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the
period covered by this report that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings.
The Company is not aware of any legal proceedings contemplated by any
governmental authority or any other party involving the Company or its
properties. As of the date of this report, no director, officer or affiliate is
a party adverse to the Company in any legal proceeding or has an adverse
interest to the Company in any legal proceedings. The Company is not aware of
any other legal proceedings pending or that have been threatened against the
Company or its properties.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
On January 19, 2005, the Board of Directors approved the offering (the
"2005 Offering") of 2,000,000 units (the "Units") for a total offering price of
$1,000,000 to accredited investors, consisting of shares of common stock and
attached warrants. The purchase price of one Unit is $0.50. Each Unit consists
of one share of common stock and a warrant to purchase one share of common stock
at an exercise price of $0.75. The warrants are exercisable at any time prior to
the fifth anniversary from the date of grant. The 2005 Offering is exempt from
registration under Section 4(2) of the Securities Act.
During the quarter ended September 30, 2005, the Company raised $548,500
and issued 1,097,000 shares of common stock and warrants to purchase up to
1,097,000 shares of stock in accordance with the terms of the 2005 Offering.
Item 3. Defaults Upon Senior Securities.
As of to September 30, 2005, the outstanding principal balance of the
Amended Evans Loan (see "Note 6. Notes Payable - Stockholders" in the "Notes to
Financial Statements") was equal to $596,490. The Company has not made the
interest payments in the amounts of $13,062, $17,692, $20,043, $21,896 and
$25,636, which were due and payable to Mr. Evans on June 30, 2003, December 31,
2003, June 30, 2004, December 31, 2004, and June 30, 2005, respectively. As of
to September 30, 2005, the Company's total arrearage under the Amended Evans
Loan with respect to accrued interest payments was equal to $107,063. Mr. Evans
has not made any demand for payment, or exercised any of his remedies, under the
Amended Evans Loan.
Item 4. Submission of Matters to a Vote of Shareholders.
No matters were submitted to a vote of the Company's security holders
during the quarter ended September 30, 2005.
Item 5. Exhibits.
The following exhibits are filed with or incorporated by reference into
this report as required by Item 601 of Regulation S-B:
19
Exhibit No. Description of Exhibit
----------- ----------------------
Exhibit 3.1 Articles of Incorporation (incorporated by reference to Exhibit 3.1 to the Company's Registration
Statement on Form SB-2 filed with the Commission on May 10, 1996).
Exhibit 3.2 Bylaws of the Company (incorporated by reference to Exhibit 3.3 to the Company's Registration
Statement on Form SB-2 filed with the Commission on May 10, 1996).
Exhibit 3.3 Amendment to Certificate of Incorporation (incorporated by reference to Exhibit A to the Company's
Definitive Proxy Statement filed with the Commission on October 28, 2002).
Exhibit 10.1 Loan Agreement dated May 9, 2002, by and between the Company and Murphy Evans (incorporated by
reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-QSB filed with the
Commission on May 15, 2002).
Exhibit 10.2 Loan Amendment and Promissory Note dated March 6, 2003, by and between the Company and Murphy
Evans (incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-QSB
filed with the Commission on May 20, 2003).
Exhibit 10.3 Lease Agreement dated January 26, 2001 by and between the Company and Fatum LLC (incorporated by
reference to Exhibit 10.4 to the Company's Annual Report on Form 10-KSB filed with the Commission
on October 12, 2004).
Exhibit 10.4 Lease Extension dated February 26, 2003 by and between the Company and Fatum LLC (incorporated by
reference to Exhibit 10.5 to the Company's Annual Report on Form 10-KSB filed with the Commission
on October 12, 2004).
Exhibit 10.5 Royalty Agreement (incorporated by reference to Exhibit 10.1 to the Company's Registration
Statement on Form SB-2 filed with the Commission on May 10, 1996).
Exhibit 10.6 Assignment of Patent Rights (incorporated by reference to Exhibit 10.2 to the Company's
Registration Statement on Form SB-2 filed with the Commission on May 10, 1996).
Exhibit 10.7 1999 Stock Option Plan (incorporated by reference to Exhibit 10.9 to the Company's Annual Report
on Form 10-KSB filed with the Commission on October 12, 2004).
Exhibit 14 Code of Ethics (incorporated by reference to Exhibit 14 to the Company's Annual Report on Form
10-KSB filed with the Commission on October 12, 2004).
Exhibit 31.1 Rule 13a-14(a)/15d-14(a) Certification of Henry E. Gemino, as Chief Executive Officer and Chief
Financial Officer of the Company.
Exhibit 31.2 Rule 13a-14(a)/15d-14(a) Certification of Philip L. Jones, as Chief Operating Officer and
Executive Vice President of the Company.
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Exhibit 32.1 Certification under Section 906 of the Sarbanes-Oxley Act of 2002 by Henry E. Gemino, as Chief
Executive Officer and Chief Financial Officer of the Company.
Exhibit 32.2 Certification under Section 906 of the Sarbanes-Oxley Act of 2002 by Philip L. Jones, as Chief
Operating Officer and Executive Vice President of the Company.
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SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
ROFILE TECHNOLOGIES, INC.
-------------------------
(Registrant)
(
Date: November 11, 2005 /s/ Henry E. Gemino
------------------------------------
Henry E. Gemino
Chief Executive Officer and
Chief Financial Officer
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