U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-QSB
(Mark one)
{x} QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 2003
{ } TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (No Fee Required)
For the transition period from ________________ to ________________
Commission file number 0-29192
PURADYN FILTER TECHNOLOGIES INCORPORATED
--------------------------------------------------------------------------------
(Name of small business issuer in its charter)
Delaware 14-1708544
------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
2017 High Ridge Road, Boynton Beach, Florida 33426
-------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number (561) 547-9499
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 Puradyn Filter Technologies Incorporated was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes { x } No { }
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: 15,692,164 shares of common stock
were outstanding as of November 13, 2003.
Puradyn Filter Technologies Incorporated
Index to Quarterly Report on Form 10-QSB
Part I. Financial Information
Page
----
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheet - September 30, 2003.......................................... 3
Condensed Consolidated Statements of Operations - Three months and nine months ended
September 30, 2003 and 2002........................................................................ 4
Condensed Consolidated Statements of Cash Flows - Three months and nine months ended
September 30, 2003 and 2002........................................................................ 5
Notes to Condensed Consolidated Financial Statements................................................ 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............... 14
Part II. Other Information
Item 1. Legal Proceedings................................................................................... 21
Item 2. Changes in Securities and Use of Proceeds........................................................... 22
Item 3. Default Upon Senior Securities...................................................................... 22
Item 4. Submission of Matters to a Vote of Security Holders................................................. 22
Item 5. Other Information.................................................................................... 22
Item 6. Exhibits and Reports on Form 8-K.................................................................... 22
Signatures............................................................................................................ 23
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Puradyn Filter Technologies Incorporated
Condensed Consolidated Balance Sheet
September 30, 2003
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 255,313
Accounts receivable, net of allowance for uncollectible accounts of $39,152 174,775
Inventories 1,250,553
Prepaid expenses and other current assets 238,936
------------
Total current assets 1,919,577
Property and equipment, net 684,406
Accrued interest receivable - stockholder notes 104,955
Deferred financing costs, net 227,209
Other noncurrent assets 198,583
------------
Total assets $ 3,134,730
============
Liabilities and stockholders' deficit
Current liabilities:
Accounts payable $ 128,037
Accrued liabilities 430,353
Current portion of capital lease obligation 3,946
Deferred revenue 80,743
------------
Total current liabilities 643,079
Notes payable to stockholder 4,501,900
Stockholders' deficit:
Preferred stock, $.001 par value:
Authorized shares - 500,000; none issued and outstanding --
Common stock, $.001 par value:
Authorized shares - 30,000,000; 15,692,164 issued and outstanding 15,692
Additional paid-in capital 31,835,855
Stockholder notes receivable (875,256)
Accumulated deficit (32,960,300)
Accumulated other comprehensive loss (26,240)
------------
Total stockholders' deficit (2,010,249)
------------
Total liabilities and stockholders' deficit $ 3,134,730
============
See accompanying notes.
3
Puradyn Filter Technologies Incorporated
Condensed Consolidated Statements of Operations
For the Three and Nine Months Ended September 30, 2003 and 2002
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
------------ ------------ ------------ ------------
Net sales $ 507,417 $ 293,217 $ 1,572,911 $ 1,619,847
Costs and expenses:
Cost of products sold 620,522 355,396 1,787,450 1,512,179
Salaries and wages 427,308 423,379 1,338,900 1,248,233
Selling and administrative 292,903 312,199 1,310,695 1,101,213
------------ ------------ ------------ ------------
1,340,733 1,090,974 4,437,045 3,861,625
------------ ------------ ------------ ------------
Loss from operations (833,316) (797,757) (2,864,134) (2,241,778)
Other income (expense):
Investment loss -- (14,065) -- (76,025)
Interest income 13,078 14,507 38,526 38,794
Interest expense (89,276) (38,620) (233,365) (145,320)
------------ ------------ ------------ ------------
Total other expense (76,198) (38,178) (194,839) (182,551)
------------ ------------ ------------ ------------
Net loss $ (909,514) $ (835,935) $ (3,058,973) $ (2,424,329)
============ ============ ============ ============
Basic and diluted loss per common
share $ (0.06) $ (0.05) $ (0.20) $ (0.16)
============ ============ ============ ============
Weighted average common shares
outstanding 15,692,164 15,597,551 15,679,898 15,573,510
============ ============ ============ ============
See accompanying notes.
4
Puradyn Filter Technologies Incorporated
Condensed Consolidated Statements of Cash Flows
For the Three and Nine Months Ended September 30, 2003 and 2002
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
------------ ------------ ----------- -----------
OPERATING ACTIVITIES
Net cash used in operating activities $ (851,553) $ (610,169) $(2,775,145) $(2,986,884)
----------- ----------- ----------- -----------
INVESTING ACTIVITIES
Proceeds from sales and maturities of
investments -- 85,000 -- 5,808,223
Purchases of property and equipment (67,503) (79,737) (109,541) (94,903)
Investment in patents and trademarks -- (47,366) -- (47,366)
----------- ----------- ----------- -----------
Net cash (used in) provided by investing
activities (67,503) (42,103) (109,541) 5,665,954
----------- ----------- ----------- -----------
FINANCING ACTIVITIES
Proceeds from exercise of stock options -- 26,393 42,666 124,362
Proceeds from note payable secured by
investments -- -- -- 1,453,250
Proceeds from notes payable to stockholder 1,000,000 500,000 2,501,900 500,000
Proceeds from short term loan payable to
officer -- -- 100,000 --
Payments on short term loan payable to officer -- -- (100,000) --
Payments on note payable secured by
investments -- (10,926) -- (5,445,010)
Payment of capital lease obligations (1,247) (1,122) (3,382) (3,280)
----------- ----------- ----------- -----------
Net cash provided by (used in) financing
activities 998,753 514,345 2,541,184 (3,370,678)
----------- ----------- ----------- -----------
Effect of exchange rate changes on cash and cash
equivalents (5,263) (4,214) (34,209) (32,655)
----------- ----------- ----------- -----------
Increase (decrease) in cash and cash equivalents 74,434 (142,141) (377,711) (724,263)
Cash and cash equivalents at beginning of period 180,879 391,917 633,024 974,039
----------- ----------- ----------- -----------
Cash and cash equivalents at end of period $ 255,313 $ 249,776 $ 255,313 $ 249,776
=========== =========== =========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest $ 43,526 $ 1,637 $ 101,554 $ 36,573
=========== =========== =========== ===========
NONCASH INVESTING AND FINANCING ACTIVITIES
Net unrealized loss on available-for-sale
investments $ -- $ (4,587) $ -- $ (85,619)
=========== =========== =========== ===========
Warrants issued for deferred financing costs $ -- $ -- $ 212,500 $ 318,000
=========== =========== =========== ===========
Common stock options issued in lieu of officer
cash bonus $ -- $ -- $ 80,000 $ --
=========== =========== =========== ===========
See accompanying notes.
5
Puradyn Filter Technologies Incorporated
Notes to Condensed Consolidated Financial Statements
September 30, 2003
(Unaudited)
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim information and with the instructions to Form 10-QSB
and Regulation S-B. Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States for complete financial statements. In the opinion of management, all
adjustments consisting of a normal and recurring nature considered necessary for
a fair presentation have been included. Operating results for the three-month
and nine-month periods ended September 30, 2003 may not necessarily be
indicative of the results that may be expected for the year ending December 31,
2003.
For further information, refer to Puradyn Filter Technologies Incorporated's
(the Company) consolidated financial statements and footnotes thereto included
in the Form 10-KSB for the year ended December 31, 2002.
Recent Accounting Pronouncements
In April 2002, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 145, Rescission of SFAS Nos. 4, 44,
and 64, Amendment of SFAS 13, and Technical Corrections (SFAS 145). Among other
things, SFAS 145 rescinds various pronouncements regarding early extinguishments
of debt and allows extraordinary accounting treatment for early extinguishments
only when the provisions of Accounting Principles Board (APB) 30, Reporting the
Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions, are met. This statement also amends SFAS 13 to require
sale-leaseback accounting for certain lease modifications that have economic
effects that are similar to sale-leaseback transactions. The provisions of SFAS
145 became effective for the Company on January 1, 2003. The adoption of the new
statement did not have an effect on the Company's financial position or the
results of its operations.
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities (SFAS 146), which addresses significant issues
regarding the recognition, measurement, and reporting of costs that are
associated with exit and disposal activities, including restructuring activities
that are currently accounted for pursuant to the guidance that the Emerging
Issues Task Force (EITF) has set forth in EITF Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring). The scope of
SFAS 146 also includes (1) costs related to terminating a contract that is not a
capital lease and (2) termination benefits that employees who are involuntarily
terminated receive under the terms of a one-time benefit arrangement that is not
an ongoing benefit arrangement or an individual deferred-compensation contract.
SFAS 146 is effective for exit or disposal activities that are initiated after
December 31, 2002. The adoption of the new statement did not have an effect on
the Company's financial position or the results of its operations.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure (SFAS 148). SFAS 148 amends SFAS No. 123,
Accounting for Stock-Based Compensation (SFAS 123), to provide alternative
methods of transition to SFAS 123's fair value method of accounting for
stock-based employee compensation. SFAS 148 also amends the disclosure
provisions of SFAS 123 and APB Opinion No. 28, Interim Financial Reporting, to
require disclosure in the summary of significant accounting policies of the
effects of an entity's accounting policy with respect to stock-based employee
6
compensation on reported net income and earnings per share in annual and interim
financial statements. SFAS 148 does not require companies to account for
employee stock options using the fair value method proscribed by SFAS 123. The
adoption of the new statement did not have an effect on the Company's financial
position or the results of its operations. Additional disclosures required for
interim periods by SFAS 148 are included in this report.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities (SFAS 149). This statement amends
and clarifies accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities
under Statement 133. SFAS 149 is effective for contracts entered into or
modified after September 30, 2003 and for hedging relationships designated after
September 30, 2003. The guidelines are to be applied prospectively. The
provisions of SFAS 149 that relate to Statement 133 implementation issues that
have been effective for fiscal quarters that began prior to June 15, 2003 should
continue to be applied in accordance with their respective effective dates. The
adoption of the new statement did not have an effect on the Company's financial
position or the results of its operations.
In May 2003, the FASB issued SFAS No. 150, Accounting for Financial Instruments
with Characteristics of Liabilities, Equity, or Both (SFAS 150). SFAS 150
established standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. The
statement is effective for financial instruments entered into or modified after
May 31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003. The adoption of the new statement did not
have an effect on the Company's financial position or the results of its
operations.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others (FIN 45). FIN 45 requires that certain guarantees be
initially recorded at fair value, which is different from the general current
practice of recording a liability only when a loss is probable and reasonably
estimable. FIN 45 also requires a guarantor to make significant new disclosures
for virtually all guarantees. The Company adopted the disclosure requirements
under FIN 45 for the year ended December 31, 2002 and has adopted the initial
recognition and initial measurement provisions for any guarantees issued or
modified after December 31, 2002. The adoption of the new interpretation did not
have an effect on the Company's financial position or the results of its
operations.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities - an Interpretation of ARB No. 51 (FIN 46), which
addresses consolidation of variable interest entities. FIN 46 expands the
criteria for consideration in determining whether a variable interest entity
should be consolidated by a business entity, and requires existing
unconsolidated variable interest entities (which include, but are not limited
to, Special Purpose Entities, or SPEs) to be consolidated by their primary
beneficiaries if the entities do not effectively disperse risks among parties
involved. This interpretation applies immediately to variable interest entities
created after January 31, 2003, and to variable interest entities in which an
enterprise obtains an interest after that date. For a variable interest in a
variable interest entity created before February 1, 2003, the recognition
provisions of FIN 46 apply to that entity as of the first interim period ending
after December 15, 2003. The Company does not believe that the adoption of this
interpretation will have a material effect on its financial position or the
results of its operations.
In November 2002, the Emerging Issues Task Force (EITF) reached a consensus on
EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables (EITF
00-21). EITF 00-21 addresses certain aspects of the accounting by a company for
arrangements under which it will perform multiple revenue-generating activities.
In applying EITF 00-21, generally, separate contracts with the same customer
that are entered into at or near the same time are presumed to have been
negotiated as a package and should, therefore, be evaluated as a single
contractual arrangement. It also addresses how contract consideration should be
measured and allocated to the separate deliverables in the arrangement. This
pronouncement is applicable to revenue arrangements entered into beginning in
2004. The Company does not believe that the adoption of this pronouncement will
have a material effect on its financial position or the results of its
operations.
7
Principles of Consolidation
The accompanying condensed consolidated financial statements include the
accounts of the Company and its wholly owned subsidiary, Puradyn Filter
Technologies Ltd (PFTL). All significant inter-company transactions and balances
have been eliminated.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the condensed consolidated financial statements and accompanying notes. Actual
results could differ from those estimates.
Basic and Diluted Loss Per Share
SFAS No. 128, Earnings Per Share, requires a dual presentation of basic and
diluted earnings per share. However, because of the Company's net losses, the
effect of outstanding stock options and warrants would be anti-dilutive and,
accordingly, is excluded from the computation of diluted loss per share. The
number of such shares excluded from the computation of loss per share totaled
2,753,570 for the three and nine-months ended September 30, 2003 and 2,626,129
for the three and nine-months ended September 30, 2002.
Inventories
Inventories are stated at the lower of cost or market using the first in, first
out (FIFO) method. Production costs, consisting of labor and overhead, are
applied to ending inventories at a rate based on estimated production capacity
and any excess production costs are charged to cost of products sold. Provisions
have been made to reduce excess or obsolete inventories to their net realizable
value.
Inventories consisted of the following at September 30, 2003:
Raw materials $ 978,189
Finished goods 272,364
-----------------
$ 1,250,553
=================
Deferred Financing Costs
The Company capitalizes financing costs and amortizes them using the
straight-line method, which approximates the effective interest method over the
term of the related debt. Amortization of deferred financing costs is included
in interest expense and totaled approximately $45,000 and $35,000 for the
three-months ended September 30, 2003 and 2002, respectively, and approximately
$129,000 and $141,000 for the nine-months ended September 30, 2003 and 2002,
respectively. The deferred financing costs related to the $2.5 million
commitment provided by the Company's stockholder, who is also a director,
totaled $318,000 and were being amortized over the nine-month draw down period
ending December 31, 2002. Upon the first draw in August 2002, the amortization
period was extended to 18 months or through December 31, 2003. On March 14,
2003, the Company recorded additional deferred financing costs of $212,500
related to an additional $3.5 million commitment provided by the same
stockholder, with a payback date of December 31, 2004. The $212,500 of deferred
financing costs is being amortized over the payback period, which is 21.5
months. In addition, the repayment period for the $2.5 million commitment was
extended to December 31, 2004. Effective March 14, 2003, the Company is
amortizing the then remaining deferred financing costs for the $2.5 million
commitment prospectively over the extended payback period (see Note 2).
8
Stock Option Plans
The Company accounts for its stock-based compensation plans under Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB
25) and FASB Interpretation No. 44, Accounting for Certain Transactions
involving Stock Compensation (FIN 44), and provides pro forma disclosures of the
compensation expense determined under the fair value provisions of SFAS 123. The
Company does not record compensation expense using the fair value provisions,
because the alternative fair value accounting provided for under SFAS 123
requires the use of option valuation models that were not developed for use in
valuing employee stock options. Under APB 25, since the exercise price of the
Company's employee stock options equals the market price of the underlying stock
on the date of grant, no compensation expense is recognized.
The Company leases its employees from a payroll leasing company. The Company's
leased employees meet the definition of employees as specified by FIN 44 for
purposes of applying APB 25.
Stock options and warrants issued to consultants and other non-employees as
compensation for services provided to the Company are accounted for based on the
fair value of the services provided or the estimated fair market value of the
option or warrant, whichever is more reliably measurable in accordance with SFAS
123 and EITF 96-18, Accounting for Equity Investments That are Issued to Other
Than Employees for Acquiring or in Conjunction with Selling Goods or Services.
The related expense is recognized over the period the services are provided.
Pro forma information regarding net loss and loss per common share as if the
Company had accounted for its employee stock options under the fair value method
of SFAS 123 is presented below. For purposes of pro forma disclosure, the
estimated fair value of the options is amortized to expense over the options'
vesting period. The Company's pro forma information is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
------------------- ---------------- ----------------- -----------------
Net loss as reported $ (909,514) $ (835,935) $ (3,058,973) $ (2,424,329)
Stock-based employee compensation cost
(intrinsic value method) -- -- -- --
Fair value method stock option expense (299,348) (480,699) (916,266) (908,646)
-------------- -------------- -------------- --------------
Pro forma net loss
$ (1,208,862) $ (1,316,634) $ (3,975,239) $ (3,332,975)
============== ============== ============== ==============
Loss per common share:
Basic and diluted loss as reported $ (0.06) $ (0.05) $ (0.20) $ (0.16)
Basic and diluted loss pro forma $ (0.08) $ (0.08) $ (0.25) $ (0.21)
Weighted average fair value per option
granted during the period(1) $ 1.83 $ 2.29 $ 1.62 $ 2.66
Assumptions:
Average Risk Free Interest Rate 3.18% 4.00% 1.95% 4.00%
Average Volatility Factor 1.237 1.256 1.203 1.256
Expected Dividend Yield 0% 0% 0% 0%
Expected Life (in years) 5 5 4.56 5
(1) A Black-Scholes option-pricing model was used to develop the fair
values of the options granted.
9
Revenue Recognition
The Company recognizes revenue from product sales to customers, distributors and
resellers when products that do not require further services or installation by
the Company are shipped, when there are no uncertainties surrounding customer
acceptance and when collectibility is reasonably assured in accordance with
Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements
(SAB 101). Cash received by the Company prior to shipment is recorded as
deferred revenue. Sales are made to customers under terms allowing certain
limited rights of return and other limited product and performance warranties
for which provision has been made in the accompanying condensed consolidated
financial statements.
Amounts billed to customers in sales transactions related to shipping and
handling, represent revenues earned for the goods provided and are included in
net sales. Costs of shipping and handling are included in cost of products sold.
During the three-months ended March 31, 2003, the Company recognized revenue on
several shipments of product to one of its largest customers. Under the terms of
the arrangement with the customer, the Company received full payment for these
shipments during the three-months ended June 30, 2003. These shipments met the
criteria for revenue recognition under SAB 101 as of March 31, 2003. In August
2003, the Company and the customer mutually agreed that the customer would, at
the customer's cost, return a portion of the shipment to the Company, the
Company would perform certain product enhancements, and the Company would then,
at the customer's cost, ship the enhanced product back to the customer. These
enhancements, which were not required to correct any product quality or
performance issues, will enable the customer to expand and broaden its industry
market targets. As of September 30, 2003, the Company has completed the
enhancements on and shipped all of the returned product to the customer.
During the three-months ended June 30, 2003, in accordance with the requirements
of SFAS No. 48, Revenue Recognition When Right of Return Exists (SFAS 48) and
SAB 101, the Company recorded a provision for sales returns of approximately
$146,000, and a corresponding reduction in the cost of products sold of
approximately $107,000, related to the product returned for enhancements. The
Company recognized revenue and cost of products sold upon shipment of the
enhanced product to the customer, which, as described above, was completed
during the three-months ended September 30, 2003.
Product Warranty Costs
In connection with the adoption of FIN 45, the Company is including the
following disclosure applicable to its product warranties.
The Company accrues for warranty costs for the expected material and labor costs
to provide warranty replacement products. The methodology used in determining
the liability for warranty cost is based upon historical information and
experience. The Company's warranty reserve is calculated as the gross sales
multiplied by the historical warranty expense return rate. Deferred revenue of
approximately $37,000, which is related to the replacement of warranty products
and accrued warranty expense of approximately $47,000, which is included in
accrued liabilities, are included in the accompanying condensed consolidated
balance sheet as of September 30, 2003.
The following table shows the changes in the aggregate product warranty
liability for the nine-month period ended September 30, 2003:
Balance as of December 31, 2002 $ 46,607
Less: Payments made (21,651)
Change in prior period estimate (10,856)
Add: Provision for current period warranties 33,344
--------
Balance as of September 30, 2003 $ 47,444
========
10
Guarantees
In August 2003, the Company made a guarantee to its wholly owned subsidiary,
PFTL, that it will provide cash for working capital on an as needed basis for a
minimum period of twelve months. The guarantee was provided as assurance that
they will continue as a going concern for 2003. This guarantee is excluded from
the recognition and measurement provisions of FIN 45, as it relates to a
wholly owned consolidated subsidiary.
Comprehensive Income
SFAS No. 130, Reporting Comprehensive Income (SFAS 130), establishes rules for
reporting and display of comprehensive income and its components. Comprehensive
income is the sum of net loss as reported in the consolidated statements of
operations and other comprehensive income transactions reported in the
consolidated statement of changes in stockholders' deficit. Comprehensive income
transactions that apply to the Company result from changes in the market value
of the available-for-sale investments and changes in exchange rates from
translating the financial statements of the Company's foreign subsidiary.
Comprehensive loss consisted of the following for the three and nine-months
ended September 30, 2003 and 2002:
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
----------- ----------- ----------- -----------------
Net loss $ (909,514) $ (835,935) $(3,058,973) $(2,424,329)
----------- ----------- ----------- -----------
Other comprehensive income loss:
Unrealized loss on available
for-sale securities -- (4,587) -- (85,619)
Less: Reclassification adjustment for
losses included in net loss -- 4,587 -- 85,619
----------- ----------- ----------- -----------
Net unrealized loss on
available-for-sale securities -- -- -- --
Foreign currency translation adjustment (5,263) (4,214) (34,209) (32,655)
----------- ----------- ----------- -----------
Total other comprehensive loss
(5,263) (4,214) (34,209) (32,655)
----------- ----------- ----------- -----------
Comprehensive loss $ (914,777) $ (840,149) $(3,093,182) $(2,456,984)
=========== =========== =========== ===========
Reclassifications
Certain prior period amounts have been reclassified to conform to the current
period presentation.
2. ISSUES AFFECTING LIQUIDITY AND MANAGEMENT'S PLANS
The Company's financial statements have been prepared assuming that the Company
will continue as a going concern. The Company has sustained losses since its
inception and has used net cash in operations of approximately $2,775,000 and
$2,987,000 during the nine-months ended September 30, 2003 and 2002,
respectively. As a result, the Company has had to rely principally on private
debt and equity funding, including the conversion of debt into stock, to fund
its activities to date.
The Company has experienced increased cash flows from 2002 and first quarter
2003 sales activity. However, additional cash will be needed to support
operations. During the first seven months of 2002, the Company sold its
remaining investments, the proceeds of which were used to repay the Company's
loan on investments in April 2002 and to fund operations.
On March 28, 2002, the Company executed a binding agreement with one of its
stockholders, who is also a director, to fund up to $2.5 million through March
31, 2003. Under the terms of the agreement, the
11
Company could draw amounts as needed in multiples of $500,000 to fund operations
subject to Board of Director approval. Amounts drawn bear interest at the prime
rate (4% as of September 30, 2003) payable monthly and become due and payable on
December 31, 2003 or upon a change in control of the Company or consummation of
any other financing over $3 million. In March 2003, the payback date was
extended to December 31, 2004. In consideration for the stockholder entering
into this agreement the Company granted the stockholder 100,000 common stock
purchase warrants at an exercise price equal to the closing market price of the
Company's stock on the date of grant (see Note 3). As of September 30, 2003, the
Company had drawn the entire $2.5 million of the available funds.
On March 14, 2003, the Company executed a second binding agreement with the same
stockholder to fund up to an additional $3.5 million through December 31, 2003.
Under the terms of the second agreement, the Company can draw amounts as needed
in multiples of $500,000 to fund operations subject to Board of Director
approval. Amounts drawn bear interest at the prime rate (4% as of September 30,
2003) payable monthly and become due and payable on December 31, 2004 or upon a
change in control of the Company or consummation of any other financing over $7
million. In consideration, the Company granted the stockholder 125,000 common
stock purchase warrants at an exercise price equal to the closing market price
of the Company's stock on the date of grant (see Note 3). As of September 30,
2003, the Company had drawn $2.0 million of the available funds.
Management believes that the commitment received from its stockholder will be
sufficient to sustain the Company's operations through December 31, 2003.
However, if the commitment does not continue to fund for any reason or budgeted
sales levels are not achieved, the Company may have to modify its business plan,
reduce or discontinue some of its operations or seek a buyer for part of its
assets to continue as a going concern through 2003. The Company is in the
process of securing other sources of funding such as a private placement.
However, there can be no assurance that the Company will complete a private
placement or obtain additional funding from any other sources.
3. STOCK-BASED COMPENSATION
During the three-month periods ended September 30, 2003 and September 30, 2002,
the Company recognized a credit to compensation expense (under the intrinsic
value method) of approximately $116,000 and $129,000, respectively, relating to
outstanding variable option awards, which is included in selling and
administrative expenses. During the nine-month periods ended September 30, 2003
and September 30, 2002, the Company recorded compensation expense of
approximately $13,000 and a credit to compensation expense of approximately
$447,000, respectively.
On March 28, 2002, the Company recorded a deferred charge of $318,000 for the
issuance of 100,000 fully vested warrants to purchase common stock relating to a
financing agreement with one of its stockholders, who is also a director, to
fund up to $2.5 million through March 31, 2003 (see Note 2). The fair value of
the deferred charge was estimated at the date of grant using a Black-Scholes
option pricing model with the following assumptions: risk free interest rate of
4.65%, volatility factors of the expected market price of the Company's common
stock of 1.385, a dividend yield of zero, and a weighted average expected life
of 3 years. The warrants have an exercise price of $4.05. The deferred charge
was initially amortized over the commitment period and subsequently revised to
include the repayment period, which was extended to December 31, 2004.
On March 14, 2003, the Company executed a second binding agreement with the same
stockholder to fund up to an additional $3.5 million through December 31, 2003
(see Note 2). In consideration, the Company granted the stockholder 125,000
common stock purchase warrants. The fair value of the warrants was estimated at
the date of grant using a Black-Scholes option pricing model with the following
assumptions: risk free interest rate of 1.70%, volatility factors of the
expected market price of the Company's common stock of 1.142, a dividend yield
of zero, and a weighted average expected life of 4 years. The warrants have an
exercise price of $2.25. The estimated fair value of the warrants of $212,500
was recorded as a deferred charge and is being amortized through the repayment
period, which is December 31, 2004.
12
During the nine-months ended September 30, 2003 and 2002, employees of the
Company exercised 43,775 and 126,100, respectively of common stock options. The
Company received $42,666 and $124,000, respectively, in proceeds in exchange for
the shares issued.
4. NOTES PAYABLE TO STOCKHOLDER
As of September 30, 2003, the Company has drawn a total of $4,501,900 from the
two available lines-of-credit, which are provided by a stockholder, who is also
a director, of the Company (see Notes 2 and 3). Amounts drawn bear interest at
the prime rate (4% as of September 30, 2003) payable monthly and become due and
payable on December 31, 2004 or upon a change in control of the Company or
consummation of any other financing over $3 million for the initial commitment
of $2.5 million and over $7 million for both the $2.5 and $3.5 million
commitments in the aggregate. For the three and nine-months ended September 30,
2003 and 2002, the Company recorded approximately $42,500 and $3,000, and
$101,500 and $3,000, respectively, of interest expense related to the notes
payable to stockholder, which is included in interest expense in the
accompanying condensed consolidated statements of operations.
5. COMMITMENTS AND CONTINGENCIES
Malt Litigation
In connection with the Company being granted worldwide manufacturing and
marketing rights for certain of the Purifiner products, a royalty agreement was
entered into with a term equal to the life of the related patents or any
improvements thereto. Pursuant to this royalty agreement, the owner of the
patents was to receive 5% of the net unit sale price of all covered Purifiner
products, as defined. Additionally, 1% of the net sales price of replacement oil
filter elements was to be paid as a royalty on certain Puradyn filters for the
use of the U.S. Purifiner trademark. The Company is no longer retaining the
Purifiner patents or trademarks and accordingly is not renewing them upon
expiration.
In May 1994, the Company and the patent owner entered into a settlement
agreement relating to royalties under which the patent owner was entitled to a
minimum annual royalty of $24,000, payable in monthly installments of $2,000. In
February 1997, the patent owner filed an action against the Company for
nonpayment of approximately $20,000 of royalties claimed by him, seeking a
permanent injunction against the Company's manufacturing and selling of the
covered Purifiner products. On March 2, 1999, the trial court ruled that the
patent owner was not entitled to any injunctive relief but was entitled to
$20,169 in past royalties, which the Company paid. The patent owner filed a
motion for additional damages and attorney fees and on December 13, 2000, the
Court found the patent owner was entitled to an additional $15,505. The Company
appealed that judgment but has paid the additional judgment. Thereafter, on
February 22, 2002, the trial court ordered the Company to pay the sum of $18,049
for the patent owner's attorney's fees and court costs, for which the Company
posted a bond in the amount of $22,238 to secure payment. That order was
appealed and combined with the first appeal. On April 24th, 2002, the judgment
for attorney's fees and court costs was reversed. In May 2002, the bond was
discharged and in June 2002, the funds were released to the Company. In April
2003, the patent owner posed two discovery requests, in order to extend the
automatic dismissal of his claim. The Company does not believe the likelihood of
an unfavorable outcome is probable.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following should be read in conjunction with Management's Discussion and
Analysis of Financial Condition and Results of Operations included in the
Company's Form 10-KSB for the year ended December 31, 2002.
Other than historical and factual statements, the matters and items discussed in
this Quarterly Report on Form 10-QSB are forward-looking statements that involve
risks and uncertainties. Actual results of the Company may differ materially
from the results discussed in the forward-looking statements. Certain factors
that could contribute to such differences are discussed with the forward-looking
statements throughout this report.
General
The Company was formed in 1987, and was inactive until it commenced
limited operations in 1991 when it obtained worldwide manufacturing and
marketing rights to the Purifiner (R) product, now called the Puradyn By-pass
Oil Filtration System or the "PuraDYN" system.
Through 1997, the Company had minimal revenues from its distribution
network, which caused the Company to change its sales strategy. In 1998, the
Company changed its name from T/F Purifiner, Inc. to Puradyn Filter Technologies
Incorporated in anticipation of its new business plan. The Company reduced its
workforce and operational overhead in an effort to reduce cash expenditures
until it had sufficient funds to support operations based on its new sales plan.
The Company began to refocus its sales effort toward the development of
commercial relationships with original equipment manufacturers ("OEM's") and
companies having medium to large size fleets of vehicles, as well as the
expansion of its international and domestic distribution networks. As part of
this refocus, the Company announced a strategic relationship in September 2002,
with Honeywell's Consumer Products Group, the manufacturer of FRAM oil filters,
under which the PuraDYN system will be sold to Honeywell and co-branded with the
FRAM trademark name. The co-branded product will be distributed through
Honeywell's Consumer Products Group's distribution network to offer a complete
filtration system in conjunction with FRAM's full flow filter so as to
significantly reduce both large and small particle contamination in the
lubricating oil. Honeywell's Consumer Products Group also includes the
Prestone(R), Autolite(R) and Holts(R) brands and is a subsidiary of Honeywell,
Inc. There can be no assurance, however, that the Company's sales efforts or
strategic relationships will meet management's expectations or result in
projected revenues.
In July 2003, the Company announced that they have been approved as a
Strategic Supplier for one of the largest equipment rental companies in North
America, which plans to fully utilize the PuraDYN system throughout their
organization. The program will encompass retrofitting existing delivery vehicles
while simultaneously specifying the PuraDYN system on new delivery vehicles.
They then plan to begin installation on selected rental fleet equipment.
Although the system is fully supported at the corporate level, the program is
expected to take some time to gain momentum as all branches become familiar
enough with the benefits of the PuraDYN system to begin purchasing. The Company
continues its efforts with the rental company's many branches and the program is
planned to be included in the 2004 budget of the rental company. There can be no
assurance, however, that the Company's sales efforts will meet management's
expectations.
The Company's sales effort not only involves educating the potential
customer on the benefits of the PuraDYN system, but also allowing the customer,
at their request, to test the PuraDYN system on its fleet vehicles. Consequently
the sales cycle can be relatively long. The Company continues to work with
several large OEM's and a large number of companies that have large vehicle
fleets to enable them to evaluate the benefits of the PuraDYN system.
14
Effective June 1, 2000, the Company formed a wholly owned subsidiary
(Puradyn Filter Technologies, Ltd. "PFTL") in the United Kingdom to sell the
Company's products in Europe, the Middle East and Africa. The subsidiary was the
result of the dissolution of a joint venture (TF Purifiner, Ltd.) the Company
had with Centrax, Ltd. The results of PFTL have been consolidated with the
Company since June 1, 2000.
The Company directly and/or with the assistance of its sales
representatives, warehouse distributors, dealers or other agents, markets its
products primarily to national, regional and local accounts. Typically these
larger customers, and some smaller customers, have required an evaluation
period, usually ranging from three to twelve months, to ensure that the
Company's products perform as claimed. Management believes this evaluation
period will continue to be shortened as the Company's products gain wider
acceptance and support from well-known customers and OEM's. Based on the results
from some of the evaluations and from orders placed, the Company experienced a
significant increase in revenues in 2002 and through the first quarter of 2003;
however, there can be no assurance that revenues for the remainder of 2003 or
beyond will meet or exceed management's expectations. Sales for the second and
third quarters of 2003 were below management's expectations. This was partially
attributable to the sluggish economy in the second quarter, which negatively
impacted sales to one of the Company's significant customers from 2002, as well
as the longer than anticipated ramp up with the equipment rental company.
The Company recognizes revenue from product sales to customers,
distributors and resellers when products that do not require further services or
installation by the Company are shipped, when there are no uncertainties
surrounding customer acceptance and when collectibility is reasonably assured in
accordance with SAB 101. Cash received by the Company prior to shipment is
recorded as deferred revenue. Sales are made to certain customers under terms
allowing certain limited rights of return and other limited product and
performance warranties for which provision has been made in the accompanying
condensed consolidated financial statements. Management believes, based on past
experience and future expectations, that such limited return rights and
warranties will not have a material adverse effect on the Company's financial
statements.
During the three-months ended March 31, 2003, the Company recognized
revenue on several shipments of product to one of its largest customers. Under
the terms of the arrangement with the customer, the Company received full
payment for these shipments during the three-months ended June 30, 2003. These
shipments met the criteria for revenue recognition under SAB 101 as of March 31,
2003. In August 2003, the Company and the customer mutually agreed that the
customer would, at the customer's cost, return a portion of the shipment to the
Company, the Company would perform certain product enhancements, and the Company
would then, at the customer's cost, ship the enhanced product back to the
customer. These enhancements, which were not required to correct any product
quality or performance issues, will enable the customer to expand and broaden
its industry market targets. As of September 30, 2003, the Company completed the
enhancements on and shipped all of the returned product to the customer.
During the three-months ended June 30, 2003, in accordance with the
requirements of SFAS No. 48, Revenue Recognition When Right of Return Exists
(SFAS 48) and SAB 101, the Company recorded a provision for sales returns of
approximately $146,000, and a corresponding reduction in the cost of products
sold of approximately $107,000, related to the product returned for
enhancements. The Company recognized revenue and cost of products sold upon
shipment of the enhanced product to the customer, which, as described above, was
completed during the three-months ended September 30, 2003.
Critical Accounting Policies and Estimates
The Company's discussion and analysis of its financial condition and
results of operations are based upon the Company's condensed consolidated
financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States. The preparation of these
financial statements requires the Company to make estimates and judgments that
affect the amounts reported in the financial statements. On an on-going basis,
the Company evaluates its estimates, including
15
those related to product returns, bad debts, inventories, investments, warranty
obligations and contingencies and litigation. The Company bases its estimates on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
The Company believes the following critical accounting policies affect
its more significant judgments and estimates used in the preparation of its
consolidated financial statements.
Revenue Recognition
Revenue is recognized when earned. The Company's revenue recognition
policies are in compliance with the provisions issued in SAB 101. Revenue from
product sales to customers, distributors and resellers is recorded when products
that do not require further services or installation by the Company are shipped,
when there are no uncertainties surrounding customer acceptance and when
collectibility is reasonably assured. The Company provides for sales returns
based on an historical returns analysis. The estimate is updated for current
return activity and the provision is adjusted accordingly. Should actual returns
exceed management's estimates, the provision may require further adjustment and
accordingly, net sales may decrease.
Allowance for Doubtful Accounts
The Company maintains allowances for doubtful accounts for estimated
losses resulting from the inability of its customers to make required payments.
If the financial conditions of the Company's customers were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances may be required. The Company provides for potential uncollectible
accounts receivable based on customer specific identification and historical
collection experience. If market conditions decline, actual collection
experience may not meet expectations and may result in decreased cash flows and
increased bad debt expense.
Estimation of Product Warranty Cost
The Company provides for the estimated cost of product warranties at
the time revenue is recognized. The Company accrues for warranty costs for the
expected material and labor costs to provide warranty services. The methodology
used in determining liability for product warranty services was based upon
historical information and experience. The Company's warranty reserve is
calculated as the gross sales volume multiplied by the historical warranty
expense rate. While the Company engages in product quality programs and
processes, including actively monitoring and evaluating the quality of its
component suppliers, the Company's warranty obligation is affected by product
failure rates, material usage and service delivery costs incurred in correcting
a product failure. Should actual product failure rates, material usage or
service delivery costs differ from the Company's estimates, revisions to the
estimated warranty liability would be required.
Estimation of Inventory Obsolescence
The Company provides for estimated inventory obsolescence or
unmarketable inventory in amounts equal to the difference between the cost of
inventory and the estimated market value based upon assumptions about future
demand and market conditions. If actual market conditions are less favorable
than those projected by management, additional inventory write-downs may be
required.
16
RESULTS OF OPERATIONS FOR THE THREE-MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO
THE THREE-MONTHS ENDED SEPTEMBER 30, 2002
The following table sets forth the amount of increase or decrease represented by
certain items reflected in the Company's condensed consolidated statements of
operations in comparing the three-months ended September 30, 2003, to the
three-months ended September 30, 2002:
(In thousands) Three Months Ended September 30,
--------------------------------
2003 2002 Change
------- ------- --------
Net sales $ 507 $ 293 $ 214
------- ------- -------
Costs and expenses:
Cost of products sold 621 356 265
Salaries and wages 427 423 4
Selling and administrative 293 312 (19)
------- ------- -------
Total costs and expenses 1,341 1,091 250
------- ------- -------
Other income (expense):
Investment loss -- (14) 14
Interest income 13 15 (2)
Interest expense (89) (39) (50)
------- ------- -------
Total other expense (76) (38) (38)
------- ------- -------
Net loss $ (910) $ (836) $ (74)
======= ======= =======
NET SALES
Net sales increased by approximately 73% from approximately $293,000 in 2002 to
approximately $507,000 in 2003 primarily due to the reversal of the provision
for sales returns of approximately $146,000 from the customer product exchange,
which was reshipped to the customer in the third quarter 2003 (for further
details see "General" section above). Other factors that contributed to the
increase include the following: the Company added three new distributors,
purchases from some of the existing major customers were up slightly, and
approximately $33,000 of deferred revenue from prior period warranty related
sales deferrals was recognized.
Sales to three customers accounted for approximately 19%, 12% and 11%
respectively, of net sales for the three-months ended September 30, 2003. For
the three-months ended September 30, 2002, two customers accounted for
approximately 20% and 19%, respectively, of net sales. Excluding the effects of
the reversal of the provision for sales returns of approximately $146,000, the
Company experienced a 23% increase in sales for the three-months ended September
30, 2003 over the three-month period ended September 30, 2002.
COST OF PRODUCTS SOLD
Cost of products sold increased by approximately 74% from $356,000 in 2002 to
$621,000 in 2003. Material costs increased approximately $60,000 due to
increased net sales and by approximately $107,000 for the reversal of the
accrual related to the above described product enhancement in the second quarter
of 2003. In addition, the inventory provision was adjusted, resulting in
approximately $16,000 in additional expense. Excluding the effect of these
items, a 9% increase is primarily due to the increased manufacturing overhead
costs of approximately $43,000, resulting from the move to a larger
manufacturing facility at the end of 2002 and from the addition of a quality
control technician and a purchasing agent as well as approximately $18,000 in
increased direct labor related costs.
SELLING AND ADMINISTRATIVE EXPENSES
Selling and administrative expenses decreased by approximately 6% from $312,000
for the three-months ended September 30, 2002, to $293,000 for the three-months
ended September 30, 2003, which was primarily due to reduced selling and
marketing and investor relations expenses of approximately $41,000
17
from a reduction in the use of outside consultants. The Company recorded a net
credit to selling and administrative expense of approximately $116,000 compared
with a net credit of approximately $121,000 for the three months ended September
30, 2003 and 2002, respectively, relating to certain variable equity awards and
other stock based compensation. As stock-based compensation expense related to
variable awards is subject to changes in the quoted market value of the
Company's common stock, the Company cannot predict the impact of stock-based
compensation expense on operations in the future.
INVESTMENT LOSS
During the three-months ended September 30, 2002, approximately $14,000 of net
investment loss was recorded when the Company sold its remaining bond
investments.
INTEREST EXPENSE
Interest expense increased by approximately $50,000 primarily due to the
interest paid for the outstanding notes payable to stockholder, the balance of
which was $500,000 as of September 30, 2002 and is $4,501,900 as of September
30, 2003. Additionally, the amortization of financing costs related to the
warrants issued for the notes increased due to the second funding commitment
from the same stockholder.
RESULTS OF OPERATIONS FOR THE NINE-MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO
THE NINE-MONTHS ENDED SEPTEMBER 30, 2002
The following table sets forth the amount of increase or decrease represented by
certain items reflected in the Company's condensed consolidated statements of
operations in comparing the nine-months ended September 30, 2003, to the
nine-months ended September 30, 2002:
(In thousands) Nine Months Ended September 30,
-----------------------------------
2003 2002 Change
------- ------- --------
Net sales $ 1,573 $ 1,620 $ (47)
------- ------- -------
Costs and expenses:
Cost of products sold 1,787 1,512 275
Salaries and wages 1,339 1,248 91
Selling and administrative 1,311 1,101 210
------- ------- -------
Total costs and expenses 4,437 3,861 576
------- ------- -------
Other income (expense):
Investment loss -- (76) 76
Interest income 38 39 (1)
Interest expense (233) (146) (87)
------- ------- -------
Total other expense (195) (183) (12)
------- ------- -------
Net loss $(3,059) $(2,424) $ (635)
======= ======= =======
NET SALES
Net sales decreased by approximately 3% from approximately $1,620,000 in 2002 to
approximately $1,573,000 in 2003. Sales for 2003 have been below the Company's
estimates in large part because of the uncertainty in the economy, which has
greatly impacted one of our largest customers from 2002, whose reduced
expenditures were also impacted by industry trends and excess assets from an
acquisition. Additionally, the war in Iraq has negatively affected sales in the
Middle Eastern region.
Sales to two customers individually accounted for approximately 20% and 18% (for
a total 38%) of net sales for the nine-months ended September 30, 2003. For the
nine-months ended September 30, 2002, one
18
customer accounted for approximately 37% of net sales. The Company's UK
subsidiary had net sales of approximately $477,000 and $365,000, which
contributed 30% and 22% to total net sales for the nine-month periods ended
September 30, 2003 and September 30, 2002, respectively, an increase of 31% over
the nine-months ended September 30, 2002.
COST OF PRODUCTS SOLD
Cost of products sold increased by approximately $275,000, or 18%, from
$1,512,000 in 2002 to $1,787,000 in 2003. This increase is due to the increased
manufacturing overhead costs of approximately $222,000 resulting from the move
to a larger manufacturing facility at the end of 2002, the addition of a quality
control technician and a purchasing agent as well as increased freight costs
totaling approximately $8,000 due to more overseas shipments. The Company is in
the process of obtaining 9001:2000 certification from the International
Standardization Organization (ISO) and therefore added personnel to accomplish
this task. Adjustments to the inventory reserves and scrapped materials
accounted for approximately $41,000 of the increase.
SALARIES AND WAGES
Salaries and wages increased approximately $91,000, or 7%, due to the addition
of two employees as well as normal adjustments for vacation accruals and salary
increases.
SELLING AND ADMINISTRATIVE EXPENSES
Selling and administrative expenses increased by approximately 19% from
$1,101,000 for the nine-months ended September 30, 2002, to $1,311,000 for the
nine-months ended September 30, 2003, which was primarily due to an increase in
compensation expense of approximately $305,000 related to certain variable
equity awards and other stock based compensation. The Company recorded
compensation expense of approximately $13,000 compared with a net credit to
selling and administrative expenses of approximately $292,000 for the
nine-months ended September 30, 2003 and 2002, respectively, related to certain
variable equity awards and other stock based compensation.
Excluding the effects of stock-based compensation, selling and administrative
expenses actually decreased by approximately $95,000, or 7%, due to decreased
spending in engineering and sales and marketing expenses. As stock-based
compensation expense related to variable awards is subject to changes in the
quoted market value of the Company's common stock, the Company cannot predict
the impact of stock-based compensation expense on operations in the future.
INVESTMENT INCOME
During the nine-months ended September 30, 2002, the Company had investments in
bonds, for which approximately $76,000 of net investment loss was incurred. The
Company sold substantially all of its bond investments in April and May of 2002.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2003, the Company had cash and cash equivalents of
approximately $255,000. For the nine-month period ended September 30, 2003, net
cash used in operating activities was approximately $2,775,000, which primarily
resulted from the net loss of approximately $3,059,000. Net cash used in
investing activities was approximately $110,000 for the purchase of property and
equipment. Net cash provided by financing activities was approximately
$2,541,000 for the period, primarily due to draws taken on the loans provided
under stockholder commitments.
The Company has incurred net losses each year since its inception and
has relied on the sale of its stock from time to time and loans from third
parties and from related parties to fund its operations.
19
At September 30, 2003, the Company had working capital of approximately
$1,276,000 and its current ratio (current assets to current liabilities) was
2.98 to 1. The Company's net cash burn rate was fairly consistent for the year
ended December 31, 2002, but increased in December 2002 and into the first
quarter of 2003, due to costs associated with the move to the new facility and
due to product enhancements that the Company made which required rework to some
of the existing inventory. The product enhancement costs to existing inventory
were completed by the end of the second quarter of 2003. During the second and
third quarters of 2003, the burn rate dropped primarily due to minimal purchases
of inventory. Additionally, the Company's efforts to decrease expenditures in
the second and third quarters contributed to the net decrease of 7% in the burn
rate for the nine-month period ended September 30, 2003, as compared to the
nine-month period ended September 30, 2002. The Company experienced increased
cash flows from 2002 and 2003 first quarter sales activity; however, additional
cash will still be needed. Currently, cash flows from sales are not sufficient
to support the Company's operations. The Company continues to try to reduce its
burn rate in an effort to achieve positive cash flows from operations.
During 2000, the Company invested the funds received from its private
placements into corporate bonds, certificates of deposit and for a brief period,
in international bonds. The investment portfolio was managed by Salomon Smith
Barney, who in April 2002 extended a credit line loan to the Company, which was
collateralized by the investment portfolio. As of July 2002, the Company had
sold all of its investments, the proceeds of which were used to repay the
Company's loan on investments in March and April 2002 and to fund operations.
On March 28, 2002, the Company executed a binding agreement with one of
its stockholders, who is also a director, to fund up to $2.5 million through
March 31, 2003. Under the terms of the agreement, the Company could draw amounts
as needed in multiples of $500,000 to fund operations subject to Board of
Director approval. Amounts drawn bear interest at the prime rate (4% as of
September 30, 2003) payable monthly and become due and payable on December 31,
2003 or upon a change in control of the Company or consummation of any other
financing over $3 million. In March 2003, the payback date was extended to
December 31, 2004. In consideration for the stockholder entering into this
agreement the Company granted the stockholder 100,000 common stock purchase
warrants at an exercise price equal to the closing market price of the Company's
stock on the date of grant. As of September 30, 2003, the Company had drawn the
entire $2.5 million of the available funds.
On March 14, 2003, the Company executed a second binding agreement with
the same stockholder to fund up to an additional $3.5 million through December
31, 2003. Under the terms of the second agreement, the Company can draw amounts
as needed in multiples of $500,000 to fund operations subject to Board of
Director approval. Amounts drawn bear interest at the prime rate (4% as of
September 30, 2003) payable monthly and become due and payable on December 31,
2004 or upon a change in control of the Company or consummation of any other
financing over $7 million. In consideration, the Company granted the stockholder
125,000 common stock purchase warrants at an exercise price equal to the closing
market price of the Company's stock on the date of grant. As of September 30,
2003, the Company had drawn $2.0 million of the available funds.
Management believes that the commitment received from its stockholder
will be sufficient to sustain the Company's operations through December 31,
2003. However, if the commitment does not continue to fund for any reason or
budgeted sales levels are not achieved, the Company may have to modify its
business plan, reduce or discontinue some of its operations or seek a buyer for
part of its assets to continue as a going concern through 2003. The Company is
currently in the process of securing other sources of funding such as a private
placement, however, there can be no assurance that the Company will complete a
private placement or obtain additional funding from any other sources.
The Company believes it has sufficient cash for the remainder of fiscal
year 2003, and while the Company believes it can attain profitable operations in
the future, there is no assurance that sales will increase to the level required
to generate profitable operations and to provide positive cash flow from
operations, and there is no assurance that the Company will not have to seek
additional financing in the future.
20
In May 2002, the Company executed a sixty-eight month agreement to
lease a new office and warehouse facility, and moved in December 2002. This new
facility, which is located near the former office and warehouse facility,
consists of approximately 20,000 square feet for manufacturing and distribution
plus 5,000 square feet of office space. A $235,000 security deposit was paid,
which will be refunded ratably on an annual basis over the first three years of
the lease term beginning on the last day of the first lease year, provided there
has been no Event of Default, as defined, by the lessor. The total minimum lease
payments over the term of the lease aggregate approximately $774,000.
The Company's former office lease expired on March 31, 2003. The
Company was obligated to pay rent of approximately $32,000 through that date of
which approximately $17,000 of rent expense was accrued in 2002, which was the
Company's net obligation for the period that the former office space was vacant.
Consistent with industry practices, the Company may accept product
returns or provide other credits in the event that a distributor holds excess
inventory of the Company's products. The Company's sales are made on credit
terms, which vary depending on the nature of the sale. The Company believes it
has established sufficient reserves to accurately reflect the amount or
likelihood of product returns or credits and uncollectible receivables. However,
there can be no assurance that actual returns and uncollectible receivables will
not exceed the Company's reserves.
Sales of the Company's products will depend principally on end user
demand for such products and acceptance of the Company's products by original
equipment manufacturers ("OEM's"). The oil filtration industry has historically
been competitive and, as is typically the case with innovative products, the
ultimate level of demand for the Company's products is subject to a high degree
of uncertainty. Developing market acceptance, particularly worldwide, for the
Company's existing and proposed products will require substantial marketing and
sales efforts and the expenditure of a significant amount of funds to inform
customers of the perceived benefits and cost advantages of its products.
Impact of Inflation
Inflation has not had a significant impact on the Company's operations.
However, any significant decrease in the price for oil or labor, environmental
compliance costs, and engine replacement costs could adversely impact the
Company's end users' cost/benefit analysis as to the use of the Company's
products.
Item 3. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
Puradyn Filter Technologies Incorporated's Chief Executive Officer and Chief
Financial Officer have evaluated the Company's disclosure controls and
procedures as of November 13, 2003, and they concluded that these controls and
procedures are effective.
(b) Changes in Internal Controls
There are no significant changes in internal controls or in other factors that
could significantly affect these controls subsequent to November 13, 2003.
Part II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Certain litigation involving the Company is described in the Company's
Form 10-KSB for the year ended December 31, 2002. Subsequent to the filing of
such Form 10-KSB, no material developments have occurred with respect to such
litigation except in April 2003, the patent owner in the Malt litigation case
posed two discovery requests, in order to extend the automatic dismissal of his
claim.
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ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULT UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On July 16, 2003, the Company held its Annual Meeting of Stockholders.
At the meeting, 13,320,717 Common Shares (84.94% of the Common Shares
outstanding) were voted. Stockholders voted in person or by proxy for the
following purposes.
(a) Stockholders voted to elect seven directors, each to serve for a term
of one year, as follows:
DIRECTOR FOR WITHHELD AUTHORITY
--------------------- ---------- ------------------
Joseph V. Vittoria 13,307,732 12,985
Richard C. Ford 13,305,207 15,510
Kevin G. Kroger 13,309,907 10,810
Alan J. Sandler 13,312,807 7,910
Peter H. Stephaich 13,316,407 4,310
Ottavio Serena 13,316,407 4,310
Michael Castellano 13,307,907 12,810
(b) Stockholders voted to approve and ratify the appointment of Ernst &
Young LLP, independent certified public accountants, as the Company's
independent auditors for the year ending December 31, 2003. 13,226,699
shares were voted in favor of this proposal, 93,808 shares were voted
against and there were 210 abstentions.
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
a) Exhibits:
31.1 Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
b) Reports on Form 8-K.
A Form 8-K was filed July 17, 2003 for a press release announcing
the Company held its annual stockholders meeting.
A Form 8-K was filed August 14, 2003 for a press release
announcing the second quarter results of operations.
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SIGNATURES
In accordance with the requirements of the Exchange Act, Puradyn Filter
Technologies Incorporated caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
PURADYN FILTER TECHNOLOGIES INCORPORATED
(Registrant)
By /s/ Lisa M. De La Pointe Date: November 13, 2003
----------------------------------------
Lisa M. De La Pointe, Chief Financial Officer