U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-KSB
(Mark one)
[x] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended DECEMBER 31, 2003
-------------------------------------------
[x] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (No Fee Required)
-----------------------------------
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 (561) 547-9499
----------------------------------------------------------------
(Address of principal executive offices including Zip Code) (Telephone Number)
SECURITIES REGISTERED UNDER SECTION 12(B) OF THE EXCHANGE ACT:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
COMMON STOCK, $.001 PAR VALUE AMERICAN STOCK EXCHANGE
Securities registered under Section 12(g) of the Exchange Act: NONE
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ ]
State issuer's revenues for its most recent fiscal year: $1,906,517
The aggregate market value of the registrant's common stock held by
non-affiliates other than officers, directors and persons known to the
Registrant to be the beneficial owner (as that term is defined under the rules
of the Securities and Exchange Commission) of more than five percent of the
Common Stock based on the closing price on the American Stock Exchange as of
March 22, 2004 ($2.45), was approximately $11,196,500.
Indicate by check mark whether Registrant is an accelerated filer (as defined in
Exchange Act Rule 12-b-2.) Yes [ ] No [X]
As of March 22, 2004, there were 17,452,164 shares of registrant's common stock
outstanding, par value $.001.
This report contains a total of 50 pages.
TABLE OF CONTENTS
PART I
ITEM 1. DESCRIPTION OF BUSINESS.......................................................................... 3
Forward Looking Statements
The Company
Products
Warranties
Marketing
Distribution
Sales
Manufacturing and Production
Competition
Intellectual Property
Governmental Approval
Engineering and Development
Employees
ITEM 2. DESCRIPTION OF PROPERTY........................................................................ 9
ITEM 3. LEGAL PROCEEDINGS.............................................................................. 9
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................ 10
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS....................................... 10
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.......... 10
General
Critical Accounting Policies and Estimates
Results of Operations
Liquidity and Capital Resources
Impact of Inflation
Quarterly Fluctuations
Risk Factors Affecting Future Results of Operations
ITEM 7. FINANCIAL STATEMENTS........................................................................... 17
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES.......... 17
ITEM 8A. CONTROLS AND PROCEDURES........................................................................ 17
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.............................................. 18
ITEM 10. EXECUTIVE COMPENSATION......................................................................... 21
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT................................. 23
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................................................. 24
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K............................................................... 25
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES......................................................... 27
2
PART I
The term "the Company", "Puradyn", "we", "us" or "our" refers to Puradyn Filter
Technologies Incorporated, unless the context otherwise implies.
ITEM 1. DESCRIPTION OF BUSINESS
--------------------------------
FORWARD LOOKING STATEMENTS
--------------------------
This Annual Report on Form 10-KSB contains forward-looking statements
that involve substantial risks and uncertainties. Forward-looking statements can
be identified by the fact that they do not relate strictly to historical or
current facts. They use words such as "may", "will", "expect", "intend",
"anticipate", "believe", "estimate", "continue" and other similar words. You
should read statements that contain these words carefully because they discuss
our future expectations, making projections of our future results of operations
or our financial condition or state other "forward-looking" information.
Forward-looking statements involve known and unknown risks and uncertainties
which may cause the actual results, performance or achievements of our Company
to be materially different from those which may be expressed or implied by such
statements. The factors listed in the section entitled "Risk Factors Affecting
Future Results of Operations " in the section "Management's Discussion and
Analysis of Financial Condition and Results of Operations", as well as any other
cautionary language in this report, provide examples of risks, uncertainties and
events which may cause our actual results to differ materially from the
expectations we described in our forward-looking statements. Except as required
by law or regulation, we do not undertake any obligation to publicly update
forward-looking statements to reflect events or circumstances after the date on
which the statement is made or to reflect the occurrence of unanticipated
events.
You can learn more about the Company by visiting our website at
www.puradyn.com. Information on the website is neither incorporated into, nor a
part of, this report. We encourage you to read this and other reports filed by
the Company with the Securities and Exchange Commission. Puradyn will provide
you with a copy of any or all of these reports at no charge. You may also read
and copy any materials the Company files with the SEC at the SEC's Public
Reference Room at 450 Fifth Street, NW, Washington, D.C. 20549, or call the SEC
Public Reference Room to obtain information at 1-800-SEC-0330.
THE COMPANY
-----------
Puradyn Filter Technologies Incorporated designs, manufactures, markets
and distributes worldwide the PURADYN(R) bypass oil filtration system (the
"PURADYN") for use with substantially all internal combustion engines and
hydraulic equipment that use lubricating oil. Working in conjunction with an
engine's full-flow oil filter, the PURADYN system cleans oil by continually
removing solid, liquid and gaseous contaminants from the oil through a
sophisticated and unique filtration and evaporation process. For engine
lubricating oil, our filters incorporate an additive package. Because
lubricating oil is kept in a continually clean state, the PURADYN has been used
effectively to extend oil-drain intervals and to extend the time between engine
overhauls. We are the exclusive manufacturer of the disposable replacement
filter elements ("Element") for the PURADYN.
We operate through:
o Puradyn Filter Technologies Incorporated - parent company
o Puradyn Filter Technologies, Ltd. ("Ltd.", "Puradyn, Ltd")
o Ltd. is a wholly owned subsidiary established in 2000 which
primarily distributes and markets the PURADYN system in
countries outside North America, including Europe, the Middle
East, the former Soviet Union, Scandinavia and South Africa
through a network of independent distributors.
The Company was formed in 1987 under the name T/F Systems, Inc. as a
distributor for Refineco Manufacturing Company, Inc., the manufacturer of the
Purifiner(R) bypass oil filtration system, as the PURADYN was then known. In
October 1990, the name of the Company was changed to T/F Purifiner, Inc. In
1995, the Company purchased from Refineco all marketing and manufacturing
rights.
In 1996, the Company entered into a joint venture agreement with
Centrax, Ltd. in the United Kingdom called TF Purifiner, Ltd. In May 2000, the
Company and Centrax agreed to dissolve TF Purifiner, Ltd., and the Company is
currently conducting operations in the UK under the name Puradyn Filter
Technologies, Ltd., a wholly owned subsidiary. At the time of the dissolution,
Centrax sold to the Company certain foreign patents, inventory and factory
equipment used in manufacturing products for the joint venture.
3
In February 1998, the Company filed a Certificate of Amendment to
change its name from T/F Purifiner, Inc. to Puradyn Filter Technologies
Incorporated.
In December 2001, the Company was accepted and listed on the American
Stock Exchange under the symbol PFT.
PRODUCTS
--------
The core product, the PURADYN bypass oil filtration system, is offered
in two models, TF and PFT, and can be attached to almost any engine and
hydraulic systems. The concept of bypass filtration is similar to a dialysis
machine that filters blood to rid it of impurities, keeping the oil continually
clean. Whenever the engine or machinery is operating, the PURADYN is extracting
from the oil solid particles down to less than one micron (1/39 millionth of an
inch), as well as gaseous and liquid contaminants, while protecting the engine
or hydraulic equipment from harmful wear caused by contaminants in the oil.
Through use of a simple oil analysis, the condition of the oil is monitored and
if the condition of the oil is considered good for continued use, the oil need
not be changed.
Consequently, the PURADYN significantly reduces maintenance costs by
decreasing oil consumption, engine wear and certain other types of general
maintenance as well as reducing environmental concerns and costs associated with
the storage and disposal of waste oil. These potential savings are achieved from
utilizing the PURADYN, which generally has a relatively short payback period of,
on average, nine to fourteen months.
The original PURADYN system, the TF model, is currently manufactured in
six different sizes suitable for placement on engines or equipment with oil sump
capacities ranging from 8 to 240 quarts. A new generation of product, the PFT
model, has been engineered to be manufactured in five different sizes with sump
oil capacities varying from 8 to 60 quarts. The PFT model offers the same
benefits and features of the TF model, with the added enhancements of easier
serviceability and the main component of the system being more
corrosion-resistant.
We also have developed and sell a specialized Hydraulic Batch System
("HBS"), which is mounted on a handcart for mobility. The HBS was developed to
clean 55-gallon drums of used hydraulic oils. The HBS consists primarily of two
60-quart puraDYN systems, a preheater, a pump and other miscellaneous parts.
All PURADYN systems are compatible with virtually all standard and
synthetic oils on the market and they work with engines using gasoline, diesel,
propane or natural gas. Except for the HBS, the PURADYN system cannot be used on
engines that do not have a pressurized lubricating system, and none of the
products can be used on any engines that mix oil with fuel.
We also manufacture and distribute replacement filter elements
("Element" or "Elements") for the PURADYN system. Depending upon the
application, we generally recommend that the Element be replaced at the engine
manufacturer's recommended/approved periodic oil change interval or as oil
analysis dictates. The type of Element used also depends upon the specific type
of engine or hydraulic application. A customer can change the Element and take
the required oil sample in approximately five to fifteen minutes.
By continually removing contaminants and replacing vital additives
through a patented time-release additive package, the PURADYN Element
substantially extends intervals between oil changes. Elements are
interchangeable between (similar-sized) models.
The Company has implemented patented technology in the filter Elements
that provides several advantages including:
o An additive package in which pelletized chemicals are added to the
filtering media to replenish additives in the oil. This additive
package helps to maintain the oil's chemical balance and viscosity.
o CGP(R) Extended Life Filter Element containing a patent-pending process
for chemical grafting. This new technology improves the attraction and
retention of soot and other solid contaminants to the packed cotton
filter material. CGP(R) technology was developed over a three-year
period inclusive of laboratory and field-testing. Consolidated results
from across the country show that test vehicles averaged more than
160,000 miles without the need for a traditional oil change.
o Ease of maintenance: The filter Element can be replaced in a matter of
seconds.
4
When the Element is changed, an insignificant amount of make-up oil is
added to replace any oil retained in the used Element or consumed during the
normal engine combustion process. The Company's performance warranties require
the user to take a small sample of the oil for submission to an oil-testing
laboratory at the same intervals that the OEM recommends for an oil change, or
as oil analysis dictates (See "Warranties"). The oil analysis also allows us to
monitor customer satisfaction and provides a trend and timeline for both the
Company and end user should a problem arise.
The PURADYN has no moving parts and consequently requires no
significant ongoing maintenance. As long as Elements are changed at the
recommended intervals and other standard preventive maintenance procedures such
as oil analysis are completed, the Company believes the PURADYN will perform as
designed.
WARRANTIES
----------
The PURADYN carries a six-month `money-back' performance guarantee, and
is currently warranted to the original user to be free of defects in material
and workmanship for one year with unlimited miles/hours. End users have the
option to purchase a four-year extended warranty, however, sales of these
extended warranties have been minimal.
For the Company's performance guarantee and warranties to remain in
effect, users must, among other things, maintain a record of the laboratory oil
analysis results. To date, there have been no material warranty claims, although
there can be no assurances that such a trend will continue.
The Company has received letters from Deere & Company, Detroit Diesel
Corporation, Caterpillar, Inc., Ford Motor Company, Mack Trucks, Inc., Cummins
Engine Company, Inc., Daimler Chrysler Corporation, Mercedes Benz of North
America, Inc. and others who have all stated that the installation and use of
the PURADYN does not void their manufacturer warranties unless an engine failure
is attributed to the PURADYN. Most engine manufacturers will accept oil analyses
as alternatives to their recommended oil change intervals. This is standard
industry practice endorsed by OEMs and various fleet maintenance organizations.
MARKETING
---------
The Company's products are marketed to numerous segments of the
transportation industry including trucking, marine, agricultural, bus,
recreational vehicle, generator, construction, mining, industrial and hydraulic
applications, and other users of engines or equipment that utilize up to 50
weight oil for lubrication. Currently, the Company's primary focus is on the
Class 3 - 8 on-highway fleet and industrial/construction, end-user and OEM
segments.
The Company determined that an advertising campaign in OEM and truck
fleet-related trade magazines, combined with editorials, trade shows and other
methods to promote its products, was prudent in order to generate awareness and
help stimulate sales primarily with targeted end-users, OEMs and on-highway
fleets. Additionally, the Company employs six sales personnel to service the
existing distribution network and stimulate new sales.
In late 2001 and throughout 2002, the Company's sales and marketing
strategy was hindered due primarily to its inability to undertake a full-scale
new product introduction as a result of design issues faced following the launch
of the PFT model in 2001. The design issues were corrected in the spring of
2002, with a significant product enhancement introduced in the fall of 2002.
Our products have achieved recognition from well-known sources,
including certification (in 1994) and re- certifications (in 1998 and 2003) by
the California Environmental Protection Agency's Department of Toxic Substances
as a `Pollution Prevention' technology. We believe that such recognition, as
well as our presence at national industry trade shows, have and will continue to
enable the Company to increase industry recognition of the PURADYN name and
products.
We rely on management's ability to determine the existence and extent
of available markets for our product. Company management and consultants have
considerable sales and marketing backgrounds and have devoted a significant
portion of their time to sales-related activities.
One of our marketing strategies is based on creating customer
`pull-through', a sustained level of request for our product on the OEM level
from end-users. To this end we established aftermarket programs in 2001 and 2002
with Mack Trucks, Volvo Trucks North America, Pierce Manufacturing and Paccar
(parent company of Kenworth and Peterbilt), all of which are OEMs that sell and
service, to offer our product through their dealer network and distribution
centers. To date, customer pull-through has resulted in a limited number of our
systems being factory-installed at individual Volvo Trucks, N.A., International
Truck and Engine, Mack Trucks, Kenworth Truck and Freightliner facilities.
Monroe Truck Equipment (a major General Motors Corporation modification center)
has installed over 600 PURADYN systems at the request of one of the largest
fleets in the US.
5
In 2002, Honeywell Consumer Products Group ("Honeywell"), manufacturer
of FRAM(R) filters, announced a strategic alliance with Puradyn. Honeywell,
which also manufactures the Prestone(R), Autolite(R) and Holts(R) brands, will
offer our products co-branded as PURADYN and FRAM through its extensive North
American distribution network. In early 2003 Honeywell finalized and placed its
initial stocking order, and in line with our strategic alliance, we are able to
offer the full line of FRAM(R) filters to our distributors.
In 2003 we were selected as a Strategic Supplier for one of North
America's larger equipment rental companies. Also in 2003, Ferrara Fire
Apparatus, an OEM of custom-crafted emergency fire and rescue response vehicles,
released a joint announcement with us stating they would install the PURADYN
system in their line of premium chassis.
The Company continues to work with a marketing and public affairs
consultant to promote PURADYN to municipalities in Florida and other specified
states. Additionally, the Company again received approval in 2003 for Florida's
State Negotiated Agreement Price Schedule (SNAPS II) to allow easier marketing
of our system to Florida local and state government agencies at discounted
prices. The program has been successful, however, as per the terms of the SNAPS
II agreement, 2003-2004 may be the last year the Company will participate in the
program.
In order to more efficiently carry out the Company's investor relations
activities, we discontinued our relationship with an outside firm in December
2002 and established an in-house investor relations department in January 2003.
DISTRIBUTION
------------
We have formal distribution agreements with domestic and international
distributors wherein they are required to maintain minimum product inventory
levels, maintain a storefront and services bay(s), and retain access to
qualified technicians trained by our technical personnel in product installation
and service. All distributors must pay in a timely fashion, and with respect to
international distributors, the agreements typically establish the minimum
dollar amount of inventory to be purchased as well as shipping terms.
The Company has warehouse distributors located throughout North
America, predominantly in the heavy-duty trucking industry. The remaining
distributors are located primarily in South America, England, Europe and Asia.
These distributors purchase product directly from the Company and sell to their
existing or new customers. The Company will accept returns of products that are
defective at the time of sale to the distributor or prove to be defective during
the warranty period. Returns are subject to specific conditions.
As a significant portion of our products are sold to distributors and
end users for use on transportation vehicles, this could unfavorably affect our
overall exposure to credit risk as these customers could be affected by
potential economic or other conditions.
Puradyn, Ltd. operates from the U.K. to generate distribution and sales
in Europe, the Middle East, the former Soviet Union, South Africa and
Scandinavia. There can be no assurance that such distributors will be successful
in introducing the PURADYN in their territories as they will face obstacles
similar to those the Company and its other distributors have encountered in
introducing an innovative technology in their territories. Ltd. has successfully
commenced or completed various evaluation programs, including those of two large
international generator manufacturers, four truck OEMs, one construction
equipment OEM and one diesel engine OEM. One of the world's largest OEMs of
medium-size power generators approved and began purchasing the PURADYN from Ltd.
in 2002.
SALES
-----
DIRECT SALES
The Company directly and/or with the assistance of its manufacturer's
representatives, distributors or other agents, markets its products directly to
OEMs, other distributors and national accounts. Typically these larger
customers, and some smaller customers, require an evaluation period to operate
the system on their equipment. While set for a specific period of time, usually
ranging from three to twelve months, evaluations are often influenced by a
number of variables including equipment downtime or servicing which may extend
the evaluation period. Consequently, the sales period can be relatively long. We
believe this evaluation period will continue to be shortened as the Company's
products gain wider acceptance and support from well-known end users and OEMs.
In 2003, we conducted a record number of 80 evaluations, most of which are
currently ongoing.
6
Currently, our products are being evaluated (in various stages of
progress) by numerous potential end users and existing customers including,
among others:
o A leading major generator set OEM
o A major construction equipment OEM
o A major engine OEM
o A leading soft drink Company
o A road materials handling Company
o Two leading food companies
o A leading truck leasing Company
o An important OEM forklift company
o The U.S. Department of Energy
In July 1995, the General Services Administration issued National
Stocking Numbers for some of our products. The Company negotiated a new contract
that was received in July 1999 and this has enabled us to sell our products to
the U.S. Government and its agencies.
During 2003 and 2002, three and two customers together accounted for
approximately 45% and 44%, respectively, of the Company's consolidated net
sales. In 2003, there were three customers that individually accounted for
greater than 10% each of net sales, or approximately $334,000, $300,000 and
$221,000, while in 2002 two customers individually accounted for greater than
10% each of net sales, or approximately $593,000 and $357,000.
In 2003 there were five customers whose trade receivable balances
equaled or exceeded 5% of total receivables, representing approximately 31%,
21%, 19%, 6% and 5%, respectively, for a total of 82% of total accounts
receivable. The loss of business from one or a combination of the Company's
significant customers could adversely affect its operations.
INTERNATIONAL SALES
The Company, directly and/or with the assistance of commission-based
manufacturer's representatives, has established primarily non-exclusive
distributors in various countries, including Denmark, South Africa, Nigeria,
United Kingdom, Kuwait, United Arab Emirates, Thailand, Colombia, and others.
The ultimate success of these and other distributors depends upon, among other
things, their abilities to successfully introduce and sell the product in their
territories including obtaining local evaluations, establishing distribution and
other factors similar to those faced by the Company in the United States. Total
international sales amounted to approximately 41% and 40% of consolidated net
sales in 2003 and 2002, respectively. Sales have been adversely affected by the
weakened local economies of some of these nations and future sales to their
distributors may be adversely affected due to these continuing economic and/or
political problems, such as the war in Iraq, which negatively affected sales in
the Middle East.
MANUFACTURING AND PRODUCTION
----------------------------
The Company purchases component parts for its PURADYN systems and
manufactures its entire line of filter Elements. The component parts are
assembled, packed and shipped from our facility in Boynton Beach, Florida.
We currently source (i.e., purchase each raw material and component
part from a specific vendor) substantially all of our raw materials and
component parts from various vendors in the United States. Substantially all the
tools and dies used by certain of our vendors are owned by the Company. We have
researched alternative sources of supply and do not anticipate that the loss of
any single supplier would have a material long-term adverse effect on our
business, operations or financial condition.
In January 2004, we received ISO 9001:2000 certification from the
International Organization for Standardization. ISO 9001:2000 is a series of
internationally accepted, multi-part quality management systems for
industry-wide standardization applied to manufacturing and service
organizations. Management believes this certification will reinforce recognition
of its tangible commitment to quality control from OEMs and other potential
large customers.
7
COMPETITION
-----------
Competitive bypass oil filters produced by other companies in varying
degrees address the issues of solid or liquid contaminant filtration through
centrifugal design, media filtration or evaporation. However, PURADYN believes
that it designs and manufactures the only bypass oil filtration system that
incorporates all of the following features:
o Filtering solid contaminants to below one micron, including
enhanced soot retention through the use of a patent-pending
process for chemical grafting;
o Effectively removing gaseous and liquid contaminants through a
heated evaporation chamber;
o Replenishing the base additives;
o Maintaining oil viscosity and,
o Specific to the TF model, confirming oil flow.
In addition, the PURADYN system is the only bypass oil filtration
system designated by the California EPA as a `Pollution Prevention' technology.
The certificate states in part, "The PURADYN(R) system has been shown to be an
effective means of extending engine oil change intervals without adversely
affecting engine wear or performance."
Recent tests performed by a leading independent testing facility
demonstrated that the PURADYN system surpassed the capacity, efficiency and
overall performance of its leading competitors. Using our standard filter with
additives, the PURADYN system tested 92.05% efficient under the SAE HS806-95
(modified) standards for filter capacity and contaminant removal. Efficiency
reflects the ability to remove particles and other chemicals from the oil. While
efficiency is not necessarily a standard of comparison to other products, it
does demonstrate the filtering capability of the PURADYN unit. These tests,
performed at the request of one of North America's largest engine manufacturers,
compare favorably with similar tests run by Puradyn in 2001 using our CGP
filter, which showed a filter efficiency of 99.75%.
The use of our products reduces the need for maintenance services,
replacement parts, original oil sales and waste oil disposal.
Most of the competitive products and services are provided by companies
that have significantly greater financial, marketing and operating resources
than does the Company.
INTELLECTUAL PROPERTY
---------------------
The Company owns patents for the PURADYN system, filter Elements, oil
flow meter, and two patents for technology which include a manifold type
full-flow filter/bypass filtration unit (side-by-side) in the U.S. and certain
other countries. The expiration dates of these patents range from May 2014 to
October 2016.
In addition, we received patents from the United States Patent Office
and certain other countries for a filter Element containing an additive package
in which pelletized chemicals are added to the filtering media to replenish
additives in used oil. This is especially important on new engines built since
the enactment of the Clean Air Act of 1992, which requires tighter
specifications for diesel engines.
We also recently applied for a provisional patent application for
improved filtration efficiency using CGP(R), a process for chemical grafting
that can significantly increase the life of the filter Element and further
extend oil drain intervals. There can be no assurance that such patents will
withstand competitive threats to their patentability or, in the case of the
redesigned PURADYN, be developed into commercially viable products.
We have registered the product trademark "Puradyn" in the United States
and other countries where the "Purifiner" trademark was registered, and have
registered the product trademark "CGP" in the United States.
GOVERNMENTAL APPROVAL
---------------------
Our products typically do not require any governmental approvals. As
part of the certification process under the California Environmental Protection
Agency's Department of Toxic Substances in July 1994 and subsequent
re-certifications in July 1998 and August 2003, the Company obtained an
Executive Order issued by the State of California Air Resources Board stating
that the PURADYN does not reduce the effectiveness of applicable vehicle
pollution control systems, and may be installed on all 2002 and older model
vehicles with pressure oil systems.
In October 2002, new environmental regulations requiring higher
standards for diesel truck emissions took effect with more stringent
conformances expected in 2004 and 2007. We believe that engine and truck
manufacturers can capitalize on our enhanced technology to remove soot from the
oil.
8
ENGINEERING AND DEVELOPMENT
---------------------------
Currently, we have two individuals directly involved in product
engineering and development: a Product Engineer Manager, an Engineering
Technician and until August 2003, a Technical Consultant (one of the original
inventors of the product), as well as fulltime staff to support the product
line. The engineering department is also testing additional design improvements
that may be candidates for patents for the Company. During the past two years
our engineering department has devoted resources to improve the product's
filtration efficiency and abilities to meet the customers extended drain
interval requirements with the next generation of diesel engines. This required
a complete redesign of the existing product to make it easier to use by our
customers.
In 2003 and 2002, we spent approximately $50,000 and $129,000,
respectively, on engineering research, the cost of which was not passed on to
our customers.
EMPLOYEES
---------
At December 31, 2003, the Company had 38 employees, including 4 from
Ltd., in the following areas:
o 12 in manufacturing, assembly, quality control, warehousing
and shipping
o 1 in purchasing
o 2 in customer service
o 6 in marketing and sales
o 1 in technical support and installation assistance
o 2 in engineering and development
o 4 in finance
o 10 in administrative positions
None of the employees are represented by a labor union. The Company
believes its employee relations are good.
ITEM 2. DESCRIPTION OF PROPERTY.
----------------------------------
In December 2002, the Company moved into new leased corporate
facilities within two miles of its former location, where substantially all of
the Company's operations are conducted, expanding from approximately 14,000 sq.
ft. to approximately 25,500 sq. ft. (5,000 sq. ft. for administration, 20,500
sq. ft. (versus former 10,000 sq. ft.) for manufacturing. The lease term at the
new facility is for 68 months with a total lease obligation of approximately
$774,000.
In order to support its operations in Europe, Ltd. had a lease for
3,150 square feet in Devon, England, which extended through March 31, 2002,
whereupon it converted to a month-to-month basis for approximately $2,000 per
month. Due to anticipated increased sales activity, Ltd. moved to a 4,260 square
foot facility in Devon in September 2003. They assumed the existing lease, which
expires in August 2004, at which time they will negotiate a new lease.
ITEM 3. LEGAL PROCEEDINGS.
----------------------------
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
9
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 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 time remaining before
the automatic dismissal of his claim. The Company does not believe the
likelihood of an unfavorable outcome is probable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
-------------------------------------------------------------
Not applicable.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
------------------------------------------------------------------
As of March 22, 2004, there were approximately 2,587 stockholders
of record of the Company's stock. The closing bid price quoted on the American
Stock Exchange for the Company's Common Stock at March 22, 2004 was $2.45. The
Company currently trades under the symbol "PFT".
The transfer agent for the Company's common stock is Florida Atlantic
Stock Transfer, Inc., 7130 Nob Hill Road, Tamarac, Florida 33321.
The Company has never declared or paid cash dividends on its common
stock. The Company presently intends to retain future earnings, if any, to
finance the expansion of its business and does not anticipate any cash dividends
will be paid in the foreseeable future. The future dividend policy will depend
on our earnings, capital requirements, expansion plans, financial condition and
other relevant factors.
The following table sets forth for the period indicated, the high and
low sales prices for the quarterly periods in 2002 and 2003.
QUARTER ENDED 2002 SALES PRICE 2003 SALES PRICE
-------------------------- -------------------------
HIGH LOW HIGH LOW
------------- ------------ ------------ ------------
March 31 $4.85 $2.70 $2.70 $1.40
June 30 $4.49 $2.70 $2.70 $2.10
September 30 $3.21 $2.20 $2.80 $1.80
December 31 $2.80 $1.80 $2.35 $1.40
As of March 22, 2004, the high sales price for the first quarter of
2004 was $3.00, while the low for the quarter was $1.91.
On December 10, 2003, the Company completed the sale of 750,000 shares
of its common stock through its current private placement to a third party
investor, initiated in November 2003, with gross proceeds of approximately
$1,500,000, all of which will be used for capital equipment purchases,
marketing, working capital and general corporate purposes. On March 12, 2004,
the Company received gross cash proceeds of $2,000,000 from the sale of
1,000,000 shares of common stock to the same investor. The funds will be used to
reduce the outstanding principal balance of the notes payable to stockholder.
The Company will then draw amounts, per the terms of the stockholder commitment
letters dated March 28, 2002 and March 14, 2003, and all amendments thereto, as
needed, for operating and capital expenditures.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
------------------------------------------------------------------------
RESULTS OF OPERATIONS
---------------------
General
-------
Sales of the Company's products will depend principally upon end user
demand for such products and acceptance of the Company's products by OEMs. The
10
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 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.
Through industry data research, we have been able to identify the
potential applications where management believes market penetration is most
accessible. Currently no bypass oil filtration system has captured a substantial
share of the estimated recurring $13 billion potential market. We believe we are
in a unique position to capitalize on the growing acceptance of bypass oil
filtration given that our product and our Company are positioned as, including,
but not limited to:
o A competitively priced, value-added unique product
o An alternative solution to the rising costs and increasing
dependence on foreign oil
o Compliant with existing and reasonably foreseeable
environmental applications
Since 2001, the Company has redirected the focus of its sales strategy
from individual sales and distribution efforts to the development of a strong
nationwide distribution network that will not only sell but also install and
service our product.
Additionally, we began to refocus our sales and marketing efforts to
target areas and issues specific to the bypass oil filtration industry,
including educating the customer on the benefits of our system and cultivating
an innovative outlook on oil maintenance, specifically, that oil does not need
to be changed on a regular basis.
This strategy includes focus on:
o The expansion of existing strategic relationships
o Development and expansion of our distribution network with
qualified distributors in order to establish a sales- and
service-oriented nationwide infrastructure
o Continuing to target existing and new medium-to-large sized
fleets, industrial/construction business and major diesel
engine and generator set OEMs
o Creating customer `pull-through', a sustained level of request
for our product on the OEM level
o Closely monitoring evaluations to ensure customer issues are
addressed on a timely basis
o Converting customer evaluations into sales, both immediate and
long term
While this is a long-term and ongoing commitment, we believe we have
achieved a limited amount of industry acceptance based on recent
accomplishments:
o 2002 strategic alliance with Honeywell's Consumer Products
Group (Honeywell), the manufacturer of FRAM(R) oil filters,
under which the PURADYN system will be sold and co-branded
with the FRAM trademark name. The co-branded product will be
distributed through Honeywell's national distribution network
to offer a complete filtration system.
o 2002 approval and purchase of the PURADYN system by a major
international OEM of medium-sized power generators.
o 2003 selection as a Strategic Supplier for one of the larger
equipment rental companies in North America, which plans to
fully utilize the PURADYN system throughout its organization.
Although the system is fully supported at the customer's
corporate level and has been included in the 2004 budget, 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.
o 2003 announcement by an OEM of custom-crafted emergency fire
and rescue response vehicles that they would be installing
the PURADYN system as standard equipment on its line of
premium chassis.
We believe that industry acceptance resulting in sales will continue to
grow in 2004; however, there can be no assurance that any of our sales efforts
or strategic relationships will meet management's expectations or result in
actual revenues.
11
The Company's sales effort not only involves educating the potential
customer on the benefits of our product, but also allowing the customer to test
and evaluate the PURADYN system on its fleet vehicles. While set for a specific
period of time, typically ranging from three to twelve months, evaluations are
often influenced by a number of variables including equipment downtime or
servicing, which may extend the evaluation period. Consequently, the sales cycle
can be relatively long. Management believes that this evaluation period will
continue to be shortened as our products gain wider acceptance, support and
usage from well-known customers and OEMs. In 2003, the Company conducted a
record number of 80 evaluations, most of which are currently ongoing.
Effective June 1, 2000, the Company formed a wholly owned subsidiary,
Puradyn Filter Technologies, Ltd. ("Ltd."), 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 Ltd. have been consolidated with the
Company since June 1, 2000.
International sales, a previously untapped market for our product due
to equity limitations, are especially well suited to our product given that
environmental controls are not as regulated in countries outside North America.
Certain applications representing a higher return on investment are more
prevalent in use outside of North America and end-users consequently are more
receptive to the total maintenance package, including the use of oil analysis,
which the PURADYN system represents. In 2003, total international sales
accounted for 41% of the Company's consolidated net sales.
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 for which collectibility is reasonably
assured in accordance with Staff Accounting Bulletin (SAB) No. 104, Revenue
Recognition in Financial Statements. 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
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.
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 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
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On an on-going basis, the
Company evaluates its estimates, including those related to product returns, bad
debts, inventories, financing operations, 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.
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.
The policy for determining past due status is based on the contractual
payment terms of each customer, which is generally net 30 or net 60 days. Once
collection efforts by the Company and its collection agency are exhausted, the
determination for charging off uncollectible receivables is made.
12
Estimation of Product Warranty Cost
The Company provides for the estimated cost of product warranties at
the time revenue is recognized. 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.
Impairment of Long-Lived Assets
The Company periodically evaluates the recoverability of the carrying
amount of its long-lived assets under the guidelines of SFAS No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets. Factors that the Company
considers in making this evaluation include estimating the undiscounted net cash
flows estimated to result from the assets over their remaining useful life.
Should the Company's estimates of these factors change, the Company's results of
operations and financial condition could be adversely impacted.
Revenue Recognition
Revenue is recognized when earned. The Company's revenue recognition
policies are in compliance with the provisions issued in SAB No. 104, Revenue
Recognition in Financial Statements. 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 for which collectibility is
reasonably assured. The Company provides for sales returns based on an
historical analysis of returns. 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.
Results of Operations
---------------------
The following table sets forth (amounts in thousands) the Company's
operating information for the years ended December 31, 2003 and 2002:
(IN THOUSANDS)
INCREASE
2003 2002 (DECREASE)
------- ------- -------
Net sales $ 1,907 $ 2,137 $ (230)
Operating costs and expenses:
Cost of products sold 2,283 2,059 224
Salaries and wages 1,728 1,872 (144)
Selling and administrative 1,667 1,522 145
------- ------- -------
5,678 5,453 225
Loss from operations (3,771) (3,316) 455
Other income (expense):
Investment loss -- (22) 22
Interest income 51 53 (2)
Interest expense (331) (231) (100)
------- ------- -------
Total other expense (280) (200) (80)
Net loss $(4,051) $(3,516) $ 535
======= ======= =======
13
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002
---------------------------------------------------------------------
NET SALES Net sales decreased by approximately $230,000 from
approximately $2,137,000 in 2002 to approximately $1,907,000 in 2003. Despite a
significant increase in revenues in the first quarter of 2003, total sales for
2003 were below management's expectations. This is due in part to a sluggish
economy in the second quarter, which negatively impacted sales to one of our
significant customers; the longer-than-anticipated ramp up of our program with
the equipment rental company; and, with respect to international sales, the
impact of the war in Iraq on business with our distributors in the Middle East.
Significant customers in 2003 included one OEM aftermarket distribution program,
one of the top three worldwide OEMs of mid-range generators for industrial use
and one of the largest privately owned fleets in the US. These three customers
purchased approximately $334,000, $300,000 and $221,000, respectively, of
products from the Company and accounted for approximately 17%, 16%, and 12% (for
a total of 45%) of the Company's 2003 consolidated net sales. Although the
Company anticipates increased sales to these customers as well as other new and
existing customers in 2004, there can be no assurance that the sales volume
generated by these customers will increase or remain at the same level in 2004.
In February 2004, one of the Company's customers requested to return
merchandise valued at approximately $67,000, for a merchandise credit, due to a
change in their sales program from a parts distribution center level to a dealer
direct level, which will continue through a corporate program. The Company
believes that the original sale complied with the revenue recognition provisions
of SAB No. 104, Revenue Recognition and there were no special rights of return.
Accordingly, the Company recorded a sales return allowance of $67,000, a credit
to cost of goods sold for $42,000 and an accrual of $7,700 for estimated costs
involved with the return, which are included in the accompanying statement of
operations for the year ended December 31, 2003.
COST OF SALES Cost of sales increased by approximately $224,000 from
approximately $2,059,000 in 2002 to approximately $2,283,000 in 2003. Cost of
sales increased primarily due to the increased overhead that the Company has
incurred as a result of moving to a larger facility in December 2002. The move
resulted in increased production capacity for the Company, which has not been
utilized due to lower than anticipated sales volumes. Additionally, cost of
sales increased due to inventory valuation adjustments related to both physical
counts as well as adjustments to the inventory reserves for obsolete and
slow-moving items.
SALARIES AND WAGES Salaries and wages decreased approximately $144,000
due to personnel changes in the sales and marketing department, which resulted
in a reduction of the sales force for a portion of 2003.
SELLING AND ADMINISTRATIVE EXPENSES Selling and administrative expenses
increased by approximately $145,000 from approximately $1,522,000 in 2002 to
approximately $1,667,000 in 2003, which was primarily due to an increase in
compensation expense of approximately $489,000 related to certain variable
equity awards and other stock based compensation. The Company recorded
compensation expense of approximately $21,000 compared with a net credit to
selling and administrative expenses of approximately $468,000 for the years
ended December 31, 2003 and 2002, respectively, related 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.
Excluding the effects of stock-based compensation, selling and
administrative expenses actually decreased by approximately $344,000, or 17%,
due primarily to a reduction in spending in the engineering and sales and
marketing departments as well as reduced investor relations costs as a result of
bringing the function in-house. Other expenses such as travel and entertainment,
office expenses and supplies, patent expense and operating overhead accounted
for approximately $145,000 of the decrease and are a result of both decreased
spending and changes in allocation of overhead to manufacturing.
INTEREST EXPENSE Interest expense increased approximately $100,000
primarily as a result of an increase in interest expense attributable to the
stockholder notes payable from approximately $17,000 in 2002 to approximately
$153,000 in 2003, an increase of $136,000. The Company pays interest monthly on
the note payable to stockholder at the prime rate, which was 4% as of December
31, 2003. In 2002, approximately $34,000 of interest expense was incurred
related to the Company's margin loan, which was collateralized by its investment
portfolio. As all investments were sold and the margin loan was paid back in
2002, no interest expense was incurred related to the margin loan in 2003,
thereby reducing the increase to approximately $100,000.
Liquidity and Capital Resources
-------------------------------
As of December 31, 2003, the Company had cash and cash equivalents of
approximately $1,395,000. For the year ended December 31, 2003, net cash used in
operating activities was approximately $3,587,000, which primarily resulted from
the net loss of approximately $4,051,000, combined with changes in working
14
capital amounts. Net cash used in investing activities was approximately
$138,000 for purchases of property and equipment. Net cash provided by financing
activities was approximately $4,539,000 for the year, primarily due to proceeds
from shareholder notes of approximately $3,000,000 and $1,500,000 of funds from
the sale of common stock to a private placement investor.
The Company has incurred net losses each year since 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.
During 2000, the Company invested the funds received from its private
placements into corporate bonds, certificates of deposits and for a brief
period, in international bonds. The investment portfolio was managed by Smith
Barney, who in April 2001 extended a credit line loan to the Company, which was
collateralized by the investment portfolio. As of April 2002, the Company had
sold all of its 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 Board Member, 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 per annum
(4.00% at December 31, 2003), payable monthly and were to 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 December 31, 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 per annum
(4.00% at December 31, 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
December 31, 2003, the Company had drawn $2.5 million of the available funds.
Both of the lines allow for discretionary principal payments, which add to the
availability of additional funds that the Company may draw.
On February 2, 2004, the Company granted this same stockholder an
additional 150,000 common stock purchase warrants at an exercise price equal to
the closing market price of the Company's stock on the date of grant in
consideration for extending the payback dates of the March 28, 2002 and March
14, 2003 agreements from December 31, 2004 to December 31, 2005; for waiving the
funding requirement mandating payback terms until such time as the Company has
raised an additional $7,000,000 over the amount raised during the Company's
current 2004 private placement offering, the Company is operating within
sufficient cash flow parameters, as defined, or until the Company is sold; and
for his involvement in equity financing in 2003 and 2004, to date.
On December 10, 2003, the Company completed the sale of 750,000 shares
of its common stock through its current private placement to a third party
investor, initiated in November 2003, with gross proceeds of approximately
$1,500,000, all of which will be used for capital equipment purchases,
marketing, working capital and general corporate purposes. In March 2004, the
same investor purchased an additional 1,000,000 shares of common stock for
$2,000,000. The funds will be used to reduce the outstanding balance of the
notes payable to stockholder. The Company will then draw amounts, per the terms
of the stockholder commitment letters dated March 28, 2002 and March 14, 2003,
and amendments thereto, as needed, for operating and capital expenditures. There
can be no assurance that the Company will raise any additional proceeds from
this private placement.
Furthermore, on December 18, 2003, the Company entered into an
agreement with an investment-banking firm in Boca Raton, Florida to assist in
raising approximately $3.0 to $5.0 in equity capital. The Company has agreed to
pay a fee of 7% of any gross proceeds received by the Company as a result of
this firm's services, as well as all reasonable out-of-pocket fees, expenses and
costs in connection with the performance of its services under the agreement.
The agreement excludes the above capital raised in December 2003 and March 2004.
At December 31, 2003, the Company had working capital of approximately
$2,406,000 and its current ratio (current assets to current liabilities) was
4.73 to 1, as compared with working capital of approximately $1,664,000 and a
current ratio of 3.02 to 1 at December 31, 2002. The Company anticipates
increased cash flows from 2004 sales activity; however, additional cash will
15
still be needed to support operations. Management believes that the commitments
received from its stockholder and the current private placement offering, as
well as cash from sales and current working capital will be sufficient to
sustain its operations at its current level through January 1, 2005. However, if
budgeted sales levels are not achieved or significant unanticipated expenditures
occur, 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 2004.
The Company believes it has sufficient cash for fiscal year 2004, 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 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.
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
recorded reserves.
In 2003, sales to a customer with one of the nation's largest privately
held fleet of trucks and equipment, represented 12% of our consolidated net
sales. This represents a 57% decrease from its percentage of consolidated net
sales in 2002. The decrease is due to its acquisitions of competititve companies
which lead to the integration of newly acquired equipment and reduced demand for
new fleet equipment purchases, and in turn, reduced demand for our bypass
filtration systems. Sales recorded and orders booked in the first quarter of
2004 by this customer, combined, equal approximately 90% of their total 2003
sales volume. There can be no assurance, however, that sales to this customer
will continue at the same level for the remainder of 2004.
In 2002, after extensive testing, one of the world's largest
manufacturers of medium-size power generators purchased over $350,000 of
product. This customer accounted for 17% of our 2002 consolidated net sales and
15% of 2003 consolidated net sales.
In February 2003, Honeywell finalized and placed its initial stocking
order for the FRAM/PURADYN co-labeled product and subsequent orders. In
addition, we are now able offer the full line of FRAM(R) filters to our
distributors.
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.
Quarterly Fluctuations
----------------------
The Company's operating results may fluctuate significantly from period
to period as a result of a variety of factors, including product returns,
purchasing patterns of consumers, the length of the Company's sales cycle to key
customers and distributors, the timing of the introduction of new products and
product enhancements by the Company and its competitors, technological factors,
variations in sales by product and distribution channel, and competitive pricing
and general economic conditions throughout the industrialized world.
Consequently, the Company's product revenues may vary significantly by quarter
and the Company's operating results may experience significant fluctuations.
Risk Factors Affecting Future Results of Operations
---------------------------------------------------
The Company's future results of operations involve a number of risks
and uncertainties - many beyond our control - that could cause actual events or
results to be significantly different from those described in this document. The
following outlines a number of risks that could impact the Company's financial
condition and results of operations.
o Our ability to raise capital to fund operations is limited.
o Potential for continuing losses and accumulated deficit affects our
outlook.
o Our products may not satisfy our customers' needs.
o Our product may not obtain market acceptance.
o We are dependent on distributors and a few significant customers and
their loss could have a significant adverse impact on us.
16
o Competition may adversely affect our operations, specifically
alternative products designed by OEMs or in conjunction with a third
party.
o We are dependent on key personnel and their loss would adversely affect
our operations.
o We market a limited number of related products, which makes us
vulnerable if our products do not gain market acceptance.
o There are risks associated with our international operations and
international distribution. Our foreign operations are subject to a
number of risks, including longer payment cycles, unexpected changes in
regulatory requirements, import and export restrictions and tariffs,
difficulties in staffing and managing foreign operations, the burden of
complying with a variety of foreign laws, greater difficulty in
accounts receivable collection, potentially adverse tax consequences,
currency fluctuations, enforcing patent protection and political and
economic instability.
o Our intellectual property rights may not provide meaningful protection
for us.
o We will likely experience possible fluctuations in operating results,
which will expose us to greater uncertainties.
o Our product acceptance represents an educational and behavioral change
resulting in a relatively long sales cycle.
ITEM 7. FINANCIAL STATEMENTS
-----------------------------
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Certified Public Accountants.......................................................... F-2
Consolidated Financial Statements:
Consolidated Balance Sheet - December 31, 2003......................................................... F-3
Consolidated Statements of Operations - Years ended December 31, 2003 and 2002......................... F-4
Consolidated Statements of Changes in Stockholders' Equity (Deficit) -
Years ended December 31, 2003 and 2002............................................................. F-5
Consolidated Statements of Cash Flows - Years ended December 31, 2003 and 2002......................... F-6
Notes to Consolidated Financial Statements............................................................. F-7
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
------------------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
None
ITEM 8A. CONTROLS AND PROCEDURES
--------------------------------
(a) Evaluation of disclosure controls and procedures. In accordance
with Rule 13a-15(b) of the Securities Exchange Act of 1934 (the
"Exchange Act"), within 90 days prior to the filing date of the
annual report on Form 10-KSB, an evaluation was carried out under
the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and
17
Chief Financial Officer, on the effectiveness of the design and
operation of the Company's disclosure controls and procedures (as
defined in Rule 13a-14(c) under the Exchange Act). Based upon their
evaluation of these disclosure controls and procedures, the Chief
Executive Officer and the Chief Financial Officer concluded that
the disclosure controls and procedures were effective as of the
date of such evaluation to ensure that material information
relating to the Company, including its consolidated subsidiary, was
made known to them by others within those entities, particularly
during the period in which this Annual Report on Form 10-KSB was
prepared.
(b) Changes in internal controls. There were not any significant
changes in the Company's internal controls or other factors that
could significantly affect these controls subsequent to the date of
their evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
----------------------------------------------------------------------
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
--------------------------------------
The following table sets forth the names, positions with the Company
and ages of the executive officers, significant employees and directors of the
Company. Directors will be elected at the Company's annual meeting of
stockholders and serve for one year or until their successors are elected and
duly qualified. The Board elects officers and their terms of office are, except
to the extent governed by employment contract, at the discretion of the Board.
Directors and Executive Officers
--------------------------------
Name Age Position
------------------------------- ---- ------------------------------------------------------
Joseph V. Vittoria 68 Chairman of the Board of Directors
Richard C. Ford 60 Chief Executive Officer and Director
Kevin G. Kroger 52 President, Chief Operating Officer and Director
Alan J. Sandler 65 Vice President, Secretary and Director
Lisa M. De La Pointe 35 Chief Financial Officer
D. Wayne Clifton 65 Director of Sales and Marketing
Joseph J. Gaynor, Jr. 53 Director of Manufacturing and Operations
Kevin Davies 45 Managing Director, Puradyn Filter Technologies, Ltd.
Peter H. Stephaich 48 Director
Ottavio Serena 51 Director
Michael Castellano 63 Director
JOSEPH V. VITTORIA was appointed to the Board of Directors and
appointed as Chairman on February 8, 2000. Mr. Vittoria was Chairman and Chief
Executive Officer of Travel Services International, Inc. where he served from
1998 to 2000. From 1987 to 1997, Mr. Vittoria served as Chairman and Chief
Executive Officer of Avis, Inc. and was President and Chief Operating Officer of
Avis, Inc. from 1982 to 1987. Mr. Vittoria also serves on the boards of several
companies, including Autoeurope, Inc.
RICHARD C. FORD has been a Director of the Company since its inception
in 1988. He served as President of the Company from its inception in 1988 until
April 1997 and as Chief Executive Officer and Treasurer until June 1997. He also
served as Secretary of the Company from its inception until August 1996. Mr.
Ford returned to the Company in April 1998 and in January 1999, was elected
Chairman of the Board of Directors and appointed Chief Executive Officer. Mr.
Ford was also a Director of TF Purifiner Ltd. through July 17, 1997 at which
time he resigned, and was re-appointed as a Director in 1999.
KEVIN G. KROGER joined the Company July 3, 2000 as President and Chief
Operating Officer, and was appointed to the Board of Directors. Mr. Kroger was
with Detroit Diesel Corporation from 1989 to the time he joined the Company,
serving in various executive positions prior to his appointment in 1998 to the
position of Vice President and General Manager of Series 30/40 Product. From
1987 to 1989 he was Vice President of R.E.S. Leasing and of VE Corporation.
Prior to this, from 1971 to 1987, he held several management positions with
Caterpillar Corporation.
ALAN J. SANDLER joined the Company in June 1998 as President, Chief
Operating Officer, Secretary, Chief Financial Officer, and Director. In January
2000, he became Vice President and resigned from the positions of President and
Chief Operating Officer. In March 2001, he resigned as Chief Financial Officer.
In August 2001, Mr. Sandler resumed the position of Chief Financial Officer and
then resigned from the position in March 2002. From 1995 until 1997 Mr. Sandler
18
served as President and Chief Executive Officer to Hood Depot, Inc., a national
restaurant supply manufacturer/distributor. From 1979 to 1995 he was President
and Chief Executive Officer of Sandler & Sons Dental Supply Company, a regional
dental supply and equipment distributor. Previous to this position he was a Vice
President of Gardner Advertising Company, a national advertising agency. Mr.
Sandler was appointed as a Director of TF Purifiner Ltd. in 1999 through 2000.
LISA M. DE LA POINTE joined the Company November 19, 2001 as the
Controller. In March 2002, she was appointed the Chief Financial Officer. Ms. De
La Pointe received a Bachelor of Science from Florida Atlantic University and is
a CPA in the state of Florida. Prior to her employment with Puradyn Filter
Technologies Inc., she worked as a senior auditor for Ernst & Young LLP from
December 1998 to June 2000 as well as a Corporate Controller for an e-commerce
company and a publishing company from October 1995 to December 1998.
D. WAYNE CLIFTON joined the Company in 1994 as Southwest Regional
Manager. With over 40 years in sales and management, Mr. Clifton became Sales &
Marketing Director of the company in July 2003. Prior to joining Puradyn, Mr.
Clifton was President/CEO of Wayne Clifton & Associates, a buying and management
services company within the apparel industry for 30 years. Mr. Clifton also
served as Western District Sales Manager of the West Coast and then National
Accounts Manager for the Philip Morris Company.
JOSEPH J. GAYNOR, JR. joined the Company in 2002. From 2000-2002, Mr.
Gaynor served as VP, Operations/General Manager at JDS Uniphase Corporation.
With over 25 years of management, manufacturing and engineering experience, Mr.
Gaynor has also held executive positions with Spectrum Control, Rockwell
International and Corning Glass Works.
KEVIN DAVIES serves as Managing Director of Puradyn, Ltd, located in
the UK. Mr. Davies has been with the Company since 1995 and at different times
has served in the positions of Technical Sales Manager, Marketing Director,
Acting Managing Director, and, as of March 2004, Managing Director. Prior to
joining Puradyn, Mr. Davies worked for Recruitment and Management Consultancy in
London, and from 1985-1990, for a diesel engine and spare parts company (part of
the Lancaster Group) in the positions of National Sales Manager, USA, as well as
Export Sales Manager for North America, Europe and the Middle East.
PETER H. STEPHAICH was appointed to the Board of Directors at its
meeting June 12, 2000, and serves as Chairman of our Compensation Committee. Mr.
Stephaich is currently Chairman, Chief Executive Officer and President of Blue
Danube Incorporated, a private holding Company engaged in the river
transportation industry on the Upper Ohio River. Mr. Stephaich has been on its
Board of Directors since 1982 and has held the titles of Chief Executive Officer
and President since 1995. Prior to 1995, Mr. Stephaich worked for various
financial institutions, including four years at Banker Trust Company where he
provided international financial advisory services to the transportation and
aerospace industries.
OTTAVIO SERENA was appointed to the Board of Directors at its meeting
on June 12, 2000. Mr. Serena is a principal of The Lynx Partners, a private
equity consulting firm. He is also President of The Explorer and Fiber Group,
and is Managing Director of Lincolnshire Management, Inc., a publicly traded
financial Company. From 1993 to 1999, Mr. Serena was with Citicorp Venture
Capital, a leveraged buyout company. Mr. Serena co-founded and was managing
director of The Lynx Partners from 1987 to 1993.
MICHAEL CASTELLANO was appointed to the Board of Directors at the
Company's January 24, 2001 meeting and serves as Chairman of our Audit
Committee. Mr. Castellano retired in 1997 from Kobren Insight Group, a financial
services company, where he served as Chief Administrative Officer from 1995 to
1997, and in 1994, he was Executive Vice President of Wall Street Access, a
discount brokerage firm. Prior to that, from 1988 to 1993, Mr. Castellano was
Senior Vice President and Corporate Controller for Fidelity Investments. Mr.
Castellano also serves on the Board of Kobren Insight Funds.
During 2003, Puradyn's board of directors met on three occasions.
Puradyn has an audit committee and a compensation committee.
Audit Committee
---------------
During 2003, the audit committee of the board of directors was composed
of two independent directors. It operates under a written charter adopted by the
board of directors. The committee members are Michael Castellano (chairperson)
and Peter H. Stephaich. On December 13, 2002, Joseph V. Vittoria, then a member
of the audit committee, resigned so that the audit committee is comprised of
only independent directors.
19
The Board has determined that Mr. Castellano satisfies the criteria as
an audit committee financial expert as established by the SEC under Item 401(e)
of Regulation S-B and the American Stock Exchange, and that both members of the
committee are independent as that term is defined in applicable SEC Rules and
American Stock Exchange listing standards. The audit committee met four times in
2003.
The audit committee reviews our financial reporting process on behalf
of the board of directors. Management has the primary responsibility for the
financial statements and the reporting process including the system of internal
controls.
In this context, the chairperson has met and held discussions with
management and the independent auditors. Management represented to the committee
that Puradyn's consolidated financial statements were prepared in accordance
with accounting principles generally accepted in the United States, and the
committee has reviewed and discussed the consolidated financial statements with
management and the independent auditors. The committee discussed with the
independent auditors matters required to be discussed by Statement on Auditing
Standards No. 61, Communication with Audit Committees, as amended.
In addition, the committee has discussed with the independent auditors
the auditor's independence from the Company and its management, including the
matters in the written disclosures required by the Independence Standards Board
Standard No. 1, Independence Discussions with Audit Committees.
The committee discussed with our independent auditors the overall scope
and plans for their respective audit. The committee meets with the independent
auditors with and without management present, to discuss the results of their
examinations, the evaluations of Puradyn's internal controls, and the overall
quality of our financial reporting.
In reliance on the reviews and discussions referred to above, the
committee recommended to the board of directors, and the board has approved,
that the audited consolidated financial statements be included in Puradyn's Form
10-KSB for the year ended December 31, 2003, for filing with the Securities and
Exchange Commission.
Submitted by the audit committee of the board of directors:
Michael Castellano Peter H. Stephaich
Compensation Committee
----------------------
The compensation committee provides overall guidance for officer
compensation programs, including salaries and other forms of compensation
including all employee stock option grants and warrant grants to non-employees.
The compensation committee consists of three independent directors, Peter
Stephaich (chairperson), Ottavio Serena and Michael Castellano.
Beneficial Ownership Reporting Compliance
-----------------------------------------
Section 16 (a) of the Exchange Act requires the Company's directors and
executive officers, and persons who own more than ten percent (10%) of a
registered class of the Company's equity securities, to file with the Commission
initial reports of ownership and reports of changes in ownership of common stock
and other equity securities of the Company. Officers, directors and greater than
ten percent (10%) stockholders are required by Commission regulation to furnish
the Company with copies of all Section 16 (a) forms they file.
To the Company's knowledge, based solely on a review of the copies of
such reports furnished to the Company and written representations that no other
reports were required, during the year ended December 31, 2003, the following
failed to meet the Section 16 (a) filing requirements applicable to its
officers, directors and greater than ten percent (10%) beneficial owners for
filing on a timely basis:
Kevin G. Kroger - 1 late filing, 1 late transaction
Joseph V. Vittoria - 1 late filing, 1 late transaction
20
Code of Ethics
--------------
We have adopted a code of ethics outlining business ethics and
conflicts of interest for all officers, directors and employees of the Company,
including procedures for prompt internal reporting of violations of the code to
the appropriate persons.
You will find a copy of our code of ethics posted on our website at
http://www.puradyn.com/ under Investor Relations, or you may write to us at
Puradyn Investor Relations, 2017 High Ridge Road, Boynton Beach, FL 33426. Our
Code of Ethics applies to all directors, officers and employees. We will provide
a copy to you upon request at no charge.
ITEM 10. EXECUTIVE COMPENSATION
---------------------------------
Compensation
------------
The following table shows, for the three year period ended December 31,
2003, the cash and other compensation paid by the Company to its Chief Executive
Officer and to each of the executive officers of the Company who had annual
compensation in excess of $100,000.
---------------------- ------ ---------------------------------------------- ------------------ -----------------
SUMMARY COMPENSATION TABLE
---------------------- ------ ---------------------------------------------- ------------------ -----------------
ANNUAL COMPENSATION LONG TERM
COMPENSATION
AWARDS
---------------------- ------ ---------------------------------------------- ------------------ -----------------
OTHER ANNUAL SECURITIES ALL OTHER
NAME AND COMPENSATION UNDERLYING COMPENSATION
PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) ($) (1) OPTIONS (#) ($) (3)
---------------------- ------ ------------- ------------- ------------------ ------------------ -----------------
Richard C. Ford 2003 $ 208,000 $ - $ 13,000 - $ -
CEO and Director 2002 208,000 - 12,000 - -
2001 208,000 - 11,000 - -
Kevin G. Kroger 2003 166,000 - 21,833 - 2,372
President, COO and 2002 166,000 80,000 (2) 18,482 100,000(2) 2,144
Director 2001 166,000 76,000 21,143 - 1,964
Alan Sandler 2003 100,000 - - - -
Vice President, 2002 100,000 - - - -
Secretary and 2001 100,000 - - - -
Director
---------------------- ------ ------------- ------------- ------------------ ------------------ -----------------
(1) This amount represents payments made by the Company for car allowances and,
in the case of Mr. Kroger, also for disability insurance premiums.
(2) In January 2003, in lieu of the contractual cash bonus amount of $80,000,
100,000 ISO stock options were granted to Mr. Kroger.
(3) Other compensation represents insurance premiums paid by the Company on
behalf of Mr. Kroger for term life insurance for the benefit of Mr.
Kroger's family. There are no dividends or cash surrender value payable on
this policy, which is renewable annually.
Incentive and Non-qualified Stock Option Plans
----------------------------------------------
The Board of Directors adopted the 2000 Non-Employee Directors' Plan
(the "Directors' Plan") on November 8, 2000 under which options to purchase
400,000 shares have been authorized for issuance. The Directors' Plan will
provide a means to attract and retain highly qualified persons to serve as
non-employee directors and advisory directors of the Company.
Each member of the Board of Directors was automatically granted 5,000
options at the date of commencement of the Directors' Plan and on their initial
election as new members to the Board of Directors. Each director receives an
additional 5,000 options at the close of each annual meeting of stockholders.
Additionally, each director automatically receives 2,500 options for each
21
committee of the Board on which the director serves. Options are granted at a
price equal to the fair market value of the stock on the date of grant, are
exercisable commencing two years following grant, and will expire five years
from the date of grant. In the event a person ceases to serve on the Board of
Directors, the outstanding options expire one year from the date of cessation of
service. The Board of Directors will administer the Directors' Plan.
The Company's 1999 Stock Option Plan (the "1999 Plan") and the 1996
Stock Option Plan (the "1996 Plan"), adopted on September 15, 1999 and amended
in June 2000, and July 31, 1996, respectively, will work to increase proprietary
interest in the Company of the employees, Board of Advisors, consultants, and
non-employee Directors and to align more closely their interests with the
interests of the Company's stockholders. The Plans will also maintain the
Company's ability to attract and retain the services of experienced and highly
qualified employees and non-employee directors.
Under the 1999 Plan and 1996 Plan, the Company had reserved an
aggregate of 3,000,000 and 2,200,000 shares, respectively, of common stock for
issuance pursuant to options granted under the Plans ("Plan Options"). The Board
of Directors or a Committee of the Board of Directors (the "Committee") of the
Company will administer the Plans including, without limitation, the selection
of the persons who will be granted Plan Options under the Plans, the type of
Plan Options to be granted, the number of shares subject to each Plan Option and
the Plan Option price.
Options granted under the 1996 and 1999 Plans may either be options
qualifying as incentive stock options ("Incentive options") under Section 422 of
the Internal Revenue Code of 1986, as amended, or options that do not so qualify
("Non-Qualified Options"). In addition, the Plans also allow for the inclusion
of a reload option provision ("Reload Option"), which permits an eligible person
to pay the exercise price of the Plan Option with shares of Common Stock owned
by the eligible person and receive a new Plan Option to purchase shares of
Common Stock equal in number to the tendered shares. Any Incentive Option
granted under the Plans must provide for an exercise price of not less than 100%
of the fair market value of the underlying shares on the date of such grant, but
the exercise price of any Incentive Option granted to an eligible employee
owning more than 10% of the Company's Common Stock must be at least 110% of such
fair market value as determined on the date of the grant. The term of each Plan
Option and the manner in which it may be exercised is determined by the Board of
the Directors or the Committee, provided that no Plan Option may be exercisable
more than 10 years after the date of its grant and, in the case of an Incentive
Option granted to an eligible employee owning more than 10% of the Company's
common stock, no more than five years after the date of the grant.
The exercise price of Non-Qualified Options shall be determined by the
Board of Directors or the Committee and cannot be less than the par value of the
Company's Common Stock.
The per share purchase price of shares subject to Plan Options granted
under the Plans may be adjusted in the event of certain changes in the Company's
capitalization, but any such adjustment shall not change the total purchase
price payable upon the exercise in full of Plan Options granted under the Plan.
Officers, directors, key employees and consultants of the Company and
its subsidiaries (if applicable in the future) will be eligible to receive
Non-Qualified Options under the Plans. Only officers, directors and employees of
the Company who are employed by the Company or by any subsidiary thereof are
eligible to receive Incentive Options.
All Plan Options are generally nonassignable and nontransferable,
except by will or by the laws of descent and distribution, and during the
lifetime of the optionee, may be exercised only by such optionee. If an
optionee's employment is terminated for any reason, other than his death or
disability or termination for cause, or if an optionee is not an employee of the
Company but is a member of the Company's Board of Directors and his service as a
Director is terminated for any reason, other than death or disability, the Plan
Option granted to him generally shall lapse to the extent unexercised on the
earlier of the expiration date or one year following the date of termination. If
the optionee dies during the term of his employment, the Plan Option granted to
him generally shall lapse to the extent unexercised on the earlier of the
expiration date of the Plan Option or the date one year following the date of
the optionee's death. If the optionee is permanently and totally disabled within
the meaning of Section 22 (c) (3) of the Internal Revenue Code of 1986, the Plan
Option granted to him generally lapses to the extent unexercised on the earlier
of the expiration date of the option or one year following the date of such
disability.
The Board of Directors or the Committee may amend, suspend or terminate
the Plans at any time, except that no amendment shall be made which (i)
increases the total number of shares subject to the Plans or changes the minimum
purchase price therefore (except in either case in the event of adjustments due
to changes in the Company's capitalization), (ii) extends the term of any Plan
Option beyond ten years, or (iii) extends the termination date of the Plan.
22
Unless the Plans shall theretofore have been suspended or terminated by the
Board of Directors, the 1996 Plan shall terminate on July 31, 2006 and the 1999
Plan shall terminate on September 15, 2009. Any such termination of the Plans
shall not affect the validity of any Plan Options previously granted thereunder.
As of December 31, 2003, under the Directors' Plan, options to purchase
315,000 shares of common stock were outstanding. As of December 31, 2003, under
the 1996 Plan, incentive stock options to purchase 157,357 shares of common
stock were outstanding and non-qualified options to purchase 585,463 shares of
common stock were outstanding and, under the 1999 Plan, incentive stock options
to purchase 1,243,750 shares of common stock were outstanding and non-qualified
options to purchase 22,000 shares of common stock were outstanding.
---------------------------------------------------------------------------------------------------------------------------
OPTIONS/SAR GRANTS IN LAST FISCAL YEAR
---------------------------------------------------------------------------------------------------------------------------
Individual Grants
---------------------------------------------------------------------------------------------------------------------------
Number of Securities % of Total Options/SARs Exercise or
Underlying Options/SARs Granted to Employees in Base Price
Name Granted (#) Fiscal Year ($/Sh) Expiration Date
-------------------------- ---------------------------- ------------------------------ ----------------- ------------------
Kevin Kroger 100,000 36.30% 1.70 1/10/2013
-------------------------- ---------------------------- ------------------------------ ----------------- ------------------
Option Exercises and Holdings
-----------------------------
The following table sets forth information with respect to the exercise
of options to purchase shares of common stock during the fiscal year ended
December 31, 2003 to each person named in the Summary Compensation Table and the
unexercised options held as of the end of the 2003 fiscal year.
AGGREGATE OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
------------------------- -------------- --------------- ------------------------------------ -----------------------------------
NUMBER OF VALUE OF UNEXERCISED
SHARES NUMBER OF SECURITIES UNDERLYING IN-THE-MONEY OPTIONS/ SARS AT FY-
ACQUIRED ON VALUE UNEXERCISED OPTIONS/SARS AT FY-END END ($) (1)
EXERCISE (#) REALIZED ($) (#) EXERCISABLE/ UNEXERCISABLE EXERCISABLE/ UNEXERCISABLE
------------------------- -------------- --------------- ------------------------------------ -----------------------------------
Richard C. Ford - - 375,000 - $ 538,500 -
Chief Executive Officer
and Director
Kevin Kroger - - 325,000 75,000 38,000 -
President, COO and
Director
Alan Sandler - - - - - -
Vice President,
Secretary and
Director
------------------------- -------------- --------------- ------------------ ----------------- ---------------- ------------------
(1) In accordance with the Securities and Exchange Commission's rules,
values are calculated by subtracting the exercise price from the fair
market value of the underlying common stock. For purposes of this
table, fair market value is deemed to be $2.08, the closing price
reported on December 31, 2003.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
-----------------------------------------------------------------------
The following table sets forth certain information regarding the
Company's common stock beneficially owned on March 22, 2004 for (i) each
stockholder known by the Company to be the beneficial owner of five (5%) percent
or more of the Company's outstanding Common Stock, (ii) each of the Company's
executive officers as reported under Item 10.Executive Compensation, and
directors, and (iii) all officers and directors as a group. In general, a person
is deemed to be a "beneficial owner" of a security if that person has or shares
23
the power to vote or direct the voting of such security, or the power to dispose
or to direct the disposition of such security. A person is also deemed to be a
beneficial owner of any securities of which the person has the right to acquire
ownership within sixty (60) days. At March 22, 2004, there were 17,452,164
shares of Common Stock outstanding. The address of each of the persons set forth
below is 2017 High Ridge Road, Boynton Beach, Florida 33426, except as otherwise
noted.
PERCENT OF
COMMON STOCK
BENEFICIAL BENEFICIALLY
NAME AND ADDRESS OR IDENTITY OF GROUP OWNERSHIP OWNED
------------------------------------------------------ ----------------- -----------------
Quantum Industrial Partners LDC ("QIP") (1) 4,570,000 22.4%
Richard C. Ford (2) 1,933,985 9.5%
Joseph V. Vittoria (5) 1,791,870 8.8%
Glenhill Capital Management, LP,
Glenhill Capital Overseas Partners, LTD (8) 1,750,000 8.6%
Kevin G. Kroger (3) 357,000 1.8%
Alan J. Sandler (4) 315,992 1.6%
Peter Stephaich (6) 120,000 -*
Ottavio Serena (6) 125,000 -*
Michael Castellano (7) 29,000 -*
--------- ----
All Officers and Directors as a group (7 persons) 4,672,847 22.9%
* Less than 1%
(1) Address is c/o Curacao Corporation Company, N.V., Kaya Flamboyan,
Willenstad Curacao, Netherlands, Antilles.
(2) Mr. Ford serves as Chief Executive Officer and as a Director. Includes
options to purchase 100,000 shares of common stock at $.56 per share
through April 14, 2009, options to purchase 100,000 shares at $.21 per
share through January 7, 2009, and options to purchase 175,000 shares
at $.94 per share through April 1, 2009.
(3) Mr. Kroger is President, Chief Operating Officer, and a Director.
Includes options to purchase 225,000 shares of common stock at $9.25
through July 3, 2010 and options to purchase 100,000 shares at $1.70
through January 10, 2013.
(4) Mr. Sandler serves as Vice President, Secretary and Director.
(5) Mr. Vittoria serves as Chairman of the Board of Directors. Includes
options to purchase 205,000 shares of common stock at $5.88 through
October 23, 2005 and three warrants to purchase 100,000 shares of
common stock at $2.05 through March 28, 2007, 125,000 shares of common
stock at $3.25 through March 14, 2008, and 150,000 shares of common
stock at $2.00 through February 2, 2008, respectively.
(6) Mr. Stephaich and Mr. Serena serve as Directors. Includes options to
purchase 10,000 and 7,500, shares of common stock, respectively, at
$5.88 through October 23, 2005, and 10,000 and 7,500 shares of common
stock, respectively, at $2.60 through October 23, 2006. For Mr. Serena,
also includes a warrant to purchase 100,000 shares of common stock at
$1.00 through December 20, 2004.
(7) Mr. Castellano serves as a Director. Includes options to purchase 7,500
shares of common stock at $6.50 through January 24, 2006, 10,000 shares
of common stock at $2.60 through October 23, 2006, and 2,500 shares of
common stock at $4.81 through May 16, 2006.
(8) Glenhill Capital LP and Glenhill Capital Overseas Partners, LTD are
investment vehicles for Krevlin Advisors and Glenhill Overseas,
respectively. Address is 650 Madison Avenue, 26th Floor, New York, NY
10022.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
---------------------------------------------------------
In July 2001, the Company received promissory notes from two of its
officers for the exercise of their vested stock options in the amount of
$875,256 and bearing interest of 5.63%. The principal and accrued interest are
due upon the earlier of the expiration of the original option periods, which
range from July 2008 to December 2009, or upon the sale of the common stock
acquired by the execution of the options.
On April 1, 2002, the Company executed an agreement with a third party
and a related party who is affiliated with an executive officer, to receive web
site and advertising consulting services. The agreement was for a term of 15
weeks and the two consultants received 20,000 stock options having a fair value
24
of approximately $61,000, as well as cash of approximately $30,000 for services
rendered. The fair value of the options was estimated at the date of grant using
a Black-Scholes option pricing model with the following assumptions: risk free
interest rates of 4.65%, volatility factors of the expected market price of the
Company's common stock of 1.298, a dividend yield of zero, and a weighted
average expected life of 3 years.
On March 28, 2002, the Company executed a binding agreement with one of
its stockholders, who is also a Board Member, 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 per annum,
(4.00% at December 31, 2003), payable monthly and were to 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 December 31, 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 per annum
(4.00% at December 31, 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
December 31, 2003, the Company had drawn $2.5 million of the available funds.
On February 2, 2004, the Company granted this same stockholder an
additional 150,000 common stock purchase warrants at an exercise price equal to
the closing market price of the Company's stock on the date of grant in
consideration for extending the expiration dates of the March 28, 2002 and March
14, 2003 agreements and amendments thereto, from December 31, 2004 to December
31, 2005; for waiving the funding requirement mandating payback terms until such
time as the Company has raised an additional $7,000,000 over the amount raised
during the Company's current 2004 private placement offering, the Company is
operating within sufficient cash flow parameters, as defined, or until the
Company is sold; and for his involvement in equity financing in 2003 and 2004,
to date.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
-----------------------------------------
A) INDEX TO EXHIBITS
Exhibits Description of Documents
-------- ------------------------
3.1 Amended and Restated Certificate of Incorporation of T/F
Purifiner, Inc. dated December 30, 1996 (2)
3.1(a) Certificate of Amendment to Certificate of Incorporation dated
February 3, 1998 (3)
3.2 Bylaws of T/F Purifiner, Inc. (1)
3.3 Memorandum and Articles of Association of TF Purifiner Ltd. (1)
4.1 Amendment No. 1 to Registration Rights Agreement (3)
10.1 1996 Stock Option Plan (1)
10.2 1999 Stock Option Plan (4)
10.3 2000 Non-Employee Directors' Plan (5)
10.4 2002 Audit Committee Charter (6)
25
10.5 2002 Supply Agreement between Puradyn Filter Technologies, Inc.
and Honeywell Consumer Products Group (6)
14.1 Code of Ethics (6)
23.1 Consent of Independent Certified Public Accountants (6)
31.1 Rule 13a-14(a)/15d-14(a) Certifications (6)
31.2 Rule 13a-14(a)/15d-14(a) Certifications (6)
32.1 Certification of Chief Executive Officer (6)
32.2 Certification of Chief Financial Officer (6)
(1) Incorporated by reference from the Exhibits to the company's
Form 10-SB 12B Registration Statement, as amended, as filed with the
Securities and Exchange Commission.
(2) Incorporated by reference from the Exhibit to the company's Form 8-K,
January 9, 1997, as filed with the Securities and Exchange Commission.
(3) Incorporated by reference from the Exhibit to the company's Form 8-KA,
February 11, 1998, as filed with the Securities and Exchange
Commission.
(4) Incorporated by reference from Form S-8, September 15, 1999, as filed
with the Securities and Exchange Commission
(5) Incorporated by reference from Form 10-KSB, April 19, 2001, as filed
with the Securities and Exchange Commission.
(6) Filed herewith.
B) THE FOLLOWING REPORTS ON FORM 8-K WERE FILED DURING THE QUARTER ENDED
DECEMBER 31, 2003:
(1) A Report on Form 8-K was filed on November 13, 2003, reporting under
Item 12 the announcement of the Company's third quarter 2003 financial
results via a press release.
(2) A Report on Form 8-K was filed on December 11, 2003, reporting under
Item 5, that the Company executed a subscription agreement with an
accredited investor.
26
ITEM 14. PRINCIPAL ACCOUNTANTS FEES AND SERVICES
------------------------------------------------
The following table sets forth the aggregate fees billed to the Company
for the years ended December 31, 2003 and December 31, 2002 by Ernst & Young
LLP, the Company's principal accountant:
2003 2002
------------------ -----------------
Audit Fees $ 150,605 $ 146,990
Audit-Related Fees -- --
Tax Fees -- --
All Other Fees -- --
Audit fees represent amounts billed for professional services rendered
for the audit of the Company's annual financial statements and the reviews of
the financials statements included in the Company's Forms 10-QSB for the fiscal
years ended December 31, 2003 and 2002. Before Ernst & Young LLP was engaged by
the Company to render audit or non-audit services, the engagement was approved
by the Company's audit committee.
27
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Puradyn Filter Technologies Incorporated
(Registrant)
Date: March 26, 2004 By: /s/ Richard C. Ford
Richard C. Ford
Chief Executive Officer
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
date indicated.
Date: March 26, 2004
By: /s/ Richard C. Ford
Richard C. Ford
Principal Executive Officer and Director
By: /s/ Alan J. Sandler
Alan J. Sandler
Vice President, Secretary and Director
By: /s/ Lisa M. De La Pointe
Lisa M. De La Pointe
Principal Financial and Accounting Officer
By: /s/ Joseph V. Vittoria
Joseph V. Vittoria
Chairman of the Board of Directors
By: /s/ Kevin G. Kroger
Kevin G. Kroger, President and Principal
Operating Officer and Director
By: /s/ Michael Castellano
Michael Castellano, Director
By: /s/ Peter Stephaich
Peter Stephaich, Director
By: /s/ Ottavio Serena
Ottavio Serena, Director
28
PURADYN FILTER TECHNOLOGIES INCORPORATED
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Certified Public Accountants.......................................................... F-2
Consolidated Financial Statements:
Consolidated Balance Sheet - December 31, 2003......................................................... F-3
Consolidated Statements of Operations - Years ended December 31, 2003 and 2002......................... F-4
Consolidated Statements of Changes in Stockholders' Equity (Deficit) -
Years ended December 31, 2003 and 2002............................................................. F-5
Consolidated Statements of Cash Flows - Years ended December 31, 2003 and 2002......................... F-6
Notes to Consolidated Financial Statements............................................................. F-7
F-1
Report of Independent Certified Public Accountants
Board of Directors and Stockholders
Puradyn Filter Technologies Incorporated
We have audited the accompanying consolidated balance sheet of Puradyn
Filter Technologies Incorporated (the Company) as of December 31, 2003, and the
related consolidated statements of operations, changes in stockholders' equity
(deficit) and cash flows for the years ended December 31, 2003 and 2002. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Puradyn
Filter Technologies Incorporated at December 31, 2003, and the consolidated
results of its operations and its cash flows for the years ended December 31,
2003 and 2002, in conformity with accounting principles generally accepted in
the United States.
/s/ Ernst & Young LLP
West Palm Beach, Florida
February 24, 2004, except for the matters discussed in the second and third
paragraphs of Note 16, as to which the date is March 12, 2004.
F-2
Puradyn Filter Technologies Incorporated
Consolidated Balance Sheet
December 31, 2003
Assets
Current assets:
Cash and cash equivalents $ 1,394,830
Accounts receivable, net of allowance for uncollectible accounts of $5,745 224,555
Inventories 1,202,500
Prepaid expenses and other current assets 228,906
------------
Total current assets 3,050,791
Property and equipment, net 659,285
Deferred financing costs 181,767
Other noncurrent assets 107,597
------------
Total assets $ 3,999,440
============
Liabilities and stockholders' deficit
Current liabilities:
Accounts payable $ 95,140
Accrued liabilities 508,821
Current portion of capital lease obligation 4,063
Deferred revenues 36,461
------------
Total current liabilities 644,485
Capital lease obligation, less current portion 15,140
Notes payable - stockholder 5,001,900
Commitments and contingencies
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; issued and outstanding - 16,442,164 16,442
Additional paid-in capital 33,309,707
Notes receivable from stockholders (992,326)
Accumulated deficit (33,952,086)
Accumulated other comprehensive loss (43,822)
------------
Total stockholders' deficit (1,662,085)
------------
Total liabilities and stockholders' deficit $ 3,999,440
============
See accompanying notes.
F-3
Puradyn Filter Technologies Incorporated
Consolidated Statements of Operations
Year Ended December 31
2003 2002
------------ ------------
Net sales $ 1,906,517 $ 2,137,118
Costs and expenses:
Cost of products sold 2,282,450 2,058,439
Salaries and wages 1,728,358 1,871,723
Selling and administrative 1,667,291 1,522,337
------------ ------------
5,678,099 5,452,499
------------ ------------
Loss from operations (3,771,582) (3,315,381)
Other (expense) income:
Investment loss -- (22,406)
Interest income 51,344 52,553
Interest expense (330,521) (230,482)
------------ ------------
Total other (expense) income (279,177) (200,335)
------------ ------------
Net loss $ (4,050,759) $ (3,515,716)
============ ============
Basic and diluted loss per common share $ (0.26) $ (0.23)
============ ============
Weighted average common shares
outstanding 15,726,140 15,588,539
============ ============
See accompanying notes.
F-4
Puradyn Filter Technologies Incorporated
Consolidated Statements of Changes in Stockholders' Equity (Deficit)
ADDITIONAL NOTES
COMMON STOCK PAID-IN RECEIVABLE
SHARES AMOUNT CAPITAL FROM STOCKHOLDERS
------ ------ ------- -----------------
Balance at December 31, 2001 15,492,873 $ 15,493 $ 31,418,509 $ (875,256)
Foreign currency translation adjustment -- -- -- --
Reclassification of realized
investment loss included in net loss -- -- -- --
Net loss -- -- -- --
Total comprehensive loss -- -- -- --
Exercise of stock options 155,516 155 170,169 --
Issuance of stock options to consultants
for services -- -- 61,200 --
Issuance of warrants to stockholder -- 318,000 -- --
Compensation expense associated with
warrant modification -- -- 94,000 --
Credit to previously recognized
compensation expense associated with
outstanding variable option awards -- -- (573,850) --
------------ ------------ ------------ ------------
Balance at December 31, 2002 15,648,389 $ 15,648 $ 31,488,028 $ (875,256)
Foreign currency translation adjustment -- -- -- --
Net loss -- -- -- --
Total comprehensive loss -- -- -- --
Exercise of stock options 43,775 44 42,622 --
Issuance of common stock in
private placement 750,000 750 1,465,500 --
Issuance of warrants to stockholder -- -- 212,500 --
Issuance of stock options in lieu
of bonus -- -- 80,000 --
Reclassification of interest
receivable related to notes
receivable from stockholders -- -- -- (117,070)
Compensation expense associated with
warrant modification -- -- 2,000 --
Compensation expense associated with
outstanding variable option awards -- -- 19,057 --
------------ ------------ ------------ ------------
Balance at December 31, 2003 16,442,164 $ 16,442 $ 33,309,707 $ (992,326)
============ ============ ============ ============
[restubbed]
ACCUMULATED
OTHER TOTAL
ACCUMULATED COMPREHENSIVE STOCKHOLDERS'
S DEFICIT INCOME (LOSS) EQUITY (DEFICIT)
- ------- ------------- ----------------
Balance at December 31, 2001 $(26,385,611) 84,170 $ 4,257,305
Foreign currency translation adjustment -- 9,419 9,419
Reclassification of realized
investment loss included in net loss -- (85,620) (85,620)
Net loss (3,515,716) -- (3,515,716)
------------
Total comprehensive loss -- -- (3,591,917)
Exercise of stock options -- -- 170,324
Issuance of stock options to consultants
for services -- -- 61,200
Issuance of warrants to stockholder 318,000
Compensation expense associated with
warrant modification -- -- 94,000
Credit to previously recognized
compensation expense associated with
outstanding variable option awards -- -- (573,850)
------------ ------------ ------------
Balance at December 31, 2002 $(29,901,327) $ 7,969 $ 735,062
Foreign currency translation adjustment -- (51,791) (51,791)
Net loss (4,050,759) -- (4,050,759)
------------
Total comprehensive loss -- -- (4,102,550)
Exercise of stock options -- -- 42,666
Issuance of common stock in
private placement -- -- 1,466,250
Issuance of warrants to stockholder -- -- 212,500
Issuance of stock options in lieu
of bonus -- -- 80,000
Reclassification of interest
receivable related to notes
receivable from stockholders -- -- (117,070)
Compensation expense associated with
warrant modification -- -- 2,000
Compensation expense associated with
outstanding variable option awards -- -- 19,057
------------ ------------ ------------
Balance at December 31, 2003 $(33,952,086) $ (43,822) $ (1,662,085)
============ ============ ============
See accompanying notes.
F-5
Puradyn Filter Technologies Incorporated
Consolidated Statements of Cash Flows
YEAR ENDED DECEMBER 31
2003 2002
----------- -----------
OPERATING ACTIVITIES
Net loss $(4,050,759) $(3,515,716)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 237,491 202,968
Provision for (recovery of) bad debts 18,184 (60,044)
Amortization of deferred financing costs included in interest expense 173,967 176,667
Loss on investments -- 107,977
Loss on disposal of property and equipment 2,280 25,494
Compensation expense (credit) on stock-based arrangements with employees
and vendors 21,057 (467,611)
Changes in operating assets and liabilities:
Accounts receivable 151,880 (72,574)
Inventories (39,851) (369,601)
Accrued interest receivable from related parties (48,067) (48,066)
Accrued interest receivable from investments -- 115,220
Prepaid expenses and other current assets 1,444 40,930
Other noncurrent assets 95,675 (286,296)
Accounts payable (168,324) (283,835)
Accrued liabilities 88,176 270,395
Deferred revenues (69,535) 6,398
Other noncurrent liabilities (263) --
----------- -----------
Net cash used in operating activities (3,586,645) (4,157,694)
INVESTING ACTIVITIES
Proceeds from sales and maturities of investments -- 5,815,930
Purchases of property and equipment (138,355) (194,213)
----------- -----------
Net cash (used in) provided by investing activities (138,355) 5,621,717
FINANCING ACTIVITIES
Proceeds from sale of common stock 1,500,000 --
Proceeds from exercise of stock options 42,666 170,324
Proceeds from note payable secured by investments -- 1,450,501
Proceeds from notes payable to stockholder 3,000,000 2,000,000
Proceeds from short term loan payable to officer 100,000 --
Payment of short term loan payable to officer (100,000) --
Payment of note payable secured by investments -- (5,430,501)
Payment of capital lease obligations (4,069) (4,781)
----------- -----------
Net cash provided by (used in) financing activities 4,538,597 (1,814,457)
Effect of exchange rate changes on cash and cash equivalents (51,791) 9,419
----------- -----------
Net increase (decrease) in cash and cash equivalents 761,806 (341,015)
Cash and cash equivalents at beginning of period 633,024 974,039
----------- -----------
Cash and cash equivalents at end of period
$ 1,394,830 $ 633,024
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest $ 147,721 $ 48,914
=========== ===========
NONCASH INVESTING AND FINANCING ACTIVITIES:
Office equipment acquired under capital lease obligation $ 19,203 $ --
=========== ===========
Common stock options issued in lieu of officer cash bonus $ 80,000 $ --
=========== ===========
Warrants issued for deferred financing costs $ 212,500 $ 318,000
=========== ===========
Stock options issued for consulting services $ -- $ 61,200
=========== ===========
See accompanying notes
F-6
Puradyn Filter Technologies Incorporated
Notes to Consolidated Financial Statements
December 31, 2003
1. SIGNIFICANT ACCOUNTING POLICIES
Organization
Puradyn Filter Technologies Incorporated (the "Company"), a Delaware
corporation, is engaged in the manufacturing, distribution and sale of by-pass
oil filtration systems under the trademark Puradyn(R) primarily to companies
with large fleets of vehicles and secondarily to original vehicle equipment
manufacturer aftermarket programs. The Company holds the exclusive worldwide
manufacturing and marketing rights for the Puradyn products pursuant to licenses
for two patents and through direct ownership of various other patents.
Puradyn Filter Technologies, Ltd. (Ltd.), a wholly owned subsidiary in the
United Kingdom, sells and distributes the Company's products in Europe, the
Middle East and certain African countries. The results of the operations of Ltd.
have been included in the Company's statements of operations since Ltd.'s
formation on June 1, 2000. All intercompany balances and transactions have been
eliminated in consolidation.
New 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 Opinion (APB) No. 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
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.
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.
F-7
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. Originally, FIN 46 applied to
the first interim period beginning after June 15, 2003, to variable interest
entities in which an enterprise holds a variable interest that it acquired
before February 1, 2003. However in December 2003, the FASB issued FASB Staff
Position No. FIN 46-e, Effective Date of FASB Interpretation No. 46,
Consolidation of Variable Interest Held by a Public Entity (FSP 46-e), that
delayed the implementation date to the first interim or annual period ending
after March 14, 2004. The Company does not anticipate that the adoption of the
new interpretation will have an effect on the Company's 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.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiary, Ltd. All significant intercompany transactions and
balances have been eliminated.
Revenue Recognition
The Company recognizes revenue from product sales to customers, distributors and
resellers when products that do not require further services or installation at
the customer's site are shipped, there are no uncertainties surrounding customer
acceptance and for which collectibility is reasonably assured in accordance with
Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition in Financial
Statements as amended and interpreted. Cash received by the Company prior to
revenue recognition is recorded as deferred revenues. 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 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.
Use of Estimates
The preparation of 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 consolidated financial
statements. Actual results could differ from those estimates.
F-8
Cash and Cash Equivalents
Cash and cash equivalents include all highly liquid investments with original
maturities of three months or less at the time of purchase.
Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, accounts receivable, prepaid
expenses and other assets, accounts payable, accrued liabilities and notes
payable to stockholder approximate their fair values as of December 31, 2003
because of their short-term natures.
Accounts Receivable
Accounts receivable are recorded at fair value on the date revenue is
recognized. The Company provides allowances for doubtful accounts for estimated
losses resulting from the inability of its customers to repay their obligation.
If the financial condition of the Company's customers were to deteriorate,
resulting in an impairment of their ability to repay, additional allowances may
be required. The Company provides for potential uncollectible accounts
receivable based on specific customer identification and historical collection
experience adjusted for existing market conditions. If market conditions
decline, actual collection experience may not meet expectations and may result
in decreased cash flows and increased bad debt expense.
The policy for determining past due status is based on the contractual payment
terms of each customer, which are generally net 30 or net 60 days. Once
collection efforts by the Company and its collection agency are exhausted, the
determination for charging off uncollectible receivables is made.
Investments
During 2002, the Company sold all its investments for approximately $5.83
million. The proceeds were used to pay in full its margin loan of $5.45 million,
which was collateralized by the investments, and to fund operations. The 2002
net investment loss of approximately $22,400 is included in investment loss in
the accompanying 2002 consolidated statement of operations. All investments sold
in 2002 were reclassified out of accumulated other comprehensive income into
earnings using the specific identification method.
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 finished goods inventories at a rate based on estimated
production capacity. 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.
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 $173,697 and $176,667 for the years ended
December 31, 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 Board Member, totaled $318,000 and were initially 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 $214,400 related to an additional $3.5 million commitment
provided by the same stockholder, with a payback date of December 31, 2004. The
$214,400 of deferred financing costs is being amortized over the payback period.
In addition, the repayment period for the $2.5 million commitment was extended
to December 31, 2004. Effective March 14, 2003, the Company began amortizing the
then remaining deferred financing costs for the $2.5 million commitment
prospectively over the extended payback period. On February 2, 2004 the payback
period which was extended to December 31, 2005 (see Note 2). Accumulated
amortization of deferred financing costs as of December 31, 2003 and 2002, was
$350,633 and $176,667, respectively.
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization are
provided using the straight-line method over the estimated useful lives of the
related assets, except for assets held under capital leases, for which the
F-9
Company records depreciation and amortization based on the shorter of the
asset's useful life or the term of the lease. The estimated useful lives of
property and equipment range from 3 to 5 years. Upon sale or retirement, the
cost and related accumulated depreciation and amortization are eliminated from
their respective accounts, and the resulting gain or loss is included in results
of operations. Repairs and maintenance charges, which do not increase the useful
lives of the assets, are charged to operations as incurred.
Impairment of Long-Lived Assets
Management assesses the recoverability of its long-lived assets when indicators
of impairment are present. If such indicators are present, recoverability of
these assets is determined by comparing the undiscounted net cash flows
estimated to result from those assets over the remaining life to the assets' net
carrying amounts. If the estimated undiscounted net cash flows are less than the
net carrying amount, the assets would be adjusted to their fair value, based on
appraisal or the present value of the undiscounted net cash flows. In 2002, a
recoverability analysis was performed due to the presence of certain indicators
of impairment. Based on the results of the recoverability analysis, the Company
wrote off the entire carrying values of the patents and trademarks of
approximately $208,000, which is included under selling and administrative
expenses in the accompanying 2002 consolidated statement of operations.
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 based on 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 $4,500, which is related to the replacement of warranty products,
and accrued warranty expense of approximately $43,000, which is included in
accrued liabilities, are included in the accompanying consolidated balance sheet
as of December 31, 2003.
The following table shows the changes in the aggregate product warranty
liability for the year ended December 31, 2003:
Balance as of December 31, 2002 $ 46,607
Less: Payments made (30,269)
Change in prior period estimate (8,004)
Add: Provision for current period warranties 34,239
--------
Balance as of December 31, 2003 $ 42,573
========
Guarantees
In August 2003, the Company made a guarantee to its wholly owned subsidiary,
Ltd., 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 displaying 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 as reported
in the consolidated statement of changes in stockholders' equity (deficit).
Other comprehensive income transactions that currently apply to the Company
result from changes in exchange rates used in translating the financial
statements of its wholly owned subsidiary, Ltd. Comprehensive income as of
December 31, 2003 and 2002 is not shown net of taxes because the Company's
deferred tax asset has been fully offset by a valuation allowance.
Advertising Costs
Advertising costs are expensed as incurred. During the years ended December 31,
2003 and 2002, advertising costs incurred by the Company totaled approximately
$106,000 and $178,000, respectively, and are included in selling and
administrative expenses in the accompanying consolidated statements of
operations.
F-10
Engineering and Development
Engineering and development costs are expensed as incurred. During the years
ended December 31, 2003 and 2002, engineering and development costs incurred by
the Company totaled approximately $50,000 and $129,000, respectively, and are
included in selling and administrative expenses in the accompanying consolidated
statements of operations.
Foreign Currency Translation
The financial statements of the Company's foreign subsidiary have been
translated into U.S. dollars in accordance with SFAS No. 52, Foreign Currency
Translation (SFAS 52). All balance sheet accounts have been translated using the
exchange rate in effect at the balance sheet date. Income statement amounts have
been translated using an appropriately weighted average exchange rate for the
year. The translation gains and losses resulting from the changes in exchange
rates during 2003 and 2002 have been reported in accumulated other comprehensive
income, except for gains and losses resulting from the translation of
intercompany receivables and payables, which are included in earnings for the
period. During the years ended December 31, 2003 and 2002, the Company recorded
a foreign currency exchange rate gain of approximately $52,000 and $24,000,
respectively, which is included in selling and administrative expenses in the
accompanying consolidated statements of operations.
Income Taxes
The Company accounts for income taxes under SFAS No. 109, Accounting for Income
Taxes (SFAS 109). Deferred income tax assets and liabilities are determined
based upon differences between financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse.
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), including related amendments and
interpretations, 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,
including related amendments and interpretations. 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:
F-11
Year Ended December 31
2003 2002
-------------- --------------
Net loss as reported $ (4,050,759) $ (3,515,716)
Stock-based employee compensation cost (intrinsic
value method) -- --
Fair value method stock option expense (1,156,992) (1,819,429)
-------------- --------------
Pro forma net loss $ (5,207,751) $ (5,335,145)
============== ==============
Loss per common share:
Basic and diluted loss as reported $ (0.26) $ (0.23)
Basic and diluted loss pro forma $ (0.33) $ (0.34)
Weighted average fair value per option granted
during the period(1) $ 1.63 $ 2.56
Assumptions:
Average risk free interest rate 2.19% 4.00%
Average volatility factor 1.210 1.256
Expected dividend yield 0% 0%
Expected life (in years) 4.64 5
(1) A Black-Scholes option-pricing model was used to develop the fair values of
the options granted.
Credit Risk
The Company minimizes the concentration of credit risk associated with its cash
and cash equivalents by maintaining its cash and cash equivalents with high
quality federally insured financial institutions. The Company performs ongoing
evaluations of its significant trade accounts receivable customers and generally
does not require collateral. An allowance for doubtful accounts is maintained
against trade accounts receivable at levels which management believes is
sufficient to cover probable credit losses. There are concentrations of credit
risk with respect to trade receivables due to the amounts owed by five customers
at December 31, 2003 whose trade receivable balances each represented
approximately 31%, 21%, 19%, 6% and 5% for a total of 82% of total accounts
receivable. The loss of business from one or a combination of the Company's
significant customers, or an unexpected deterioration in their financial
condition, could adversely affect the Company's operations.
Basic and Diluted Loss Per Share
The Company follows SFAS No. 128, Earnings Per Share (SFAS 128), which requires
a dual presentation of basic and diluted earnings per share. However, because of
the Company's net losses, the effects of stock options and warrants would be
anti-dilutive and, accordingly, are excluded from the computation of earnings
per share. The number of such shares excluded from the computations of diluted
loss per share totaled 2,763,570 in 2003 and 2,654,912 in 2002. In March 2004,
the Company issued 1,000,000 shares of common stock to a private placement
investor (see Note 16).
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year
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
inception in 1987 and used net cash in operations of approximately $3,587,000
and $4,158,000 during the years ended December 31, 2003 and 2002, respectively.
As a result, the Company has had to rely principally on private equity funding,
including the conversion of debt into stock, as well as stockholder loans to
fund its activities to date.
In December 2003, the Company issued 750,000 shares of common stock for $1.5
million from its current private placement offering ($1,466,250 net of related
expenses). In March 2004, an additional 1,000,000 shares of common stock were
issued for $2.0 million. Subscriptions for the private placement will expire on
April 30, 2004, unless extended by the Company. The $2.0 million in funds will
be used to reduce the outstanding balance of the notes payable to stockholder.
The Company will then draw amounts, per the terms of the stockholder commitment
letters dated March 28, 2002 and March 14, 2003, as needed, for operating and
capital expenditures. There is no assurance that the Company will raise any
additional proceeds from this private placement.
On March 28, 2002, the Company executed a binding agreement with one of its
stockholders, who is also a Board Member, 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 per annum
F-12
(4.00% at December 31, 2003), payable monthly and were to 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 13). As of December 31, 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 per annum (4.00% at
December 31, 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 13). As of
December 31, 2003, the Company had drawn $2.5 million of the available funds.
On February 2, 2004, the stockholder amended both agreements to extend the
payback dates to December 31, 2005 and to waive the funding requirement
mandating payback terms until such time as the Company has raised an additional
$7 million over the amount raised in the Company's current private placement
offering ending April 30, 2004; or until such time as the Company is operating
within sufficient cash flow parameters, as defined, to sustain its operations;
or until the Company is sold. In addition, the second agreement was amended to
allow the Company to draw the remaining available balance of $1.0 million
through December 31, 2004. In consideration for the amendments, as well as for
compensation in obtaining private placement funding, the Company granted the
stockholder 150,000 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
16).
The Company anticipates increased cash flows from 2004 sales activity; however,
additional cash will still be needed to support operations. Management believes
that the commitments received from its stockholder and the current private
placement offering, as well as cash from sales and current working capital will
be sufficient to sustain its operations at its current level through January 1,
2005. However, if budgeted sales levels are not achieved or significant
unanticipated expenditures occur, 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 2004.
3. INVENTORIES
At December 31, 2003, inventories consisted of the following:
Raw materials $ 921,219
Finished goods 281,281
-------------
$ 1,202,500
=============
4. PREPAID EXPENSES AND OTHER CURRENT ASSETS
At December 31, 2003, prepaid expenses and other current assets consisted of
the following:
Prepaid expenses $ 137,129
Current portion of refundable security deposit 66,667
Deferred costs 25,110
----------
$ 228,906
==========
F-13
5. PROPERTY AND EQUIPMENT
At December 31, 2003, property and equipment consisted of the following:
Machinery and equipment $ 1,077,468
Furniture and fixtures 95,865
Leasehold improvements 122,622
Website development 72,960
Computer hardware and software 216,010
-------------
1,584,925
Less accumulated depreciation and amortization (925,640)
-------------
$ 659,285
=============
Depreciation and amortization expense of property and equipment for the years
ended December 31, 2003 and 2002 is $237,491 and $202,968, respectively, of
which approximately $136,000 and $122,000 is included in cost of products sold
and approximately $101,000 and $81,000 is included in selling and administrative
costs, respectively, in the accompanying consolidated statements of operations.
6. LEASES
The Company leases its office and warehouse facilities in Boynton Beach, Florida
under a long-term noncancellable lease agreement, which contains renewal options
and rent escalation clauses. A $235,000 security deposit was paid in 2002, 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 Company. Of this amount, $66,667
was paid to the Company in November 2003, $66,667 is included in prepaid
expenses and other current assets and the remainder is included in other
noncurrent assets in the accompanying consolidated balance sheet. The total
minimum lease payments over the term of the lease aggregate approximately
$774,000. The terms of the lease include a period of free rent and scheduled
annual rate increases. As such, rent expense is recognized on a straight-line
basis over the 68-month term of the lease.
The Company leases a condominium in Ocean Ridge, Florida to provide
accommodations for Company use. The lease is renewable annually and is paid in
two six-month installments.
The Company's wholly owned subsidiary, Ltd., rented office space in Devon,
England under a lease that extended through March 31, 2002 and was subsequently
extended on a month-to-month basis. In September 2003, Ltd. moved to new office
space by assuming the existing lease, which expires in August 2004, at which
time they will negotiate a new lease.
Rent expense under all operating leases for the years ended December 31, 2003
and 2002 totaled approximately $257,000 and $194,000, respectively, of which
approximately $199,000 and $97,000 is included in cost of products sold and
approximately $58,000 and $97,000 is included in selling and administrative
costs, respectively, in the accompanying consolidated statements of operations.
In December 2003, the Company entered into a capital lease obligation for the
purchase of approximately $19,000 of office equipment, which is included in
property and equipment, net of approximately $300 of accumulated amortization,
in the accompanying consolidated balance sheet.
Future minimum lease commitments due for facilities and equipment leases under
noncancellable capital and operating leases at December 31, 2003 are as follows:
CAPITAL LEASES OPERATING LEASES
---------------- -----------------
2004 $ 5,922 $ 122,751
2005 5,922 151,645
2006 5,922 156,194
2007 5,922 160,880
2008 and thereafter - 96,421
----------- ------------
Total minimum lease payments 23,688 $ 687,891
============
Less amount representing interest (4,485)
-----------
Present value of minimum lease payments
including current portion of $4,063 $ 19,203
===========
F-14
7. ACCRUED LIABILITIES
At December 31, 2003, accrued liabilities consisted of the following:
Accrued wages and benefits $ 124,964
Accrued warranty costs 42,573
Accrued expenses relating to vendors and others 341,284
--------------
$ 508,821
==============
8. LONG-TERM DEBT
NOTES PAYABLE TO STOCKHOLDER
On March 28, 2002, the Company executed a binding agreement with one of its
stockholders, who is also a Board Member, 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 per annum
(4.00% at December 31, 2003), payable monthly and were to become due and payable
on December 31, 2003 or upon a change in control of the Company or consummation
of any other financing arrangement 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 (see Note 13). As of December 31, 2003, the Company had
drawn the entire $2.5 million of the available funds.
On March 14, 2003, the Company executed a second agreement with the same
stockholder to fund up to $3.5 million through December 31, 2003. Under the
terms of the second 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 per annum (4.00% at December 31,
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 (see Note 13). As of December 31, 2003, the Company had
drawn $2.5 million of the available funds. Both of the lines allow for
discretionary principal payments, which add to the availability of additional
funds that the Company may draw.
On February 2, 2004, the stockholder amended both agreements to extend the
payback dates to December 31, 2005 and to waive the funding requirement
mandating payback terms until such time as the Company has raised an additional
$7 million over the amount raised in the Company's current private placement
offering ending April 30, 2004; until such time as the Company is operating
within sufficient cash flow parameters, as defined, to sustain its operations;
or until the Company is sold. In addition, the second agreement was amended to
allow funding through December 31, 2004 as needed for the available balance of
$1.0 million. In consideration for the amendments as well as for compensation
for services to raise private placement funding, the Company granted the
stockholder 150,000 common stock purchase warrants (see Note 16). During the
years ended December 31, 2003 and 2002, the Company incurred interest expense of
approximately $152,000 and $17,000, respectively, on its draws, which is
included in interest expense in the accompanying consolidated statements of
operations.
MATURITIES OF LONG-TERM OBLIGATIONS FOR FIVE YEARS AND BEYOND
Long-term obligations consisted of the following at December 31:
2003
--------------
Notes payable to shareholder - LOC #1 $ 2,500,000
Notes payable to shareholder - LOC #2 2,501,900
Capital lease obligation 19,203
--------------
5,021,103
Less: current maturities (4,063)
--------------
$ 5,017,040
==============
F-15
The minimum annual principal payments of notes payable and capital lease
obligations at December 31, 2003 were:
2004 $ 4,063
2005 5,006,420
2006 5,028
2007 5,592
------------
$ 5,021,103
============
9. INCOME TAXES
The United States and foreign components of loss from continuing operations
before income taxes are as follows for the years ended December 31:
2003 2002
----------- -----------
United States $(3,901,744) $(3,372,243)
Foreign (200,900) (120,235)
Intercompany elimination 51,885 (23,238)
----------- -----------
$(4,050,759) $(3,515,716)
=========== ===========
The significant components of the Company's net deferred tax assets consisted of
the following at December 31, 2003:
Deferred tax assets:
Net operating loss carryforwards $ 9,900,413
Depreciation and amortization 82,118
Accrued expenses and reserves 74,245
Impairment loss 78,304
Compensatory stock options and warrants 57,354
Other 56,883
------------
Total deferred tax assets 10,249,317
Valuation allowance (10,249,317)
------------
Net deferred tax assets $ --
============
SFAS 109 requires a valuation allowance to reduce the deferred tax assets
reported if, based on the weight of the evidence, it is more likely than not
that some portion or all of the deferred tax assets will not be realized. After
consideration of all the evidence, both positive and negative, management has
determined that a full valuation allowance of $10,249,317 against its net
deferred taxes is necessary as of December 31, 2003. The change in valuation
allowance for the years ended December 31, 2003 and 2002 is $1,495,133 and
$1,303,920, respectively.
At December 31, 2003, the Company had approximately $30,268,000 of U.S. net
operating loss carryforwards remaining, which expire beginning in 2018. The
Company will record the benefit of approximately $3,958,000 of the net operating
loss carryforwards through additional paid-in capital if and when the net
operating loss carryforwards are utilized, as such amounts relate to the
unrecognized tax benefit from stock option exercises.
As a result of certain ownership changes, the Company may be subject to an
annual limitation on the utilization of its U.S. net operating loss
carryforwards pursuant to Section 382 of the Internal Revenue Code. A study to
determine the effects, if any, of this change has not been undertaken.
A reconciliation of the Company's income taxes to amounts calculated at the
federal statutory rate is as follows for the years ended December 31:
2003 2002
------- ------
Federal statutory taxes (34.00)% (34.00)%
State income taxes, net of federal tax benefit (3.63) (3.63)
Nondeductible items 0.19 0.21
Change in valuation allowance 38.32 37.11
Other (0.88) .31
------- ------
--% --%
======= =======
F-16
10. 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 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 time remaining before
automatic dismissal of his claim. The Company does not believe the likelihood of
an unfavorable outcome is probable.
INVESTMENT BANKING AGREEMENT
On December 18, 2003, the Company entered into a one-year agreement with an
investment-banking firm in Boca Raton, Florida, to assist in raising
approximately $3.0 to $5.0 million in equity capital. The Company has agreed to
pay a fee of 7% of any gross proceeds received by the Company as a result of
this firm's services, as well as all reasonable out-of-pocket fees, expenses and
costs in connection with the performance of its services under the agreement.
The agreement excludes the capital raised in December 2003 and March 2004.
11. STOCK OPTIONS
The Company has three stock option plans, one adopted in 1996 and amended in
July 1997 (the "1996 Option Plan"), one adopted in September 1999 and amended in
June 2000 (the "1999 Option Plan"), and one adopted on November 8, 2000 (the
"Directors' Plan"). The 1996 Option Plan provides for the granting of up to
2,200,000 options, the 1999 Option Plan provides for the granting of up to
3,000,000 options and the Directors' Plan provides for the granting of up to
400,000 options.
Both the 1996 and 1999 Plan provide for the granting of both incentive and
non-qualified stock options to key personnel, including officers, directors,
consultants and advisors to the Company, at the discretion of the Board of
Directors. Each plan limits the exercise price of the options at no less than
the quoted market price of the common stock on the date of grant. The option
term is determined by the Board of the Directors or the Compensation Committee,
provided that no option may be exercisable more than 10 years after the date of
its grant and, in the case of an Incentive Option granted to an eligible
employee owning more than 10% of the Company's common stock, no more than five
years after the date of the grant. Generally, under the 1996 and 1999 plans,
options to employees vest over four years at 25% per annum, except for certain
grants to employees that vest 50% upon grant with remaining amounts over two
years at 25% per annum.
The Directors' Plan provides for the granting of non-qualified options to
members of the Board of Directors at exercise prices not less than the quoted
market price of the common stock on the date of grant and options expire five
years from the date of grant. In the event a person ceases to serve on the Board
of Directors, the outstanding options expire one year from the date of cessation
of service. Such options may be exercised commencing two years from the date of
grant. During each of 2003 and 2002, 27,500 of options were issued to
non-employee Directors.
F-17
Additional information concerning the activity in the three option plans is as
follows:
2003 2002
----------------------------- ---------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE
-------------- -------------- -------------- ------------
Outstanding, beginning of year 2,285,845 $ 3.87 2,482,161 $ 4.00
Granted 275,500 1.99 347,500 3.05
Exercised (43,775) .97 (155,516) 1.10
Expired (194,000) 3.07 (388,300) 5.09
------------ -------- ------------ --------
Outstanding, end of year 2,323,570 3.77 2,285,845 3.87
============ ============
Exercisable, end of year 1,808,070 $ 3.76 1,580,345 $ 3.53
============ ============
Options available for future grant,
end of year 956,255 1,050,255
============= =============
Summarized information with respect to options outstanding under the three
option plans at December 31, 2003 is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------ -------------------------------
REMAINING
AVERAGE
CONTRACTUAL WEIGHTED WEIGHTED
RANGE OF NUMBER LIFE (IN AVERAGE NUMBER AVERAGE
EXERCISE PRICE OUTSTANDING YEARS) EXERCISE PRICE EXERCISABLE EXERCISE PRICE
------------------ --------------- --------------- ---------------- --------------- ---------------
$ .21 - $ 1.70 829,400 5.5 $ .86 779,400 $ .81
1.86 - 4.50 718,795 6.5 2.62 353,295 2.63
4.81 - 6.81 287,875 3.0 6.05 275,375 6.01
8.50 - 9.25 487,500 4.8 9.07 400,000 9.04
--------- ----- -------- ----------- --------
Totals 2,323,570 5.7 $ 3.77 1,808,070 $ 3.76
========= ===== ======== =========== ========
During 2003, approximately $19,000 of compensation expense was recognized
related to variable option awards outstanding. In 2002, the Company recognized a
credit to compensation expense of approximately $574,000, relating to the
variable option awards, which is included in selling and administrative
expenses. At December 31, 2003, approximately 212,000 awards subject to variable
accounting remained outstanding with an average exercise price of $0.47.
In July 2001, the Company received promissory notes from two of its officers for
the exercise of their vested stock options in the amount of $853,750 and bearing
interest of 5.63%. The principal and accrued interest are due upon the earlier
of the expiration of the original option periods, which range from July 2008 to
December 2009, or upon the sale of the common stock acquired by the execution of
the options. Interest income on these notes of approximately $48,000 in 2003 and
$48,000 in 2002, is included in interest income in the accompanying consolidated
statements of operations.
12. COMMON STOCK
On December 10, 2003, the Company received $1,500,000 for the issuance of
750,000 shares of common stock from a third party private placement investor.
Issuance costs of $33,750 are recorded in accrued liabilities in the
accompanying consolidated balance sheet, related to this issuance. Included in
this amount is $18,750 for services rendered to raise private placement funding
by the individual who is both a stockholder and a Board Member, and who has
provided funding to the Company since 2002.
In February 2004, the stockholder was granted 150,000 warrants to purchase
common stock, in consideration for the amendments to extend the payback periods
of the notes payable to stockholder to December 31, 2005, the extension of the
remaining available draws on the second commitment letter through December 31,
2004, as well as for services related to raising private placement funding. The
fair value of the warrants was estimated at the date of grant using a
Black-Scholes option pricing model, and was allocated between costs of the
private placement investment and deferred financing costs (see Notes 2 and 16).
F-18
13. WARRANTS
At December 31, 2003 and 2002, 440,000 and 369,067 shares, respectively, of
common stock have been reserved for issuance under outstanding warrants. All of
the warrants are fully vested and have expiration dates ranging from January 15,
2004 to March 14, 2008. Information concerning the Company's warrant activity is
as follows:
2003 2002
------------------------- -----------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE
EXERCISE EXERCISE
------------------------- -----------------------
OPTIONS PRICE OPTIONS PRICE
-------------- ---------- ------------- ---------
Outstanding, at the beginning of year 369,067 $ 3.16 269,067 $ 2.83
Granted 125,000 2.25 100,000 4.05
Exercised - - - -
Expired (54,067) 4.11 - -
--------- ---------- ---------- --------
Outstanding, at the end of year 440,000 $ 2.79 369,067 $ 3.16
========= ========== ========== ========
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 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 factor
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, which was equal to quoted market value on the
date of grant. The deferred charge was initially amortized over the commitment
period and subsequently revised to include the repayment period, as amended.
During the years ended December 31, 2003 and 2002, the Company had amortized
approximately $80,000 and $177,000 of such costs, respectively, which are
included in interest expense in the accompanying consolidated statements of
operations.
On March 14, 2003, the Company recorded a deferred charge of $212,500 for the
issuance of 125,000 fully vested warrants to purchase common stock relating to a
second financing agreement with the same stockholder to fund up to $3.5 million
through December 31, 2004 (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 2.24%, volatility
factor 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, which was equal to quoted market value
on the date of grant. The deferred charge is being amortized over the repayment
period of 21.5 months. During the year ended December 31, 2003, the Company had
amortized approximately $94,000 of such costs, which is included in interest
expense in the accompanying 2003 consolidated statement of operations.
On May 23, 2002, the Company extended the life of a vendor warrant to purchase
100,000 shares of common stock that was issued in March 2000 and was fully
vested. The expiration date of the warrant was extended from March 2003 to March
2005. The fair value of the modified warrant 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 factor of the expected market price of
the Company's common stock of 1.298, a dividend yield of zero, and a weighted
average expected life of 2.79 years. The warrant has an exercise price of
$3.875. The difference in the fair value of the old award and the new award was
estimated to be $94,000, and is included in selling and administrative expenses
in the accompanying 2002 consolidated statement of operations.
On November 21, 2003, the Company extended the life of a director's warrant to
purchase 100,000 shares of common stock that was issued in December 1999 and was
fully vested. The expiration date of the warrant was extended from December 2003
to December 2004. The fair value of the modified warrant was estimated at the
date of grant using a Black-Scholes option pricing model with the following
assumptions: risk free interest rate of 1.33%, volatility factor of the expected
market price of the Company's common stock of .367, a dividend yield of zero,
and a weighted average expected life of 1 year. The warrants have an exercise
price of $1.00. The difference in the fair value of the old award and the new
award was estimated to be $2,000, and is included in selling and administrative
expenses in the accompanying 2003 consolidated statement of operations.
14. MAJOR CUSTOMERS
During 2003 and 2002, three and two customers together accounted for
approximately 45% and 44%, respectively, of the Company's net sales. In 2003,
there were three customers that individually accounted for greater than 10% of
net sales, or approximately $334,000, $300,000 and $221,000, while in 2002 there
were two customers that individually accounted for greater than 10% of net
sales, or approximately $593,000 and $357,000. There were five customers in 2003
F-19
whose trade receivable balances equaled or exceeded 5% of total receivables,
representing approximately 31%, 21%, 19%, 6% and 5%, respectively, of total
accounts receivable. The loss of business from one or a combination of the
Company's significant customers could adversely affect its operations.
15. GEOGRAPHIC INFORMATION
The Company has two lines of product, which it manufactures and distributes from
its locations in the United States and the United Kingdom. Information with
respect to sales activity and long-lived assets (consisting entirely of property
and equipment) in the United States and United Kingdom is as follows:
YEAR ENDED DECEMBER 31
2003 2002
------------- -----------
Net sales:
United States $ 1,318,180 $1,510,440
United Kingdom 588,337 626,678
------------- -----------
$ 1,906,517 $ 2,137,118
============= ===========
Long-lived assets by area:
United States $ 592,989
United Kingdom 66,296
---------------
$ 659,285
===============
16. SUBSEQUENT EVENTS
On February 2, 2004, the Company granted a stockholder, who is also a Board
member, an additional 150,000 common stock purchase warrants at an exercise
price equal to the closing market price of the Company's stock on the date of
grant in consideration for extending the payback dates of the March 28, 2002 and
March 14, 2003 funding commitment agreements from December 31, 2004 to December
31, 2005; for waiving the funding requirement mandating payback terms until such
time as the Company has raised an additional $7,000,000 over the amount raised
during the Company's current 2004 private placement offering, the Company is
operating within sufficient cash flow parameters, as defined, or until the
Company is sold; and for his involvement in equity financing in 2003 and 2004,
to date. The fair value of the warrants was estimated at $112,500. The Company
accrued $18,750 of the fair value related to the services rendered by the
stockholder in association with the private placement funds raised in December
2003, in the accompanying 2003 consolidated balance sheet, and recorded a
deferred charge of $93,750 in 2004 for the amendments to the commitment
agreements.
In February 2004, one of the Company's customers requested to return merchandise
valued at approximately $67,000, for a merchandise credit, due to a change in
their sales program from a parts distribution center level to a dealer direct
level, which will continue through a corporate program. The Company believes
that the original sale complied with the revenue recognition provisions of SAB
No. 104, Revenue Recognition and there were no special rights of return.
Accordingly, the Company recorded a sales return allowance of $67,000, a credit
to cost of goods sold for $42,000 and an accrual of $7,700 for estimated costs
involved with the return, which are included in the accompanying statement of
operations for the year ended December 31, 2003.
On March 9, 2004, the Company extended the expiration date of the exercise
period of 270,000 fully vested stock options for a terminated employee who left
the Company in August 2003. The Company's Stock Option Plan permits an employee
to exercise their stock options for up to one month after their termination
date, at which time they expire. The exercise price of the options ranges from
$1.00 to $8.50. In accordance with FIN 44, the Company compared the options'
intrinsic value on the modification date to the original intrinsic value on the
date of grant. The Company will record approximately $263,000 of compensation
expense related to this modification, which will be included in the condensed
consolidated statement of operations for the period ending March 31, 2004.
On March 12, 2004, the Company received gross cash proceeds of $2,000,000 from
the sale of 1,000,000 shares of common stock from its private placement
offering. The funds will be used to reduce the outstanding principal balance of
the notes payable to stockholder. The Company will then draw amounts, per the
terms of the stockholder commitment letters dated March 28, 2002 and March 14,
2003, and amendments thereto, as needed, for operating and capital expenditures.
The Company estimates related offering costs will be approximately $22,500.
F-20