UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For quarterly period ended June 30, 2006
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number: No. 0-24368
FLEXPOINT SENSOR SYSTEMS, INC.
---------------------------------------------------
(Exact name of small business issuer in its charter)
Delaware 87-0620425
------------------------ ----------------------------------
(State of incorporation) (I.R.S. Employer Identification No.)
106 West Business Park Drive, Draper, Utah 84020
-------------------------------------------------
(Address of principal executive offices)
801-568-5111
--------------------------
(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 [ ]
Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of July 17, 2006, Flexpoint Sensor Systems, Inc. had a total of 22,992,887
shares of common stock issued and outstanding.
Transitional small business disclosure format: Yes [ ] No [X]
TABLE OF CONTENTS
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements...............................................2
Index to Financial Statements......................................3
Item 2. Management's Discussion and Analysis or Plan of Operation.........12
Item 3. Controls and Procedures...........................................18
PART II: OTHER INFORMATION
Item 6. Exhibits..........................................................18
Signatures.................................................................19
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
The financial information set forth below with respect to our condensed
consolidated financial position as of June 30, 2006, the condensed
consolidated statements of operations for the three and six month periods
ended June 30, 2006 and 2005, and the condensed consolidated statements of
cash flows and stockholders' equity for the three and six month periods ended
June 30, 2006 is unaudited. This financial information, in the opinion of
management, includes all adjustments consisting of normal recurring entries
necessary for the fair presentation of such data. The results of operations
for the six month period ended June 30, 2006, are not necessarily indicative
of results to be expected for any subsequent period.
2
FLEXPOINT SENSOR SYSTEMS, INC. AND SUBSIDIARIES
(A Development Stage Company)
Index to Financial Statements
Page
Condensed Consolidated Balance Sheets (Unaudited)
June 30, 2006 and December 31, 2005.................................4
Condensed Consolidated Statements of Operations (Unaudited)
for the Three Months Ended June 30, 2006 and 2005, for
the Six Months Ended June 30, 2006 and 2005, and for the
Cumulative period from February 24, 2004, (Date of Emergence
from Bankruptcy) through June 30, 2006..............................5
Condensed Consolidated Statements of Stockholders' Equity
(Unaudited) for the period from February 24, 2004 (Date of
Emergence from Bankruptcy)through December 31, 2004, for the
year ended December 31, 2005 and for The Six Months Ended
June 30, 2006.......................................................6
Condensed Consolidated Statements of Cash Flows (Unaudited)
for the Six Months Ended June 30, 2006 and 2005, and for the
Cumulative period from February 24, 2004, (Date of Emergence
from Bankruptcy) through June 30, 2006..............................7
Notes to Condensed Consolidated Financial Statements..................8
3
FLEXPOINT SENSOR SYSTEMS, INC. AND SUBSIDIARIES
(A Development Stage Company)
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
June 30 December 31
2006 2005
------------------------------------------------------------------------------
ASSETS
Current Assets
Cash and cash equivalents $ 1,371,987 $ 1,964,487
Accounts Receivable 4,550 -
Prepaid expenses 25,056 34,661
------------------------------------------------------------------------------
Total Current Assets 1,401,593 1,999,148
Long-Term deposits 6,500 6,500
Property and Equipment, net of accumulated
depreciation of $287,730 and $205,640 1,158,577 1,238,404
Patents and Proprietary Technology, net of
accumulated amortization of $341,151 and $264,667 1,627,200 1,703,683
Goodwill 5,356,414 5,356,414
------------------------------------------------------------------------------
Total Assets $ 9,550,284 $ 10,304,149
==============================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 4,202 $ 41,737
Accrued liabilities 38,532 43,325
------------------------------------------------------------------------------
Total Current Liabilities 42,734 85,062
------------------------------------------------------------------------------
Stockholders' Equity
Preferred stock - $0.001 par value; 1,000,000
shares authorized; no shares issued or outstanding - -
Common stock - $0.001 par value; 100,000,000 shares
authorized; 23,292,887 and 22,992,887 shares
issued and outstanding 23,292 22,992
Additional paid-in capital 14,324,756 13,777,276
Warrants and options outstanding 2,891,738 2,699,565
Deficit accumulated during the development stage (7,732,236) (6,280,746)
------------------------------------------------------------------------------
Total Stockholders' Equity 9,507,550 10,219,087
------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $ 9,550,284 $ 10,304,149
==============================================================================
The accompanying notes are an integral part of these
condensed consolidated financial statements.
4
FLEXPOINT SENSOR SYSTEMS, INC. AND SUBSIDIARIES
(A Development Stage Company)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Cumulative
Period from
February 24, 2004
(Date of Emergence)
For the Three Months For the Six Months from Bankruptcy)
Ended June 30, Ended June 30, through
2006 2005 2006 2005 June 30, 2006
-----------------------------------------------------------------------------------------------------------------
Design, Contract and Testing Revenue $ 52,784 $ 2,087 $ 53,526 $ 18,365 $ 411,554
-----------------------------------------------------------------------------------------------------------------
Operating Costs and Expenses
Amortization of patents and
proprietary technology (38,242) (32,026) (76,483) (64,054) (300,674)
Cost of revenue (1,819) (7,418) (2,184) (89,597) (96,481)
Administrative and marketing expense (795,515) (379,140) (1,218,994) (647,045) (5,618,511)
Research and development expense (124,796) - (231,777) - (711,192)
-----------------------------------------------------------------------------------------------------------------
Total Operating Costs and Expenses (960,372) (418,584) (1,529,438) (800,696) (6,726,858)
-----------------------------------------------------------------------------------------------------------------
Other Income and Expenses
Interest expense - (1,108) - (7,231) (1,576,054)
Interest income 11,222 24,526 22,478 29,044 82,022
Sublease rent income 972 972 1,944 1,944 5,832
Gain (loss) on forgiveness of debt - (5,000) - (5,000) 71,268
-----------------------------------------------------------------------------------------------------------------
Net Other Income (Expense) 12,194 19,390 24,422 18,757 (1,416,932)
-----------------------------------------------------------------------------------------------------------------
Net Loss $ (895,394) $ (397,107) $ (1,451,490) $ (763,574) $ (7,732,236)
=================================================================================================================
Basic and Diluted Loss Per Share $ (0.04) $ (0.02) $ (0.06) $ (0.03)
==============================================================================================
Basic and Diluted Weighted-Average
Common Shares Outstanding 22,999,554 22,974,537 22,997,887 22,208,079
==============================================================================================
The accompanying notes are an integral part of these condensed consolidated financial statements.
5
FLEXPOINT SENSOR SYSTEMS, INC. AND SUBSIDIARIES
(A Development Stage Company)
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE PERIOD FROM FEBRUARY 24, 2004 (DATE OF EMERGENCE
FROM BANKRUPTCY) THROUGH DECEMBER 31, 2004, FOR THE YEAR ENDED DECEMBER 31, 2005,
AND FOR THE SIX MONTHS ENDED JUNE 30, 2006
(UNAUDITED)
Deficit
Accumulated
Common Stock Additional Warrants During the Total
-------------------------- Paid-in and Options Development Stockholders'
Shares Amount Capital Outstanding Stage Equity
--------------------------------------------------------------------------------------------------------
Balance - February 24,
2004 (Date of Emergence
from Bankruptcy) 14,098,202 $ 14,098 $ 4,952,166 $ - $ - $ 4,966,264
Beneficial debt
conversion option - - 1,500,000 - - 1,500,000
Conversion of note
payable, March 31 and
May 19, 2004, $.50
per share 3,000,000 3,000 1,497,000 - - 1,500,000
Issuance for consulting
services, March 3, 2004,
$1.15 per share 100,000 100 114,580 - - 114,680
Stock based compensation
from 650,000 warrants
issued on March 3, 2004
for consulting services - - - 731,328 - 731,328
Issuance for acquisition
of equipment and
proprietary technology
from Flexpoint Holdings,
LLC, a company controlled
by a stockholder, March
31, 2004, $1.21 per share 1,600,000 1,600 1,929,709 - - 1,931,309
Issuance for compensation
November 24, 2004, $1.48
per share 1,200,000 1,200 1,774,800 - - 1,776,000
Net loss - - - - (4,510,726) (4,510,726)
-------------------------------------------------------------------------------------------------------
Balance -
December 31, 2004 19,998,202 19,998 11,768,255 731,328 (4,510,726) 8,008,855
Issuance of common stock
at $.77 per share and
2,826,335 warrants at
$0.61 per warrant for
cash net of $347,294
cash offering costs and
140,000 common shares
and 140,000 warrants,
January through March
2005 2,976,335 2,976 1,977,294 1,926,937 - 3,907,207
Issuance of 30,000 warrants
at $1.38 per warrant for
services rendered July 2005 - - - 41,300 - 41,300
Issuance of common stock at
$ 1.73 per share, as
compensation to director
of company for services
rendered, August 2005 18,350 18 31,727 - - 31,745
Net loss - - - - (1,770,020) (1,770,020)
-------------------------------------------------------------------------------------------------------
Balance -
December 31, 2005 22,992,887 22,992 13,777,276 2,699,565 (6,280,746) 10,219,087
Stock-based compensation
from stock option to
employees expensed
through 06/30/06 - - - 529,953 - 529,953
Exercise of 300,000
warrants issued March 3,
2004 @ $0.70 per warrant
by Summit Resource Group,
Inc. 300,000 300 547,480 (337,780) - 210,000
Net loss - - - - (1,451,490) (1,451,490)
-------------------------------------------------------------------------------------------------------
Balance - June 30, 2006 23,292,887 $ 23,292 $14,324,756 $2,891,738 $(7,732,236) $ 9,507,550
=======================================================================================================
The accompanying notes are an integral part of these condensed consolidated financial statements.
6
FLEXPOINT SENSOR SYSTEMS, INC. AND SUBSIDIARIES
(A Development Stage Company)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Cumulative
Period from
February 24, 2004
(Date of Emergence)
For the Six Months from Bankruptcy)
Ended June 30, through
2006 2005 June 30, 2006
-----------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities:
Net loss $ (1,451,490) $ (763,304) $ (7,732,236)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation 82,089 80,392 287,729
Amortization of patents and proprietary technology 76,483 75,771 341,150
Issuance of common stock and warrants for services - - 2,695,053
Expenses paid by increase in convertible note payable - - 60,000
Amortization of discount on note payable - - 1,556,666
Stock-based compensation expense for employees 529,953 - 529,953
Changes in operating assets and liabilities:
Accounts receivable (4,550) (6,546) (4,550)
Accounts payable (37,535) (100,370) (203,904)
Accrued liabilities (4,793) 23,109 36,040
Deferred revenue - - (343,750)
Prepaid expenses 9,605 (8,398) (25,056)
Deposits - - (6,500)
-----------------------------------------------------------------------------------------------------
Net Cash Used in Operating Activities (800,238) (699,346) (2,809,405)
-----------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities:
Payments for the purchase of equipment (2,262) (35,600) (197,574)
Payments for patents - (15,658) (43,626)
Payment for acquisition of equipment and proprietary
technology from Flexpoint Holdings, LLC - - (265,000)
-----------------------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (2,262) (51,258) (506,200)
-----------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities:
Net proceeds from issuance of common stock and warrants 210,000 3,907,207 4,117,207
Principal payments on notes payable - related parties - (409,958) (460,300)
Proceeds from notes payable - related parties - - 445,300
Proceeds from borrowings under convertible note payable - - 583,334
-----------------------------------------------------------------------------------------------------
Net Cash Provided By Financing Activities 210,000 3,497,249 4,685,541
-----------------------------------------------------------------------------------------------------
Net Change in Cash and Cash Equivalents (592,500) 2,746,645 1,369,936
Cash and Cash Equivalents at Beginning of Period 1,964,487 54,358 2,051
-----------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 1,371,987 $ 2,801,003 $ 1,371,987
=====================================================================================================
Supplemental Cash flow Information:
Cash paid for interest $ - $ 7,231 $ 16,888
=====================================================================================================
The accompanying notes are an integral part of these condensed consolidated financial statements.
7
FLEXPOINT SENSOR SYSTEMS, INC. AND SUBSIDIARIES
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Condensed Interim Financial Statements - The accompanying unaudited condensed
consolidated financial statements include the accounts of Flexpoint Sensor
Systems, Inc. and its subsidiaries (the "Company"). These financial
statements are condensed and, therefore, do not include all disclosures
normally required by accounting principles generally accepted in the United
States of America. These statements should be read in conjunction with the
most recent annual consolidated financial statements of Flexpoint Sensor
Systems, Inc. and subsidiaries for the years ended December 31, 2005, included
in the Company's Form 10-KSB filed with the Securities and Exchange Commission
on March 15, 2006. In particular, The Company's significant accounting
principles were presented as Note 1 to the Consolidated Financial Statements
in that report. In the opinion of management, all adjustments necessary for a
fair presentation have been included in the accompanying condensed
consolidated financial statements and consist of only normal recurring
adjustments. The results of operations presented in the accompanying condensed
consolidated financial statements are not necessarily indicative of the
results that may be expected for the full year ending December 31, 2006.
Nature of Operations - The Company is located in Salt Lake City, Utah and is a
development stage company engaged principally in designing, engineering, and
manufacturing sensor technology and equipment using flexible potentiometer
technology. The Company is in the development stage as planned operations have
not commenced. Development stage activities primarily include acquiring
equipment and technology, organizing activities, obtaining financing and
seeking manufacturing contracts. At June 30, 2006, the Company had not entered
into any manufacturing agreements except as discussed in Note 4. Even though
the Company is making strides forward with its business plan, it is likely
that significant progress may not occur within the next four to six months.
Accordingly, the Company may not realize significant revenues or become
profitable within the next twelve months which would require additional
financing to fund its long-term cash needs. The Company may be required to
rely on debt financing, loans from related parties, and private placements of
common stock for additional funding.
Valuation of Long-lived Assets - The carrying values of the Company's
long-lived assets are reviewed for impairment annually and whenever events or
changes in circumstances indicate that they may not be recoverable. When
projections indicate that the carrying value of the long-lived asset is not
recoverable, the carrying value is reduced by the estimated excess of the
carrying value over the projected discounted cash flows. As a result of
management's assessment of the recoverability of long-lived assets at June 30,
2006, no impairment was recognized at that date.
Research and Development - Research and development costs are recognized as
expense during the period incurred until the conceptual formulation, design,
and testing of a process is completed and the process has been determined to
be commercially viable.
Stock Based Compensation - In December 2004, the FASB issued Statement No. 123
(Revised 2004), "Share-Based Payment" ("SFAS No.123R"). SFAS No. 123R
supersedes APB 25 and requires the recognition of the cost of employee
services received in exchange for stock options and awards of equity
instruments based on the grant-date fair value of such options and awards,
over the period they vest. Under APB 25, no compensation was recorded in
earnings for the Company's stock-based options granted under the 2005 Stock
Incentive Plan (the "Plan"). The pro forma effects on net income and earnings
per share for the awards issued under the Plan were instead disclosed in a
footnote to the financial statements. Under SFAS No. 123R, all share-based
compensation is measured at the grant date, based on the fair value of the
award, and is recognized as an expense in earnings over the requisite service
period. On January 1, 2006, the Company adopted the provisions of SFAS No.
123R, for its share-based compensations plans and began recognizing the
unvested portion of employee compensation from stock options and awards equal
to the unamortized grant-date fair value over the remaining vesting period.
Furthermore, compensation costs will also be recognized for any awards issued,
modified, repurchased, or canceled after January 1, 2006.
8
FLEXPOINT SENSOR SYSTEMS, INC. AND SUBSIDIARIES
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Basic and Diluted Loss Per Share - Basic and diluted loss per share is
computed by dividing net loss by the weighted-average number of common shares
outstanding during the period. Diluted loss per share is computed by dividing
net loss by the weighted-average number of common shares and common
equivalents outstanding during the period. At June 30, 2006, there were
warrants to purchase 3,356,335 shares of common stock. These warrants were
not included in the computation of diluted loss per share as their effect
would have been anti-dilutive, thereby decreasing loss per common share.
NOTE 2 - COMMON STOCK
Exercise of Warrants - On June 27, 2006, Summit Resource Group exercised its
rights in connection with 300,000 warrants (originally issued March 3, 2004)
to purchase 300,000 shares of common stock at an exercise price of $0.70 per
share; or two hundred ten thousand dollars ($210,000), which money the Company
received. These shares were registered in the Company's SB-2 Registration
Statement and declared effective by the Securities and Exchange Commission on
August 18, 2005.
Private Placement of Common Stock and Warrants - From January 25, 2005 through
March 31, 2005, the Company issued 2,836,335 shares of common stock and
warrants to purchase 2,836,335 shares of common stock at $3.00 per share from
October 1, 2005 through September 30, 2007 in a private placement offering.
The Company realized proceeds of $3,907,207, net of $347,294 of cash offering
costs. As part of this private placement, the Company also issued the
placement agent 140,000 shares of common stock and 140,000 warrants
exercisable at $3.00 per share for the agent's services in connection with the
offering. The fair value of the warrants issued was $4,047,816 as estimated by
the Company using the Black-Scholes pricing model with the following
assumptions: risk free interest rate of 4.58%; volatility of 200%; estimated
life of two years; and dividend yield of 0%. The net proceeds were allocated
to the shares of common stock and the warrants based upon their relative fair
values and resulted in allocating $1,980,271 to the shares of common stock and
$1,926,937 to the warrants.
An investor may not exercise their warrants if the exercise of the warrant
would cause the investor to own more than 4.99% of the then issued and
outstanding common stock of the Company. If the closing bid price of the
Company's common stock is greater than $4.00 per share for five consecutive
trading days after October 1, 2005, the Company may call the warrants, in
whole or in part, for no consideration, which would require the investor to
either exercise the warrants within fifteen trading days or forfeit the
warrants.
Compensation to Board Members - On August 25, 2005, the company issued to a
Director 18,350 shares of restricted common stock for director services valued
at $31,745 or $1.73 per share, the quoted market value of the stock on the day
of this transaction.
NOTE 3 - STOCK OPTION PLANS
On August 25, 2005, the Board of Directors of the Company approved and adopted
the 2005 Stock Incentive Plan (the Plan). The Plan became effective upon its
adoption by the Board and will continue in effect for ten years, unless
terminated. This plan was approved by the stockholders of the Company on
November 22, 2005. Under the Plan, the exercise price for all options issued
will not be less than the average quoted closing market price of the Company's
trading common stock for the thirty day period immediately preceding the grant
date plus a premium of ten percent. The maximum aggregate number of shares
that may be awarded under the plan is 2,500,000.
9
FLEXPOINT SENSOR SYSTEMS, INC. AND SUBSIDIARIES
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The Company utilized the Black-Scholes model for calculating the fair value
pro forma disclosures under SFAS No. 123 and will continue to use this model,
which is an acceptable valuation approach under SFAS No. 123R. This model
requires the input of subjective assumptions, including the expected price
volatility of the underlying stock. Projected data related to the expected
volatility and expected life of stock options is based upon historical and
other information, and notably, the Company's common stock has limited trading
history. Changes in these subjective assumptions can materially affect the
fair value of the estimate, and therefore, the existing valuation models do
not provide a precise measure of the fair value of the Company's employee
stock options.
On August 25, 2005 the Company granted options to employees to purchase an
aggregate 1,159,000 shares of common stock at an exercise price of $1.91 per
share. The options vest over three years on the employee's employment
anniversary. The Company used the following assumptions in estimating the
fair value of the options issued August 25, 2005: market value at time of
issuance - $1.73; expected holding period - 8 years; risk-free interest rate -
4.18%; dividend yield - 0%; expected volatility - 200%; estimated forfeiture
percentage - 0%. Using these assumptions, the options granted have a weighted
average fair value of $1.723 per share.
On February 27, 2006 the Company granted options to employees to purchase an
aggregate 75,000 shares of common stock at an exercise price of $2.07 per
share. The options vest over three years on the employee's employment
anniversary. The Company used the following assumptions in estimating the
fair value of the options issued February 27, 2006: market value at time of
issuance - $2.00; expected holding period - 7 years; risk-free interest rate -
4.26%; dividend yield - 0%; expected volatility - 200%; estimated forfeiture
percentage - 0%. Using these assumptions, the options granted have a weighted
average fair value of $1.986 per share.
During the six month period ended June 30, 2006, the Company recognized
$529,953 of stock-based compensation expense. Information about all employee
options outstanding is as follows:
2005
---------------------
Weighted- Weighted-
average average
For the Period Ending exercise exercise
June 30, 2006 Shares price Shares price
------------------------------------------------------------------------------
Outstanding at beginning of year 1,159,000 $ 1.91 - $ -
Granted Jan-Jun 2006 75,000 2.07
------------------------------------------------------------------------------
Outstanding at end of period 1,234,000 $ 1.92 1,159,000 $ 1.91
==============================================================================
A summary of employee options outstanding and employee options exercisable
under the Company's plan is set forth below:
Outstanding Exercisable
-------------------------------------- -------------------
Weighted-
Average Weighted- Weighted-
Number of Remaining Average Number of Average
Range of Options Contractual Exercise Options Exercise
Exercise Prices Outstanding Life Price Exercisable Price
---------------------------------------------------------------------------
$1.91 - $2.07 1,234,000 9.19 $ 1.92 274,000 $ 1.91
---------------------------------------------------------------------------
10
FLEXPOINT SENSOR SYSTEMS, INC. AND SUBSIDIARIES
(A Development Stage Company)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 4 - RELATED PARTY MANUFACTURING CONTRACT
In September 2005 the Company entered into a manufacturing agreement with R&D
Products, LLC, a Utah limited liability company, doing business in Midvale,
Utah. For the purpose of this contract, management considers R&D Products to
be a Related Party because a controlling member of R&D Products, LLC is also a
non-controlling interest shareholder of Flexpoint Sensor Systems, Inc. R&D
Products has developed a mattress with multiple air chambers that use Bend
Sensors(R) and the Company has agreed to manufacture the Bend Sensors(R) for
the mattresses. The initial order is for 300,000 Bend Sensors(R) to be used
to begin manufacture of 10,000 mattresses. The realization of the
manufacturing and sales of the Bend Sensors(R) is dependent upon R&D Products
selling either their bed directly or licensing their technology to a third
party. There are no guarantees that R&D will make such sales in such
quantities to meet the demands of this contract.
NOTE 5 - PATENT PROTECTION PROCEEDINGS
In January 2006, the Company filed a complaint in the United States District
Court for the District of Utah in Salt Lake City against Michael W. Wallace
for possible Patent encroachment.
11
In this report references to "Flexpoint Sensor," "we," "us," and "our" refer
to Flexpoint Sensor Systems, Inc. and its subsidiary.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
The Securities and Exchange Commission ("SEC") encourages companies to
disclose forward-looking information so that investors can better understand
future prospects and make informed investment decisions. This report contains
these types of statements. Words such as "may," "will," "expect," "believe,"
"anticipate," "estimate," "project," or "continue" or comparable terminology
used in connection with any discussion of future operating results or
financial performance identify forward-looking statements. You are cautioned
not to place undue reliance on the forward-looking statements, which speak
only as of the date of this report. All forward-looking statements reflect
our present expectation of future events and are subject to a number of
important factors and uncertainties that could cause actual results to differ
materially from those described in the forward-looking statements.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
EXECUTIVE OVERVIEW
We are a development stage company engaged principally in designing,
engineering and manufacturing Bend Sensor(R) technology and equipment. Our
planned operations have not commenced and our activities primarily include
acquiring equipment and technology, organizing activities, obtaining financing
and seeking manufacturing contracts.
During the past quarter we have focused our efforts on third party testing of
our technology as required in our protocol for Stage II development of our
technology. In June 2006 we announced our Pedestrian Impact Detection System
was tested by MGA Research and this research confirmed results of our internal
testing. This system is placed in the vehicles' front bumper to detect crash
impact. Within milliseconds of contact, the system can differentiate between
a human leg and an inanimate object and trigger a safety response in
accordance with the manufacturer's specifications.
We also announced that we had entered into a cooperative testing agreement
with Faurecia Automotive ("Faurecia") in June 2006. Faurecia is the second
largest automotive supplier in Europe and it supplies components to large
automotive manufacturers, such as BMW, Toyota, Ford, Daimler-Chrysler and
others. This agreement will allow both companies to use their resources,
knowledge and capabilities to develop a working prototype of the Pedestrian
Impact Detection System.
Our production of the medical bed has been delayed as a result of waiting for
a final design and configuration of the medical bed from R&D Products.
Flexpoint is prepared to produce the sensors under the terms of the agreement
as soon as R&D Products determines the final design and configuration of the
bed.
Negotiations for potential automotive applications using our Bend Sensors
technology are in process, but we have not yet entered into a major contract
for the sale of our automotive products. We are also continuing to develop
new products that we may sell or license to an industrial control company.
Finalizing a major contract with a customer remains our greatest challenge.
We must continue to obtain funding to operate and expand our operations so
that we can deliver our product to the market. Management believes that even
though we are making positive strides forward with our business plan, it is
likely that significant progress may not occur for the next four to six
months. Accordingly, we cannot guarantee that we will realize significant
revenues or that we will become profitable within the next twelve months.
LIQUIDITY AND CAPITAL RESOURCES
Our revenues are not to a level to support our operations. Our revenues are
primarily from design, contract and
12
testing services. For the past twelve months we have relied on proceeds from
the private placement we completed in March 2005 to satisfy our cash
shortfalls. We conducted the private placement during the first quarter of
2005 to raise funds for operations. We realized net proceeds of $3,907,207
from this private placement and as a result we have cash to continue our
operations and business development. In this private placement we issued an
aggregate of 2,836,335 units to purchasers and 140,000 units were issued to
the placement agent. Each unit consisted of one share and one warrant to
purchase one share at an exercise price of $3.00.
Management believes that our current cash burn rate is $150,000 per month and
that the remaining proceeds from the private placement will fund our
operations for at least the next six months. For the six month period ended
June 30, 2006 ("2006 six month period") net cash used by operating activities
was $800,238 compared to $699,346 for the six month period ended June 30, 2005
("2005 six month period").
Another source of cash for the 2006 six month period was the exercise of
warrants. On June 27, 2006, Summit Resource Group exercised warrants to
purchase 300,000 common shares at an exercise price of $0.70 per share and we
received $210,000 proceeds from the exercise of these warrants. We issued
these warrants to Summit Resource Group on March 3, 2004, as part of a
consulting agreement with that company to provide investor relations services.
The underlying common shares were registered under a Form SB-2 registration
statement declared effective August 18, 2005.
We may receive additional funds in the future from warrants issued in the
private placement. If all of the warrants issued in the private placement are
exercised, then we may realize an additional $8,929,005, based on an exercise
price of $3.00 per warrant. Except for a "call" provision, the warrant
holders have total discretion as to when or if the warrants are exercised. If
the closing bid price of our common stock is greater than $4.00 per share for
five consecutive trading days after October 1, 2005 and during the exercise
term of the warrant, then we have the right to call the warrant in whole or in
part, forcing the investor to exercise the warrant within fifteen trading days
or the warrant is forfeited. We cannot guarantee that the price of our common
stock will reach $4.00 and, in that case, the warrant holders will determine
when and if the warrants are exercised.
We will require additional financing to fund our long-term cash needs and we
may be required to rely on debt financing, loans from related parties, and
private placements of our common stock for additional funding. However, we
cannot assure you that we will be able to obtain financing, or that sources of
financing, if any, will continue to be available, and if available, that they
will be on terms favorable to us. We intend to use revenue and our cash to
purchase and install equipment and develop our ISO/TS-16949 certified
facility.
As we enter into new technology agreements in the future, we must ensure that
those agreements provide adequate funding for any pre-production research and
development and manufacturing costs. If we are successful in establishing
agreements with adequate initial funding, management believes that our
operations for the long term will be funded by revenues, licensing fees and
royalties related to these agreements. However, we have formalized only a few
additional agreements during the past year and there can be no assurance that
agreements will come to fruition in the future or that a desired technological
application can be brought to market.
COMMITMENTS AND CONTINGENCIES
Our principal commitments consist of total current liabilities of $42,734 at
June 30, 2006, and our operating lease. The operating lease has average
monthly payments of $8,718, including common area maintenance and a 2% annual
increase. The total future minimum payments under this lease as of December
31, 2005 were $395,889.
Our total current liabilities include accounts payable of $4,202 related to
normal operating expenses, including health insurance, utilities, production
supplies and travel expense; also expenses for professional fees regarding
audit fees and legal fees related to the defense of patent rights. Accrued
liabilities at June 30, 2006, were $38,532 and were related to payroll tax
liabilities, accrued audit and tax expenses, accrued lease expense and accrued
Paid Time Off, a combination vacation-sick leave policy.
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In January 2006 we initiated a legal action for patent encroachment and we
anticipated that this legal action would result in legal costs of
approximately $100,000; however, the cost of this action has been higher than
anticipated and we now estimate that this legal action will result in legal
costs of approximately $200,000. Management believes it is critical to
protect our patents and will divert a portion of our financial resources to
continue this legal matter.
OFF-BALANCE SHEET ARRANGEMENTS
None.
CRITICAL ACCOUNTING 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 the amounts reported
in the consolidated financial statements and accompanying notes. Estimates of
particular significance in our financial statements include goodwill and the
annual tests for impairment of goodwill and valuing stock option compensation.
We annually test goodwill for impairment or when a triggering event occurs.
Impairment is indicated if undiscounted cash flows are less then the carrying
value of the assets. The amount of impairment is measured using a
discounted-cash-flows model considering future revenues, operating costs and
risk-adjusted discount rate and other factors. We performed a goodwill
impairment test during 2005 and concluded there was no impairment of goodwill.
We account for stock options under Statement of Financial Accounting Standards
No. 123(R), effective January 1, 2006. Statement 123(R) requires that
recognition of the cost of employee services received in exchange for stock
options and awards of equity instruments be based on the grant-date fair value
of such options and awards, over the period they vest. The fair value of the
options we have granted is estimated at the date of grant using the
Black-Scholes American option-pricing model. Option pricing models require
the input of highly sensitive assumptions, including expected stock
volatility. Also, our stock options have characteristics significantly
different from those of traded options, and changes in the subjective input
assumptions can materially affect the fair value estimate. Management
believes the best input assumptions available were used to value the options
and that the resulting option values are reasonable. During the 2006 first
quarter we recognized $529,953 of stock-based compensation expense for our
stock options.
RESULTS OF OPERATIONS
The following discussions are based on the consolidated operations of
Flexpoint Sensor and its subsidiary, Sensitron, and should be read in
conjunction with our unaudited financial statements the three and six month
periods ended June 30, 2006 and 2005. These financial statements are included
in this report at Part I, Item 1, above.
SUMMARY OPERATING RESULTS
Three month Three month Six month Six month
period ended period ended period ended period ended
June 30, 2006 June 30, 2005 June 30, 2006 June 30, 2005
-------------- ------------- ------------- -------------
Revenue $ 52,784 $ 2,087 $ 53,526 $ 18,365
Total operating
costs and expenses (960,372) (418,584) (1,529,438) (800,696)
Net other income 12,194 19,390 24,422 18,757
Net loss $ (895,394) $ (397,107) $ (1,451,490) $ (763,574)
Basic and diluted
loss per share $ (0.04) $ (0.02) $ (0.06) $ (0.03)
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Revenue from research and development engineering contracts is recognized as
the services are provided and accepted by the customer. Revenue from
contracts to license technology to others is deferred until all conditions
under the contract are met and then the sale is recognized as licensing
royalty revenue over the remaining term of the contract. Revenue from the
sale of a product is recorded at the time of shipment to the customer.
Our revenue for the 2006 and 2005 interim periods was from design, contract
and testing services. The increase in revenue for the three month period
ended June 30, 2006 (the "2006 second quarter") and for the 2006 six month
period compared to the 2005 comparable periods was the result of increases in
revenue from design engineering work. Management does not anticipate that
revenues will increase until we finalize a major contract.
Total operating costs and expenses increased for the 2006 interim periods
compared to the 2005 interim periods primarily as a result of increases in
administrative and marketing expenses and research and development expense.
Administrative and marketing expenses increased in the 2006 interim periods
due to litigation fees and compensation expense recognized for share-based
option compensation according to SFAS No. 123(R), discussed above. In
addition, research and development expense increased in the 2006 interim
periods as we moved forward with the Stage II development of our technology.
Due to a change in account methodology we directly expensed research and
development costs in the 2006 interim periods, rather than including them in
cost of revenue.
Total other income for the 2006 and 2005 interim periods was primarily the
result of interest income related to interest on the proceeds of the private
placement offering which were deposited in a savings account. Interest
expense for the 2005 interim periods was primarily the result of interest
expense related to loans.
Due to minimal revenues and increased operating costs and expenses, we
recorded a net loss for both the 2006 and 2005 interim periods. Management
expects losses to continue in the short term.
SUMMARY BALANCE SHEET INFORMATION
The chart below presents a summary of our balance sheets at June 30, 2006, and
December 31, 2005.
June 30, 2006 December 31, 2005
-------------- -----------------
Cash and cash equivalents $ 1,371,987 $ 1,964,487
Total current assets 1,401,593 1,999,148
Total assets 9,550,284 10,304,149
Total current liabilities 42,734 85,062
Deficit accumulated during (7,732,236) (6,280,746)
the development stage
Total stockholders equity $ 9,507,550 $ 10,219,087
Cash and cash equivalents decreased 30.1% at June 30, 2006, compared to
December 31, 2005 because we had minimal revenue in the 2006 six month period
to provide cash. Until our revenue increases, our cash will continue to
decrease.
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Our non-current assets decreased at June 30, 2006, due to adjustments for
depreciation and amortization. These assets include property and equipment
valued at $1,158,577, patents and proprietary technology of $1,627,200,
goodwill of $5,356,414, and long-term deposits of $6,500.
Total current liabilities decreased at June 30, 2006, primarily as a result of
decreases in accounts payable and accrued liabilities.
Factors Affecting Future Performance
We have a history of losses and may never become profitable.
We are unable to fund our day-to-day operations from revenues and the lack of
revenues for continued growth may cause us to delay our business development.
For the 2006 six month period, we incurred a net loss of $1,451,490 and had
negative cash flows from operating activities of $800,238. We anticipate
proceeds from our private placement completed in March 2005 will fund our
operations for at least the next six months; however, we expect that revenue
will not increase until late 2006 or early 2007. In addition, if we decide to
expand our business activities outside the automotive market in the next
twelve months, we anticipate needing more than approximately $1,000,000 in
additional funding.
We may not have adequate experience to successfully manage
anticipated growth.
In January 2005 we restructured our management team and brought in an
experienced group of executive level management personnel to direct the growth
of our business operations. However, we may not be equipped to successfully
manage any possible future periods of rapid growth or expansion, which could
be expected to place a significant strain on our managerial, operating,
financial and other resources. Our future performance will depend, in part,
on our ability to manage growth effectively, which will require us to:
.. improve existing, and implement new, financial controls and systems,
management information systems, operating, administrative, financial and
accounting systems and controls,
.. maintain close coordination between engineering, programming, accounting,
finance, marketing, sales and operations, and
.. attract and retain additional qualified technical and marketing personnel.
There is intense competition for management, technical and marketing personnel
in our business. The loss of the services of any of our key employees or our
failure to attract and retain additional key employees could have a material
adverse effect on our ability to continue as a going concern.
We may not have adequate manufacturing capacity to meet anticipated
manufacturing contracts.
Based on projected business development, we will need to complete a second
production line and have it installed and approved in 2008. The second
manufacturing line is expected to result in increased manufacturing capacity
and manufacturing efficiencies. We have completed installation of our first
production line and are in the process of qualifying our own manufacturing
facility for ISO/TS-16949 certification. However, we cannot assure you that
we will satisfy ISO/TS-16949 qualification or that the production lines will
produce product in the volumes required or that the production lines will
satisfy the requirements of our customers.
Our success is dependent on our intellectual property rights which are
difficult to protect.
Our future success depends on our ability to protect our intellectual
property. We use a combination of patents and other intellectual property
arrangements to protect our intellectual property. There can be no assurance
that the protection provided by our patents will be broad enough to prevent
competitors from introducing similar products or that our patents, if
challenged, will be upheld by courts of any jurisdiction. Patent infringement
litigation, either to enforce our patents or defend ourselves from
infringement suits, will be expensive and could divert our resources from
other planned uses. Patent applications filed in foreign countries and
patents in these countries are subject to laws and procedures that differ from
those in the U.S. and may not be as favorable to us. We also attempt to
protect
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our confidential information through the use of confidentiality agreements and
by limiting access to our facilities. There can be no assurance that our
program of patents, confidentiality agreements and restricted access to our
facilities will be sufficient to protect our confidential information from
competitors.
Research and development may result in problems which may become
insurmountable to full implementation of production.
Customers request that we create prototypes and perform pre-production
research and development. As a result, we are exposed to the risk that we may
find problems in our designs that are insurmountable to fulfill production.
In that event, we will be unable to recover the costs of the pre-production
research and development. However, we are currently unaware of any
insurmountable problems with ongoing research and development that may prevent
further development of an application.
Our products must satisfy governmental regulations in order to
be marketable
During the past several years, the automotive industry has been subject to
increased government safety regulation. Among other things, proposed
regulations from the National Highway Transportation and Safety Administration
required automakers to incorporate advanced air bag technology into vehicles
beginning in 2005 with the phase-in to be completed by 2008. Our products may
not meet the proposed National Highway Transportation and Safety
Administration standards or the standards may be modified. These proposals
call for upgraded air bag system performance tests for passenger cars and
light trucks. The new testing requirements are intended to improve the safety
of infants, children and out-of-position adults, and maximize the protection
of properly seated adults. The National Highway Transportation and Safety
Administration tests are similar to conditions that we have already been using
to test our Seat Mat System and we believe that our Seat Mat System will meet
the standards as proposed. In addition, automakers may react to these
proposals and the uncertainty surrounding these proposals by curtailing or
deferring investments in new technology, including our Bend Sensor(R)
technology, until final regulatory action is taken. We cannot predict what
impact, if any, these proposals or reforms might have on our financial
condition and results of operations.
Because we are significantly smaller than the majority of our
competitors, we may lack the financial resources needed to capture
increased market share.
The market for sensor devices is extremely competitive, and we expect that
competition will intensify in the future. There can be no assurance that we
will be able to compete successfully against current or future competitors or
that competitive pressures we face will not materially adversely affect our
business, operating results or financial condition. Our primary competitors
in the air bag market are International Electronics and Engineering, Siemens,
Robert Bosch GmbH, Denso, Inc., Breed Technologies, TRW Automotive, Delphi
Corporation, Autoliv Inc., Takata and Temic. We believe that none of our
competitors have a product that is superior to our Bend Sensor(R) technology
at this time. However, many of our competitors and potential competitors have
substantially greater financial, technical and marketing resources, larger
customer bases, longer operating histories, greater name recognition and more
established relationships than we do. These competitors may be able to
undertake more extensive marketing campaigns, adopt more aggressive pricing
policies and devote substantially more resources to developing new products
and markets than we can.
Ongoing industry consolidation among worldwide automotive parts
suppliers and financial difficulties of U.S. auto makers may limit
the market potential for our products.
In the automotive parts industry, there is a trend of consolidation through
business combinations and acquisitions of complementary technologies among
worldwide suppliers as these suppliers seek to build stronger customer
relationships with automobile manufacturers. Automobile manufacturers look to
Tier 1 suppliers (major suppliers) to provide fully engineered systems and
pre-assembled combinations of components rather than individual components.
This trend of consolidation of suppliers may result in fewer Tier 1 suppliers
and thus limit the marketing opportunities for our Bend Sensor(R) technology.
In addition, in recent months large U.S. auto makers
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have announced plans to close plants and reduce their work force, some Tier 1
suppliers are in bankruptcy or in financial difficulty, and two automobile
manufacturers have reported increased financial difficulties. These industry
trends may limit the market for our products.
ITEM 3. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in our filings under the Exchange
Act is recorded, processed, summarized and reported within the periods
specified in the rules and forms of the SEC. This information is accumulated
and communicated to our executive officers to allow timely decisions regarding
required disclosure.
Our Chief Executive Officer and our Chairman of the Board who acts in the
capacity of our principal financial officer evaluated the effectiveness of our
disclosure controls and procedures as of the end of the period covered by this
report. Based on that evaluation, they concluded that our disclosure controls
and procedures were effective.
Also, these executive officers determined that there were no changes made in
our internal controls over financial reporting during the second quarter of
2006 that have materially affected, or are reasonably likely to materially
affect our internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS
Part I Exhibits
No. Description.
31.1 Chief Executive Officer Certification
31.2 Principal Financial Officer Certification
32.1 Section 1350 Certification
Part II Exhibits
No. Description.
2.1 Order Confirming Plan, dated February 24, 2004 (Incorporated by
reference to exhibit 2.1 for Form 8-K filed March 5, 2004)
2.2 Debtor's Plan of Reorganization, dated January 14, 2004 (Incorporated by
reference to exhibit 2.2 for Form 8-K filed March 5, 2004)
2.3 Asset Purchase Agreement between Flexpoint Sensor and Flexpoint
Holdings, LLC, dated March 31, 2004 (Incorporated by reference to
exhibit 2.3 of Form 10-QSB, filed May 3, 2004)
3.1 Certificate of Incorporation of Flexpoint Sensor, as amended
3.2 Bylaws of Flexpoint Sensor, as amended (Incorporated by reference to
exhibit 3.4 of Form 10-QSB, filed May 3, 2004)
4.1 Common stock purchase warrant of Investors Stock Daily, Inc., dated July
26, 2005 (Incorporated by reference to exhibit 4.1 to Form 10-KSB filed
March 15, 2006)
10.1 Lease Agreement between Flexpoint Sensor and F.G.B.P., L.L.C., dated
July 12, 2004 (Incorporated by reference to exhibit 10.2 of Form 10-QSB,
filed November 15, 2004, as amended)
10.2 Consulting Agreement between Flexpoint Sensor and Summit Resource Group,
dated March 3, 2004 (Incorporated by reference to exhibit 10.3 of Form
10-QSB, filed May 3, 2004)
10.3 Manufacturing Agreement between Flexpoint Sensor and R&D Products, Inc.,
dated September 28, 2005 (Incorporated by reference to exhibit 10.1 of
Form 8-K, filed October 3, 2005)
20.1 Flexpoint Sensor Systems, Inc. 2005 Stock Incentive Plan (Incorporated
by reference to Schedule 14A, filed October 27, 2005)
20.2 Audit Committee Charter (Incorporated by reference to Schedule 14A,
filed October 27, 2005)
21.1 Subsidiaries of Flexpoint Sensor Systems, Inc. (Incorporated by
reference to exhibit 21.1 to Form 10-KSB filed March 15, 2006)
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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, who are duly
authorized.
FLEXPOINT SENSOR SYSTEMS, INC.
/s/ Clark M. Mower
Date: August 3, 2006 _______________________________________
Clark M. Mower
President, Chief Executive Officer and Director
/s/ John A. Sindt
Date: August 3, 2006 _______________________________________
John A. Sindt
Chairman of the Board
Principal Financial and Accounting Officer
/s/ B. Fred Atkinson, Jr.
Date: August 3, 2006 _______________________________________
B. Fred Atkinson, Jr.
Secretary/Treasurer and Comptroller
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